Zhihu Inc. (NYSE:ZH) Q1 2023 Earnings Call Transcript May 24, 2023

Zhihu Inc. misses on earnings expectations. Reported EPS is $-0.16 EPS, expectations were $-0.07.

Operator: Ladies and gentlemen, thank you for standing by, and welcome to Zhihu Inc. First Quarter 2023 Financial Results Conference Call. [Operator Instructions] Today’s conference call is being recorded. At this time, I would like to turn the conference over to Ms. Iris Liu, IR Manager. Please go ahead, ma’am.

Yolanda Lian Liu : Thank you, operator. Hello, everyone. Welcome to our first quarter 2023 financial results conference call. Participants on today’s call will include Mr. Zhou Yuan, Founder, Chairman and the Chief Executive Officer of Zhihu; Mr. Li Dahai, Chief Technology Officer; and Mr. Henry Sha, our Chief Financial Officer. Before we continue, please note that today’s discussion will contain forward-looking statements made under the safe harbor provisions of U.S. Private Securities Litigation Reform Act of 1995. Forward-looking statements include inherent risks and uncertainties. As such, the company’s results may be materially different from the views expressed today. Further information regarding these and other risks and uncertainties is included in the company’s prospectus and other public filings as filed with U.S. Securities and Exchange Commission.

The company does not assume any obligation to update any forward-looking statements, except as required under applicable law. During today’s call, management will also discuss certain non-GAAP financial measures for comparison purpose only. For a definition of non-GAAP financial measures and a reconciliation of GAAP to non-GAAP financial results, please see the earnings release issued earlier today. In addition, a webcast replay of this conference call will be available on our website at ir.zhihu.com. I will now turn the call over to Mr. Henry Sha, CFO of Zhihu.

Henry Sha: Thank you, Iris. I’m pleased to deliver today’s opening remarks on behalf of Mr. Zhou Yuan, Founder and CEO of Zhihu. Hello, everyone. Thank you for joining Zhihu’s first quarter 2023 earnings call. We are delighted to start 2023 with a solid first quarter highlighted by sustaining the revenue growth and a significantly narrowed net loss, both beating the market consensus. While continuously expanding our user base over the past two years, we have also been closely following and capturing the evolving demand for short-form online reading, including both knowledge sharing and notebooks. In addition to the various Yan Selection membership services, we launched a new app Yanyan Stories in major app stores recently to serve the broader user content demand as a part of Zhihu’s product metrics.

Yanyan Stories will not only contain content generated from the Zhihu community, but also provide more differentiated content. Moreover, Yanyan Stories will cover users from different tier cities and support more audio books, by offering more effective assistance for content creators. The installations are bouncing the premium content, compared with our widely recognized brand name, compared to the number of average monthly subscribing members to a record high of 14.9 million in the first quarter, representing 116% year-over-year and 14.5% sequential growth respectively. We also continued to advance our technological development during the quarter, through a combination of internal initiatives and the joint development efforts, as we actively explored the possibilities, and potential of revolutionary AI technology.

Zhihu is now equipped with large language model technology that has 20 billion parameters. We launched our first language with large language model, or LLM, Zhihaitu AI in April, aiming to enable our content creators to generate high quality content more efficiently. Additionally, our users may utilize our LLM summarization function to consume more content and accelerate their readings in a more enjoyable way. At the beginning of 2023, we optimized our organizational structure by combining advertising and content-commerce solutions, or CCS, to enhance the overall competence and operational efficiency of our combined marketing services business. This upgrade has empowered us to better utilize resources within the Zhihu community and provide our clients with a more effective and comprehensive marketing solutions.

As we optimize our marketing services business, I will personally spend more time on the segment and the monetary exclusion. Starting from the recent months, we have already seen a revival of advertisers’ engagement in e-commerce and 3C factors. We are confident that our marketing services will achieve sequential growth in the second quarter and pickup growth momentum in the second half of the year. Now, let me move on to our users and accountants where we have made a remarkable progress, especially in our short-form content. In the first quarter, we continued to broaden our content coverage, and deepen our penetration across our cornerstone verticals, optimizing our content composition, and format to better satisfy users’ evolving needs to used their fragmented time efficiently and obtain information quickly.

