iQIYI, Inc. Q2 FY2020 Earnings Call

Thank you, operator. Hello, everyone, and thank you for joining iQIYI's Second Quarter 2020 Earnings Conference Call. The company's results were released earlier today and are available on the company's Investor Relations website at ir.iqiyi.com. On the call today are Mr. Yu Gong, our Founder, Director and CEO; Mr. Xiaodong Wang, our CFO; Mr. Xiaohui Wang, our Chief Content Officer, and Mr. Xianghua Yang, Senior Vice President of our Membership business. Mr. Gong will give a brief overview of the company's business operations and highlights, followed by Xiaodong, who will go through the financials and guidance. After their prepared remarks, Xiaohui and Xianghua will join Mr. Gong and Xiaodong in the Q&A session. Before we proceed, please note that the discussion today 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 are subject to risks and uncertainties that may cause actual results to differ materially from our current expectations. Potential risks and uncertainties include but are not limited to those outlined in our public filings with the SEC. iQIYI does not undertake any obligation to update any forward-looking statement except as required under applicable law. With that, I would now turn the call over to Mr. Gong. Please go ahead.

Hi, everyone. Thank you for joining us today. It's obvious that much has changed around the world since our last earnings call. Like many other companies and industries, we have experienced unusual user behavior, fluctuating numbers, and great challenges. Clearly, the pandemic is the most influential factor for us and other businesses in the first half of this year. Our subscribers, MAU, and user time spent all peaked during the first quarter because of home confinement. With the pandemic gradually being controlled in Q2 earlier than most other countries, people went back to work, and students in China started to study online and prepare for critical exams, such as the national entrance examination for college and high school, and the final term exams, all of which took place in June and July. As a result, we saw a decline in both people's video-viewing time and frequency in Q2. The pandemic also influenced our content supply. Movies, especially theatrical movies, have served as one of our most important content categories in user acquisition and membership attraction. Due to the shutdown of cinemas, no new movies were released offline. Online video platforms, which act as the second window for theatrical movies under the SVOD model, are also facing supply shortages and adverse effects on subscriber retention and acquisition. Fortunately, cinemas in China were permitted to reopen on July 20, with a limitation of 30% attendance rate, though. Considering that the average attendance rate of last year was lower than 30%, we believe that even with the limitation, the offline movie industry will normalize step by step. We expect more movies will be released in cinemas, and the amount will possibly peak during the October national holiday. These movies could be aired on the Internet in 2 to 8 weeks after the offline window. The supply recovery will somehow improve our subscriber growth and stickiness in late 2020. The pandemic also delayed the airing of new episodes of Japanese animation, which normally generates half of the traffic in our animation channel. The good news is that the release has been resuming since the end of June. By late July, almost all Japanese animations have returned, and our paying members' growth and retention will benefit from it gradually. As for variety shows, the pandemic somehow affected the production, resulting in release delays. On the other hand, our pipeline needs to be adjusted according to the postponement of advertisers' sales promotions, considering brand advertising acts as the key driver for variety show revenue. Currently, the good news is that this delay situation is being eased, and all these delayed variety shows will be released gradually. Therefore, it will have a positive effect on the advertising business, though it will take time for financials to reflect. Just like variety shows, the drama series' production has also been delayed for 1 to 3 months in general due to the pandemic. But considering the much longer production cycle for dramas, this kind of delay will not influence much on the releasing time. We will also take all measures we can to mitigate the possible risk on drama title release next year. Now let's go through the specifics of this quarter, starting with our membership business. As of June 30, our total subscribers were 104.9 million. Subscription revenues grew by 19% year-over-year to RMB 4 billion. Because of a weaker content slate of exclusive dramas in Q2, along with the above-mentioned reasons, our subscriber number decreased. Having said that, we believe the second-quarter membership slowdown is temporary as our subscribers are already rebounding from the end of June. We are also encouraged by all the positive signs we are seeing. As mentioned, the adverse effects on content supply are receding along with the pandemic containment in China, although it may take some time to fully recover. With our content and service getting better, we believe these new users will stay in or come back later to our platform. Additionally, our user data proves the large demand potential for long-form videos in lower-tier cities. Most importantly, we are steadily improving our original production capabilities. Our 40-plus in-house studios keep working on projects across various genres, including dramas, variety shows, movies, animations, and more. Many of the original titles launched have shown extreme popularity, and more exciting titles will be on air in succession soon. In summary, despite the temporary volatility, we are still confident that our membership business will show healthy and sustainable growth over the long run.

