Zhihu Inc. (NYSE:ZH) Q2 2023 Earnings Conference Call August 23, 2023 8:00 AM ET

Company Participants

Yolanda Lian Liu - IR Manager

Zhou Yuan - Founder, Chairman and CEO

Li Dahai - Chief Technology Officer

Henry Sha - CFO

Conference Call Participants

Xueqing Zhang - CICC

Steve Qu - Goldman Sachs

Vicki Wei - Citi

Daisy Chen - Haitong International

Yiwen Zhang - Chinese Renaissance

Operator

Hello, ladies and gentlemen. Thank you for standing by, and welcome to the Zhihu Inc. Second 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.

Yolanda Lian Liu

Thank you, operator. Hello, everyone. Welcome to our second quarter 2023 financial results conference call. Participants on today's call will include Mr. Yuan Zhou, Founder, Chairman and Chief Executive Officer of Zhihu; Mr. Dahai Li, 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 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 as 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 purpose 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 in our 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 our CEO, Mr. Zhou Yuan. Hello, everyone. Thank you for joining us for Zhihu's second quarter 2023 earnings call.

We continue to accelerate development across our business during the second quarter, achieving sustainable growth through effective execution of our community ecosystem first strategy. As we enriched our content library, user engagement increased throughout the Zhihu community, and our average MAUs continued to increase as well, rising to 109.4 million in the second quarter, representing 3.3% year-over-year growth and 6.9% sequential growth.

Furthermore, our unremitting efforts to diversify monetization channels and upgrade our service capabilities during the second quarter drove robust growth in total revenue, which increased by 24.9% year-over-year. At the same time, we further enhanced operating efficiency, boosting our gross margin to 53.8%, up by 6 percentage points year-over-year. Our non-GAAP net loss narrowed significantly as a result of ongoing operating efficiency improvements by 49.9% compared with the same period last year, despite our newly initiated investment in generative AI technology.

Speaking of generative AI technology development, following the launch of our first large language model Chat AI in April, we are currently conducting internal trials of AI applications, aiming to strengthen the vibrancy of our community and further unlock commercial value. Leveraging our vast content portfolio potential applications of this cutting-edge technology in our community could include more efficient content search and more customized recommendations for our users.

AI technology could also help content creators increase productivity and creativity to further enrich Zhihu's content pool. Let me now move on to our users and content. In the second quarter, we focused on content quality enhancement, particularly by continuously enriching our professional content library and enhancing users' interaction with professional users.

To that end, we upgraded our content creator incentive scheme, high end plan 5.0 in April, providing selected content creators with an array of supportive tools as well as better user traffic support and financial wealth for their high-quality work. With these efforts, we were encouraged to see increased growth momentum in both the volume of content created and the number of the content creators.

By the end of the second quarter, our 66.6 million cultivated content creators had contributed 711.3 million pieces of content covering over 1,000 verticals. To further refine the content quality, we also upgraded our professional identity verification functions in this quarter. Many of our content creators who have been endorsed by our blue metal professional identification veterans in specific industries, such as Internet, finance, legal, engineering, et cetera.

With the credentials from well-known enterprises, college and institutions, professional identity status has broadened enhanced credibility, greater recognition of their professional content and up to 10x more user interaction post identification. A growing number of professional users have collectively contributed content and is growing Zhihu's reputation as a professional community with high credibility.

Our reliable professional and abundant content made Zhihu a desirable destination for users to search for answers and follow trending topics. Discussions on trending topics in valid formats such as Q&A, live streaming and ideas, enlivened the Zhihu community also in addition to enjoying our discussion content. Consumers are becoming more reliant on Zhihu's detailed and informative commerce content as a decision-making reference.

Moving forward, we will continue to focus on content quality, while expanding our content library, creating value for our users across all aspects of studying and consumption. Users have always been the cornerstone of the Zhihu community. Our content encourages users to stay and grow on our platform, driving our average MAUs to 109.4 million in the second quarter. Furthermore, increasing user engagement is critical in promoting the healthy development of our ecosystem. Many of our long-term frequent users started their journey on Zhihu when they were students.

Now they are between 18 and 40 years old, with higher education and have become new generation professionals. They want to share their insights, experience and stories and to become key opinion professionals. Zhihu has expanded its content verticals to capture key opinion professionals involving interest accordingly.

This deepening generational engagement reflects Zhihu's superior ability to captivate users for the long term and serve them at different stage of life. In addition, by leveraging Zhihu's strong run awareness, content library and AI-powered technology, we are confident Zhihu can further extend coverage in lower-tier cities by attracting more professionals, young generations and consumers.

