iQIYI, Inc. Q2 FY2021 Earnings Call

Good day and thank you for joining us. Welcome to the iQIYI Second Quarter 2021 Earnings Conference Call. All participants are currently in listen-only mode. After the presentations, there will be a question-and-answer session. I will now turn the call over to Ms. Fan Liu, Head of Capital Market at iQIYI, for the opening remarks and Safe Harbor statement. Please proceed.

Thank you Operator, and thank you for joining iQIYI Second Quarter 2021 earnings conference call. The Company's readout was released today and is 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 CCO, Chief Content Officer; and Mr. Wenfeng Liu, our CTO, Chief Technology Officer. Mr. Yu 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 Wenfeng will join Xiaodong in the Q and 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 and are not limited to those outlined in our public filings with the SEC. The SEC undertakes no 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.

Hello, everyone. For the second quarter we maintained favorable momentum from the first quarter, with total revenue approaching the high end of our previous guidance. Our operating loss narrowed for five consecutive quarters on a year-over-year basis due to our effective cost and expense control. During the quarter, we continued to lead the market in multiple operating metrics. According to third-party data, we ranked at the top of the long/mid-form video industry in terms of mobile MAUs, mobile DAUs and the total user time spent. First, let's start with our membership business. As of June 30, our total number of subscribers reached 106.2 million. This represented 0.9 million net add sequentially despite the heightened uncertainty of content launch during the second quarter. Our membership growth was mainly due to three factors; 1, our premium content, especially dramas, performed well, which helped to drive the number of subscribers to increase. For example, dramas launched in June, including: My Dear Guardian and The Rebel were well received by the audience. In addition, films such as Detective Chinatown 3 and Break Through the Darkness also did well. Second, we saw strong membership growth on TV devices as we approached summer vacation. Third, we further deepened our overseas expansion, driven by our premium content and efficient operation, we consistently improved the conversion of our subscribers. The number of our overseas subscribers at the end of the quarter exceeded 1 million. Apart from bringing our domestically produced content to the overseas users, we also made a breakthrough in local original content. For example, we launched our first original Korean drama series: My Roommate Is a Gumiho, in May, which was a remarkable success. In addition, the Sweet On Theater was launched for the first time in the overseas market, keeping pace with the domestic success of theater scheduling mode and improving the retention of specific user cohorts with a sequence of genre-specific content. The slightly sequential decline of membership services revenue was mainly due to the volatility of subscriber numbers during the quarter, which was mainly attributable to: one, lack of blockbusters to continue the popularity from Q1, which caused the volatility of subscriber numbers, particularly in the first half of Q2. Two, the delayed launch of premium content to the end of Q2. Despite the volatility of our membership services business, our ARPU grew nicely. Average monthly ARPU saw high single-digit growth year-over-year during the quarter, mainly due to the price adjustment we launched in November last year. With more premium and diversified content portfolio to be launched since the second half of the year, we remain confident in our mid- and long-term subscribers and ARPU growth. Furthermore, we also expanded new market space for paid online videos. During the quarter, we launched our Cloud Cinema brand. The brand includes three major categories: theatrical movies launched under our PVOD mode, S-rated online movies, and our original movies. The revenue-sharing ratio of PVOD movies to content partners increased to 42%, which is higher than theatrical releases. By doing this, we hope to explore a new area for growth and establish a new online distribution ecosystem for movies. Moving over to our advertising business, our total advertising revenue increased by 15% year-over-year, but declined slightly quarter-over-quarter. The year-over-year growth was mainly attributable to the peak season for food and beverage advertising partially offset by a decline in revenue due to our content delay. We expect both brand and performance ads to increase in the third quarter due to our ad inventory increase during the summer vacation. Brand ads recorded significant growth year-over-year during the quarter, mainly due to an improvement in ARPU. Our major dramas during the quarter, such as A Love for Dilemma, The Rebel, My Dear Guardian and Sweet On Theater, all performed well in terms of popularity, word of mouth and video views, which helped to drive our client ARPU to the peak level over the past few years. Performance ads regained year-over-year growth during the quarter, mainly driven by the contribution of key industries such as internet movies, e-commerce platforms, and internet service apps. We also enhanced our monetization capabilities with our products and technologies, which helped to significantly improve our effective CPM. Meanwhile, new resources from connected TVs and ad alliances both performed well. Moving over to content. Although we experienced certain challenges in content scheduling during the second quarter, we maintained our leading position in terms of the total number and video views of top content across categories, from dramas and variety shows to animation and children's content. According to third-party data, video views of our dramas and variety shows accounted for nearly 40% and over 30%, respectively, of the overall market viewership. Our animation content, including children's cartoons, had over 40% market share. During the quarter, we launched a series of classic titles. The content perfectly catered