Morning everyone. Let me comment on our financial highlights. Despite the volatile macro-environment in China, we delivered another quarter of growth, with total revenues increasing 4% year over year. Our membership business continued to be the main business pillar, with revenues up 19% year over year, accounting for 55% of our total revenues. Our advertising business continued to be soft, with revenue declined year over year due to the advertisers' budget cuts, traffic decline after the pandemic containment, and the delay of certain variety shows. Both our cost of revenues and operating expenses decreased year over year, and our content costs were only up 2%. We kept spending strategically on original content to drive in-house production capability while making wise and disciplined investments across the board. As a result, our operating loss margin narrowed to 17% from 26% in the same period last year. Our net loss decreased to RMB 1.4 billion from RMB 2.3 billion in the same period last year. As of June 30, 2020, the company had cash, cash equivalents, restricted cash, and short-term investments of RMB 9.5 billion. For detailed financial data, please refer to our press release on our IR website. For the third quarter of the year 2020, iQIYI expects total net revenues to be between RMB 6.95 billion and RMB 7.4 billion, representing a 6% decrease to flat year over year. This forecast reflects iQIYI's current and preliminary view, which may be subject to change. I will now open the floor to Q&A.

My question is about the subscriber growth outlook. You mentioned that the subscriber growth momentum has returned since the end of June. I'm curious about how subscriber growth has been so far in the second half of the year now that the college entrance exam has concluded and the summer peak season has begun. I would also like to know your expectations for subscriber levels in the medium to longer term.

So my question is about the subscriber growth outlook. You mentioned that the subscriber growth momentum has returned since the end of June. I'm curious about how subscriber growth looks so far for the second half of the year now that the college entrance exam has concluded and the summer peak season has begun. Additionally, what are our expectations for subscriber levels in the medium to long term?

Thank you, Wendy. You're correct that the examination for the entrance to college already ended in July. But concerning this situation, this summer break is different from normal seasons in that, for example, the exams were delayed by 1 month, and also the other consideration is the shortened holiday for high school and maybe junior high school students as well, so that we cannot predict precisely the net add numbers, but we are seeing a very clear trend in the rebounding of our traffic and the subscribers. Thank you.

My question is about the advertising outlook in the second half. Given that we are seeing some recovery in Q3, how should we think about the momentum for KA as well as SME? And my second part of the question is about our mid-form video strategies in the second half. Should we expect there will be a step-up in sales and marketing and any KPI that can share would be great.

We are observing a clear trend in the recovery of our traffic and subscriber numbers. Thank you. My question is regarding the advertising outlook for the second half. Considering the recovery we are seeing in Q3, how should we assess the momentum for KA and SME? Additionally, I would like to ask about our mid-form video strategies for the second half. Should we anticipate an increase in sales and marketing efforts, and could you share any key performance indicators?

For the first question, yes, our most ad revenue comes from brand advertisement. So KA reflects a large proportion of our ad revenue. As we can see that KA brand advertisers have indicated that their budget is coming back as our variety shows are gradually coming on air. However, it will take some time to reflect in the financials. Some of our new variety shows will begin airing in August, and some might air in September, possibly peaking in October. So it will take some time for the financials to reflect this. Regarding in-feed advertisers and SME advertisers, since they do not account for a substantial portion of our advertising revenues, even if there’s some rebound, it will not have a significant impact on the financials. Regarding the Suike, we have implemented various activities on market promotion and technology platform building, and we have made some progress already, but we need time to build it into a larger scale. Most advertisement from the Suike will come in the form of in-feed advertisement, meaning that the ad inventory will not be large, therefore we do not expect a substantial reflection in ad revenues from the Suike perspective.

Some rebound will not significantly impact the financials. Regarding the Suike, we have initiated various market promotion and technology platform building activities, and we've seen some progress, but it will take time to scale up. Most advertisements from the Suike will be in the form of in-feed ads, so the ad inventory will be limited, and we do not anticipate a substantial increase in ad revenues from the Suike perspective.

We have implemented various activities for market promotion and building our technology platform, and we have made some progress already, but we need time to scale it up. Most advertisements from the Suike will take the form of in-feed ads, meaning that the ad inventory will not be large, so we do not expect a significant impact on ad revenues from the Suike perspective.

I will answer the first question, and then we'll leave Xiaodong to answer the second one. We have different scheduling strategies regarding the different content categories. Starting with the dramas, there are a few influential factors regarding the scheduling. The first two are the most important ones, including the production cycle and our license cycle. The second one is the regulation cycle. It may also be influenced by advertisers, but not significantly. For the variety shows, the majority of revenue comes from advertisements, so it will be primarily determined by advertisers' budgets and their promotional activity schedules. Therefore, most variety shows need to be aired, produced, or scheduled based on the contractual agreements with the major advertisers or appropriate ROI assessments. Very few variety shows are scheduled without agreements with advertisers. Now Xiaodong, you have...

No, go ahead.

Sorry that Mr. Gong wants to add some points on this question, please.

Given the characteristics of variety shows, their airing, production, or scheduling largely depends on the budgets and promotional plans of advertisers. As a result, it is rare for variety shows to be scheduled without prior agreements in place with advertisers. Now Xiaodong, you have...Xiaodong Wang, CFO, please continue. Lei Zhang, Investor Relations Director, I apologize as Mr. Gong would like to provide additional insights on this topic.

