iQIYI, Inc. Q3 FY2021 Earnings Call

Good day and thank you for standing by. Welcome to the iQIYI Third Quarter 2021 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. Please be advised that today's conference is being recorded. I would now like to hand the conference over to Ms. Chang You, IR Director of the Company, please go ahead.

Thank you, Operator. Hello, everyone. And thank you for joining iQIYI’s Third Quarter 2021 Earnings Conference Call. The Company's results were released today and are available on the Company's Investor Relations website at ir.iQIYI.com. On the call today, we have Mr. Gong, our Founder, Director, and CEO; Mr. Xiaodong Wang, our CFO; Mr. Xiaohui Wang, our Chief Content Officer; Mr. Wenfeng Liu, our Chief Technology 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, Wenfeng, and Xianghua will join Mr. Gong and Xiaodong for 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 statements, except as required under applicable law. With that, I will now turn the call over to Mr. Gong. Please go ahead.

Hello, everyone. Thank you for joining us today. In the third quarter, we faced a lot of volatility as we navigated through a particularly challenging operating environment. We've experienced uncertainty in terms of content scheduling, which resulted in softer than expected top-line performance. Despite the short-term volatility, we are delighted to see encouraging signs across multiple operating metrics. Our leading market position remains intact as we continue to be number one in various user metrics according to third-party data. We firmly believe there are a couple of eternal truths when it comes to entertainment. The first is that audiences constantly demand high-quality entertainment content such as movies and dramas. The second is that creators have infinite potential to develop excellent material. With this market dynamic in mind, we think we have tremendous space for growth and development. During the quarter, we continued to enhance the production capabilities of our original content, explore new genres to diversify into, and expand our user base by refining our products and the overall user experience. Meanwhile, we have been driving the industrialization of video production to improve the efficiency of our operations. We believe all of these developments will enable us to navigate through the short-term challenges and we are on the right path to achieve long-term success. Now, let's go through the performance of our business segments in the third quarter. Let's start with the membership. During the quarter, our membership services revenue grew both annually and sequentially. Our core strategy is to cater to the demands of specific user segments with diversified content and continuously improve member benefits that enhance the member experience, driving new member sign-ups and user retention. At the same time, we are focused on raising ARPU and improving the long-term monetization of our membership business by developing innovative new business models, adjusting our price points, eliminating ineffective discounts, and pushing through operational initiatives. However, as I mentioned earlier, the uncertainty of our content scheduling caused fluctuations in terms of subscriber numbers. In the future, we will continue to enhance our library of content across different genres and strengthen our ability to withstand risks related to content scheduling. In the third quarter, membership services revenue grew by 8% year-over-year, mainly due to the success of hit dramas such as One And Only, The Legend, and Forever and Ever, which were launched in the third quarter, as well as the continued interest in dramas launched at the end of the second quarter, such as My Dear Guardian and The Rebel. As of September 30, the total number of subscribers was 103.6 million. The sequential fluctuation was mainly due to delays in the release of some highly anticipated content. Meanwhile, the major content that we did release in the third quarter was less diversified in terms of genres. Despite the soft performance, we are happy to see that subscriber growth on TV devices and from overseas maintained good momentum. We believe that higher conversion of users on TV devices and the continued expansion of our overseas user base will be significant drivers of future subscriber growth. On the other hand, our ARPU recorded both annual and sequential growth. The annual growth rate of 10% was mainly due to the successful price adjustment that was rolled out last November. We expect the ARPU of our membership business will continue to improve going forward driven by our content and our multiple operating initiatives. The member experience is one of the most important subjects that we focus on. On October 4th, we proactively canceled the paid advance viewing model ahead of our peers. This should further help improve the member experience and support subscriber growth and retention while laying a solid foundation for the long-term monetization of our platform. In addition, we continue to enhance member benefits on our platform via our cooperation with top industry partners. In terms of new services and new business models, one of our key focuses is to promote the development of cloud cinema, primarily across three content categories: theatrical films distributed via a PVOD model, premium films only distributed via online platforms, and iQIYI Original Films. Since 2020, theatrical releases of feature