to user demand and further serialized the development and innovation for top intellectual properties. To give you some examples: One, for dramas, we launched the exclusive title The Rebel, which was a hit among a wide range of users. The dramas topped a number of ranking lists since its launch and were rated 8.3 on average by over 220,000 accounts on Douban, a widely used user rating platform. Other exclusive dramas, such as A Love for Dilemma, My Dear Guardian, My Treasure, and others were well received on our platform. In addition, A Love for Dilemma also aired on CCTV-8 and the Dragon TV, which helped to attract a lot of TV audiences back to the iQIYI platform. Following the success of the Mist Theater, we continue to broaden our content offering via theater mode. We are working to meet the diversified needs of users through this new mode, enhancing their user experience while attracting fans in the niche segment. In May, we launched the Sweet On Theater in which Moonlight and The Day of Becoming You successfully gained popularity and word of mouth. For variety shows, we continued to innovate new original content across various genres. Original titles, such as The Detectives' Adventures, Mr. Housework season 3, and Working Mom were especially popular shows during the quarter. For animation, our self-produced animation Immortal Demon Species maintained its popularity throughout the quarter. Other titles launched include No Choice But to Betray Earth! and our self-produced cartoon The Tales of Wonder Keepers. For online movies, in April, we exclusively released Raid, which up to now, its box office is about to break RMB 30 million and was well received by the audience. For original films, Break Through the Darkness, which was produced by iQIYI Pictures, was released in theaters during the quarter. The cumulative box office has surpassed RMB 400 million so far. It has received great reviews and commercial returns. At the same time, another two movies produced by iQIYI Pictures started shooting in the second quarter, and another four are in post-production and expected to be released soon. In addition, iQIYI Original Films has 14 films under development. For the second half of the year, we have a better pipeline than either the first half of the year or the second half of last year in terms of numbers of titles, quality, and genres. Meanwhile, we will continue to push to launch our scheduled content on time. For the second half, key dramas include traditional dramas with regular numbers of episodes such as Ace Troops, The Ideal City, and Fengqi Luoyang, as well as vertical theater brands, such as Who is the Murderer, Gold Panning, and The Pavilion in Mist Theater. For variety shows, we are focused on developing innovative new content across a number of themes such as the already launched Game of Shark, and New Generation Hip-hop Project, an upgraded version of the Rap of China, as well as What's Your Name and Born to Dance. For animation and children's content, while expanding our content library, we are also exploring the area of in-house production. A couple of exciting titles included the already released self-produced 3D animation Immortals of the Godless Age, Princess Doremi, and Tuktak Man 5. In addition, on sports content, after successfully broadcasting the Euro 2020, we will present full competitions of the Premier League for the next four seasons, 2022 FIFA World Cup qualification games in Asia, as well as La Liga and other top sports events. Moving over to technology, advanced technology is the cornerstone of our business. Among other things, it allows us to continuously develop innovative content, enhance the user experience, and improve our operating efficiency. During the quarter, we were pleased to see that iQIYI lite that targets users in lower-tier cities had rapid take-up. The peak DAU exceeded 1.3 million, and the average user time spent exceeded the same metrics on our iQIYI mobile app, the number is as at the end of last quarter. In terms of demographics, users on iQIYI Lite consist mainly of elderly and young people, groups that tend to have more spare time, mainly in lower-tier cities. In June, the average DAU overlap between iQIYI lite and our main app is around 7%. In addition, we constantly work hard to improve the technology of our recommendation engine so that users are effectively matched with the most appropriate content from our vast library. We believe nearly 30% of our DAUs were driven by our content library during the second quarter. Recently, we also made progress in the industrialization of video production by utilizing our intelligent production toolset. For example, we currently launched the Production Business Intelligence System, PBIS, internally. PBIS is a professional data system for our content production teams. As a business intelligence product designed and developed centering on content producers, PBIS offers producers one-stop data inquiry, acquisition, analysis, and evaluation to support their decision-making. On the first day of its launch, dozens of our producers tried out the system. In the near future, PBIS will be widely promoted internally and then cover all our in-house studios within a year, promoting the industrialization of video production within iQIYI as well as in our partner ecosystem. In general, we are still in the early stages of industrialization of video production. The supply of high-quality content, especially of hit vertical content, needs to be amplified. Our core content strategy is to focus on high-quality content across selective verticals while providing more premium mass market hits so that we can optimize subscriber penetration and conversion. We admit that there is still a large gap between us and our global peers. In the future, leveraging our deep understanding of users, our highly innovative in-house production teams, as well as our advanced technologies for industrialization production, we believe we are well positioned to address the current challenges to narrow the gap with our global peers and capture the future market opportunities. With that, I will turn it over to Xiaodong to talk about our financials.

