Zhihu Inc. (NYSE:ZH) Q3 2023 Earnings Call Transcript

Zhihu Inc. (NYSE:ZH) Q3 2023 Earnings Call Transcript November 29, 2023

Zhihu Inc. beats earnings expectations. Reported EPS is $-0.05, expectations were $-0.46.

Operator: Ladies and gentlemen, thank you for standing by, and welcome to the Zhihu Inc. Third Quarter 2023 Financial Results Conference Call. [Operator Instructions] Today’s conference 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.

Iris Liu: Thank you, operator. Hello, everyone. Welcome to our third quarter 2023 financial results conference call. Participants on today’s call will include Mr. Zhou Yuan, Founder, Chairman, and 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 the U.S. Private Securities Litigation Reform Act of 1995. Forward-looking statements involve 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 filed with the 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 purposes only. For a definition of non-GAAP financial measures and the 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 IR website at ir.zhihu.com. I will now turn this 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 third quarter 2023 earnings call. During the quarter, we made considerable progress in our multi-engine commercialization across the entire community, boosting our total revenue by 12.1% year-over-year. Notably, revenues from our membership and vocational training business increased 39.2% and 85.6% year-over-year, contributing 45.7% and 14.2% of our total revenues, respectively. Throughout the quarter, we continued to unlock the vitality and prosperity of the Zhihu community, inspiring our content creators’ high-quality production while continuously expanding our user base and encouraging user interaction.

Our number of MAUs reached another milestone for the quarter, rising to 110.5 million. We continue to view cost control and operational efficiency as one of our strategic priorities. Consequently, we’ve witnessed a 5 percentage points increase in our gross margin, bringing it to 53.7% for the quarter, along with a notable 10.1% reduction in our non-GAAP net loss compared to the previous year. Going forward, I will be dedicated to leading the team to enhance our operating efficiency and further narrow losses. Now I’d like to delve into the details of our third quarter initiatives and discuss our progress concerning content and creators and the commercialization progress. Let’s start with our content and content creators. As of Q3, the accumulated pieces of content across the Zhihu community reached 743.7 million, representing a year-over-year increase of 28.4%.

In addition to expanding our overall content library across various verticals, since our users’ carnival in July, we have specifically focused on expanding and enriching content related to new generation professionals’ evolving demands, including their career growth, lifestyle, and consumption-related scenarios. Furthermore, to bolster our community ecosystem, we continued to focus on organic commercialization of our content. At our Zhihu business conference in September, we announced the official release of a new commercial content product, [Zhiyao], designed for credential professionals. With this product, professionals can answer questions, share product experience, and provide industry insights as experts in their specific fields. Alongside this initiative, we also enhanced our new generation professional content creators by providing high-quality traffic support through our mega-influencer incubation plan, [Foreign Language], leading to greater and more direct influence on users’ consumption decisions.

We also launched a data product, the Zhihuishu Mini Program, which can help our merchants and brands capture precise market growth potential by analyzing trending topics, industry research, and many other factors as a valuable part of our marketing services. We also drove the increased operational efficiency and performance across the Zhihu community in the third quarter as we continued to elevate our content supply by integrating AI and other technologies. By enhancing algorithms and AI-powered content comprehension, we were able to deliver more customized and balanced content to users, especially content with higher commercial value. Content creators continue to contribute immense value to the Zhihu community. During the quarter, in addition to enhancing our content library, we strove to inspire new content creators to join us while also increasing support for our existing content creators.

During Q3, the average financial income of content creators who received financial income from our platform increased by more than 30% year-over-year. We stimulated both the quantity and quality of their production by actively engaging in operating activities. Simultaneously, we provided support through improved community governance and strengthened the interest protection mechanism. Additionally, we intensified our crackdown on pirated content. To promote the sustainable growth of our dynamic and flourishing content ecosystem, we adopted a more active approach to our multi-engine commercialization in this quarter. As a result, our memberships business maintained its accelerated growth momentum, and the revenue contributions from the vocational training business continued to increase.

This stands as a strong testament to our outstanding content monetization capability and the effectiveness and resilience of our business model. Our total revenue for the quarter was RMB 1.0 billion, up 12.1% year-over-year. Among our various revenue streams, paid membership revenue grew by 39.2% year-over-year and average monthly subscribing members increased by 35.9% year-over-year to 14.8 million. This strong revenue performance was boosted by our persistent efforts to broaden content coverage while improving content distribution efficiency. Zhihu IP products have begun to demonstrate huge potential within the online entertainment industry in China. Our content and blockbuster IP have garnered broad recognition beyond the Zhihu community, amplifying the potential for audience-based growth.

