iQIYI, Inc. Q4 FY2020 Earnings Call

Ladies and gentlemen, thank you for standing by. And welcome to the iQIYI Fourth Quarter and Fiscal Year 2020 Earnings Conference Call. At this time, all participants are in listen-only mode. After the speaker's presentation, there will be a question-and-answer session. I must advise you that today's conference is being recorded. I would now like to hand the conference over to your first speaker today. Investor Relations Director of iQIYI, Fan Liu. Thank you. Please go ahead.

Thank you, operator. Hello, everyone, and thank you for joining iQIYI's fourth quarter and fiscal year 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 the 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 doesn't 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.

During the quarter uncertainties in the macro environment and the industry remained. However, we saw some positive signs of stabilization in our operational metrics. Our video viewership and total time spent through all devices, and the average time spent per user on mobile apps, all sequentially increased in December. During the fourth quarter, we continued to execute our strategy and maintain our industry-leading position. We believe that as long as we focus on our core strategy which centers on content, we will be able to secure sustainable long-term growth. Up to now, we have already seen some clear rebound of our membership business. Now let's go through our business segments. Membership. First, let's start with membership. As of December 31, 2020, our total subscribers reached 101.7 million. Membership services revenue declined by 3.5% year-over-year to RMB 3.8 billion, mainly attributable to the decrease in subscriber numbers. During the quarter, our subscribers declined by 3 million, which was mainly impacted by the lack of top content during the first half of the quarter. In Q4, we launched several movies that performed well during the quarter, including The Eight Hundred, The Sacrifice, Legend of Deification and others. However, we didn't have enough exclusive blockbusters in the drama or variety shows before November 15. Starting in the second half of the quarter, we launched several well-received new dramas and shows such as Ultimate Note, Qipa Talk and My Best Friend's Story, which to some extent helped to relieve the sliding trend of the subscribers. Despite the volatility in our membership during the first quarter, we observed some positive data points. First, our S-diamond membership which can be used on all terminals and the QIYIGUO VIP membership which can be used on smart TV both recorded the highest quarterly net additions for the past 3 quarters. We believe it reflects user recognition of our premium membership benefits and experience on the TV side. Second, our diversified high-quality content catered to the varied interests of our members, which significantly increased our membership conversion. And third, we rolled out a number of membership benefit upgrades during the quarter. For example, we merged our literature membership into our VIP membership, providing an exclusive library of premium books for free. We also established partnerships with famous brands to provide more value-added benefits to our members. In 2020, we provided more than 2,700 benefits for our members. More than 60 million members have received over 200 million benefits for the whole year, which was more than 4 times higher than last year. Despite the volatility in total subscriber numbers in the short term, we remain confident in the mid- and long-term development of our membership services business. Our confidence is largely a result of our continuous exploration of premium original content and the enhancement of our in-house production capabilities. Meanwhile, we continued to develop new innovative business models across various content categories to further open room for revenue growth. Take movies for example. We made breakthroughs in our Premium Video on Demand or PVOD mode and in original movies during the quarter. For PVOD mode on December 31, we launched Fight For Love, the online movie with a huge fan base, in iQIYI Super Cinema through PVOD mode. The title has triggered great word-of-mouth on social platforms. During the Chinese New Year, iQIYI Super Cinema launched 2 cinema-level films, Fortune Diary and Legend of Obtaining Treasure in Shaolin Temple, with revenue exceeding expectations. On January 4, 2021, our new revenue-sharing rule for online movies was rolled out. For original movies, the PVOD mode without a theatrical release is a key direction to expect in the future. We believe there are only a very limited number of online platforms that are capable of providing this kind of service. As you know, we did the pricing adjustment which took effect on November 13. Specifically, we raised the price for our Golden membership on non-iOS devices to the same level as that on iOS devices. This adjustment has had some temporary impact on our subscriber numbers, but the impact was very minimal and we have already seen a very healthy growth plan of subscribers now. Moving over to our advertising business. Overall, the Chinese advertising market continued to recover and our advertising business stabilized. While the fourth quarter is the traditional off-season for advertising, our advertising revenue achieved stable growth both year-over-year and quarter-over-quarter. This is mainly due to our strong revenue from content marketing, which contributed 53% of our brand ad revenue, up 2 to 3 percentage points over last quarter. For brand ads, the number of advertisers on our platform continued to recover, almost to the same level as last year. Despite the situation that advertisers from food and beverage, cosmetics as well as toiletries traditionally spent less in the fourth quarter, e-commerce, medical services and mobile phone advertisers contributed most of the incremental growth during the fourth quarter. For performance ads, the sequential growth during the quarter was largely attributable to the contribution of e-commerce and network services industry. The conversion rates and monetization capabilities of these key industries improved with the rollout of new products and technologies. The year-over-year decrease was mainly driven by a decline in available inventory as well as tightened regulation such as the APP rectification that was ordered by the Ministry of Industry and Information Technology. Content. We continued to execute our content strategy with a focus on top-tier content, in-house production and innovation. This is critical for catering to the entertainment demands of different user cohorts, allowing us to launch these hit dramas, variety shows and animations in innovative forms. During the fourth quarter, dramas, variety shows, animations and children's channels retained their leading position among all the platforms in terms of the number of top titles and video viewerships. According to the third-party data, video views of our drama account for 41% of overall market viewership in Q4. The comparable number of animations, including children's animations, was 43%. We led in both of these 2 verticals. In terms of original content, we continued to advance serial development of IPs, catering to both the basic needs of mass users and the in-depth needs of different user segments. One, for dramas, following the completion of The Sound of the Providence series, we launched a new youth adventure drama, Ultimate Note, adapted from Nanpai Sanshu's Daomu series, which has been well received by our users and has immediately gained in popularity since it first aired. Similarly, following Marry Me and Love is Sweet, our youth romance titles like My Best Friend's Story, Dear Missy, The Blooms at Ruyi