Good evening, everyone. Let me review our key financial highlights for the second quarter. Our total revenues reached RMB 7.6 billion. Membership business continued to be our largest business pillar, accounting for 52% of our total revenues. Our advertising business continued to rebound with a 15% increase on a year-over-year basis. Our other revenues achieved 20% growth on a year-over-year basis as we continue to diversify our monetization channels. Our cost of revenues was flat compared with the same period last year, among which content cost remained stable. Our operating loss margin on GAAP basis narrowed to 15% from 17% in the same period last year, and our net loss narrowed for the fifth consecutive quarter on a year-over-year basis driven by our disciplined investment strategy. As of June 30, 2021, the company had cash, cash equivalents, restricted cash, and short-term investments of RMB 12.3 billion. For detailed financial data, please refer to our press release on our IR website. For the third quarter of 2021, we expect total revenues to be between RMB 7.62 billion and RMB 8.05 billion, a 6% to 12% increase year-over-year. This forecast reflects iQIYI's current and preliminary view, subject to change. I will now open the floor for Q&A. Thank you.

Please ask your question in Chinese first and then translate it into English. Participate by asking one question at a time. Please wait while we prepare the Q&A session. Your first question comes from Ella Ji from China Renaissance. You may begin with your questions.

And thank you for taking my question. My first question is, I would love to hear management elaborate on the latest regulatory environment, especially overall directions regarding the content. Thank you.

Thank you for taking my question. I would love to hear management elaborate on the latest regulatory environment, especially overall directions regarding the content. Thank you.

Hello, Ella. It includes four major parts. Firstly, as a video platform, the main focus is on content censorship, which has remained consistent over the years. This year, due to significant events on July 1, we experienced a stricter censorship environment in the second quarter, but we expect it to return to a normal regulatory pace afterward. The second area involves tighter regulations across the internet industry, which affects not just us. This primarily concerns two aspects: one is anti-monopoly regulation. In the video sector, especially for long-form content, the industry is very competitive, so the impact from anti-monopoly regulations is limited. The other aspect is data security, where we noted that the government has introduced more stringent and detailed guidelines. Internally, we have improved our management and technology to comply and adopted a more specific approach in this regard. Finally, concerning the education sector, due to stricter regulations, we anticipate that students may have more time for entertainment in addition to their studies, making entertainment one of the key areas where they might spend additional time.