To that end, we significantly upgraded our [ideas tab] or [ITT], making a short form content pool to complement the long-form knowledge-based content currently available in Zhihu’s community. We also expanded our short-form content library to cover more lifestyle and consumption scenarios in response to users’ needs. By upgrading an array of tools and functions, such as the picture editor and video caption, among many others, we provided a more efficient scenario to inspire creativity for new content creation. This is making progress in content successfully and saw an increase in the number of users in our community, driving our MAUs in March to more than 110 million. We achieved reacceleration in MAU growth in the first quarter and expect MAUs will grow up to 120 million within 2023 to mark another historical highs.

While we remain dedicated to further solidifying Zhihu’s leadership with leading positions as a platform for users to discuss and exchange ideas, we are also looking for ways to enhance our offerings by incorporating AI technology within our community. At the Zhihu [Discovery Conference] in April, we introduced our AI strategy, along with our first [indiscernible] Zhihaitu AI. Through investments and joint development efforts, we are accelerating our progress in integrating AI technology across various applications scenario throughout our ecosystem. The trending topics summary is our first trial AI functions. By leveraging AI language learning ability to collect thoughts, and integrated answers, the trending topics summary is able to summarize answers and present them to our users in an intuitive and a clear manner.

We’re now opening this AI and summarization function to more users via the Zhihu mobile App. By further capitalizing on all unique advantages in both the data layer and application layer, Zhihu is committed to becoming an important to developer and ultimately a leading contributor to the industry’s overall developments in this area of AI technology. Next, our membership business. Driven by our premium content offers and continuously expanding brand influence, our pay membership business grew rapidly during the quarter, delivering logos to increases on both an annual and a sequential basis. Paid membership revenue for the first quarter increased by 105.2% year-over-year, while average monthly scribing members grew by 116% year-over-year to 14.9 million in this quarter.

We streamline content creation procedures to improve efficiency and enforce the community compliance to protect the content creators’ rights and the benefits. As part of a multi-brand strategy, we launched our new ex-U.S. Yanyan Stories, featuring numerous user favorite functions, such as story search, audiobooks, and recommended reading lists. This new app will help us attract more memberships and subscribers begin with the Zhihu community while building a distinct user base, peaking for a more concentrated reading experience inside the Zhihu community and cohort. We hope Yanyan differentiated content will also penetrate the massive Internet users from Tier 2 and Tier 3 cities in China. Now moving on to our vocational training business. Revenue from vocational training business increased by 170.6% year-over-year to RMB107 million in this quarter.

We grew our footprint in the vocational training industry value chain by organic growth and the business acquisition. To see the greater potential in the graduate student entrance examination market, we recently completed the acquisition of MBA Masters, a training institution specializing in preparation for MBA entrance examination in China. Completing the integration of MBA Masters, first it enhances our industry competence, with an improved business structure and enrich the service offers. Additionally, we continue to extend our vocational training services across major categories by developing programs that are in high demand in this evolving market, including civil service examination, ESG, judicial examination and story writing, among others.

As I mentioned earlier, we are integrating AI technology into our course offerings as we look to enhance the overall quality and user experience. Encouraged by the positive feedback, we have received our first new AI powered program, we will continue to deepen our exploration of innovative technologies. Before I conclude, I’d like to provide a brief update on our ESG efforts. We published our ESG annual report for 2022 last month, presenting Zhihu’s longstanding commitment to social responsibility. As a leading online content community in China, our top priority and greatest assets is and will always be our people, our employees, our content creators, our users and our society. Therefore, we strive to improve our ecosystem for each of these stakeholders throughout 2022.

With the initiatives including an upgraded leadership development system for employees, our high-end campaign 4.0 incentive plan for content creators, and array of programs to protect and serve our most vulnerable users including minors, those with disabilities and seniors. We also leveraged our wealth of knowledge content to promote childhood education, particularly in new areas that we believe education equality and the growth and the development of China’s young generation are critical to Zhihu’s progress. Going forward, we will remain committed to our stakeholders, improving their lives as we seek new ways to create value for our society and our planet sustainably. Looking ahead to the rest of 2023, we will remain focused on both monetization and user growth.

