iQIYI, Inc. Q4 FY2021 Earnings Call

Good day. And thank you for standing by. Welcome to iQIYI Fourth Quarter and Fiscal Year 2021 Earnings Conference Call. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your first speaker today, Ms. Chang You, IR Director of the company, to read the opening remarks and the safe harbor statement. Please go ahead.

Thank you, operator. Hello, everyone, and thank you for joining iQIYI's fourth quarter and fiscal year 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 are Mr. Yu Gong, our Founder, Director and CEO; Mr. Jun Wang, our CFO; Mr. Xiaohui Wang, our CCO, Chief Content Officer; Mr. Wenfeng Liu, our CTO, Chief Technology Officer; Ms. Vivian Wang, our CMO, Chief Marketing Officer; Mr. Youqiao Duan, Senior Vice President of our Membership business; and Mr. Xianghua Yang Senior Vice President of Movies and Overseas Business. Mr. Gong will give a brief overview of the company's business operations and highlights, followed by Jun, who will go through the financials. After the prepared remarks, Xiaohui, Wenfeng, Vivian, Youqiao, and Xianghua will join Mr. Gong and Jun 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 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 obligations 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. 2021 was a unique year for iQIYI. One year ago, we shared with investors in our shareholder letter that iQIYI delivers its core value in producing and distributing premium entertainment content. We believe premium long-form video content is a fundamental need for human beings, and iQIYI has established solid leadership in this space. We delivered what we said. In the past year, despite turbulence in the macro environment, we still consistently delivered blockbusters quarter over quarter, including 'My Heroic Husband', 'Feng Qi Luo Yang', and 'Who is The Murderer', just to name a few, and we continue to rank number one in various user metrics according to third-party data. Today, we would like our shareholders to recognize that iQIYI is leading the opening of a new chapter in the Chinese long-form video industry, which involves a number of structural changes. The market competition is shifting from quantity to quality, and the operational priority is shifting from market share to business efficiency. Everyone within the industry is now taking a more balanced approach that results in higher business efficiency, profitability, and positive social impacts. These changes are positive and are the consensus of industry leaders, including iQIYI, and they will help the entire industry to achieve sustainable growth in the long term. These structural changes also brought near-term benefits resulting in a healthy fourth quarter for iQIYI. For instance, we proactively dropped projects that generated low ROI and had limited value creation. Meanwhile, we are more disciplined in investing in non-core businesses and initiatives with long payback periods. Our organization has become slimmer and nimbler. We are more focused on our core business than ever, resulting in significant improvements in cost and operating efficiency. The initial results have been very encouraging in the fourth quarter of 2021. The non-GAAP operating loss, a key measure for our business performance, decreased significantly by 45% annually and 52% sequentially, exceeding our expectations. The benefits from these changes will extend beyond Q4. We expect the non-GAAP operating loss to be further narrowed significantly in the first quarter of 2022. Our goal is to reach operating breakeven for the full year of 2022 on a non-GAAP basis, and we hope to reach quarterly non-GAAP operating breakeven as soon as possible. We believe we are on the right path in reaching our goal. We will continue to increase our operating efficiency and improve the quality of our diversified content portfolio through content innovation, production refinement, industrialization of video production, and diversified monetization methods. We firmly believe premium long-form video content is one of the core needs of human beings. Through the execution of our short-term strategy and the rich experience we have accumulated in the industry, we will continue to produce and deliver more high-quality and diversified premium content to expand our member and user base over the long term. Now let's go through the performance of business segments in the fourth quarter and the full year of 2021. Let's start with our membership. Our core business strategy remains focused on the three aspects that drive membership service growth: first, increasing average revenue per membership, also known as ARM; second, improving retention of paying members; and third, continuing to attract new members and reconvert inactive members. In the fourth quarter, our membership revenue grew by 7% annually, and the full year 2021 membership revenue grew slightly from last year, mainly driven by ARM improvement. For the fourth quarter, monthly ARM was RMB14.16, up 14% annually and 4% sequentially. The improvement of ARM was mainly attributable to more premium services provided for our users, the success of our innovative operating initiatives, and efficient promotion efforts, along with the successful price adjustment that we rolled out in November 2020. For example, we launched various innovative marketing campaigns for several highly anticipated content launches in December, such as our original drama series 'Feng Qi Luoyang' and 'Who is The Murderer' from Mist Theater, bringing exclusive perks to our members. Benefiting from the success of last year's Mist Theater, the membership revenue of 'Who is The Murderer' recorded a historical high among all Mist Theater dramas. During the first two months of the quarter, we faced substantial uncertainty in content scheduling, and many key titles were delayed towards the end of the quarter. The average daily number of total subscribing members for the fourth quarter was 97 million compared to 102.7 million for Q4 2020 and 104.7 million for Q3 2021. As we launched many premium titles since December, the current number of subscribers is now back at an ideal level. Despite the sequential fluctuations in average daily subscribers for the quarter, we are happy to see that subscriber growth on large screen devices maintained