iQIYI, Inc. Q4 FY2022 Earnings Call

Thank you for joining us, and welcome to the iQIYI Fourth Quarter and Fiscal Year 2022 Earnings Conference Call. All participants are in a listen-only mode. There will be a presentation followed by a question-and-answer session. I would now like to hand the conference over to Ms. Chang You, Investor Relations Director. Please go ahead.

Thank you, operator. Hello everyone and thank you for joining iQIYI's Fourth Quarter and Fiscal Year 2022 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; Mr. Youqiao Duan, Senior Vice President of our Membership business; Mr. Xianghua Yang, Senior Vice President of Movie and Overseas business; and Mr. Gang Wu, Senior Vice President of Brand Advertising 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, Youqiao, Xianghua and Gang 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 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 the 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. We wrapped up a remarkable year of turnaround, with outstanding performance in Q4 '22. Our market share reached a historical high, as did our membership revenue, operating profits, and free cash flow. To be specific: in Q4, we launched 6 blockbuster dramas, with subscribing members' time spent growing by over 40% annually and 30% sequentially, which is unprecedented. As a result, we continue to gain market share. Our leadership in terms of effective video views in the drama category remained unchallenged, according to Enlightent data. Strong content performance brought the highest quarterly membership revenue in our history, up 15% annually and 13% sequentially. In Q4, our average daily number of total subscribing members was 111.6 million, representing a sequential net addition of more than 10 million. The number of subscribing members as of the end of December was 119.7 million, representing a net addition of over 13 million compared with the end of September. In the meantime, our advertising business continued to recover with a sequential growth rate of 25%. Now let's move on to profit. We had a record-setting quarter of RMB979 million non-GAAP operating profit, up 87% compared with last quarter. The non-GAAP operating margin continues to expand for the fifth consecutive quarter and reached 13% in Q4, showcasing the operating leverage embedded in our business model. In Q4, free cash flow reached over RMB840 million, growing by 4.7 times compared with Q3. We have been generating positive free cash flow for two consecutive quarters. The outstanding Q4 performance is not a surprise. In fact, our Q4 performance may just be the start if we look ahead for one or two years. The driving force behind our current and future success is our ability to produce and deliver high-quality, popular original content, which is our unique core competence. iQIYI Original is now synonymous with the “MUST-SEE SHOW”. iQIYI's brand perception has been elevated from 'iQIYI is capable of creating blockbusters' to 'iQIYI is THE blockbuster powerhouse'. As a perfect footnote to our statement, right after the closing of Q4 '22, we launched the original drama, The Knockout. It has become another major hit, breaking records across every key metric, being the fastest to break iQIYI's popularity index of 10,000, achieving the highest peak popularity index, the highest daily user time spent, the largest daily audience, and the highest membership revenue. The Knockout also generated tremendous social buzz and has become a true nationwide phenomenon. The success of the show demonstrates that the production and operation of our original content has entered a virtuous cycle, with the flywheel effect being released. Stable premium content supply drives user growth, improves cost efficiency and profitability, which supports the company to create more premium content. Therefore, we firmly believe that this success is replicable, and we could exceed our past performance in the future. We believe that our original drama production capability is unique and cannot be easily copied. Because creating a blockbuster has no shortcuts. To get where we are today, we invested numerous resources, including time, capital, talent, and technology. We initiated our original content strategy back in 2014 and made substantial breakthroughs in 2022 after almost a decade of persistent efforts. In the most recent two years, our investment in original content almost reached RMB20 billion. With time and money, we have established in-house studios that bring together the industry's most creative talent. We have also gradually established our complex, data-driven, and highly efficient decision-making system that can capture every critical moment in the entire lifecycle of content production. As a result, we have witnessed the gradual ramp-up of high-quality original dramas. Among the key dramas we launched each year, the proportion of original productions increased from 20% in 2018 to over 50% in 2022. For 2022, original content accounted for over 60% of blockbuster dramas and also contributed more than 60% of the revenue during the new release window. In Q4, the total subscribing members' time spent on original content doubled year-over-year. Hence we conclude that we enjoy structural advantages that are very difficult for others to imitate. The entry barrier is extremely high. In the past 12 months, we have completed three rounds of capital raising, with proceeds totaling around $1.3 billion to remove debt overhang. We truly appreciate the generous support of our investors who are as confident as we are in the future of iQIYI. With a healthier balance sheet and cash-generating business, the management will be able to focus entirely on accelerating the company's growth and creating more value for our investors. Looking ahead to 2023, we will start a brand new journey. We have upgraded our 2023 annual goal to achieve high-quality growth. Under this strategy, our goal is to achieve growth in revenue and operating profit to realize high-quality growth. We will continue to invest in our core business while remaining cautious when assessing material new business opportunities. We will continue to invest in top premium content to maintain a high-quality yet diversified content pipeline and to invest in high ROI marketing and member benefits. Also, we keep a close eye on industry opportunities powered by technological advancement, such as AI-generated content (AIGC) and other innovative technologies. We will explore AIGC application scenarios in the long-form video industry together with our strategic partner Baidu in areas such as improving content production efficiency, content distribution, and promotion. We believe the AIGC strategy will help iQIYI unlock even more potential, further improve our overall business efficiency, and generate greater value. Now let’s go through the detailed performance of our business segments, starting with membership services. Membership services revenue was RMB4.7 billion, the highest in our corporate history, representing an increase of 15% annually and 13% sequentially. As we had a very strong quarter of blockbuster content, we utilized the opportunity to attract and grow our subscriber base with a marginal increase in average revenue per member (ARM). Our subscriber base showed strong growth in Q4, with the average daily number of total subscribing members at 111.6 million, a net addition of 10.6 million compared with Q3. The total number of subscribing members was 119.7 million as of the end of December, a net addition of 13.5 million compared with the end of September. Very importantly, we are glad to see the improvement in membership structure, with the proportion of annual subscribers increasing significantly in Q4 compared to the same period last year. We believe the higher subscription rate for annual packages will help improve stickiness and long-term monetization. In Q4, our monthly ARM was RMB14.17, up 2% sequentially. We further raised our membership pricing in December, which will drive ARM increase in the future. For our membership business, we are committed to growing revenue. In the long-term, we believe our ARM has plenty of room to grow as we continue to upgrade content