A hit TV drama, Scent of Time, adapted from novel Xi Qian Hua on the Zhihu platform, debuted on Youku in October to broad market acclaim. We believe that the strong sense of connection and the broad appeal of the original stories in Zhihu’s library offers great opportunities for film and television adaptation, which will further unlock our content ecosystem’s growth and the monetization potential for our valuable IPs. Zhihu has already accumulated more than 100,000 IPs in its library, including short stories and science fiction, et cetera. There are currently many other Zhihu works in the film and television pipeline, and we look forward to sharing more details of these projects once they are available. By leveraging our technology and operations capabilities, we are confident we can share the massive value and influence of our IPs with our users, content creators, and business partners.

We will continue advancing the development of our high-quality IP content and integrate AI technologies from content creation to commercialization. The array of functions and tools we have recently launched or improved, such as our AIGC-powered illustration tool, Writer Assistant, have significantly boosted content creation. Meanwhile, our updated interactive functions, together with our broader and more diverse content categories, have effectively expanded our user coverage. Moving forward, we will continue to strengthen our commercialization capabilities through innovation and exploration to increase ARPU. Moving on to marketing services. In the third quarter, our marketing services were still affected by the overall fluctuations in the macro environment.

Despite these challenges, our cornerstone verticals, especially those advertisers’ products requiring a relatively longer decision-making process with high values, have been widely recognized among brands and manufacturers. For example, IT and 3C and home appliances continue to make solid progress. Together, these increased significantly by double digits year-over-year, highlighting the effectiveness of our content-centric marketing solutions. To further unleash the commercial value of the Zhihu community’s high-quality content, traffic, and other opportunities for brands and manufacturers, we have been consistently upgrading our products and expanding content consumption scenarios. We have enhanced our partnerships with third-party e-commerce platforms such as Taobao for traffic data and analysis.

This includes live monitoring of comprehensive indices, including traffic volume, user engagement, user acquisition, and transaction numbers. This enables merchants and brands to enhance their ROI through more optimized performance-based marketing. Our newly launched content product also helps to maximize the value of the credential professionals and influence users’ consumption decisions. Furthermore, we continue to upgrade our underlying technology capabilities to achieve better ROI for our brands through our smart advertisement allocation model and streamline order placement functions. Boosted by these efforts, our advertising business recovery has begun to pick up sequentially in the fourth quarter. Moving forward, we are confident that our operational effectiveness and enhanced brand recognition will enable us to capture the market’s growth potential.

Moving on to our Vocational Training business, we have been striving to broaden and diversify our program offerings by identifying and fulfilling users’ demand for academic and vocational qualifications as well as our employee management skills. Our well-rounded product and service spectrum now covers postgraduate entrance examination, civil service examination, ESG, CFA and CPA examinations, language testing, writing or data analytical skills, and AGI, among others. As a result, vocational training revenue soared 85.6% year-over-year in the third quarter. We will continue to adjust our service offerings to capture market growth. We also boosted the operational efficiency of our vocational training business and focused on resources and post-merger integration during the quarter.

The resulting optimized ROI in user acquisition significantly strengthened our business product competitiveness. Furthermore, we remain confident in the opportunities that the AI revolution is bringing to the education industry. As such, we continue to fortify our R&D capabilities and integrate AI into products and services to improve user experience. During the quarter, we released the AI Powered Paper Correction Tool, which sets a new benchmark for user experience in the vocational training industry. We also expanded our AI technology application scenarios to improve our sales conversion and users’ interactive learning experience. Our strategic investment in AI technology is playing a pivotal role in our development as we approach our next stage of growth.

Our large language model, Zhihaitu AI, which received regulatory approval in early November, has now reached 100 billion level parameters. With regulatory approval secured, Zhihaitu AI can serve more users and commercial clients, marking another milestone in the process of transforming the Zhihu Community into Zhihu Intelligent Community. We believe Zhihaitu AI’s advantage lies in the ability to naturally combine large language model with specific scenarios powered by superior content understanding and inference abilities. We will gradually open our large language model, benefiting our users and partners, while preparing the sustainable growth of the entire industry. We will better empower our content creators and users in various scenarios when enabling brands and manufacturers to reap the benefits and reach their operational targets.