films have been significantly hit by the COVID-19 pandemic. The cloud cinema model will reduce the reliance of online video platforms on theatrical films. It also enables users to watch new films soon after their offline release at a price that is cheaper than a traditional movie ticket, which further maximizes the monetization potential of each film. During our third quarter, we released our new titles, Kungfu Stuntmen and Malignant under our Cloud Cinema model. These films fall into different genres, namely comedy, action, and suspense, which helps to satisfy the demands of different user cohorts. In addition, our first original PVOD film Northeastern Bro was launched in October and received positive user feedback since its launch. In terms of overseas expansion, we were able to significantly expand our user base with DAUs increasing sequentially in a number of Southeast Asian countries. Downloads of the IQiyi app remained at the top of the charts across various regions. It ranked number 1 in Thailand, Malaysia, and Vietnam. Unforgettable Love, Forever and Ever, and other domestic blockbusters drove continued growth of our overseas revenue. We've also recently kicked off the development of six overseas original dramas, including four Korean and two Filipino originals. In addition, we continue to expand our cooperation with local partners, including multiple media platforms and operators in Malaysia, Thailand, and Singapore. We also launched our advertising system and signed annual cooperation framework agreements with numerous advertisers, successfully expanding local sponsorship for our Sweet ON Theater. Moving on to advertising, during the quarter our advertising revenue came in soft, mainly due to a drop in brand ad revenues. The decline was primarily due to the delay of key content, including dramas and variety shows. We continue to work on developing new innovative variety shows to diversify our content and mitigate risks from content scheduling uncertainty. We are still refining and fine-tuning some of these productions, and it is going to take some time to win over advertisers and stimulate their interests with these new genres. The softness of our brand advertising business was also due to the overall challenging micro-economic environment in China. Revenue from performance ads increased steadily both year-over-year and sequentially during the quarter. Our iQIYI Lite app was the main driver behind this. In contrast to our main app, iQIYI Lite mainly focuses on lower-tier cities. There is low overlap with our main app, which primarily targets brand ads. iQIYI Lite is expected to be a great complement that drives new growth for our advertising business. The year-over-year growth of performance ads also benefited from one, an improvement in our monetization capabilities driven by our technology, and two, contribution from key sectors, including internet services and e-commerce. The sequential growth was also partially driven by the growth in our ad inventory during the summer vacation. Looking forward to the fourth quarter, we have observed some slowdown in China’s overall macro economy, which might negatively impact our advertising business. Nonetheless, we're proactively adapting ourselves to the environment to minimize our potential exposure. Moving over to content, we have experienced increased uncertainty in content and scheduling, and prompted content approval processes since our last earnings call. Although we prepared a rich slate of content during the quarter, some top dramas and variety shows in our pipeline experienced launch delays. Going forward, to offset these types of risks, we are looking to further expand and enrich the diversity of our content portfolio, exploring new and different categories and deepening user awareness of our diversified content offerings, all in an effort to mitigate our business from content scheduling issues in the future. In addition, we actively responded to the guidelines issued by various government authorities to promote the health of entertainment and online media industries. We believe these actions will further resolve long-standing problems in the industry, which should help us to optimize content costs, eliminate the chaos in content production and promotion, and reduce irrational industrial combinations. Overall, these changes should be beneficial for supporting a healthy development of the industry over the long term. I would like to highlight our content strategy: efficiency in content production and operation has always been a primary target that we strive for, and we are now putting even more focus on it. We're proactively taking initiatives to improve the efficiency of our operations and reduce ineffective investments in content by cutting projects that are expected to generate low ROI. The online video industry has rapidly developed over the past decade, and now we've reached a point where content is king and efficiency is key. We're happy to see continued results in our progress to optimize content costs driven by enhanced production capability, disciplined content spending, and improved operations. The important metric we use to track the efficiency of our content spending is the content-related cost ratio. This metric is calculated by dividing the total costs related to our titles by the revenue generated by them. Based on this measurement, we can see the operating efficiency of our overall content in 2021 (including both licensed and