quality and bring more value to our users. In the short-term, we strategically choose to optimize the growth of subscriber base and membership duration so that more people can enjoy our content and the relationship between the platform and users becomes more enduring. A good example is that as the monthly ARM of the annual package is lower than the monthly package, when we enroll more annual subscribers, our average ARM might be impacted in the short-term. However, we value our relationship with subscribers and believe that the long-term trust we build with them will bring more strategic value. In Q4, we continued to expand our exclusive membership benefits package, including exclusive IP-based souvenirs and limited-time discounted offers, as well as exclusive fan events. Moving on to content in Q4, we continued to lead the market with dominant market share. According to Enlightent data, we remain number one in terms of effective video views for both overall dramas and exclusive dramas categories, reaching quarterly new highs in the past two years. For variety shows, we also ranked number one in terms of effective video views, with the launch of popular original programs including Super Sketch Show 2, Memoon Player, and Folk 2022. 2022 was a harvest year for our dramas. We had the most number of blockbusters that covered diverse themes, released evenly throughout the year. First, we launched five dramas with popularity index over 10,000 in a single year, with four of them being originals. Not only did we bring our content quality to the next level, but we also significantly improved our financial performance and generated profitability at scale. Second, our content releases covered diverse themes, including modern-themed A Lifelong Journey, Ordinary Greatness, and Wild Bloom; the ancient costume epics Love Between Fairy and Devil and New Life Begins; the suspenseful Strange Tales of Tang Dynasty; and the fantasy and youth story The Heart of Genius. Third, the timing of our releases was evenly spaced throughout the year. The five blockbusters with a popularity index over 10,000 were released at the beginning of the year, during summer vacation, and during winter. Users can turn to iQIYI to watch the most current hit shows at any time. We also maintained the best word-of-mouth in the industry. Among the top 10 highest-rated Chinese dramas on douban.com in 2022, seven were iQIYI's exclusive dramas and four were original productions. Our original titles Ordinary Greatness and Wild Bloom ranked first and third respectively. As we move into 2023, we plan to launch a number of highly anticipated dramas. Original productions Unchained Love and The Knockout were launched in Q1 and highly acclaimed by users. The Knockout became another mega-hit and a true nationwide phenomenon. Just to name a few highlights: first, it has the highest popularity index score and is the 8th drama that broke the popularity index of 10,000, generating huge social buzz and high word of mouth, with a peak Douban score of 9.1. Only very selective Chinese dramas have such high scores. The drama was broadcasted on leading national TV networks including CCTV and BRTV, all of which had outstanding viewership. Just on CCTV network alone, The Knockout has been watched by over 300 million audience members so far. During 2023, a variety of key dramas will be launched, such as the ancient costume epics, The Demon Hunter’s Romance, Story of Kunning Palace, Destined, and Fox Spirit Matchmaker. Modern-themed dramas such as Miles to Go, Take us Home, and We Are Criminal Police, among others. For original variety shows, we will continue to launch multi-season shows and introduce new programs. We will focus on building franchise values and enhancing synergy between dramas and variety shows. Please also anticipate a slate of well-crafted original movies, children's content, and animations. Our advertising business recovered sequentially in Q4, with total ad revenue of RMB1.6 billion in Q4, up 25% sequentially and down 7% annually, which was significantly narrowed from the 25% annual decline in Q3, exceeding our expectations at the beginning of the quarter. In particular for Q4, brand ads returned to double-digit sequential growth, and the year-over-year decline continued to narrow better than anticipated. The sequential growth was beneficial from three factors: first, hit dramas and variety shows attracted ad budgets; second, the domestic reopening boosted advertisers' confidence and increased ad demand; and third, there was growth in sectors such as internet services, telecommunications, and healthcare. Heading into 2023, we believe reopening will support economic recovery. We are positive about brand ads for the full year 2023 and expect to see healthy growth compared with 2022. For performance ads, we achieved strong revenue growth both sequentially and annually, driven by algorithm optimization and tailored operational initiatives for advertisers from the e-commerce, internet services, and online game sectors. We believe that iQIYI’s core user group is highly attractive for advertisers and that with our appealing content and advanced technology, we will be able to effectively help advertisers increase their brand influence. In the future, we will adopt multiple strategies to improve our ads business. We will focus on growing our revenue scale and offering tailored campaigns on large screens. Meanwhile, we will continue to develop the ad-supported basic subscription package on iQIYI Lite, which is similar to Netflix's low-priced ad-supported initiative. We believe the solid growth in iQIYI Lite basic subscription package will drive ad inventory on our platform and lead to ad revenue growth. Moving onto technology and products, technical innovation is one of our core values. We continuously promote video industrialization and improve efficiency in content production and distribution through innovative technologies. We started to explore AIGC-related opportunities since mid-2022 and have seen promising results. We believe our rich video entertainment resources, combined with cutting-edge technologies, will empower iQIYI to further improve efficiency in content production, distribution, and other areas. On February 15th, we announced the strategic cooperation with Baidu, and both companies will jointly explore AIGC application scenarios through Baidu's Ernie Bot. We anticipate that content distribution and promotion will be among the earliest areas to be implemented, and this cooperation will further accelerate our progress in AIGC-related areas. We look forward to implementing more applications as we strengthen our technology advancement in the future. Moving on to new business: first, iQIYI Lite. In Q4, iQIYI Lite reached breakeven for the first time and recorded solid revenue growth both annually and sequentially. We continued to develop the monetization model of iQIYI Lite, and the new ad-supported basic subscription package was well-received by users. Moving onto overseas business, in Q4, overseas membership revenue increased 30% year-over-year and the growth rate in America and Canada exceeded 70%. Original content, especially original dramas, performed quite well. Our original Chinese dramas, New Life Begins, achieved the top ranking in Thailand, the Philippines, Indonesia, and South Korea only three days after its launch. We are also delighted that our original dramas released in Q4 attracted advertising budgets. In 2022, we successfully completed an iconic turnaround with substantial improvement in financial performance, business operations, and market share. Meanwhile, our unique content production methodology helped us produce a continual stream of blockbusters, enhancing our core barrier. Our industry-leading original content production ability and superior operational capability are our core competitive strengths and the key to our rapid long-term growth. As we move through 2023, we are committed to delivering high-quality growth. We firmly believe our best days are yet to come. We will release the flywheel effects of our business and bring higher value to our users, partners, and stakeholders. Now let me pass on to Jun to go through our financial performance.