In short, Zhihu’s success and resilience are underpinned by our dynamic ecosystem with high-quality content at its core. With progress across content and commercialization of our diverse revenue streams in this quarter, we are well-positioned to capture driving healthy and sustainable growth while enhancing profitability. Going forward, we will continue to seek and seize opportunities to empower users and creators with advanced technology, creating value for all of our stakeholders. This concludes Mr. Zhou Yuan’s remarks. Now I will turn to our financial details in the third quarter. For a review of our third quarter 2023 results, please see our press release issued earlier today. I am pleased to announce another solid quarter with accelerated progress in our multi-engine commercialization, driven by robust growth in paid membership and the Vocational Training business.

Our total revenues for the quarter increased with strong resilience, rising by 12.1% year over year, which is in line with our management’s guidance provided previously. As we consistently broaden and diversify our products and service, paid membership revenue for Q3 increased by 39.2% year-over-year, while Vocational Training revenue increased by 85.6% from the same period of last year. Our gross margin for Q3 further expanded by 5 percentage points year-over-year to 53.7% as we focused on high-margin business and projects. Our ongoing improvement in cost control measures and operating efficiency enhancements also improved the company’s bottom line. Accordingly, our non-GAAP net loss for Q3 narrowed by 10.1% from the same period of 2022. Our paid membership revenue for the quarter was RMB 466.8 million, up 39.2% from RMB 335.4 million for the same period of 2022.

This increase was propelled by the continued growth of our subscribing members, which increased by 35.9% year-over-year to 14.8 million. Our Vocational Training business revenue for the third quarter was RMB 144.8 million, up 85.6% year-over-year. This organic growth came from new courses offerings provided by our existing business. And notably, our newly launched online courses for ESG-related examination preparation received excellent feedback from our users. The remainder of the revenue growth was attributable to the acquisition of MBA Master, which was acquired previously. Our marketing services revenue for the quarter was RMB 383 million despite the overall industry challenges. Our cornerstone verticals, including IT and 3C and home appliance, maintained their growth momentum, increasing significantly by double digit year-over-year.

Gross profit for the third quarter increased by 23.4% year-over-year to RMB 548.5 million, with gross margin expanding to 53.7% from 48.7% for the same period of 2022. Primarily due to our enhanced monetization efforts as well as our improved efficiency in cloud services and the bandwidth utilization, total operating expenses were RMB 898.6 million for the third quarter compared with RMB 723 million for the same period of 2022. Selling and marketing expenses for the third quarter increased to RMB 534.3 million from RMB 478.3 million for the same period of 2022 as we continued to invest in promoting our products and brand name. Research and development expenses increased to RMB 249.7 million for the third quarter from RMB 160.8 million for the same period of 2022.

The increase was primarily attributable to our increased spending on technology innovation as we believe strongly in the potential opportunities in large language model technology. General and administrative expenses increased for the quarter to RMB 114.6 million from RMB 83.9 million in the same period of 2022 due to increased rental expenses and an increase in share-based compensation expenses from our acquired business. In this quarter, we incurred approximately RMB 18 million relocation expenses as we moved into our new headquarters in Beijing. Driven by our ongoing efforts to control costs and operational efficiency improvements, our GAAP net loss for the quarter was RMB 278.4 million, narrowed by 6.5% on a year-over-year basis. Our non-GAAP adjusted net loss, which primarily excludes share-based compensation expenses and amortization of intangible assets resulting from business acquisition, was RMB 225.3 million for the third quarter, narrowed by around 10% from the same period last year.

As of September 30, 2023, the company had cash and cash equivalents, term deposits, and short-term investments of approximately RMB 5.7 billion compared with RMB 6.3 billion as of December 21, 2022. As of September 30, 2023, we repurchased approximately 18.3 million Class A ordinary shares for a total of USD 42.6 million on both the New York Stock Exchange and the Stock Exchange of Hong Kong. This concludes my prepared remarks on our financial performance for this quarter. Let’s turn the call over to the operator for Q&A session. Thank you.

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Q&A Session

Operator: [Operator Instructions] The first question today comes from Steve Qu with Goldman Sachs.

Steve Qu: [Foreign Language] So first, congratulating on receiving the approval for our large language model Zhihaitu AI. Could management share with us the latest progress of our large language model as well as the future monetization roadmap?

Li Dahai: [Foreign Language]

Iris Liu: This is Dahai Li, CTO of Zhihu. To summarize, Zhihu is well positioned as a content community that has high-quality content and data on its platform, and we have made tremendous progress in terms of building out our large language model capabilities in the past few months. And in the future, our key focus will be on the application of our Zhihaitu AI into different business scenarios on our platform.

