Zhihu Inc. Q1 FY2024 Earnings Call

Ladies and gentlemen, thank you for standing by and welcome to the Zhihu Inc. First Quarter 2024 Financial Results Conference Call. At this time, all participants are in the listen-only mode. After the speakers' presentation, there will be a question-and-answer session. Today's conference is being recorded. At this time, I would like to turn the conference over to Yolanda Liu, Director of Investor Relations. Please go ahead, ma'am.

Thank you, operator. Hello everyone. Welcome to Zhihu's first quarter 2024 financial results conference call. Joining me today are Mr. Zhou Yuan, our Founder, Chairman, and Chief Executive Officer and Mr. Wang Han, our Chief Financial Officer. Before we get started, I'd like to remind you that today's discussion will include forward-looking statements made under the Safe Harbor provisions of the U.S. Private Securities Litigation Reform Act of 1995. These statements involve inherent risks and uncertainties. As such, actual results may be materially different from the views expressed today. Other information regarding these and other risks and uncertainties is included in our public filings with the U.S. SEC and Hong Kong Stock Exchange. The company does not assume any obligation to update any forward-looking statements, except as required under applicable law. Additionally, the matter will discuss today will include both GAAP and non-GAAP financial measures for comparison purposes only. For a definition of non-GAAP financial measures and 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 investor relations website at ir.zhihu.com. I will now turn the call over to Mr. Wang Han, CFO of Zhihu. Han, please go ahead.