Thank you.

Thank you.

So just a quick follow-up regarding your content because we have seen some regulatory directions regarding the short video industry that they are promoting more positive content. I wondered if that could also affect the long-form video content in both dramas as well as variety shows.

Thank you.

This is Xiaodong. I think probably, you mentioned recently released regulation regarding the enhanced censorship on short-form videos. I think Dr. Gong just said, for long-form videos, they have always been important for us. If there's any indirect or direct impact on our business, it should be positive because those short-form videos haven't gone through all this kind of process before. Now I think we are on the same track right now; we have more experience on how to handle this and we have gone through all these kinds of things for the past decade.

Thank you for addressing that question. If I may, I have a second one regarding the lite version. Could management elaborate on the recent progress of iQIYI lite because we see that the iQIYI lite app has quite impressive user growth in the recent months?

I think we are on the same track now; we have more experience in handling this and have gone through all these processes over the past decade.

I will briefly introduce the iQIYI lite app, and then I will hand it over to our CTO, Wenfeng, for further details. We have been developing the iQIYI lite app for about six months. This project aims to reach non-major users, while our core demographic currently consists of users aged 25 to 35. Although we have some coverage of younger and older generations, it’s not sufficient. In the past year or two, we've noticed that many new users have not developed a habit of using the iQIYI app. We aimed to create a product that specifically targets these new users and encourages them to engage with our content. So far, the app has met our expectations. Now, I will pass it to our CTO, Wenfeng, for more details.

Our core users right now are individuals aged between 25 to 35 years old. While we've reached some younger and older generations, it's not sufficient. Over the past couple of years, we've noticed that a growing number of new users have yet to develop a habit of using the iQIYI app. We have been working on a new product designed to attract these new users and encourage them to engage with our product and watch our content. So far, the app meets our expectations. Now, I will hand it over to our CTO, Wenfeng, for further details.

The iQIYI lite app is designed for users in lower-tier cities and has seen strong user growth since its launch. By the end of the second quarter, weekly daily active users exceeded 1 million. The overlap between the iQIYI lite app and the main iQIYI app is very low at just 7%, and this percentage is decreasing. Users of the iQIYI lite app tend to engage more with our existing library rather than new content. In terms of time spent, it has performed exceptionally well. We aim to attract new users through advertising in channels popular in lower-tier cities and through user-sharing methods. We also focus on enhancing user retention with personalized recommendations, easier interactions, and better compatibility with less advanced smartphones. User retention for the iQIYI lite app is strong.

The performance has been strong regarding user time spent, as we focus on encouraging users to consume more content from our library instead of new content. We aim to attract new users through targeted advertising in lower-tier cities and by promoting user sharing. Our efforts to enhance user retention include personalized recommendations, user-friendly interactions, and ensuring accessibility for low-functionality smartphones. Additionally, the retention rates for our iQIYI lite app are impressive.

Our CEO has something to add. The iQIYI lite app aligns with our belief in a consumption upgrade regarding content for Chinese users.

Thank you.

Thank you. Basically, we expect those kinds of users, who previously didn't watch TV dramas or films, when they have a chance to access high-quality entertainment content, they will spend more time on it. From our initial data set, it seems that our thesis has been demonstrated through user retention rates and user growth.

Thank you. Your next question comes from Eddie Leung from Bank of America, Merrill Lynch. Please go ahead.

My question is about content costs. We have seen good cost control in the past few quarters. While the company has been conservative in guiding future content costs, I'm curious about the recent cost control in content. Specifically, in the last one or two quarters, how much was attributed to the delay of some popular content, and how much stemmed from reduced production and licensing costs?

This is Xiaodong. I think if you're talking about one or two quarters content cost, it could be caused by the delay of certain content. But if you look at the past few quarters numbers, you see the consecutive optimization of our content costs, which is more driven by the efficiency improvement on the content investment. We see the price stabilize since 2018. Given that we have launched more original content in the past few quarters, we have more control over the quality and the efficiency of the content investment. Of course, conservative is not the right word here; we are going to expand the category of our content investment, including original movies and overseas content. That's why we see the potential slight increase on the dollar amount of content cost, but the percentage of revenue will continue to show an optimized trend in the next few quarters.