original serial dramas) has improved substantially from last year. We will continue to use this metric as an effective tool in managing the efficiency of our investments in content and operations. For example, One and Only and Forever and Ever, which created synergy regarding IP and are quite innovative in both content creation and broadcasting models, are good examples demonstrating our increased efficiency in content operation as measured by the content-related cost ratio. The performance of One and Only showed a 13% improvement over last year's drama Love is Sweet, which features the same leading actress and belongs to the same genre. We would also like to share some highlights on the performance of our vertical content theater model strategy. We have always been the industry pioneers in terms of content innovation and operation, and our theater model strategy is definitely one of our successful attempts. This model helps us build recognition among audiences and advertisers in genres, which is beneficial for attracting new users and driving up user retention. It offers better ROI as it brings synergy among different titles within the same content genre and thus provides more flexibility in working with advertisers. For instance, we've observed that the recent broadcast of The Pavilion and Wisher boosted the viewership of Mist Theater’s first season titles. Specifically, the daily video views and user time spent on The Bad Kids increased by more than two times since the new season of The Mist Theater was launched. Looking forward to the fourth quarter, although we predict that uncertainty will remain in the market, we will continue to execute our diversified content strategy in addition to the new season of Mist Theater launched in the fourth quarter. Other key titles include the drama series Feng Qi Luoyang, the variety show Super Sketch Show, and animated content such as Deer Squad 2 and Princess Doremi. The Super Sketch Show premiers in mid-October and received highly acclaimed feedback from audiences, solidifying our market leadership in variety shows. Moving on to technology, advanced technology is the foundation of our business, and we are constantly developing new technologies to improve user experience, increase user penetration, develop innovative new content formats, and enhance content production and the efficiency of our operations. At the same time, technical innovation is key to the industrialization of video production in the industry and will greatly improve the probability of success, improve ROI, simplify the production management process, reduce production costs, and enhance the viewing experience. We continue to make progress in terms of user penetration. The user scale of iQYI Lite grew rapidly, with our peak DAUs increasing nearly two times sequentially, and user retention and monetization have also improved. iQIYI Lite mainly targets lower-tier cities, so the growth we've seen with this app speaks to our success in penetrating these regions. In terms of content production and efficiency improvements, we continue to apply AI technology to effectively reduce production costs during the quarter. For example, operating costs can be significantly reduced with our proprietary intelligent translation tools. We have fully replaced manual translation with automated AI translation for B-level and below dramas in Malaysia. Going forward, once we fully adopt this technology for our overseas business, it will save us hundreds of millions of RMB in translation costs. In terms of industrialization of video, we have launched and applied multiple technologies and products to our content production, reducing production costs, increasing efficiency, and enhancing the user experience. Take our proprietary multi-view capture system as an example; the system significantly shortens shooting time, reduces the volume of manual work, and supports the full production process from camera deployment, video shooting to post-production, making content production more efficient. Other intelligent tools launched include our script supervisor management products, which can be used in the mid-stage production process. These products have been applied to 16 variety shows, including some of the external works in production. Additionally, a management tool for the post-production editing process has been used by several post-production companies in the third quarter, improving transcoding efficiency by 3.7 times. In summary, we are proactively adapting ourselves to the current environment, continuing to be a pioneer when it comes to content innovation and operation. Meanwhile, we are seeing a promising growth trajectory for our new initiatives, such as iQIYI Lite and overseas business. Our original content, especially our theater-model content, is highly recognized by users and advertisers, and we will continue to lead in rolling out new technologies and tools for intelligent production and drive the industrialization of the long-form video production process, which should help further optimize our operating efficiency. We have evolved with the changes in the online video market over the past decade. The experiences we have accumulated and our expertise align perfectly with where the industry is heading. We value the current challenges as a precious learning opportunity. We continue to believe that what does not defeat us makes us stronger. With that, I will hand it over to Xiaodong to talk about our financials.