Pavilion and The Moon Brightens For You continued to satisfy strong user demand for emotional content. We also would like to recommend Hikaru No Go, adapted from Japanese animation. The title has been deeply loved by the younger generation. This success demonstrates that we are deepening our penetration of the original youth drama vertical. Two, in terms of variety shows, our original content launched during the quarter includes Qipa Talk, Dimension Nova, Glory Is Back and Ladies' Talk. Among these titles, our classic self-produced show, Qipa Talk, continues to give our audience surprises in its seventh consecutive year of running. Dimension Nova created dialogues between humans in the real world and virtual figures, penetrating the younger generation. Glory Is Back combines documentary-style and reality show shooting methods, incorporating new and popular elements into historical documentary. Third, for animations, we continued to update our most popular self-produced animations, for example, Be My Wife and the children's animation, Deer Squad Episode 21-40. Deer Squad has been a remarkable success, not only in China but also in various overseas countries. On January 25, 2021, Deer Squad was aired in the U.S. and became the first original Chinese animation that was launched on the U.S. channel of Nickelodeon. According to Nickelodeon data, Deer Squad was well received by kids overseas. For example, during the broadcasting period in Australia and the Philippines, the average rating of Deer Squad topped their kids channels, surpassing some famous IPs such as Peppa Pig. For the first quarter of 2021, our key dramas will include My Dear Guardian, My Heroic Husband, A Little Dilemma, Breath of Destiny, Spirit Realm, Good Life and Vacation of Love, etc. Among which, Spirit Realm was aired on January 9 and is widely followed by its fans. Vacation of Love was aired on January 25, which is the first light comedy produced by the long-form video platform to celebrate the Chinese New Year. For variety shows, Theatre for Living was launched on January 16 and scored 9.2 on Douban. Our blockbuster title, Youth with You Season 3 was released yesterday. Others to be launched in the first quarter include Stage Boom, Be with You, and I Told The Spring About You. For animations, the key programs include Tuktak Man 4, etc. You may have noticed that there was a resurgence of COVID-19 in many places in China since December. Although our users returned to normal life and work, large group gatherings and cross-regional travels for business were still largely limited. This new outbreak also impacted our offline production work. We will follow strict quarantine requirements and try our best to meet the schedule of our content launch. Technology. During the quarter, we continued to implement more precise and efficient user growth strategies. By using proprietary algorithms and technology, we can more effectively match content and users in various scenarios. Two technical details worth highlighting in this quarter include: One, personalization. We enhanced our user satisfaction via our personalized algorithm in multiple scenarios such as in the iQIYI App homepage and channel pages. As a result, the number of users who watched the content recommended by the iQIYI App homepage doubled year-on-year in Q4. Two, user interaction. We took the lead in initiating the screen bullet with no spoiler feature. The feature essentially blocks the early disclosure of storylines by the users. In less than a month since its launch, reports of spoilers were reduced by about 30%. Meanwhile, we continue to assist our content production with intelligent technology. Two developments worth highlighting this quarter include: One, IMF delivery standard adoption. We took the lead in adopting the IMF delivery standard in China. Applying this standard, we collaborate with domestic production companies to standardize the process of post-production, network delivery, sample submission for censorship and production by online platforms. Additionally, it can unify our delivery standards with the international mainstream OTT platforms such as Netflix and HBO. Currently, we have adopted the standard in self-produced dramas and expect it to double our delivery efficiency. Two, iQIYI's proprietary intelligent film and television production system provides an intelligent script dismantling function which can identify the scenes, characters, and other elements from the scripts. This analysis can achieve a 95% accuracy rate. Furthermore, efficiency is greatly improved by more than 20 times versus the manual work. For example, the dismantling of a 200,000-character script can be completed within minutes. The system has been used in many self-produced dramas such as Good Life, Out of the Dream, Crush and My Treasure. During the quarter, we maintained our leading position in TV time spent and traffic. We believe that the larger screen is an important future trend in the long-form video industry. Compared with developed markets like the United States, China's TV user time, traffic, and monetization have greater growth potential. We entered into a formal agreement with BMW China in December. The agreement allows us to create a connected car service on BMW's luxury models, with updated film and drama content and an AI-driven interactive experience. In terms of VR, we stick to our strategy that allows us to capitalize on content via various approaches. iQIYI's VR full-sensing interactive movie, Virus Crisis, was launched in November. Another movie, The Mystery of Kunlun, will be launched in Q1. We are also advancing the offline operations that utilize our VR content. Following the opening of our flagship VR full-sensing cinema in Shanghai, similar stores are being delivered or are under trial operations in Beijing, Shenzhen, Ningbo, and Suzhou. You may have also noticed that our VR devices subsidiary, which mainly focuses on VR hardware, recently completed a Series B financing round of more than RMB 100 million. This is China's largest financing in the VR arena since the end of 2019. This round of financing will be used for research and development of key VR technologies, algorithms, new products, and the construction of a more robust content ecosystem. 2020 conclusion and the 2021 outlook. 2020 has been an unusual and challenging year for us as well as other players in the industry. On one hand, our Mist Theater became the industry benchmark for self-produced content and generated both strong reputation and ROI. This validated the success of the vertical content theater model. On the other hand, COVID-19 pulled forward quite a lot of users' consumption of long-form videos in the first quarter. And the lack of content, especially the scarcity of movies in the first 9 months caused great volatility in our subscriber numbers. However, as we began to aggressively launch more content in the second half of the fourth quarter, our subscriber retention rate started to improve steadily. In 2021, our more than 50 in-house studios will enter full production. These studios focus on diversified content categories that cater to the viewing demands of different user cohorts. We expect the originality of our platform as well as the diversification of our content will be largely improved. This will undoubtedly promote the sustainable development of our membership business. At the same time, we strive to make breakthroughs in movies, especially original movies. Despite the recent resurgence of COVID-19 in multiple regions of China, we will try our best to cope with the interruptions to our shooting schedule. We believe that with the possible large-scale promotion of vaccines later this year, the pandemic will be well contained, and our business can restart the growth from then.