good momentum. The user time spent on TV devices continued to increase, showing a growing appreciation for content distribution via big screens. This trend presents greater monetization potential on big screens. In the future, we will continue to improve the acquisition and retention of paying subscribers through refined operational strategies, and simultaneously, the penetration into large screens will be another driving force for the continuous growth of our business. Moving on to overseas business, our overseas business made great progress, with user base and revenue achieving significant year-over-year growth. The influence of our overseas platform continues to grow, bringing wider recognition of Eastern culture amongst overseas users. First, the user base recorded explosive growth, with average DAU in 2021 tripling from last year. We saw the best growth momentum in Thailand with annual growth nearing 700%. Meanwhile, the growth rate in many other regions exceeded 100%, such as in Southeast Asian countries, the U.S., Korea, and Australia. Second, the overall revenue growth of the overseas platform was also encouraging. Membership revenue grew by over 40% sequentially in the fourth quarter, and over 80% for the full year. Advertising revenue grew by about 10% sequentially in the fourth quarter and over 100% for the full year. Lastly, continuous releases of hit titles successfully garnered recognition from overseas users, significantly increasing our ability to continuously expand our user base. During the year, a variety of Chinese mainland content such as original and licensed dramas and original variety shows achieved top trending rankings in 14 countries, including Malaysia, Thailand, Japan, Korea, and the U.S. Furthermore, we continue to improve our platform capabilities and expand cooperation with local partners. We launched our app on Amazon Fire TV and Roku TV in North America, and also on many TV devices, such as Samsung, Hisense, and LG TV. During the year, we also launched an overseas ad platform to expand our cooperation with overseas brand advertisers and agencies. In the future, we will continue to focus on expanding the scale of our user base and revenue by leveraging the premium content on iQIYI's main app and continuous improvement of operational efficiency. We aim to maximize our monetization capability for our overseas platform. Moving on to advertising. The advertising revenue decreased by 10% year-over-year during the quarter, mainly due to the decline in brand ads. The decline in brand ads was primarily attributable to: first, the lack of hit content, both for dramas and variety shows, in the first two months of Q4; and second, the weak overall macro environment. Despite the decline in brand ads, we are pleased to see that ad revenue from the Mist Theater doubled in 2021, highlighting the success and importance of our vertical theater model strategy. For 2022, we are targeting to secure more key accounts and increase their revenue contribution, driven by continuous content innovation and development of sequels to our successful titles. Revenue from performance ads achieved steady growth, both annually and sequentially during the quarter. iQIYI Lite was a major driving force, as the operating metrics of iQIYI Lite increased significantly, specifically ad inventory which benefited from strong traffic growth. The annual growth of performance ads also benefited from the improvement of our ad products as we continue to optimize our algorithm. Moving over to content. We experienced turbulence and faced many uncertainties that directly impacted content launches during the year, especially in the first two months of the fourth quarter. As we gained a deeper understanding of the latest industry policies, we were able to better comprehend the boundaries of content production and scheduling. Thus, we proactively managed the process and increased our resilience relative to content scheduling uncertainty. We launched many premium contents toward the end of the fourth quarter. The optimization of the overall content cost is the foremost aspect of our recent operational strategy. For the fourth quarter, the content-related cost ratio continued to improve. This ratio effectively reflects the operating efficiency of the content we invested in. So far, the ratio has improved by over 20 percentage points annually for the fourth quarter, as the number of low-performing titles decreased both annually and sequentially. Meanwhile, we have utilized our intelligent production technology to increase our data analytical and forecasting capabilities, which in return, has enhanced our content success rate. We believe we have a team of content professionals with the best industry know-how. By executing the aforementioned initiatives, the overall quality of our content team will further improve. Now, let's go through the key titles during the quarter and in 2021. During the quarter, we ranked number one for the number of new dramas launched in the industry according to Enlightent, and we maintained the leading position in terms of market share for variety shows, cartoons, and animation. For the full year of 2021, our market share for movies, dramas, variety shows, cartoons, and animations all ranked number one, and the number of new dramas launched was the highest in the industry. For dramas, we focused on enriching and diversifying our IP monetization capabilities. For example, we are building the iQIYI Chinese Historic City Universe Franchise, developing content based on traditional Chinese culture, showcasing the history of rich Chinese culture to global users through diversified original production. We debuted our first work in the franchise, the original TV drama 'Feng Qi Luoyang', which generated immediate buzz among viewers. The popularity index of 'Feng Qi Luoyang' broke 9,000 on the second day of launch, making it one of the top-ranking hit dramas that achieved such high index score on our platform. In the future, we anticipate developing a series of productions under the same concept to expand the franchise. For the second season of Mist Theater, several titles were debuted in the fourth quarter, further reinforcing its brand influence among viewers. The monetization capability for the Mist Theater series has become an important