Meanwhile, we will continue to support the content creators and uphold a high standard of community governance, reinforcing our healthy culture of sincerity, expertise and respect. Now, let me go into the details of our commercialization progress.

Let's start with our membership business which sustained its strong growth momentum in the second quarter. Paid membership revenue for the second quarter increased by 65.6% year-over-year, while average monthly subscribing members grew by 65.3% year-over-year, reflecting our dedication to expanding premium content coverage.

In the second quarter, we continued to enhance the effectiveness of our story creation tools and upgrade our financial reward plans to inspire passion among content creators while protecting their rights and the benefits through enhanced antipiracy measures.

The number of Zhihu core premium content business increased by more than 200% year-over-year during the quarter. Also, the number of membership content creators who earned income from Zhihu increased by almost 50% year-over-year. Thanks to creators' passion and their premium content contributions.

Our users were able to enjoy a larger content library with superior quality. In the second half of this year, we will further differentiate ourselves with our content and membership products from those of our competitors and expand our content categories to cover the evolving needs of both male and female members.

We will also expand our content distribution channel by partnering with more platforms, such as Huawei, among smartphone manufacturers. Whatsmore, a web drama series adapted from a Novo in Zhihu content library was recently launched on Tencent video platform, disseminating our premium content to a broader audience in a visual format. We anticipate that more of our premium stories will be adapted, unlocking our IP value going forward.

Next, our vocational training business, which continued to deliver excellent results with its revenue increasing by 213.3% year-over-year and 35.1% quarter-over-quarter. Following the acquisition of MBA Master in the second quarter, we were able to further optimize our program offerings.

Meanwhile, by encouraging professionalism and sincerity in our community for young professional users, we increased their interest in sharing and learning vocational skills on Zhihu, driving organic growth across our proprietary vocational training offerings. While our vocational training business is still in the early stage, we will continue to invest in human resources and technology infrastructure to build a solid foundation as a leading content-centric community.

Zhihu's unique proposition enable us to deeply understand our users' involving learning demands, then satisfy those demands through well selected, targeted programs. Moving on to Marketing Services. Back in the first quarter of 2023, we combined advertising and content commerce solutions or CCS, into marketing services.

This change helped to optimize our organization structure and synergize resources. By strengthening our service capabilities and optimizing the service offerings, we are able to provide more precise comprehensive marketing solutions and improve operating efficiency. In Q2, we recorded a sequential quarterly revenue increase of 5.3% with expanded gross margin.

Among the various industries we serve, IT and TC and home appliance stood out, growing significantly by double digits both year-over-year and sequentially, benefiting from increasing ROI across the related sectors within Zhihu community. Going forward, we will continue to streamline our marketing services offerings and optimize recommendation algorithm to meet advertising clients' evolving needs.

Overall, as we move into the second half of 2023, we will focus on enhancing our efficiency to further narrow our losses and advance our progress in terms of our profitability while prioritizing healthy and sustainable growth across all of our business segments. Before I conclude, I would like to specifically highlight our progress in generative AI technology.

As I mentioned earlier, Zhihu has been focusing on innovatively applying large language model technology into our services and the products over the past several quarters. We are currently exploring AI's potential application to enhance users' content search experience, optimize algorithms and improve content creation efficiency.

For instance, we aimed to develop search tools that analyze our Q&A content pool to present a more precise and better summarize the results, thereby improving both the accuracy and the efficiency of content searching.

In addition to these breakthroughs, we have been empowering our internal operating system with AI technology to further increase its data monitoring and operational capabilities. Moving forward, we will continue to invest prudently in generative AI technology to create new AI-powered functions that can improve the content creators creation experience as well as enhance our service capabilities. We firmly believe that AI-powered technology's true value lies in empowering human being across all aspects of life as an extension of our innate capabilities. This concludes Mr. Zhou Yuan's remarks.

Now I will turn into our financial details for the second quarter for a review of our second quarter 2023 results. Please see our press release issued earlier today. We delivered solid results for the second quarter of 2023 on a use of a strong first quarter. Our total revenues for the second quarter increased by 24.9% year-over-year, which is in line with the management guidance. Our gross margin further expanded by 6 percentage points and our non-GAAP net loss margin narrowed by 22 -- sorry, 32 percentage points, both on a year-over-year basis.

Thanks to our effective ongoing cost control measures, guided by our community ecosystem first strategy, we continued to expand our premium content library and simulate content creators' passion for creation, preparing our prosperity across Zhihu's vibrant community. Both our paid membership and the vocational training services continued to grow robustly, increasing by 65.6% and 213.3% respectively, on a year-over-year basis.