Morning, everyone. Let me review our key financial highlights for the December quarter. For the fourth quarter, total revenues reached RMB 7.5 billion. Membership business continued to be our largest business pillar, accounting for 51% of our total revenue. Our advertising business remained stabilized both on a year-over-year and quarter-over-quarter basis despite the weak seasonality. Our cost of revenues decreased 14% year-over-year, mainly due to the 10% year-over-year decline in content costs. SG&A expenses decreased 6% year-over-year. As a result, our operating loss margin narrowed to 18% from 34% in the same period last year. As of December 31, 2020, the company had cash, cash equivalents, restricted cash, and short-term investments of RMB 14.3 billion. We closed our USD 800 million convertible senior notes offering and a public follow-on offering of 40 million ADSs at a price to the public of USD 17.5 per ADS on December 21, 2020. The underwriters exercised their option in full to purchase an additional USD 100 million aggregate principal amount of the notes and their option in part to purchase 4.6 million additional ADSs, which closed on January 8, 2021. For details on our financial data, our CB and the follow-on offering, please refer to our press release on our IR website. For the first quarter of 2021, we expect total revenues to be between RMB 7.07 billion and RMB 7.53 billion, an 8% to 2% decrease year-over-year. This forecast reflects iQIYI's current and preliminary view, subject to change. I will now open the floor for Q&A.

