iQIYI, Inc. Q3 FY2020 Earnings Call

Thank you, operator. Hello, everyone, and thank you for joining iQIYI's Third Quarter 2020 Earnings Conference Call. The company's results were released earlier today and 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; and Mr. Xianghua Yang, Senior Vice President of our Membership business. Mr. Gong will give a brief overview of our company's business operations and highlights, followed by Xiaodong who will go through the financials and guidance. After their prepared remarks, 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 provision of the United States 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 not limited to those outlined in our public filings with the SEC. iQIYI does not undertake any obligation to update any forward-looking statements except as required under applicable law. With that, I will now turn the call over to Mr. Gong. Please go ahead.

Good morning. As we all know, with the alleviation of the COVID-19 epidemic in this abnormal year of 2020, we see both the users' behavior and the macro economy gradually back to normal. Despite the negative impact in the first half of the year, the content production industry is trying to catch up. In the third and the fourth quarters, we are taking a variety of measures to speed up this recovery process and prepare for next year's growth. Now let's go through our business segments. First, I'll talk about our membership business. As of September 30, our total subscribers reached 104.8 million, and the paying ratio reached 99.5%. Membership services revenue grew by 7% year-over-year to RMB3.98 billion. Although total subscribers remained flat this quarter, the membership revenue still increased compared with last year. There are a few factors we observed regarding membership business trends. First, there was a lack of new content on our platform due to the content release delay and new theatrical movie shortage. The fact that fewer new movies were released in cinemas this year accordingly affected the movie supply. As a result, we launched fewer movies in Q3 compared to the same period last year. In Q4, we expect some sequential rebound of new movie supply although still not as much as Q4 last year. Specifically, we are very happy to see that one of the most expected movies this year, The Eight Hundred just started streaming on our platform from November 1 and became a hit immediately. We expect more and more theatrical movies coming online gradually for our subscribers. Second, we see the users are spending more time on short-form videos. However, we also notice that larger screens, such as smart TVs and set-top boxes, are becoming more popular. More users prefer watching the content on large screens for a better home entertainment experience. On our platform, the time spent via TV devices is growing for the past several years, and recently, total time spent on TV surpassed that on mobile devices. Accordingly, we will take more initiatives on large screen-related business and develop monetization abilities. We believe, with appropriate operational tactics, larger screens can be an important monetization driver for us in the mid to long term. Lastly, the summer vacation this year was shorter than usual, which led to soft traffic and time spent on our platform compared to last year. We believe the membership growth slowdown is temporary. As content is always the key to attracting subscribers, we have high confidence in our premium original content and in-house production capabilities. Most of our over 50 in-house studios will go into full production in the second half of next year. These studios are expected to largely improve both the originality and the diversification of content on our platform and ultimately drive continued growth in our membership business. Additionally, we are targeting different user groups by focusing on diversified content categories. Considering the more diverse user needs and our large group members, we have invested in a variety of content verticals and have already seen some great initial results. iQIYI Mist Theater, which features 12-episode suspense dramas, has been watched by over 68 million subscribers as of the launch of its finale. We are happy to see that these shorter dramas are attracting new subscribers as strongly as the longer series and with even better ROI. Also, we continue to explore more monetization models. We have provided early access to premium content for an extra charge to our users and launched the premium video-on-demand mode for a few movies. In addition, the S-diamond membership, our premium membership package with plenty of