We also further improved our operational efficiency with streamlined organizational structure and product offerings. As a result, while our quarterly marketing services revenue decreased by 13.7% year-over-year, it picked up sequentially for growth of 5.3% quarter-over-quarter. In particular, our cornerstone vertical of our advertisement business, IT and TC and home appliance outperformed with a high double-digit year-over-year increase.

Our paid membership revenue for the quarter was RMB 449.1 million, up 65.6% from RMB 271.2 million in the same period of 2022. This increase was attributable to the rapid growth of our subscribing members. For the second quarter, our average monthly subscribing members reached RMB 14 million, increasing by 65.3% year-over-year.

In Q3, we anticipate the paid membership revenue will achieve both sequential and year-over-year growth. Our vocational training business revenue for the second quarter increased by 213.3% year-over-year, reaching RMB 144.5 million from RMB 46.1 million in the same period of last year. As we continue to enrich our program offerings through both M&A and self-developed products as well as enhance our service capability with cutting-edge technology, we are confident we can harness even more of this industry's massive potential.

Our marketing services revenue for the quarter was RMB 412.7 million, compared with RMB 478.1 million in the same period of the last year. During the quarter, we focused on better utilizing our resources and phased out some low-margin marketing services and products all of which contributed to the margin improvement of the quarter.

We expect these strategy adjustments in marketing services business to generate recovery growth and increase our resilience in the face of macroeconomic uncertainty in the second half of this year.

Gross profit for the second quarter increased by 40.7% year-over-year to RMB 562.1 million with gross margin expanding to 53.8% from 47.8% in the same period of 2022. Demonstrating the effectiveness of our refined monetization efforts as well as our improvements in cloud services and bandwidth utilization efficiency.

Total operating expenses were RMB 889.3 million in the second quarter, compared to RMB 860.3 million in the same period of last year. Selling and marketing expenses increased slightly to RMB 540.6 million from RMB 532.4 million in the same period of 2022, as we continue to invest in promoting our product offerings and branding, while remaining prudent in our overall marketing-related spending. Research and development expenses increased to RMB 236.2 million from RMB 223.6 million in the same period of last year.

The increase was primarily attributable to our increased spending in technology innovation as we believe such investments will better position us in the competitive landscape over the long term. General and administrative expenses increased to RMB 112.5 million from RMB 104.3 million in the same period of 2022 due to the increased share-based compensation expenses. Our ongoing efforts to control costs and improve operational efficiency continued to bear fruit.

Our GAAP net loss for the quarter was RMB 279.1 million, down by 42.7% 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 acquisitions, was RMB 222.3 million for the second quarter, decreasing by approximately 50% from the same period last year.

Non-GAAP net loss margin for the quarter was 21.3%, narrowing significantly by 32 percentage points from a year ago. We will still prioritize loss reduction for the rest of the year. Our net cash used in operating activities was RMB 58.3 million for the first half of 2023, a significant reduction from RMB 515.1 million for the same period of last year, highlighting our improved operational efficiency and the shift in our revenue structure.

As of June 30, 2023, the company had cash and cash equivalents, term deposits and short-term investments of approximately RMB 6.2 billion compared with RMB 6.3 billion as of December 31, 2022. This concludes my prepared remarks on our financial performance for this quarter.

Let's turn the call over to the operator for the Q&A section. Thank you.

Question-and-Answer Session

Operator

We will now begin the question-and-answer session. [Operator Instructions]. Today's first question comes from Xueqing Zhang with CICC. Please proceed.

Xueqing Zhang

[Foreign Language] Management, thanks for taking my questions and congratulations on the solid results. My question relates to AI. You mentioned in the prepared remarks that you had some progress on AI empowered technology. Could management share with us more color that what's the specific application scenarios are involved and what's our advantage in AI empowered technology compared to others. Also, what changes will the utilization of AI bring to Zhihu. Thank you.

Li Dahai

[Foreign Language] Thank you for the question. This is a Dahai Li, CTO of Zhihu. Zhihu community has abundant language, Chinese language database and in this AI technology evolution, we have unique competitive advantages. AI technology has a wide range of generic applications in our community to enhance our user experience and enhance our operating efficiency.

We are now training about 20 billion parameters for our large language model, our beta testing results is significantly improved, and now we are expanding our large language model to about 80 billion parameters and reach 100 billion parameters towards year-end.

We have been trying to identify the implied this meanings of our large language model, and we have made significant progress in terms of content categorization and SIM identification. In the future, the AI technology will be used in our community, and I will give some examples to the specific applications in our community.