Thank you, Yolanda. Hello everyone. Thank you for joining Zhihu's first quarter year 2024 earnings call. I'm pleased to deliver today's opening remarks on behalf of Mr. Zhou Yuan, Founder, Chairman, and CEO of Zhihu. The first quarter of 2024 marked a significant turning point for Zhihu. Strategically, we concentrated on our core strengths and the most crucial aspects of our development in the AI area. This involved a series of tactical adjustments, including resource reallocation and organizational optimization. From an operating perspective, our top priority in the short-term is to achieve profitability. The element of AI has disrupted the traditional Internet business model, which relies on expanding user base behind user engagement and boosting user-added value to gain market share. In the AI era, the focus has shifted to high-quality content and user value. Zhihu's core value lies not only in processing the highest quality content library in Chinese, but also in our unique content creation mechanism and our communities for a fostering atmosphere, which fosters the continued emergence of new high-quality content. Zhihu users are not passive recipients of information, but are active participants in content creation and knowledge sharing. These core strengths provide us with the first-mover advantage in exploring new business models and position us uniquely in the market, increasing our pricing power. Following our proactive reduction in community-related user acquisition costs, the size of our user base declined to something great in line with our expectations. However, engagement among our monthly active users increased; core user retention sustained its growth momentum and daily active user spending also increased significantly. Furthermore, our efforts to enhance trustworthiness within the Zhihu community continued to drive community prosperity. Our strategy for scenario-oriented content ensures a continued stream of authentic in-depth, high-quality content based on our users' own experiences. As of the end of the first quarter, the cumulative business of content on our platform reached 804.2 million, including 611 million Q&As, up 15.4% year-over-year. Cumulative content creators within the Zhihu community reached 73.6 million, an increase of 13% year-over-year. We also observed a notable year-over-year increase in the proportion of highly active users engaged in creation and a percentage of high-level daily active creators. Utilizing the power of AI-driven technology, we continue to equip our content creators with a variety of user-friendly creation tools, offering a professional and supportive environment to help them earn financial rewards. In the first quarter, the total number of content creators earning income on Zhihu grew by more than 25% year-over-year. Notably, the number of content creators benefiting from our monetization plan was nearly fourfold compared to the same period last year. In the AI era, we have continually upgraded our cybersecurity capabilities to ensure better protection of user data privacy and intellectual property rights. At the same time, we fully leverage AI model capabilities to enhance the efficiency of content identification, review, and governance within the Zhihu community. In certain scenarios, AI reviewers can achieve higher accuracy compared to manual identification and review, allowing us to significantly reduce the number of manual reviewers while maintaining high efficiency. We continue to refine and upgrade our existing systems, leveraging our Zhihu LLM model. These improvements have further enhanced user engagement and effectively combat fake traffic leading to a continued decline in users' negative feedback and propelling Zhihu's community sustainable development. We're progressing steadily towards our goal of achieving quarterly profitability within this year. To that end, we have accelerated our loss reduction through two operating tactics. First was to continue to improve employee efficiency, further reducing labor costs. Second was to reduce community-related user acquisition costs. Meanwhile, we have maintained a higher ROI in our pay membership and location training businesses, which extended our reach beyond the Zhihu community. With these efforts, the cost of revenue and total operating expenses in Q1 decreased by over RMB 130 million quarter-over-quarter. Notably, we recorded our sixth consecutive quarter of year-over-year growth in gross profit margin and three consecutive quarters of sequential decline in our sales and marketing expenses in the first quarter. Additionally, we have been accelerating the application of Zhihu LLM to further enhance our operating efficiency across every aspect of our businesses, for example, teaching, learning, and research assets for our vocational training business. By integrating our own knowledge library, we have driven notable efficiency improvements in AI teaching assistants, cell services, homework assessment, and more. As a leading content-centric community, Zhihu serves as a leading platform where professionals engage in the most extensive and in-depth discussions on AI-related topics. Since the beginning of this year, the amount of AI-related content and the number of creators have continued to surge with double-digit year-over-year growth. Specifically, the number of AI creators certified by Blue Label has increased by 130% year-over-year. Moreover, tens of thousands of specialized terms related to AI are being discussed within our community. In 2024, our exploration of investment in AI will shift to focus on the application layer. Our advancement in AI enables us to enhance operating efficiency across our existing businesses as well as unlock emerging potential beyond the Zhihu community, albeit on the foundation of unique philosophies. Since the launch of our AI-powered search feature in March, we have observed double-digit growth in app active days, user retention rate, and user engagement -- the amount of users who are using our new AI search feature. Now, I would like to dive into more details on the progress we achieved across our multiple business lines for the first quarter. First, our vocational training business continued to grow robustly with the revenue increasing 35.9% year-over-year to RMB 145.4 million. Its contribution to our total revenue also grew, surpassing 15% for the first time. As of the end of the first quarter, we established more than 30 sub-category courses through both self-operated business and acquisitions. Notably, our self-operated offerings are closely connected to Zhihu community, allowing us to address users' needs richly and precisely, while yielding higher profits. Our acquired offerings, on the other hand, meet specific demand and cater to a broader market. Together, these courses complement each other and broaden our offerings, driving the rapid and sustainable growth of our vocational training business. In the first quarter, our self-operated offerings grew rapidly, particularly in AI, AG, and self-exam portions, demonstrating excellent profitability and rapid growth. Formally, our program tutors are also content creators within the Zhihu community. With this dual role, tutors are deeply involved in the course development while maintaining ongoing interactions with students in the community about real course experiences, skill improvement, and