Marketing services and paid membership have become our major revenue drivers, improving our continued expansion of the vocational training business and an LLM development. We will further expand discussion and research scenarios in the Zhihu community, as we leverage our resources and refine experience to study and respond to the evolving needs, thereby better serving both users and clients. Thanks to our organizational optimization and operational efficiency improvements, in the first quarter, our non-GAAP net loss narrowed to RMB 120 million with adjusted net loss margin narrowed to 12.1%. We expect our business growth will continue accelerating, and we are confident, we will achieve 20% year-over-year increase in MAU as we strive to make innovative breakthroughs.

We also believe our passion for progress and dedication will continue to empower our strength and resilience, as we grow in this exciting and dynamic industry. This concludes Mr. Zhou Yuan’s remarks. I will now turn to our financial details in the first quarter for review of our first quarter 2023 results. Please see our press release issued earlier today. We were excited to have commenced 2023 with a strong first quarter. Both our top-line and bottom-line meet The Street consensus, while our operating cash flow turned positive for the first time since our initial public offering. Total revenue for the first quarter increased by 33.8% year-over-year to reach RMB994.2 million, effectively beating the market consensus. Our paid membership and vocational training services continued to be exercised in robust growth during the quarter, increasing their contributions to total revenues to 46% and 11% respectively.

However, as a variety of market factors continue to affect the overall online advertising market, advertising spending remained sluggish in the first quarter. To mitigate the impact we optimized our organizational structure during the quarter, enabling us to better utilizing our community resources and enhance our service capability by integrating brand advertisements and CCS. Starting from the first quarter, our advertising business is now combined with CCS into marketing services to align with our new strategy and upgrade here the business structure. Our paid membership revenue for the quarter was RMB454.8 million up 105.2% year-over-year from RMB221.7 million in the same period of 2022. Our average monthly subscribing members grew by 116% year-over-year to 14.9 million, which is a record high.

Our appealing premium content and outstanding user experience continue to attract the broader user base, even beyond our Zhihu community. The company’s marketing services revenue for the quarter with RMB392.1 million. We are encouraged to see some even signs of recovery in our marketing services in the recent months. And we expect our marketing services business to gain faster recovery during the second half of this year. Our vocational training business revenue for the quarter reached one RMB107 million, representing year-over-year increase of 170.6% from RMB39.5 million in the same period of 2022. Moving forward, we will continue to enhance our service capabilities and advance our footprint in an industry with both organic growth and business acquisition.

Gross profit for the first quarter increased by 52.7% year-over-year to RMB512.2 million. Gross margin expanded to 51.5% from 45.1% in the same period of 2022, representing more than 6 percentage points expansion, thanks to our enhanced monetization efforts, and the improvements of our cloud services and bandwidth utilization efficiency. We were particularly happy to see our investments in research and development rewarded us with the savings in cloud service utilization. Total operating expenses for the first quarter were RMB729 million down by 25.9% from RMB983.7 million in the same period of 2022. Selling and marketing expenses decreased by 12% to RMB445.6 million, from RMB506.6 million in the same period of 2022. The decrease was primarily due to our disciplined promotion spending and decrease in salaries and welfare expenses for sales and marketing related personnel.

In the meantime, the number of Zhihu’s MAUs recovered significantly to 110 million in March. We will remain dedicated to driving user growth through our ongoing constant ecosystem first strategy. Research and development expenses increased RMB183 million from RMB166.5 million in the same period of 2022. The increase was primarily attributable to the increase in the salaries and the welfare of research and the development personnel, as well as the increased expenditures Zhihu’s large language model training for this year’s largest technology upgrades. Our large language model will gradually serve a broader user base in the Zhihu community going forward. General and administrative expenses decreased by 67.7% to RMB100.4 million from RMB310.6 million in the same period of 2022, primarily due to the lower share-based compensation expenses recognized and the decrease in professional service fees.

Benefiting from our ongoing operations, efficiency improvements and cost control strategy, we greatly narrowed our net loss in Q1. Our GAAP net loss in the quarter was RMB179 million narrowing by 70.9% year-over-year. Our adjusted net loss on a non-GAAP basis, which primarily excludes share-based compensation expenses and amortization of intangible assets resulting from business acquisition, was RMB120.2 million for the first quarter, down by 67.3% from the same period of last year, with an adjusted net loss margin of 12.1%. In this quarter we generated RMB59.9 million operating cash flow marking the first time we have achieved positive operating cash flow since our IPO. This milestone demonstrates Zhihu’s revenue diversification and business model and generative positive cash flow from its operations and represents an additional step towards becoming a profitable company.