For example, in terms of content creator empowerment, in the future, AI technology will help us content creators to enhance their productivity and enhance their quality of creation, especially through, for example, recommending different writing styles according to the scenario and also writing correction. We will further enhance high-quality content through lowering the area for content creation.

Next is for our content recommendation. AI technology will empower our content recommendation according to the scenario user relationship and help us to realize more accurate and more efficient content recommendation for our users to enhance their engagement and stickiness and in the future, we are exploring to apply AI technology for our marketing services content recommendation to enhance our commercialization efficiency.

Thirdly is our content search. We are bisecting integrated search function that use AI technology to enhance the intelligence of our search function to enhance the accuracy results and also to make the search results more customized and correct, and users can easily get what they want in a summarized way. Next is our content auditing. AI will help us to identify the safe manning of content and help us to increase the efficiency of our content auditing.

And also to save the operational cost for our content auditing. Next is for our application scenarios in our different business. AI will also further increase our operating efficiency. I will also give some examples on that front. For our paid membership business, AI technology will empower our -- the fraud covers and pictures in our short stories and also enhance the quality and efficiency for our future generation.

Next is for our vocational training business. AI Technology is going to promote the digitalization and intelligent business of our vocational training and it'll help our users to get more customized course recommendation and coaching solutions. Another thing is that AI will help us to correct the essays and homework's for our users.

So to summarize our AI applications, we believe that AI evolution is actually a very important opportunity, a once in a lifetime opportunity for Zhihu and we are trying to use our Zhihu to AI technology, which is released in April this year to enhance our technology capabilities and to empower our users and content creators to obtain more better user experience and help us to increase the commercialization efficiency. Thank you very much. That's it from my answers.

Henry Sha

And this is Henry. I'm the CFO of the company. I will help to supplement the answer from Dahai and answer the second question raised by the CICC. Actually we believe that we have a very obvious differentiating points with the other large language model competitors on the market that we are in Zhihu, we have large number of the data accumulated in the past 10 years, which -- the answers and data contributed by our user more than like 100 million MAUs. .

So we believe that in the simplified Chinese language environment, our user data and our content has scarcity value. And we are doing a lot of work in the anti- corrosion technology. And we are very, how to say, resistant to those like data abuse actions on the market, that we are defending ourselves from our competitors on data side. That's my answer to Xueqing. Next one.

Xueqing Zhang

Thank you.

Operator

The next question is from Steve Qu with Goldman Sachs. Please proceed.

Steven Qu

[Foreign Language] Thank you for taking my question. This quarter, we have seen very strong membership growth from a year-on-year perspective. But the number of subscribers were facing some issue quarter-over-quarter given the pirating issue. So could management share with us your outlook on the membership revenue growth for the second half as well as your thoughts on the long-term growth profile, such as collaboration with [Weixin] or perhaps Q2 reading as well as your thinking of how to extend the lifetime value of the users beyond just charging the membership fees. Thank you.

Zhou Yuan

[Foreign Language] Thank you for your question. So I'm going to -- this is CEO of Zhihu. I'm going to discuss about this question through both our short-term and long-term objectives or strategies for our paid membership business. We are providing premium short stories in our platform and we believe that we are forming a clear competitive advantage or differentiate from other traditional online reading platforms on this front. For example, our stories are very short and cater to the evolving needs of users, especially to users' recommended time in terms of their reading.

Another thing is that, as mentioned in our previous earnings call, we have released our Yan Yan story application, and this forms as another channel for our user acquisition for our paid membership business. And inside this Yan Yan story application, our users can get more immersive and differentiated reading experience.

And also for our Yan Yan stores, we are extending to form more partnerships with other platforms. And recently, we have formed partnership with Huawei Reading to enlarge our user base and extend our different content providing channels. I think that with all these efforts, in the second half of this year, our membership business is -- will keep the momentum and increase at very high trend in the future.

In the future, I think the paid membership business will enhance its LTV through three fronts. First is through our AI applications in paid membership business as mentioned by our CTO, Li Dahai, just now and secondly is through the upgrade of different distribution channels for different formats as we are making progress. And thirdly, it's through unlocking IP value in the future.

Henry Sha

Steve, this is Henry. I will further explain the trend you have seen, there is some fluctuation of the subscriber numbers between Q1 and Q2. Actually, in Q1, I think it's a high base during the spring festival. We have a promotion activity, which allowing the users to subscribe for the first month with RMB 9. I think it was a successful promotion activity in Q1 which created a high base of the subscribing members.