Li Dahai: [Foreign Language]

Iris Liu: And more specifically speaking, our Zhihaitu AI is now upgraded to 100 billion level parameters of multi-model large language model. And in early November, we have obtained the regulatory approval for our large language model. In terms of application, internally, we have used our Zhihaitu model into different search aspects of our daily operations.

Li Dahai: [Foreign Language]

Iris Liu: And speaking of content comprehension, our large language model has been used on the content classification, our content search, and recommendation to enhance its operating efficiency. For example, in the past, our content classification system upgrade takes about 1 quarter and now is shortened to 2 weeks. In this way, we will enhance our user engagement [indiscernible].

Li Dahai: [Foreign Language]

Iris Liu: In terms of our marketing services, our large language model helps us to refine the titles of our content commercial articles and help us to refine our content products to enhance our commercialization conversion rate.

Li Dahai: [Foreign Language]

Iris Liu: Our multi-model large language model also facilitates the generation of cover pictures of stories of our paid membership business. And in this way, users will be able to interact with the virtual characters of our short stories and get an in-depth understanding of the contents of the stories.

Li Dahai: [Foreign Language]

Iris Liu: Speaking of our Vocational Training business, our large language model helps the system to correct the essays for our students and also help our tutors to answer the basic or frequent questions from the students, in this way to enhance the operation efficiency of our Vocational Training business.

Li Dahai: [Foreign Language]

Iris Liu: In terms of our content auditing, the large language model — with the help of our large language model, the in-depth mainly identification abilities, the large language model is able to filter low quality content and identify the non-compliant contents of our questions and the user reviews, in this way to enhance the overall efficiency and accuracy.

Li Dahai: [Foreign Language]

Iris Liu: So this summarizes our past explorations in terms of the utilization of large language models in our community.

Li Dahai: [Foreign Language]

Iris Liu: So in terms of our future plans, with the approval of the regulators, we plan to utilize our Zhihaitu AI into more products or functions that can be accessed by our users to enhance our content creation and consumption experiences.

Li Dahai: [Foreign Language]

Iris Liu: AI at Zhihu is a very important opportunity. And through the R&D of Zhihaitu AI’s large language model and continuously upgrade our basic model capabilities, we will provide better experiences for our users and content creators and also enhance our commercialization efficiency.

Operator: The next question comes from Xueqing Zhang with CICC.

Xueqing Zhang: Congratulations on another solid result. The Membership business once again demonstrates strong growth this quarter. What’s the strategy for this business in the future? And how does the company view the recent development trend of micro drama series?

Zhou Yuan: [Foreign Language]

Iris Liu: This is Zhou Yuan, CEO of Zhihu. As you can see that as our CFO has introduced previously, in the third quarter this year, our revenue from paid membership business has increased year-over-year by 39.2%, and we have accumulated average monthly paying users for about 15 million. And currently, we have accumulated a mass audience base and content creator base for our paid membership business.

Zhou Yuan: [Foreign Language]

Iris Liu: And based on our content business fared well, our paid membership business is experiencing a resilient growth. And firstly, we have explored our content IP commercialization currently. And in October, our hit drama, Scent of Time, has released on Youku and have received broad market appeal from the market.

Zhou Yuan: [Foreign Language]

Iris Liu: And secondly speaking, our paid membership business has constantly improved in terms of our operating efficiency with the help of technology innovation. As Dahai has mentioned just now, with the approval of AI large language model, our AI technology will facilitate us in terms of the Writer’s Assistant and also the cover picture generation for our stories in our membership business.

Zhou Yuan: [Foreign Language]

Iris Liu: And another aspect I would like to mention is that AI will not only help us to enhance operating efficiency, but it will also help us to create more in-depth interaction with the contents of the stories, for example, the interaction with virtual characters in the stories. And in this way, we will create more in-depth content consumption and help to increase our ARPU for our paid membership business.

Zhou Yuan: [Foreign Language]

Iris Liu: And the final aspect I would like to mention is that we are constantly exploring different means of media for our paid membership business. And in our Yan Selection business, not only the short video dramas you have mentioned that is developing very rapidly in China recently, but we also have about 100,000 number of stories or contents in our paid membership business. And we will constantly innovate our media to help us to enhance our paid membership business.

Henry Sha: And Xueqing Zhang, this is Henry, the CFO of the company. To comment on the answers to our CEO about the short form, the TV drama, we believe it’s a huge market with brilliant potential. And as the CEO mentioned, Zhihu was equipped with a very large — we accumulated more than 100,000 stories in the library. So we believe that the market will recognize Zhihu’s IP — the scarcity value of the Zhihu Ips in this very, how to say, unique and booming market.