growth driver for our membership service; 'Who is The Murderer' generated the highest membership revenue among all titles. This success also attracted more advertising budgets to our platform and demonstrated great flexibility in working with advertisers under the vertical theater model. For variety shows, we continue to explore new genres and have received praise from both industry professionals and audiences. For Q4, our original production, the Super Sketch Show, maintained the number one position in user time spent within the variety genre. For films, we continue to build our cloud cinema during the quarter, aiming to further expand monetization possibilities and establish a new online ecosystem for film distribution. For example, some of our original films were only released online via the PVOD model, with initial success being encouraging. In 2021, we launched a total of nine films under the PVOD model, among which our original film, 'Northeastern Bro', was released in Q4 and became the second-best performing PVOD film of the year in terms of viewership and revenue contribution. For the full year of 2021, we launched diverse films in Cloud Cinema across different genres, including comedy, action, suspense, thriller, and others. Cloud cinema provides an open and fair platform for film distribution, significantly increasing the supply of premium content and giving talented content creators better exposure, thus achieving a win-win result for both filmmakers and our platform. For cartoons and animation, we also achieved substantial success in the fourth quarter. We introduced animation 'Feng Qi Luoyang Shen Ji Shaonian' within the iQIYI Chinese Historic City Universe franchise, which is a good example that demonstrates our diversified IP monetization strategy. Its popularity index broke 4,000 within 13 hours of its launch, topping the charts on our platform. Looking into 2022, regarding dramas, we will continue to improve the quality of our content portfolio, especially for our premium original productions, and build competitive barriers for our content ecosystem. The key is enhancing brand awareness, exploring the brand value of vertical content, and extending the content lifecycle by producing multi-season dramas and short series under the vertical theater model. We will continue to pursue achievements with our iQIYI Chinese Historic City Universe franchise. We now have three vertical theaters that provide differentiated content and services for our users, namely the suspense and mystery-themed Mist Theater, the romance-themed Sweet ON Theater, and our newly launched comedy-themed Laugh On theater. We recently launched 'Lifelong Journey' on January 28, our first key drama for the year, which has maintained a leading position in terms of effective viewership according to the latest Enlightent data. For variety shows, we will maintain our leadership position in this genre and focus on categories with which we have rich experience, such as mystery-style competition games, comedy, music, and romance, while also further innovating and developing shows in sports and performance competitions to meet the latest user demand. For films, we will enhance the scale and variety of original film projects compared to 2021, anticipating 6 to 9 theatrical releases of our original films. For cartoons and animations, we will continue to cultivate and develop our IPs through serialized productions. For example, our original cartoon 'Deer Squad' is the first original Chinese animation broadcasted on Nickelodeon TV channel and has become an instant hit, already under multi-season development. Next, moving on to products and services. In the fourth quarter, iQIYI Lite achieved outstanding performance across various operating metrics; particularly, peak DAU reached five million during the period. iQIYI Lite helps us penetrate into lower-tier cities, and we are observing low user overlap between iQIYI Lite and our main app, with such overlap continuing to decline. The consumption of library content is much higher on iQIYI Lite, showing differing user behaviors between these two apps. As for our interest-based community, Suike continued to improve and enrich our content ecosystem. For the full year of 2021, Suike contributed about 17% of user time spent on our platform. Interest-based video constitutes one of the very important components of our content ecosystem. With the relatively low cost of content on Suike, it eased our cost pressure to some extent. Additionally, traffic generated by Suike contributed to the growth of performance ad inventory, driving revenue growth. We hope that user-generated short-form videos will attract attention and drive the consumption of respective long-form videos, creating a closed loop for our online video ecosystem. Special events in Q4. During the quarter, we optimized the organization structure and created a flatter organization, which helped us to bring more focus back to our core business and increase the efficiency of our operations. As a result, there were non-recurring severance costs recorded in the fourth quarter. By optimizing the organization structure, we have assembled a more elite team, which enables us to better focus on our core business and improve operational efficiency. To summarize, we have seen initial positive effects from our cost optimization and organizational alignment. Despite the turbulence in the past year, we still maintained our market leadership while dramatically improving our business performance. We will keep enriching and improving the quality of our diversified content portfolio, refining operations of our theater model, improving the efficiency of content investment, and cultivating a content ecosystem that grows our community culture. Additionally, we aim to continue increasing our penetration in different geographies and user cohorts through iQIYI Lite, large screens, and overseas business initiatives; as a result, our fundamentals will continue to improve. Again, our goal is to reach non-GAAP operating breakeven for the full year of 2022 and to reach quarterly non-GAAP operating breakeven as soon as possible. We are confident and look forward to bringing everyone a better and healthier iQIYI in 2022. Now I will hand over to Mr. Jun Wang to go through our financials.