privileges and higher charges, was well received by part of our users since its launch. Looking ahead to the rest of the year, we expect there might be some uncertainties on our membership trend due to our recent pricing adjustment. As you may know, we just launched our new subscription price plan, effective on November 13. Moving over to advertising. Despite all of the recent macro headwinds, the domestic advertising market is recovering. While the industry remains under pressure in the second half of the year, we are already seeing some positive signs. The successful launch of our hit content, including The Rap of China 2020, The Big Band 2, and all of the new series in Mist Theater, coupled with a gradual recovery of advertisers' confidence during the third quarter, has allowed both our brand ads and the performance ads to rebound compared with the second quarter. Our brand ads revenue has recorded a sequential increase for two consecutive quarters. The sequential growth during the third quarter was mainly attributable to the increase in the number of advertisers. In terms of industry, the revenue increase was mainly from food and beverage, online games, and transportation. Besides, education and consumer electronics recovered faster sequentially. During the quarter, we continue to innovate advertising campaigns within our theaters. Mist Theater has sparked new ideas and provided a template for advertising across shorter series. So far, we have already attracted Volkswagen and Yili, along with over 30 other advertisers. As a result, Mist Theater has generated decent advertising revenue in addition to word-of-mouth buzz. In the future, we plan to launch more theaters in categories such as romance and comedy, providing advertisers with more choices. Moving on to the content. During the quarter, we accurately identified our users' demand for entertainment post the pandemic and during the summer vacation and released a number of hit dramas, variety shows, and animations with innovative scheduling. We are trying to establish our self-branded content vertical. The Mist Theater was our first trial and achieved phenomenal success. We will continue to launch different self-branded content verticals in the coming quarters. We believe the self-branded content verticals can raise our user stickiness to our platform rather than just to a single title. As mentioned under the Mist Theater banner, we have released several high-quality short suspense dramas, namely Kidnapping Game, The Bad Kids, Crimson River, Sisyphus, The Long Night. Because of its high quality and widespread popularity, Mist Theater has drawn global attention. Recently, The Bad Kids became the first Chinese drama series to win the Best Creative award in the second Asia Contents Awards at the 2020 Busan International Film Festival. In addition, Reunion: The Sound of the Providence Season 2 rapidly broke the 9,500 mark on our content popularity index after its exclusive launch on our platform. Meanwhile, we also released a number of dramas that featured a theme of female personal growth stories, including Love Yourself, My Unicorn Girl, and Love is Sweet, to cater to the demand of the female user group who are contributing most to drama viewing. Besides, another one of our original dramas, The Thunder, has recently been honored as Outstanding Television Series at the 30th China TV Golden Eagle Award and the 26th Shanghai TV Festival Magnolia Awards. For our top original varieties, such as The Big Band Season 2, The Rap of China 2020 and Mr. Housework Season 2, they aired and performed nicely during the quarter. Also, shows catering to diversified user groups such as Summer Surf Shop for athletic people; Dear Little Desk for parents; and Let's Party for fans of girl idol THE9 were also well received during the quarter. In addition, our self-produced animations, including Are You OK, and Deer Squad were released during the quarter and became quite popular among ACG fans and children. For the fourth quarter, we plan to release more high-quality dramas, including My Best Friend's Story, Dear Missy, Spirit Realm, and The Duke of Mount Deer, along with upcoming key variety shows, including Hahahahaha, FOURTRY Season 2, Qipa Talk Season 7, and Dimension Nova. In conclusion, despite the unprecedented, volatile, and difficult situation we and many others are facing, we have made considerable progress with a variety of operational initiatives. Our Mist Theater has been a success. In the future, we will continue to innovate and develop new production and operational strategies in running our business to achieve sustainable growth over the long term.