other topics. This approach effectively addresses the ever-growing new demand of our users. Growth from our acquired offerings remained steady during this quarter further elevating our brand name awareness and service advantages. In April of this year, one of our subsidiaries, hosted a dedicated live broadcast inviting executives from the CFA Institute. They provided professional insights into CFA exam reforms, offering first-hand preparation guidance and expert analysis. This initiative garnered significant attention and sustained feedback from both the industry and examinees. Our paid membership business remained our largest revenue contributor this quarter, reaching RMB 449.7 million. As of the end of this first quarter, our average monthly subscribing members stood at 14.8 million, showing a slight decrease of 0.8% year-over-year, but an increase of 4.1% quarter-on-quarter. Average revenue per user remained stable compared to the same period last year. Leveraging the support of the Zhihu community and our unique positioning, our premium short stories continue to captivate revenue with our users. In April, 123 historically chart-topping business, including Zhihu's exclusive story, were included in the national library digital collection. Zhihu's premium content library, including short stories, continued to expand in the first quarter. The total volume of premium content increased by 14% year-over-year, attracting new subscribers while encouraging increased consumption among existing subscribers. On the content creator side, we are delighted to see our creators building a solid market reputation and achieving financial rewards on our platform. In the first quarter, the number of content creators' income increased by 78% year-over-year. In addition to top creators earning substantial income, many mid-tier and long-tail content creators within our community also earned significant income through high-quality content creation this quarter. As a market leader, Zhihu continues to unlock the monetization potential of our vast array of premium short story IPs, spearheading our expansion into the short drama market and consistently setting new industry benchmarks for growth. In the first quarter, IP monetization revenue increased by 165.7% year-over-year. In April, another short drama adapted from a story in Zhihu's content library achieved a new record high for popularity on its debut day on Tencent's Micro drama platform. In the long run, the ongoing expansion of our premium content and diverse content consumption formats will continue to drive growth in the lifetime value of subscribing members. Let's now shift to our marketing services. In the first quarter, marketing services revenue were RMB 330.5 million, representing a decrease of 15.7% year-over-year. Within this total, revenue from our brand advertising business increased significantly by 40% year-over-year, while our performance-based advertising business returned to growth on a quarter-over-quarter basis. Our key clients in cornerstone verticals continue to demonstrate healthy improvements in retention rates, consumption, and ARPU. Apart from the information technology industry, which maintained its year-over-year growth rate of over 40%, the fast-moving consumer goods sector also experienced high double-digit year-over-year growth. We're currently in the process of upgrading our CCS product, including proactively enhancing content governance and reducing the distribution of commercial content that negatively impacted user experience. As we are striving for quality profitability by the first quarter of 2024, we are increasing our efforts to narrow our losses. Meanwhile, we firmly believe the emerging potential of our AI search and the value we continue to unlock across Zhihu's trustworthy community will provide price momentum for our sustainable growth and a clear path to profitability for the remaining quarters of this year. This concludes Mr. Zhou Yuan's remarks. Now, I will review the details of our first quarter financials. For a complete overview of our first quarter 2024 results, please see our press release issued earlier today. We have continually optimized our cost structure over the past several quarters. As a result, we recorded our sixth consecutive quarter of year-over-year growth in the gross profit margin. On the expense side, we significantly reduced community-related user acquisition costs, while maintaining a prudent level of investment in cutting-edge technology, including AI. This initiative has effectively optimized our fixed costs, enhancing our commercialization efficiency. With these proven strategic adjustments, we are confident of achieving quarterly profitability in 2024. Our marketing services revenue for the first quarter were RMB 330.5 million, a decline of 15.7% year-over-year. This decrease was primarily due to the ongoing refinement of our CCS product to strategically focus on margin improvement. However, we have observed a recovery in our brand advertising segment in the first quarter. Performance-based advertising also demonstrated sequential growth, particularly in the consumer goods sector. Pay membership maintained a stable trend in the first quarter, reaching RMB 449.7 million. The number of subscribing members grew to 14.8 million, up 4.1% quarter-over-quarter. Vocational training revenues for the quarter were RMB 145.4 million, increasing by 35.9% year-over-year. Our self-operated offerings, particularly in AI and software exam areas showed robust growth, while our acquired business also retained solid momentum. Benefiting from enhanced operating efficiency, our gross profit for the first quarter increased by 6.1% year-over-year to RMB 543.5 million, propelling a gross profit margin improvement of 5.1 percentage points year-over-year to 56.6%. Our total operating expenses for the quarter were RMB 768.2 million compared with RMB 729.0 million in the same period last year. Selling and marketing expenses increased to RMB 478 million from RMB 445.6 million in the same period of 2023. Moving forward, we will maintain our prudent financial policies and rigorously narrow ROI across marketing channels. Our research and development expenses for the first quarter increased to RMB 197.4 million from RMB 183 million in the same period of 2023. The increase was primarily due to our increased spending on technology innovation. G&A expenses decreased by 7.5% to RMB 92.9 million. The decrease was primarily due to lower share-based compensation expenses combined with improved operating efficiency. Our GAAP net loss for the first quarter narrowed by 7.4% year-over-year to RMB 165.8 million. Our non-GAAP net loss for the first quarter was RMB 135.7 million. As of March 31st, 2024, the company had cash and cash equivalents, term deposits, and short-term investments of RMB 1.2 billion compared to RMB 5.5 billion as of December 31st, 2023. In the first quarter, the company repurchased 4.8 million Class A ordinary shares for a total price of $8 million. In summary, as we continue to optimize our cost and expense structure, our operating efficiency is steadily improving. Throughout the remainder of 2024, we're confident that our strong strategic execution will provide a solid foundation for achieving our quarterly profitability goals in the near future. 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 session.