Now moving to our balance sheet. As of March 31, 2023, the company had cash and cash equivalents, term deposits and short-term investments of approximately RMB6,258 million compared with RMB6,262 million as of December 31, 2022. Also, as of March 31, 2023, we have repurchased approximately 6.9 million Class A ordinary shares at an aggregate price of US$17.8 million. This concludes my prepared remarks on our financial performance for the quarter. Let’s turn the call over to the operator for the Q&A section. Thank you.

Q&A Session

Operator: [Operator Instructions] And the first question comes from Vicky Wei with Citi.

Vicky Wei: Thanks for taking my questions and congrats on the stronger than expected quarter. Will management share some color on the company AIGC technology strategy and how should we think of the AI investment and the future monetization potential?

Henry Sha: Thank you. Thank you, Vicki. I think your AIGC related strategic questions will be answered by our Chief Technology Officer, Dahai and I will help answer your question about the budget.

Li Dahai: This is Li Dahai, CTO of the company. To answer your question, Zhihu is having unique positioning in terms of Chinese based database in China. And we are uniquely positioned in the artificial intelligence revolution in China, especially in a lot of different verticals, for professional field content accumulation. Zhihu is open-minded towards AI revolution. And in early April, we have released Zhihaitu AI, our large language model. We released Zhihaitu AI through both internal investments and joint development with other companies. These have largely enhanced our speed of development and also brought along team and knowledge flow between different teams. Now we are having about 20 billion parameters in terms of our latest LLM and we are planning to reach about 100 billion parameters for our large language model towards the end of this year. Thank you.

Henry Sha: Vicky, the second question about co-investments in this area, I think — still I think we are in the progress of doing new plan for this large language model training. We believe is one of the most important technology development projects for this year. But I think the impact on the P&L that were no more than RMB300 million. Thank you, Vicky.

Operator: Thank you. And the next question comes from Steve Qu with Goldman Sachs.

Steve Qu: Thanks for taking my questions. Congrats on the positive operating cash flow as well as the MAU crossing the 110 million milestone. Could you please share with [us] the driving forces behind our strong MAU growth, as well as our strategy and changes in user behavior and your outlook for the future MAU growth? Thanks.

Zhou Yuan : This is Zhou Yuan, CEO of the company. In the past year, we have made a lot of remarkable progress in terms of content ecosystem-first strategy. This also helped us to grow our MAU through a robust growth. And during the first quarter of this year, and MAU has also experienced steady growth. [Foreign language]

Henry Sha: I will help answer — I will help translate Mr. Zhou Yuan’s answer to you. So just one that our user acquisition strategy was executed well. The efficiency of the user acquisition improved in the past quarter. And second, we have something like adjustment often too on the product, and on the content. As I presented during the remarks in the conference before, we are now focusing on the short-form content, as you may know. So we have long-form, very large base of the long-form knowledge bandwidth. And now we are going to provide more short-form content which is very welcomed by our users. I said one that we are more focusing on the people between the age between 18 to 35 years of — with job in maybe Tier 1, 2, 3 cities in China.

This large group of users we estimated will be beyond around like 300 million or 400 million people population, has a large potential for us. Lastly, but importantly, we believe AI driven technology, larger language model that technology will be applied to more scenarios on Zhihu’s mobile app. We believe it will help improve our user experience and it will cover user growth going forward. And actually on question about user behavior changing and the reason that — I have some numbers to be shared with you. The first one about the user engagement and user time spend on mobile app is unchanged in comparison with Q4 last year, was still between 27 to 28 minutes users per day. And our membership, the people subscribing membership spend even more longer time, like 15 minutes per user, per day.

This is my answer to your question.

Zhou Yuan : So the users beyond 30 years old is growing, the cohort, according to our internal statistics. And the second is the female users is also increasing in terms of the percentage of the total user cohort.

Operator: And the next question is comes from Xueqing Zhang with CICC.

Xueqing Zhang: Can management share with us the recovery progress of marketing business, what time management expects to return to positive growth? And we’ve noticed that the revenue from advertising, since that’s being merged into the marketing services business this quarter. So just wondering the company’s consideration for the adjustment?