As for the scheduling of other two content categories, animation and theatrical movies, the Japanese animation generates half of our traffic in our animation channel. Since the pause of the Japanese animation, the new episode releasing has somehow influenced our animation traffic as well. To cope with this possible risk, we will invest more in domestic animation production. Regarding theatrical movies, as everybody can see there have been no theatrical movies released offline for the first half of the year. This shortage in content supply influenced us the most regarding theatrical movies. The good news is that cinemas have already reopened as of July 21. We expect more and more movies will be released offline, possibly appearing on the Internet 2 to 8 weeks after their offline release. The national holiday may be the peak time for theatrical movie releases. Additionally, to further coordinate with this kind of possible risk, we will invest more in original movies, ensuring the quality matches that of theatrical movies, and build up our own self-produced movie confidence and independence as well.

This is Xiaodong. Regarding the internal review on the SEC's queries, it's been more than 4 months now. However, understand that it is an internal independent review. We do not know exactly what the results and the status is right now. What I can tell you is that the voluntary disclosure of this inquiry itself demonstrates the confidence of the management in the potential results of this internal review. We believe that due to the solid and disciplined internal control processes and corporate governance we have built in the past 10 years, together with our corporate culture, the results will be quite positive for the company. That's our belief. Also, because many people are asking similar questions, I want to explain that we focus on creating value, rather than destruction. Under the leadership of Dr. Gong Yu, we aim to impress all investors with the company's quality and the management's potential.

The first question is whether the company can provide more details on the S-diamond member and the second part concerns the revenue per member. Can this level be maintained at the current market cap, and are there additional strategies to achieve greater monetization beyond the member fee? What are the management's thoughts on this?

I want to see if the company can provide some insight on the S-diamond member and whether the revenue per member can be sustained at this market cap. Are there additional strategies for achieving significantly larger monetization beyond the member fee? What are the management's thoughts on this?

Yes, you can see that we developed various subscriber fees and other monetization methods to cater to different choices and options for our customers. I think we have a massive user base, and this seems controversial but fundamentally, it's not conflicting at all. We will further explore possible monetization methods to cater to our users' demand without adverse feelings from them. As we can see, previously, there were many explorations regarding monetizing subscribers or paying users monthly or yearly. Until now, we can acknowledge the current user changes and willingness to pay for various entertainment forms—this trend is clearly on an upward slope. We can see that the willingness to pay is increasing; thus, we believe we can meet expectations with various monetization avenues.

We are exploring different monetization methods to meet our users' needs without causing any negative feelings. In the past, we considered various strategies for monetizing our subscribers or charging users on a monthly or yearly basis. Currently, we recognize that user preferences are evolving, and there is a growing willingness to pay for different forms of entertainment. This trend is clearly increasing, so we believe we can fulfill expectations through multiple monetization options.

Regarding our business model, we firmly believe that our major source of revenue is still subscriber revenue. The subscriber revenue still cannot cover our costs. This is due to the intense competition over the past 9 or 10 years. Currently, our monthly fee is RMB 19.8. This was calculated in discussions a few years ago, considering that a normal audience in China typically watches 4 movies per month and unlicensed DVDs are usually priced at RMB 5 for one disc. Combined together, it represents RMB 20 for 1 month, which is why we set our price at RMB 19.8. Therefore, it is relatively low in comparison, and because of the competition, it cannot cover our content cost. Hence, other revenues, including those from advertising and different monetization methods, need to work together to achieve profitability or at least cover our content costs.

I will translate for myself. I want to know more about the 12-episode summer series like The Bad Kids, which received very positive feedback in the second quarter. I'm interested in understanding if there is any difference in return on investment between the short drama series and the longer ones we have traditionally produced. Is this a key area for us to focus on for future investment?

I will translate for myself. I want to know more about the 12-episode summer series like The Bad Kids, which received very positive feedback in the second quarter. I want to know if there's any difference in terms of ROI between the short drama series and the longer ones we used to produce more. Is this a key area for us to invest in moving forward?

Our Chief Content Officer, Xiaohui, just answered this question. We very much appreciate and are happy to receive the very positive feedback regarding the return on investment from Mist Theater since we launched it, especially for the titles you mentioned, The Bad Kids. We will definitely invest more in this type of intense suspense dramas and other themed theaters as well. However, we will not decrease our investment in longer episode dramas, as they have different expressions and ways to attract our users. Whether long or short episodes, we will continue to improve our capability to provide high-quality content.

We have received positive feedback about the return on investment from Mist Theater since its launch, particularly for titles like The Bad Kids. We plan to invest more in intense suspense dramas and other themed theaters. However, we will maintain our investment in longer episode dramas, as they engage our users in different ways. Regardless of episode length, we are committed to enhancing our ability to deliver high-quality content.

For this type of 12-episode short drama titles, the content cost per episode is a little higher than that of longer episode dramas. However, the ability to attract subscribers is as strong as other forms of drama titles, so we can see a slightly better ROI for this kind of 12 episode drama. Thank you. Thank you for joining us today. Thank you very much. Have a good day.

Thank you. Ladies and gentlemen, that does conclude our conference for today. Thank you for participating. You may all disconnect.