Thank you very much. We will now begin the question-and-answer session. Our first question is from the line of Xueqing Zhang from CICC. Please go ahead.

Thank you, management, for taking my question. Can you provide an update on the timetable to achieve quarterly breakeven and share the latest progress? Thank you.

This is Wang Han, CFO of Zhihu. Our profitability target remains unchanged. We expect to achieve a quarterly non-GAAP net profit in the fourth quarter of this year. At the end of the first quarter and the start of the second, we strategically refined and restructured our approaches, driving a notable reduction in losses. Starting from the second quarter, you will see more pronounced improvements across other metrics. The core philosophy behind this adjustment is what we shared at last earnings. We will always prioritize user quality over user scale. We are dedicated to protecting and elevating our core users' experience and ensuring a continuous flow of high-quality content. We believe that our industry is undergoing a fundamental shift as we move from the Internet era to the AI era. In the Internet era, the dominant logic was to maximize user engagement through large user bases and metrics like ad load and eCPM. But currently, in the AI era, advancements in large language models and compute power amplify the importance of top-tier users and high-quality content. The most crucial factors for Zhihu going forward are, first of all, having sufficient capital to invest in high-performance chips; second, having the highest quality content and data; and third, having the highest quality and productive content creators. Zhihu has been a pioneer in these aspects. First, our substantial investments have made us one of only a select few platforms in China with a license to operate self-operate LLM; and second, we already have natural advantages, thanks to our abundant high-quality content and a high-quality user base. The advent of the AI era presents a golden opportunity for Zhihu to return to what we do best, that is high-quality Q&As. This has enabled us to make strategic adjustments with confidence. Next question, please.

Sure. Thank you. The next question is from the line of Steve Chu from Goldman Sachs. Please go ahead.

Good evening. Thank you for taking my questions. I would like to ask about the user trends following your sales and marketing strategy and what future strategies you have to further enhance user engagement. Thank you.

Thank you, Steve, for your question. This is Zhou Yuan, Zhihu's CEO. Our adjustment in sales and marketing strategy is focused on prioritizing quality over quantity. Overall, these changes align with our expectations. Although our core user retention rates continue to grow, there has also been a significant increase in the time daily active users spend on our platform. The adjustment in our sales and marketing strategy is merely one component of our broader community strategy. Enhancing the community's content and atmosphere is equally important for boosting user engagement. The credibility of Zhihu stems mainly from our professional users, including many professionals and industry experts who often find their value overlooked. These individuals have discovered a platform for discussion and sharing their knowledge on Zhihu. We see substantial engagement from professionals across various sectors, particularly in the AI industry, where we host numerous senior technical executives from leading LLM companies who engage in cutting-edge discussions. Recently, the number of blue label certified AI contributors has increased by 130% year-over-year. Therefore, one key aspect of our daily community operations is to improve the experience for our core content creators. For instance, our Zhihu plan recently optimized the revenue distribution model, resulting in a quarter-over-quarter revenue increase of 30% to 50% in broader knowledge-related fields such as science and engineering. These adjustments have been occurring during Q2. Our approach to supporting creators focuses on enhancing efficiency through product development and research. Thus, in terms of content distribution, we will emphasize the importance of professionals creating in-depth and authentic content. Zhihu captures a wide array of real user experiences and insights. For instance, recent open-source industry incidents sparked significant discussions on Zhihu, with Chief Scientists directly engaging in responses. Professionals in the AI sector, members of the open-source community, operators, and legal experts from both local and international backgrounds contributed to this discussion, generating considerable attention and engagement. The influence from this content transcends mere curiosity-driven traffic; it empowers individuals with substantial knowledge behind the news through professional insights, leading to a sense of fulfillment. We will continue to refine our operational systems to align with our content fulfillment standards. Furthermore, we are working to integrate and streamline our operational system and community governance, including user service teams, to foster a culture of sincerity, expertise, and respect within our community. The share of professional, in-depth, and original content discussing training topics is steadily growing, in accordance with our expectations. Thank you.