And in Q2, we do not continue too much for that RMB 9 for the first month's activity. So there is some fluctuation. And also, we have already established a professional team for the antipiracy measures to take actions internally. So we are very confident to see the rebound or I say, sequential growth as well as year-over-year growth for the Q3 and Q4 for the paid membership business revenue growth. This is my answer for you. Thank you.

Steven Qu

Thank you.

Operator

The next question comes from Vicki Wei with Citi. Please proceed.

Vicki Wei

[Foreign Language] Good evening, management. Thanks for taking my question. I have one question regarding the marketing services. What is management's view on the recovery pace of the marketing services and how should we think of Zhihu's strategy to improve the marketing services competitiveness. Thank you.

Henry Sha

Thank you, Vicki. This is Henry. Thanks for the question. So as we introduced earlier in the last quarter, we have been facing some like uncertainties from the macro economy for the second quarter. And also, we have seen that the entity will still be sustained for the second half of this year. But internally, we are doing several taking actions to phasing and to solve the problems for us.

The first one that we are combining two teams together, as we introduced earlier that we combined our CCS team together with our advertising team and we have been seeing the demand, the increasing demand from our clients on the, how to say, the effective basis or the ROI basis, the advertising products like CCS, which I believe that will be still welcomed in the second half of this year.

And secondly, we are improving our efficiency. As I said earlier on this call that we're taking actions to phase out some low-margin business from our advertising business to enhance our competitiveness to achieve the healthy growth continuously. So that's what our thoughts about our marketing services business. So for now, we cannot guarantee that we will achieve like the year-over-year growth in Q4. But we are confident that this business should be seeing the rebound trend in the second half of this year. Thank you.

Vicki Wei

Thank you.

Operator

The next question comes from Daisy Chen with Haitong International. Please proceed.

Daisy Chen

[Foreign Language] Thanks for taking my question. My question is about the vocational training business. First of all, congratulations to the strong growth in this segment. Can I ask you about the current situation of our vocational training business from operation or deployment CapEx such as SPU of corrosion and promotion strategy. And can management share your outlook for the momentum of the second half and then next year as well as the revenue contributions from our long-term expertise and also any strategy what work do you think you need to do to actually those goals, if that goes right, can you share more color on the profitability of this segment? Thank you.

Henry Sha

Thank you Daisy. This is Henry. I will help you answer your question. For the second half of this year, we believe that our vocational training business will still achieve the year-over-year and sequential growth for the second half of this year with more than like 100% year-over-year growth rate. I think for the full year, that will be 2x the growth in comparison with that in last year.

And on the cost offerings of the education vocational training business, the product offerings, I think we have already almost complete the structure of our vocation training business, the allocation on that. by including, for example, national graduate students entrance examination as well as the IELTS, the English or foreign language teaching the courses as well as, for example, like the MBA courses as well as like the teachers' certification service offerings, et cetera, et cetera.

So I believe that if we say that, that will form our organic growth going forward. And maybe in

next one or two years, there is a one or two more acquisition will be formed like to provide some like the M&A growth looking forward. And about your question, the capability of our -- looking to like a whole vocational training business, I think we're still in the investment stage.

So for example, I think for this whole year, the vocational training business will still bear a loss like the loss-making for the whole group. So that will be between RMB 100 million to RMB 200 million hit to our bottom line, like the P&L. That's our answer for your question.

Operator

The next question comes from Yiwen Zhang with Chinese Renaissance. Please proceed.

Yiwen Zhang

[Foreign Language] So my question regarding our margin. Is there any update on reaching breakeven timetable? And what are the drivers for us to reach in such breakeven point. Thank you.

Henry Sha

Thank you Yiwen. This is Henry. I think in the second half of this year, we will reaffirm and prioritize our loss reduction strategy for the rest of the year. And also, this is the main topic for the next year. I think the approach is two ways.

First one, we will enhance our commercialization capability by booting our both marketing services business and to see the business by including the growth of the membership business as well as the vocational training business, which to see.

We believe that there is some changing happening with our revenue structure. And we are confident that we will get a recovery in terms of the revenue growth for the second half of this year and the next year.

The second way is to the more prudent investment as well as in the -- like the marketing spending. I think that we are doing a cost reduction program for the second half of this year. I think the loss reduction strategy is on track so far by looking to our Q2 business and the results. Does that answer your question?

Yiwen Zhang

Yes.

Henry Sha

Thank you, Yiwen.

Operator

That concludes today's question-and-answer session. At this time, I would like to turn the conference back to Iris for any closing remarks.

Yolanda Lian Liu

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.

Operator

The conference has now concluded. Thank you for attending today's presentation, and you may now disconnect.