Morning, everyone. Let me review our key financial highlights for the September quarter. Total revenue reached RMB7.2 billion. Membership business continued to be our largest business pillar, with revenues up 7% year-over-year, accounting for 55% of our total revenues. Our advertising business recorded a notable rebound with a 16% increase on a quarter-over-quarter basis. Our cost of revenues decreased 22% year-over-year, mainly due to a 24% year-over-year decline in content costs. SG&A expenses were only up 1% year-over-year. As a result, our operating loss margin narrowed to 17% from 38% in the same period last year. As of September 30, 2020, the company had cash, cash equivalents, restricted cash, and short-term investments of RMB7.4 billion. For detailed financial data, please refer to our press release on our IR website. For the fourth quarter of 2020, we expect total revenue to be between RMB7.28 billion and RMB7.73 billion, reflecting a 3% decrease to a 3% increase year-over-year. This forecast reflects iQIYI's current and preliminary view and is subject to change. I will now open the floor for Q&A.

Operator, I think we can open the floor for the Q&A.

So, my question is about what Dr. Gong just mentioned regarding the potential uncertainty in the subscriber number after the price hike. I am just wondering if you could add some color on that, whether we are seeing some weakness in the subscriber growth after the price hike.

As our new pricing plan was effective on November 13, and this time, the pricing plan was targeted to the Android terminal. This means we increased the Android terminal price to balance with the iPhone or iOS terminals, with the monthly subscription fee rising from RMB19.8 to RMB25 per month, and auto renewals monthly fee increasing from RMB15 per month to RMB19 per month. Now it's only 4 days that we have had since we launched our new pricing plan. And so far, all the data shows that there hasn't been much change in new subscriber growth. However, the fee for new subscribers has, of course, increased. As we do not have much time yet, we cannot definitively say whether it is positive or negative. Based on previous analyses as well as our peers' experiences, we expect that there may be some negative impact in the coming 1 or 2 quarters. But overall, in the long term, we think the negative impact will fade and that user behavior will return to normal. Thank you. One point to add is that the main motivation users have to subscribe is the exclusive premium content, which is based on our strong original content production abilities. Looking at our pipeline, it is quite rich. So we firmly believe that our rich pipeline of self-exclusive content that will be released will definitely help mitigate the impact of our new pricing plan. In the long-term and mid-term, we do believe that subscriber trends will return to normal. Thank you.

So, I translated into English. I'm asking on behalf of Alicia. The question is also regarding the subscription price hike. Dr. Gong previously talked about the rationale behind the RMB19.8 price set 9 years ago. Can you talk about the rationale behind the 25% rise of the new price? And in the future, when we do the periodic review of the price, what factors will you consider?

The evidence we collected for this new pricing adjustment plan is based on a user survey we launched, which we executed from the second half of 2018. We collected data on user behavior, income trends, and their acceptance of the new pricing. Based on this data, we think that the new auto-renewal price from RMB15 to RMB19 per month is quite reasonable. Thank you.

My question is about the advertising outlook. Can management comment on how we should think about the trend coming into 2021 and also regarding any special events we need to pay attention to for next year?

Yes. I think that for this year, our brand advertisement is our main driver of our advertising business that was quite significantly impacted by the pandemic. For next year, we believe, along with the pandemic being largely under control globally, the outlook for next year would be much better than this year. However, this year is really abnormal and unprecedented, so it's lacking systematic patterns we can trace from this year's experience. It will take more time for us to provide a more accurate prediction for next year. We think that there are four key factors that will drive our business. The first is our original content production abilities, as next year and in the future we will focus on drama series selection, variety shows, and animation, including adult animations and animations for kids. Also, we will be looking into movies, which include both internet movies and theatrical movies with higher budgets. We plan to boost our self-studio production capabilities and strengthen our cooperation with our content partners. The second factor is that we will invest more in technology and execute the application of new technology in content distribution and production. We will leverage 5G, artificial intelligence, and even blockchain technologies in our content production and distribution process. The third factor is our investment and development of the mid-form video platform, Suike. After a one-year trial of Suike, we have identified its business position, which is to build up a video interest community for creators and fans. We hosted a recent Suike event that was very well received by our fans and customers, which further strengthens our confidence in building up this video interest community. The fourth factor is our overseas business development focusing on Asian-oriented content, including Chinese, Korean, and Japanese content. The overseas business will prioritize Southeast Asia and possibly explore globally. It is important to note that our subscriber numbers announced do not include our sports members, but they do include our overseas members, which are a small fraction of our overall subscriber count. The overseas subscribers are driven by organic growth, primarily through our Asian-oriented content. We aim to build our overseas subscribers organically, in contrast to some peers who may engage in aggressive membership acquisition strategies. Thank you.

Let me translate the questions as well. I have two questions. The first question is related to competition. After our recent announcement of price changes, do we expect our competitors or other players in the market to also increase their prices? How should we look at membership business market share going forward? The second question concerns the recent announcement from Baidu about acquiring YY's domestic business. How should we view the potential synergies with iQIYI's business?

As for the pricing plan for our peers, we have no knowledge of their plans. We are not in a position to provide predictions on their pricing strategies. However, from the entire industry's perspective, as I mentioned during our last earnings call, after 9 years, the original subscription fee represents a significant gap between content supply costs and the subscription fee in China. It is quite unreasonable to maintain the situation as it has been. We think that the adjusted pricing plan is reasonable for our business. Regarding the acquisition from Baidu, we believe that the YY business is quite different from our nature of business and thus lacks direct or significant influence on iQIYI. Thank you.

My first question was about content costs. The content cost has just decreased quarter-over-quarter. What's your view on the outlook for content costs in the next quarters? The second question is about Mist Theater. You mentioned that these potential series received quite good feedback from customers. What is the impact on the subscriber growth for Mist Theater? How do you compare the ROI with previous original dramas and original variety shows?