Thanks Mr. Gong, and hello everyone. Q4 was a record-setting quarter for our membership revenue, operating profits, operating cash flow, and free cash flow. The operating margin continued to expand driven by operating leverage. In addition, we raised around $1.3 billion over the past 12 months to remove the debt overhang. With operational and financial performances in great condition, and significant capital structure enhancement, the management will be able to focus on delivering high-quality growth in the long run. Now I would also like to take this opportunity to review the overall performance for the year 2022 for iQIYI. First, we delivered what we promised earlier in the year. We set a goal of reaching non-GAAP operating breakeven for the full year of 2022 and ended up with a non-GAAP operating profit of RMB2.2 billion, far exceeding our expectations. Then we shifted our operational focus from cost reduction in Q1 and Q2 to scaling up in Q3 and Q4 and rolled out our calm growth strategy in the middle of the year, which resulted in healthy expansion of market share, membership services revenue, and profit in the second half. The momentum continues beyond December 31, 2022. Additionally, we also promised to protect the interest of all stakeholders and address the immense challenge of debt overhang despite the extremely volatile market, and we made that happen. Secondly, we humbly ask our investors to look beyond iQIYI-specific achievements and reassess the long-form video industry as a whole. iQIYI continued to outperform to deliver alpha, but the ROI for the entire industry was quickly recovering throughout 2022 as well, driven by structural change on the supply side: less quantity, more quality, and more concentrated supply of platform-originated content lead to higher hit ratios and more efficient cost control. On the demand side, as Mr. Gong mentioned, long-form video remains a fundamental entertainment need for the mass market. Over time, the higher quality of content naturally leads to a higher willingness to pay, hence a higher ARM. We are in a virtuous cycle and will see a more promising future. Third, we would like to thank everyone who supported us in a very dramatic 2022, including our users, employees, content partners, shareholders, bondholders, and creditors. Our commitment to achieving healthy business growth remains unchanged, and we are more confident than ever in our ability to generate value for all stakeholders in the long run. For detailed financial data for Q4 and fiscal year 2022, please refer to our press release on our IR website. Now we will open the floor for Q&A.