Henry Sha : Thank you, Xueqing. This is Henry, I’ll help answer the question. So the first one, we have seen some rebound or recovery in the second quarter but we believe that the headwind of the macro was still there. And we still haven’t seen some sluggish climb of the advertisers but the rebounding was coming from those 3C and the e-commerce, e-commerce factor. So we think the recovery should be seen in the second half of this year. For the second question, that’s — because we have business upgrading on our patented products, so — and according to our company levels, new strategy, we believe that these adjustments about CCS and advertising will be — increase our marketing and competitive competence to increase our power of our integrated marketing solution for our clients. And also can — to support our more longer-term growth. So that we make the change. That’s my answer to your question.

Operator: And the next question comes from [Eileen Lim] of China Renaissance.

Unidentified Analyst : I have a question regarding Zhihu’s new app, Yanyan Stories. Can management share more details about future plans, long-term growth potential and likely monetization method other than membership? Thank you.

Zhou Yuan : Yanyan Stories is our newly released application. We have released — we have received a lot of positive feedback from the market for this new story application and we are generally optimistic about the future growth of this application. The Yanyan Stories application compared with our original Zhihu Yan Selection has lot of clear differentiations. And the Yanyan Stories application is focused on premium short stories, and it provides immersive and concentrated reading experience for users. It also helps us to attract more users from the Yanyan Stories outside the Zhihu community. We believe that for this year the Yan Selection will continue its healthy and robust growth in terms of both year-on-year growth and the sequential growth. And in the future, we believe that with the improvement of general macroeconomic condition in China, we will also generate IP gains from the application.

Henry Sha : And to supplement the CEO’s answers to you. First, I believe that Yanyan will be positioned at different tier cities users in China. And Yanyan’s content will not be all the same as Zhihu’s content. So that’s the differentiation. And the second from the product level, for example, Yanyan will provide like the audio books or the flying bullet chat function. These are very welcomed function by our users, which is quite different from Zhihu mobile app. That’s our answer for you, [Eileen]. Next?

Operator: Thank you. Next question comes from [Daisy Chan] with Haitong International.

Unidentified Analyst: Thanks management for taking my question. Congratulations for the decent top-line growth and quality of operational cash flow. So my question is about the education business. Can management share the lead and strong hiring strategy for this segment and for example, how to maintain the growth momentum for this segment. And can management also please provide more color on the recent update for this segment?

Zhou Yuan : Thank you, [Daisy] for your question. Vocational training is one of the second growth drivers that we have been building on recently. And we think Zhihu is naturally uniquely positioned to do the vocational training bits. Firstly, it is because our user base is — have a lot of overlap with the target users published in vocational training. And secondly, is that our content to our vocational training services have a scope. And third is that our technology and data has — will increase the efficiency of our vocational training. We have made a lot of tremendous progress in the last year. Our long term goal for vocational training business is to enhance the efficiency and wuality for the industry. And we have been focusing on two directions. Firstly is that we are diversifying to provide comprehensive services for our clients. And secondly is that we will utilize our data and technology to enhance the efficiency to provide better services for our customers.

Henry Sha : To supplement CEO’s answers for you [Daisy]. The company has been really emphasizing the focus and the reasonable development of the reactive knowledge to be applied to the whole education or vocational training industry. And we believe that our large language model training will also empower our vocational training business in the future. That’s our answer to your question. Next?

Operator: The next question comes from Thomas Chong with Jefferies.

Unidentified Analyst: So my question is how should we think of the GP margin outlook and the timing to reach breakeven? Thanks.

Henry Sha : So my answer to your questions are quite straightforward. The first one, we’re seeing some progress in the gross margin improvements in this year and in this quarter. So — but we believe that we — it’s too early to say that what kind of gross margins will be achieved within the next few quarters. But believe us that we’re doing the strict cost control strategy as well as improving our efficiency. So we believe that we’re on our way to improving our margin. The second question is that because we have the — like the new investments and — in the R&D, the development for our large language model training, so this also has some impact on our P&L for the rest of the year. So we believe that our breakeven point will be some quarter next year, [2024]. That’s our answer to your question.

Operator: And this concludes the question-and-answer session. I would like to return the call to Mr. Iris Liu for any closing comments.

Yolanda Lian Liu: Thank you. Thank you once again for joining us today. If you have any further questions, please contact our IR team directly or Piacente Financial Communications. Thank you very much.

Operator: Thank you. The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect your lines.