Thank you. Our next question is from the line of Daisy Chen from Haitong International. Please go ahead.

Good evening, management. Thank you for taking my question. I have two inquiries about AI. First, I would like to know more about the recent development of our AI publications, such as the AI power search feature announced last quarter. Are there any new products? Can management explain how this product benefits the Zhihu community? For instance, does management observe any positive effects on user activity or behavior? My second question is about our announced partnership with OpenAI to incorporate its Q&A content into Open products, along with the agreement with Google to use its data for AI training, which is expected to generate around $60 million annually in revenue. Are we considering a similar business model approach to increase revenues for the group? Thank you.

Thanks for your two questions. This is Zhou Yuan, Zhihu's CEO. In late March, we launched a beta version of our AI search feature called Discovery. The initial testing results have been very encouraging, showing that users engaging with our AI search have become significantly more active. We see this as a positive sign of a considerable increase in our users' content creation activities. Based on the feedback and usage patterns from the past two months, we are thrilled to announce that we will release a new version of AI search by the end of June. This version will have a new product name and will first be available on our PC platform. We believe that our PC platform is essential for productivity and efficiency, complementing the mobile experience well. In the AI era, the quality of users and content is far more important than sheer numbers. Our AI search function is built on the high-quality and reliable content in our community, allowing it to deliver excellent search results. We think that AI search is an effective tool, while the community provides a space for multi-user online interaction, and these two elements are highly complementary. Moving forward, integrating AI search with our community ecosystem will be our primary product development focus. Regarding the second question, many companies are interested in acquiring content from us, but we haven't made any decisions yet. Thank you for the questions.

Thank you. Our next question is from the line of Cici from CLSA. Please go ahead.

What's the long-term growth outlook for the vocational training business? And how could we differentiate ourselves from other educational institutions? Thank you.

Thank you for your question, Cici. This is Zhou Yuan, Zhihu's CEO. In the first quarter, our vocational training business continued to outperform the industry with a year-over-year growth rate of 35.9%. This is primarily driven by the robust growth of our community-enabled self-operated offerings. Notably, the AI, AGI, and software, and other vocational courses mentioned in the opening remarks not only received positive feedback but also demonstrated improved profitability. Unlike other educational institutions, Zhihu's vocational training model is built on the foundation of high-quality content and accumulated knowledge originating from our community, which naturally extends to supervised learning services. This process is primarily driven by the needs of our users who are also potential learners in our vocational training business. As we shared in the last quarter, Zhihu's community mechanism continuously identifies and rapidly validates our users' demands in vocational sub-segments, providing us with a significant customer acquisition advantage. Community users and content creators effectively support our course development, resulting in high labor efficiency across existing offerings. Besides, our community-based approach means that when learners' needs are satisfied, they can, in turn, contribute back to the community, fostering the development of subsequent programs and enhancing learners' lifetime value. This helps mitigate the common challenge of low renewal rates in the vocational training industry. Our future growth strategy targets enhanced profitability. First of all, we will continue to expand into subsegments across three main categories: academy improvements, career enhancements, and vocational and interest courses. Our primary focus will remain on vocational courses and interests, which have higher certainty and better profit margins. We aim to enhance our learners' renewal and repurchase rates by leveraging Zhihu's unique advantages, thereby increasing our average GMV. Secondly, we will further improve the ROI of our resource investments and leverage AI to enhance internal operational efficiency. Our goal is to achieve operational breakeven as soon as possible. This is in line with Zhihu's overall top priority. Thanks. Next question, please.