As a reminder, please restrict to one question at a time. Your next question comes from Alicia Yap from Citigroup. Please, go ahead.

Hi. Thank you. Can management give us the longer-term prospect of the long-form video industry in China? Will the current model between the membership subscriptions and the advertising model remain in place? Any breakthroughs in terms of content production for the monetization model, especially I think management talked about the industrialization in video production, how would that transform the future monetization model for the video industry?

Hi. Thank you. Can management provide insights on the long-term outlook for the long-form video industry in China? Will the existing model that combines membership subscriptions and advertising continue? Are there any advancements in content production for the monetization model, particularly regarding the industrialization of video production, and how might that evolve the future monetization model for the video industry?

Okay. So Alicia, I actually have a very positive view for this industry personally. My positive view is still based on these two parts. One is that in terms of penetration, we still have a very low penetration of paying users. Our paying ratio is also low. In China, a small percentage of people are willing to pay for professional and high-end entertainment content. We expect more people will join as iQIYI users with the trend of consumption upgrade of content we mentioned earlier. Regarding monetization, our core users are those aged between 20 to 40. We lack sufficient content for users older than 40 and also for the younger generation. We are trying to expand our content supply to satisfy these users’ needs. Based on that, we expect improvements in penetration and paying ratios. In the monetization model for most internet verticals in China, new users often start as free users, consuming advertising. If they enjoy our content, they will start to pay for it, leading to no advertising for them. So these users will convert into high-ARPU users through our membership package and PVOD methods.

As you have noticed, we experienced some volatility regarding content launches. The main reason for this is our inability to provide enough content and a more diverse range of it. As we stated in our shareholder letter last quarter, we believe that the industrialization of video content production is crucial to addressing this issue. The key is to improve our forecasts and enhance their accuracy throughout the entire content production cycle, allowing us to reduce risk and costs. Since the first quarter, we have increased our investments in video content production industrialization. This quarter, we began implementing the Production Business Intelligence System, which will help our producers forecast traffic and revenue for projects.

Yes. Thank you.

Thank you. Your last question comes from Piyush Mubayi from Goldman Sachs.

Thank you for taking my question. When I look at your content cost as an indication of how you are industrializing content production, your content spend was about, at its peak, 84% of revenue, and it's come down gradually to about 67% of revenue. With the industrialization, where does that content spend come down to? And how long do you think it will take to reach that trough level? That's my first question. Related to that, you've moved into iQIYI Sports in the major world with the EPL at a price point of around RMB 19 or RMB 20 per month based on the price I've seen. What has been the initial indication of demand for EPL on your platform?

This is Xiaodong. I will comment on the first question. I think the industrialization of the content production is mainly to increase the supply and quality of the content. Definitely, as a percentage of revenue, it will contribute positively. In fact, better monetizing ability of this content over the last few years has been more driven by slight increases in hit ratio and quality. The more diversified content strategies, like the Mist Theater, have also played a role. Within the next three to five years, definitely, you will see significant improvements in efficiency of the content production due to the industrialization progress we expect to achieve. Regarding sports, I'm not quite following your question regarding the CPM because sports content is not like we charge the user directly for the nominal price you saw on the website. It's more like the revenue share between iQIYI and our joint venture that operates the sports business. So it has very little impact on the ARPU of the membership business or the revenue of iQIYI since they only have a very low percentage of the total membership or subscription business.

This concludes the question-and-answer session. I will now pass the line to the management for closing remarks. Thank you.

Thank you, everyone, for joining our call today. Please feel free to reach out to us if you have any questions. Let's speak next quarter. Thank you.

Thank you.

This concludes today's conference call. Thank you for participating. You may now disconnect.