Your first question comes from Thomas Chong from Jefferies.

I have a question regarding the membership revenue. Management has just talked about the number of studios in 2021 will be more than in 2020, producing diversified content as well as some data points showing the recovery in terms of the paying subs. Can management talk about how we should envision the medium to long-term paying subs trend? And on the other hand, how should we think about the ARPU outlook in the coming years?

We experienced a peak in our subscriber numbers in the first quarter of last year. However, several factors affected our performance, including the COVID-19 pandemic, which led to a lack of theatrical movie supply for much of last year, impacting the films available on our platform. Additionally, delays in our drama supply and censorship issues affected that category, while our variety show supply was hindered by reduced advertiser budgets. There were also delays in our animation content. All these factors contributed to significant fluctuations in our subscriber numbers last year. However, we have observed considerable improvements this year, including enhancements in both our self-produced content and the licensed content supply. During the Spring Festival, we noted strong performance in theatrical movies, indicating promising results for the films category on our platform. Overall, we are seeing a positive trend in subscriber growth thus far this year.

I need to add a point. While we observe a very healthy growth trend for subscribers, we also have certainty regarding this growth. It's important to remind investors to keep this in mind.

We anticipate growth in our average revenue per user. However, it will not be significant since it primarily results from our pricing adjustment; we've increased the prices of Android devices to match those of iOS. This change will lead to a modest improvement in our overall average revenue per user.

So I have 2 quick questions. The first one is a follow-up on our first quarter. Wondering if there is any outlook or points to note about the content cost in the first quarter, given more content being released? And then the second question is about the so-called big screen strategy mentioned before. We noticed that there have been more users accessing video content via smart TVs. So wondering whether there has been any change in the time spent for users on TV versus mobile and PC and whether there will be any indication on our production strategy.

Okay. I will turn over to Xiaodong for your question regarding the content cost. For the TV side, we have already observed that Internet-connected TV has a similar or even slightly higher traffic share than mobile devices, which include phones and tablets. So our TV side has contributed more than 40% of our user traffic. The combined user traffic share of the TV side and the mobile side has already reached 90%.

I think when we talk about releasing more key content or blockbuster content, the keyword here is not more but hit or blockbuster. So as we discussed before, if we talk about total content cost investment for our membership business, the entire investment, I think, would have been about the same level. What we are going to do is to increase the quality of the content and not the number or the quantity of the content for now. But you're right, to some extent, if we are talking about some new drivers of the content cost, you might have observed some slightly content cost increase. For example, we are going to expand slightly in overseas areas to enhance the foundation of our future growth. I think when we talk about additional or new business scopes or areas, you will only observe some content cost increase. Otherwise, if you talk about our core business, we remain, as we discussed before, the outlook, the content cost will be well controlled. Thank you.

Your next question comes from Yiwen Zhang from Citi.