Thank you. The next question is from the line of Vicky Wei from Citi. Please go ahead.

Thank you to management for addressing my questions. I would like to inquire about the competitive landscape and strategy for the membership business. Could you provide insights into genuine user stories and their payment behaviors, as well as updates on other ventures like IP operations? Thank you.

Thank you, Vicky, for your question. This is Han, Zhihu's CFO. In terms of the competitive landscape, we remain the leader in this segment. Although we've faced competition from other major Internet companies and some fluctuations in the number of content creators and submissions, many content creators have returned to Zhihu, confirming that we offer the best environment for short story creators to thrive. I would like to share two points regarding our strategic plan. Zhihu's excellence in the short-form story segment has been widely recognized. However, some believe that the presence of stories on our platform dilutes the quality of our content library. In response, we want to highlight that literature is undeniably valuable content. The price of novels reflects their literary value, and bestseller lists highlight their importance. We have decided to separate the display and distribution of story content from non-story content, which we believe will improve user experience for those with differing preferences. Just as the best libraries and bookstores categorize fiction and non-fiction, we launched the stand-alone Yin Yang Story app. This app saw a nearly 40% quarter-over-quarter increase in MAU for Q1 2024, reaching millions of users. This segmentation allows us to optimize each domain for specific user preferences without impacting the experience of the other user group. Additionally, Zhihu's short story IP has become the leading premium revenue-sharing drama on the market. The premium short drama adapted from our short stories has achieved remarkable market results, becoming the highest revenue share in short dramas thus far. Its success has increased awareness among major reading platforms regarding the value of Zhihu's short story copyrights, leading premium channels to approach us for collaboration, further enhancing the value of our intellectual properties. How do we understand the value of short story IP? In recent discussions with the academic community, we noted that short stories may represent an advanced format of content evolution, effectively showcasing the latest authentic and valuable trends. Short stories may be five years ahead of novels, which are in turn five years ahead of film and television production. We look forward to sharing more successes related to Zhihu IP content with all of you in the future. Thank you for your question.

Thank you. The next question is from the line of Thomas Chong from Jefferies. Please go ahead.

Thank you to management for addressing my question. I would like to inquire about the outlook for online marketing revenue and our long-term strategy in marketing and services. Thank you.

Thank you for your question. This is Wang Han, Zhihu's CFO. As we noted last quarter, Zhihu is dedicated to improving the community's trustworthiness, even if it means sacrificing some short-term low-quality revenue. Consequently, we have proactively refined our commercial content and distribution mechanisms, which is expected to lead to a decline in our community content services. Nonetheless, our brand advertising grew by 40% year-over-year during the non-peak season, and performance advertising saw quarter-over-quarter growth compared to Q4 2023. For the remainder of 2024, we will concentrate on enhancing performance advertising by improving our AI and data infrastructure. In the long run, we believe Zhihu's commercial potential should be evaluated based on brand premium rather than solely on in-platform traffic. For instance, many emerging domestic 3C tech brands have demonstrated their R&D technologies and principles on Zhihu. They consider it the best platform to effectively popularize their tech in a professional and in-depth manner and build market awareness for new product categories. We even integrate and upgrade their products based on Zhihu's data and user feedback. In the consumer sector, most products on the market are quite similar. The key differentiator is the amount invested in advertising and promotion. However, products that gain a solid reputation among professional users within the Zhihu community likely have a competitive edge. You might see terms like 'Zhihu high praise' or 'Zhihu [Indiscernible]' in various articles. These affirm the trust premium and endorsement value of Zhihu's content compared to that from other Internet platforms. We are very confident that in the commercial sector, Zhihu has significant potential to further enhance brand credibility. Thank you for your question.

Thank you. That concludes today's question-and-answer session. At this time, I will turn the conference back to Yolanda for any additional or closing remarks.

Thank you, operator. Thank you all once again for joining us today. If you have any further questions, please contact our investor relations team directly. Thank you.

Thank you. This conference has now concluded. Thank you for attending today's presentation. You may now disconnect.