Good morning and good evening everyone. Let me review our key financial highlights for the third quarter. Our total revenue reached RMB 7.6 billion. Membership service business continued to be our largest business pillar, with revenue increasing 8% year-over-year and accounting for 57% of our total revenue. Online advertising revenue decreased 10% year-over-year primarily due to fewer premium content launches during the quarter and the challenging macroeconomic environment in China. Our content distribution revenue achieved a 60% growth on a year-over-year basis as we distributed more content and titles to other platforms during the quarter. Our cost of revenues increased 10% from the same period last year, among which content costs increased 13% from the same period in 2020. The increase in content costs was mainly due to more investments in original content during the quarter. Our operating loss margin on a GAAP basis was 18%, remaining largely flat compared to the same period last year, driven by our disciplined investment strategy. As of September 30th, 2021, the Company had cash, cash equivalents, restricted cash, and short-term investments of RMB 11 billion. For detailed financial data, please refer to our press release on our IR website. For the fourth quarter of 2021, iQIYI expects total net revenue to be between RMB 7.08 billion and RMB 7.53 billion, expecting a 5% decrease to a 1% increase year-over-year. This forecast reflects iQIYI's current and preliminary view, which may be subject to change. I will now open the floor for Q&A. Thank you.

Operator, please open the floor to questions.

Certainly. For the benefit of all participants in today's call, if you wish to ask your question to management in Chinese, please immediately repeat your question in English. Please limit your questions to one at a time. If you wish to have follow-up questions, please rejoin the queue. Your first question comes from the line of Ella Ji from China Renaissance, please go ahead.

Thank you. First question is relating to the recent improvement plans you had with a local provincial government. I just wondered how this is going to affect our future business? A second question relates to the future membership growth potential. I guess the wonder regarding the future membership is, will it be mainly from lower tier cities or still from the major tier cities? Lastly, I just want to know if management could share anything new, exciting, or promising relating to the variety shows going forward. Thank you.

I would like to know how the recent improvement plans with the local provincial government will impact our future business. Additionally, I'm curious about the growth potential for future membership. Will we primarily see this growth in lower tier cities or continue to see it in the major tier cities? Lastly, could management share any new, exciting, or promising updates regarding the variety shows moving forward? Thank you.

I'll translate Mr. Gong's feedback. Regarding your first question about the Consumer Council, this applies to all industry players. Our feedback comes from two aspects: product design and operation flows. For product design, we have been communicating with the Consumer Council and collecting feedback from our customer service department. Our goal is to enhance user experience by trying to lower accidental clicks of any unnecessary steps. Overall, the user experience will be increased and improved. From the business model perspective, we have also been engaging with the Consumer Council regarding the user agreement to ensure all messages are communicated clearly with the users. As for the second question about our penetration into different tiers of cities, for now, penetrations in first and second tier cities are high, while lower tier cities have relatively low penetration. Our iQIYI Lite app primarily targets this demographic. Right now, we offer a lot of free content, so users consume this free content and subsequently see advertisements. Currently, iQIYI Lite's performance ad has a high percentage of revenue contribution. Going forward, iQIYI Lite will take 1 to 2 years to improve and grow, while we will continue optimizing our main iQIYI app operations to elevate user experience and product features.

Our iQIYI Lite app primarily targets lower tier cities, which have relatively low penetration. We currently provide a significant amount of free content, allowing users to engage with it and see advertisements. At this time, iQIYI Lite's performance ads contribute significantly to revenue. In the coming 1 to 2 years, we aim to enhance and expand iQIYI Lite, while also continuing to optimize our main iQIYI app operations to improve user experience and product features.

So the third question will be answered by Xiaohui, our CCO.

Right now, we offer a lot of free content, so users consume this free content and subsequently see advertisements. Currently, iQIYI Lite's performance ad has a high percentage of revenue contribution. Going forward, iQIYI Lite will take 1 to 2 years to improve and grow, while we will continue optimizing our main iQIYI app operations to elevate user experience and product features. The third question will be answered by Xiaohui, our CCO.

Xiaohui responded to the talent show question. Because of the existing fan culture in this entertainment sector, it does have some impact on the variety show segment. Currently, the Korean-style talent shows are prohibited in the video space, but there is still ample room for growth in variety shows. We can focus on areas for genres like comedy, emotional, and some talent shows that are not related to the Korean style. We also launched our new comedy variety show called the Super Sketch Show, which is a newly innovated content genre. Based on its initial feedback since launch, we have seen promising user feedback and viewership from this show. Our variety show performance is back to the number one position in the market. Moving forward, especially in the fourth quarter, we'll still launch innovative variety show content genres, such as Action, an innovative variety show that will be introduced to the users. Thank you.

Thank you very much.

Thank you. Due to time constraint, please limit your questions to one at a time. If you wish to have follow-up questions, please rejoin the queue. The next question comes from the line of Alicia Yap from Citigroup. Please go ahead.

Hi. Thank you. My question is related to the overall longer-term outlook for the long-form video industry. Will there be any changes to the strategies for your self-developed content across all content genres, and even for example, the type of drama series length that you plan to produce? Also, can long-form video monetization models break beyond the current membership subscriptions and advertising? If so, what could be the new model? Thank you.

Thank you. My question is about the long-term outlook for the long-form video industry. Will there be any changes to your strategies for self-developed content across various genres, including the lengths of drama series you plan to produce? Additionally, can long-form video monetization models expand beyond current membership subscriptions and advertising? If so, what could those new models be? Thank you.