Thanks. Now let me walk you through our key financials for the fourth quarter. In this quarter, we introduced the concept of non-GAAP operating loss for the very first time. We believe it will help our shareholders to better understand and track our business performances. So, starting with revenues, in the fourth quarter, our total revenues reached RMB7.4 billion, a solid performance considering macro headwinds. Our Membership Services revenue increased by 7% year-over-year, mainly driven by the growth of membership ARM, or Average Revenue per Membership. Our fourth quarter ARM increased by 14% annually and 4% sequentially. We expect the momentum to continue going forward. Next, moving to cost and expenses. With all the initiatives previously explained, the fourth quarter cost of revenue decreased by RMB277 million compared with the same time last year, which contributed to the narrowing of our operating losses. On the other hand, our operating expenses also decreased by RMB125 million, down by 6% year-over-year, along with one-time severance costs. As a result, our fourth quarter non-GAAP operating loss decreased significantly, down 45% annually from RMB941 million to RMB516 million, representing a saving of RMB425 million. Compared with the previous quarter, the non-GAAP operating loss was also narrowed by RMB557 million or 52% sequentially. Heading into the first quarter of 2022, we expect to see further significant improvements in both GAAP and non-GAAP operating losses compared with the fourth quarter of 2021. Again, this is a result of our initiatives in cost optimization and efficiency improvement. Our goal is to reach non-GAAP operating breakeven for the full year of 2022 and to reach quarterly non-GAAP operating breakeven as early as possible. As of December 31, 2021, the company had cash, cash equivalents, restricted cash, and short-term investments totaling RMB4.4 billion. For detailed financial data, please refer to our press release on our IR website. Now I will open the floor for Q&A.