There are two reasons behind the decrease in content costs over the recent one or two quarters. The first is the content release delay caused by the pandemic influence, and the second is the lead time necessary for regulatory audits. The titles we purchased at higher prices from the first half of 2018 are now gradually being released. Therefore, this gradual release of previously high-cost titles is leading to a decrease in content costs this year. In the long term, we do not expect a sharp decrease in content costs, but there may be fluctuations. Regarding our Mist Theater, it consists of 5 series of 12-episode short dramas. In our context, a short drama model differs significantly from the traditional longer episodes seen on television. Since television revenue is driven by advertising based on viewing time, longer series typically generate more ad revenue, and producers often create longer dramas for more income. However, for an internet platform like ours, the key focus is on subscription revenue driven by user attraction and content stickiness. The changing schedules of modern audiences, who may have less leisure time for entertainment, indicate that they might prefer shorter dramas which allow them to sample different titles. This offers a compelling subscription incentive for them to stay. Therefore, developing more short dramas that have lower total costs but yield better ROI will be a very wise strategy for us. We will definitely continue to produce more short dramas. Thank you.

My question is as we see that Focus Media has seen some very good recovery in the past two quarters, can we see that branded advertising is still very attractive for many advertisers?

With respect to brand advertising in the domestic internet platform, content targeting is essential to ensure that advertising reaches a specific audience. Due to the pandemic, the delayed release of some content significantly affected our brand advertising. However, since movie releases have begun to recover now that the pandemic is under control and our advertising supply has become plentiful, we remain positive about the trend and outlook for our brand advertising. Thank you.

I will translate for myself. First question on short video platforms: We noticed many people are watching dramas and movies on short video platforms now. What is the net impact on us? They serve as a promotional channel but may also attract potential paying users for us. Overall, is this impact good or bad for us? Are there any licensing deals? How do we handle copyrights on short video platforms? Second question is about our theater model. In the long term, what percentage of dramas can come from these theater models? If we achieve this percentage, does it mean we can further lower our content costs given that the total number of ads will also decrease?

As there are many clips of long-form videos present on short video platforms, this has a significant negative impact on long-form video platforms. We are pursuing legal actions and negotiations with these short video platforms. There are positive impacts, for instance, in attracting new users. However, overall, we believe that the negative impacts outweigh the positives. Regarding the advantages of our theater model, typically after a title is fully released, audience interest tends to wane. However, with the theater model, our paying users or audience are more inclined to remain engaged with the theater and stay connected, maintaining a higher level of user retention rather than just revolving around a single title. In the future, we anticipate that approximately half of our provided content will consist of short-episode dramas versus long dramas. It’s important to note that while viewing times for long dramas remain longer, the average viewing times per title has been decreased due to the introduction of shorter dramas. However, these short dramas represent a solid strategy to enhance both monetization and user retention on our platform. Thank you.

I'll just quickly translate. If you look at content spending, Tencent has announced that in the next 3 years, they plan to increase their content spending to CNY 100 billion compared to CNY 50 billion in the last three years. How does this affect iQIYI's content strategy? In terms of the mix between self-production and licensing, how do we view the split now? What is our optimal structure?

Regarding the total content spending, it is indeed our main and largest investment in the coming years. Over the next three years, this can be easily calculated based on past expenditures. Today’s earnings call is not an event to disclose new press releases. I think the number will become clear when viewed in light of our spending patterns over the previous few years, showing little significant change. Generally speaking, we see a trend towards increasing our original content proportion. The proportion of original content versus licensed content can vary significantly based on content categories. For variety shows, almost all operating costs relate to our self-produced content. For dramas, a substantial proportion of our productions are original. However, this year's release may show a higher licensing content cost. As for movies, nearly all theatrical or licensed movies still lead in terms of costs. This year, we only released one self-produced movie, and while we recognize that our production quality and investment scale still have a ways to go to achieve mainstream status, we have conducted internal analyses comparing our advertisers and their peers. We believe we are poised for a stronger recovery in our advertising sector. Overall, we feel the most challenging times have already passed, and this year has indeed been tough, but we are optimistic that it will improve. Thank you.

Thank you. Operator, I think that is all for us today.

Thank you. Ladies and gentlemen, we have reached the end of our conference call. Thank you for participating. You may all disconnect.

Thank you very much. Have a good day.

Thank you.

Bye, bye.