Currently, I think the biggest problem for the online video space is the supply shortage contributed by several reasons. The first one, of course, is COVID-19. The number of movies launched since COVID-19 is only less than half of the 2019 level. Traditional satellite TV series have dropped to only 1/3 of their previous quantity. New forms of internet series, web series have also experienced major delays due to stricter censorship. Even for the content launched, the quality has often been discounted or received less promising feedback. These factors have all contributed to the supply shortage of video content. For monetization models, we are working on taking the full process of the entire IP Chain. For example, if we have a good IP, whether from the script level or the story level, we wanted to take this through the entire process of the IP lifecycle, developing this into TV series, movies, games, franchise products, etc. Going forward, from a long-term perspective, a healthy model will be one that combines advertising revenue, subscription revenue, and PVOD models. We believe this model will provide a sustainable outlook in the long-term prospect of the online video industry.

We want to take strong intellectual property, whether it originates from scripts or stories, through all stages of its lifecycle, transforming it into TV series, movies, games, and franchise products. Looking ahead, a successful model will integrate advertising revenue, subscription revenue, and premium video on demand. We are confident that this approach will create a sustainable future for the online video industry.

If you look at the overall grand picture of the online or entertainment space, movies started 126 years ago. We believe the consumer demand for high quality, premium content is eternal, and the talent for this area is continuous. All of these need time to grow the space. We strongly believe there is ample room for growth in our online video space; we are proactively adapting ourselves to embrace the changes in the environment and we are an experienced team with the expertise that will enable us to face these challenges and succeed in the industry.

The consumer demand for high quality, premium content is eternal, and the talent for this area is continuous. All of these need time to grow the space. We strongly believe there is ample room for growth in our online video space; we are proactively adapting ourselves to embrace the changes in the environment and we are an experienced team with the expertise that will enable us to face these challenges and succeed in the industry.

Thank you.

The consumer demand for high-quality, premium content is everlasting, and there is a constant influx of talent in this area. All of these require time to develop. We firmly believe there is significant potential for growth in our online video sector. We are actively adjusting to embrace the changes in the environment, and our experienced team possesses the expertise to meet these challenges and thrive in the industry. Thank you.

Thank you. The next question comes from the line of Thomas Chang from Jefferies. Please go ahead.

Thanks, management, for taking my questions. I have a question regarding overseas competition. We have just talked about using technology and achieving efficiencies for the translation process. I just want to understand how we think about the competitive landscape in different markets, and will we step up investment in overseas growth going forward? Thank you.

Thank you, management, for taking my questions. I have a question regarding overseas competition. We have just talked about using technology and achieving efficiencies for the translation process. I just want to understand how we think about the competitive landscape in different markets, and will we step up investment in overseas growth going forward? Thank you.

Our Senior Vice President Xianghua, in charge of the membership service, will answer this question. Our primary goal for overseas business is to export our original content to various regions around the world. The first challenge we will encounter is translation and different regions with different cultures and backgrounds. Our initial goal was to find countries with similar cultural backgrounds, such as Southeast Asian countries and North America, because there are a lot of Chinese citizens in that area. We also introduced some of the content there. Going forward, we will continue to bring more premium content to our overseas business, and based on our internal data, we know that many of our series are very well received by young audiences in overseas regions.

Thank you. Due to time constraint, that was the last question. I would like to hand the call back to management for any closing remarks.

We have a significant presence in international markets, particularly in areas with a large Chinese population. We are committed to providing more premium content for our overseas operations, and our internal data indicates that many of our series are popular among younger audiences in these regions. Thank you for your understanding regarding the time constraints, and I will now turn the call back to management for closing remarks.

I will summarize our short-term and long-term goals for our Company. As you all know, we introduced several short-term challenges related to the government regulatory environment in our opening remarks. However, we have been proactively adapting ourselves to this new environmental situation. We expect that over the next one or two quarters, the regulatory environment will stabilize. Our main goal going forward is first to reduce our losses and optimize our content costs based on our initiatives for video industrialization. We will execute according to our strategy and eliminate or drop content that does not align with policy, while simultaneously exploring new monetization opportunities. That is our overall strategy for both the short-term and long-term. Thank you. Thank you everyone for joining us. Feel free to reach out if you have any questions, and we will talk to you next quarter.

Thank you. Bye.

Thank you. That concludes the conference today. Thank you for participating. You may all disconnect now.