Thank you. The first question comes from the line of Alicia Yap from Citi. Please go ahead.

Hello. Thank you. My question is related to cost and profitability. It seems like you have successfully narrowed down your loss ratio over the past few quarters. Can management elaborate on how the company has managed to effectively lower the operating losses? I mean, you mentioned about the full year breakeven timeframe. So, is that indicating it's possible that you can even achieve profitability as soon as the second quarter or even the third quarter? Thank you.

In the fourth quarter, we proactively adjusted our operating strategy, focusing on optimizing costs and improving operating efficiency to reduce our overall operating loss. The results have been very encouraging. We also optimized our organizational alignment, which will help to reduce our employee costs and create a flatter operation with a more elite team to help us focus on the core business of iQIYI and improve overall operating efficiencies. On the content side, we are focusing more on high premium quality content, and we won't decrease the number of head content, but we will use the content-related cost ratio to identify low-performing content and proactively drop those content investments. Overall, our processes for investment, procurement, and operations will be refined to increase overall operating efficiency. We built a promotional mechanism focused on increasing the revenue performance of library content, which enhances content portfolio utilization, creates more inventory for advertising, prolongs the life span of our content, and increases subscriber revenue. More importantly, we are driving video industrialization, which creates efficiency for content production and operations. The whole premise is to maintain stable revenue performance, stable market share, and traffic while lowering employee and content costs, as well as marketing expenses. For Q4, as all the investors will see, we have reduced our content costs and operating expenses, narrowing our non-GAAP operating loss by approximately RMB500 million. These positive impacts will continue to be released over the next few quarters. Regarding the breakeven timetable, I would like to emphasize that we are committed to our goal for the year. Our goal is to reach non-GAAP operating breakeven for the full year of 2022 and to achieve quarterly breakeven on a non-GAAP operating level as soon as possible.

Thank you for the questions. The next question will come from the line of Thomas Chong of Jefferies. Please go ahead.

Thanks, management, for taking my questions. My question is about the competitive landscape for the long-form video market. Is management seeing any changes that we need to anticipate in 2022? And number two is more about the content production and procurement side. Are we getting more rational going forward? And finally, on the policy or regulatory environment side, are we seeing the sector becoming more stable? What should we expect in terms of any policies that may come out in the future? Thank you.

For the overall competitive landscape of the online video industry, we believe it is entering a new chapter. In this chapter, we focus more on efficiency, hoping to reduce our operating loss and increase profitability. This is a shift compared to the competitive landscape before when major players concentrated on the quantity of content. Now, we think operating efficiency is much healthier than the market share-driven focus. Regarding content production, the competition should be softer overall, as the process for original production is much longer compared to procuring licensed content, giving us leeway to enhance the quality of our original productions. Regarding policies, we view the current environment as relatively stable. With a better comprehension of the industry's regulatory landscape, we understand the boundaries of content production and scheduling, improving our forecasting capabilities. This will help subscriber growth and advertising revenue. In the past two or three years, our strategic focus has been on expanding original production scale and improving production capabilities. In 2022, everyone will see a significant increase in our original production capabilities and a robust lineup of highly competitive original productions in our pipeline.

Thank you for your questions. The next question comes from Eddie Leung of Bank of America Merrill Lynch. Please go ahead.

So, my question is about membership growth. We have seen a bit of a slowdown last year, probably related to regulation and content issues. Just wondering about the outlook for membership growth this year and in the future. Thank you.

For our overall member subscriber base, we have experienced some pressure in growing membership numbers due to various factors, including COVID impacts, regulatory environment uncertainties, and overall video production capabilities. All these negatively affected our membership growth. Additionally, user time spent on long-form online video has been decreasing, which is a real factor in the market. However, we want to stress the importance of the online video industry; we believe long-form video is a core need for human beings, and its importance is irreplaceable. For the online video market in China, as it matures, it will positively impact the overall industry. Lastly, large screen usage, such as iPads and Smart displays, is increasing, leading to different user behaviors. For mobile phones, communication is the primary use, but for larger screens, video viewing is the key feature. Overall, these trends are positive factors that will contribute to future revenue and subscriber growth alongside average revenue per member. Furthermore, we are noticing better protection for long-form video IPs, which will also benefit our overall revenue growth in the future. Thank you.

Thank you for the questions. Due to time constraints, I would now like to hand the call back to management for closing.

Thank you for joining us today. Feel free to reach out to us if you have further questions. Thank you.

That does conclude today's conference call. Thank you for your participation. You may now disconnect the lines.