So the first part is on the user preference change on drama series and this implication on self-production capabilities and subscriber additions. In the past year, we may have like one blockbuster in one year, but now we have several large titles year-on-year. I believe that users are showing a more diversified content preference and also different content format or preference as you were. This is the first part. And the second part on the content broadcasting strategy. Noted in the past, we sometimes would swap drama series with other video platforms. Now we also sort content on the variety show. Can you talk about what drives this?

Okay. The successful titles have been impressive successes not just in China but also in several international markets. While you noted that there are fewer blockbusters in recent years, I believe that's more of a perception. This could be due to two main factors. One is increased regulation or censorship. The other is the rise of diverse entertainment consumption methods. For instance, since 2017, 2018, and 2019, we've seen increased theatrical movie consumption and the rise of short-form video. However, from a data perspective, the number of blockbusters has remained stable. On average, each year, there are about 6 to 10 top blockbuster TV dramas. Our users have demonstrated flexible demand for these dramas, suggesting strong and consistent interest. Moreover, we have made significant innovations in our content, such as launching a new creative format for TV dramas that has successfully attracted user attention.

And also for the variety shows, our Qipa Talk has been successfully running for its seventh consecutive year. We are seeing improved traffic for this new season, with consistent growth in traffic across all seasons of Qipa Talk. This confirms our success in managing our IP from a variety show perspective.

For your question about the barter transaction of aligning production, it actually needs to be assessed on a case-by-case basis. For example, some licensed drama shows primarily broadcast on TV stations are aired on multiple platforms. For the variety shows produced by an independent studio, there is co-investment from both iQIYI and Tencent.

The decision to self-distribute solely on our platform is based on two factors. One is the content we produce ourselves, and the other concerns content that is purely broadcast over the Internet. There will be instances where certain types of content are only available on one specific platform.

This is Xiaodong. I believe the positive trend we have observed will likely continue over the next few years. Regarding cost expenses, there are two primary components to consider: content costs and other expenses. When examining content costs, as I mentioned earlier, the core business will show a healthy growth trend in both percentage of revenue and dollar amount. The two main factors that may lead to an increase in content costs in the coming years are the types of content we pursue, such as iQIYI original movies, and our expansion into international markets. These are the only significant factors that could drive up content costs. That said, there may be fluctuations in content costs depending on development efficiency and related factors. Aside from content costs, the major costs remaining are related to marketing expenses, including content promotion and branding. We anticipate economies of scale will emerge in the next few years, leading to a favorable trend in costs or expenses as a percentage of revenue.

And your final question comes from Zhijing Liu from UBS.

What is the latest progress of our Suike app? What is the strategic importance of Suike’s mid-form video for our core long-form video business?

Happy New Year. As you may know, Suike is already in its second year of operation. We have assessed its position. It's actually a video-based interest community, encompassing our short, mid, and long video content. The most popular content tends to be the short videos, which usually run for 5 to 6 minutes or up to 10 minutes. It features a diverse range of categories, including interest-based topics like slime, as well as popular TV dramas and variety shows. Regarding user traffic for Suike, it has seen some fluctuations over the past year. However, we believe that with correct execution of our strategy, we can anticipate a positive trend in traffic for Suike this year.

Okay. Just to add one point. Take Bilibili for example. They have done well over the past year and are working to expand further. They started with ACG content but are now trying to reach a broader user base. For Suike, we began with mass user interest, but we are looking to dive deeper into more specific content categories and interest communities. I also want to elaborate on the impact from the pricing adjustment we made last November. Specifically, we raised the pricing on the non-iOS devices to the same level as on iOS devices. Our observation is that after the pricing adjustment, our orders on the iOS devices improved. However, there is some negative impact for our non-iOS orders. Nonetheless, overall, our average revenue per user improved. We also implemented a pricing guarantee program for existing users on non-iOS devices, and we observed that for these users, the retention rate improved in the following month. For some newly added users, their retention rate also improved in the first month.

Overall, the impact from the pricing adjustment program has been better than we expected. We believe this impact has been temporary and minimal. However, this adjustment will positively influence our average revenue per user and support long-term subscriber growth.

Thank you.

So okay, this is the end of our earnings call. We will just keep in touch after the results. Happy New Year for 2021. Thank you.

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