Thank you. The first question is from Xueqing Zhang from CICC. Please go ahead.

Thank you for taking my question and congratulations on your impressive performance, indicating that The Knockout was a major success in January. How does management view the overall content trend in the first quarter? As mentioned in the letter to investors, people recognize iQIYI as a leader in blockbuster content. Can management share insights on how to continue producing original blockbusters in the future? Lastly, how should we approach the number of subscribing members in the long term? Thank you.

First of all, the Q1 content was excellent and exceeded our expectations. For the overall content performance, I will invite our CCO, Xiaohui, to answer the question. In regards to the membership business, we will invite our Senior Vice President, Youqiao Duan, to answer the question.

As a media platform, one of the main goals for iQIYI over the past decade has been to systematically enhance the success rate of blockbuster productions. Reflecting on our content performance this past year, with dramas like Love Between Fairy and Devil, Wild Bloom, New Life Begins, Chasing the Undercurrent, Homesick, and the recent The Knockout, we can observe the continuity and diversity of our blockbuster offerings. The first key competitive advantage is our talent. Through our in-house studio strategy, we have created several distinct and diverse studios that attract the most creative minds in the industry, who resonate with the unique qualities of creative work. Additionally, we've built a robust supporting mid-platform that streamlines the content production process, improving efficiency and increasing the likelihood of successful outcomes. The second advantage is our internal development content management system, which is complex, data-driven, and enhances decision-making throughout the content production lifecycle. The third is our operational strength. We possess strong capabilities in content operation that encompass creation, production, scheduling, and promotion. The fourth advantage lies in our innovative and intelligent technology; we utilize smart production technology to significantly enhance efficiency and reduce costs, ensuring a solid foundation for our content production. The fifth advantage is our industry insight. With years of experience in the field, we have developed clear perspectives on content creation and a precise understanding of the preferences of the Chinese entertainment consumer market. These factors collectively represent our core competitive strengths. Consequently, our current content production system and robust operational capabilities will enable us to maintain a steady and ongoing supply of premium content in the future. Thank you.

In 2022, we continued to enhance our membership operations, sales, and subscriber base, resulting in strong growth momentum. In the fourth quarter, we broke through the subscriber range that fluctuated over the past two years. We are optimistic about the continued growth of our subscriber base in 2023. By the end of December, our subscriber count approached 120 million. Our high-quality content has allowed our subscriber base to maintain a strong level and show consistent growth since the start of the year. The structure of our subscriber base has become more optimized, with increases in annual memberships, membership packages, and large screen subscribers, which will enhance the platform's membership retention and long-term monetization potential. Over the long term, the potential of the domestic subscriber base will be influenced by the consumption of long-form video content, the number of families, and the competitive landscape of the industry. There remains significant room for subscriber growth compared to the number of internet users and families in China. Looking ahead, the membership business shows favorable prospects in both direct-to-consumer sales and channel sales markets. In the direct-to-consumer market, there is a strong demand for long-form video memberships in the mass entertainment sector. In the channel sales market, our video membership packages have also become preferred products among partners in telecommunications, internet services, and financial sectors. Furthermore, as our content quality continues to improve, it will surely enhance subscribers’ willingness to pay and boost our monetization capabilities in the future. Thank you.

Thank you. Your next question comes from Lei Zhang from Bank of America Merrill Lynch. Please go ahead.

Thank you to the management for addressing my question and congratulations on the impressive results. My question is primarily about the online industry; we have seen that key players have concentrated on ROI and content quality in 2022. How should we view the future development of the industry? Thank you.

I believe that there is a general agreement in the industry that there is a fundamental demand for long-form video memberships in the mass entertainment market. A few years ago, some players were skeptical, but now it seems that the consensus has shifted. At the end of 2021, we recognized that changes in the online video market would lead to a new phase of growth for the industry. Competition in long-form video is now focusing more on content quality rather than just quantity, and many players are working on improving operational efficiency and profitability. Our experience over the past year has shown that enhancing the quality of video content results in better returns on investment. The results from 2022 confirm that our understanding of the industry's structural changes was accurate. Our significant turnaround last year was due to advancements in our original content production. This trend is also seen among our industry peers, who are experiencing a greater variety of content, increased success rates, and improved cost management, all of which promote a greater willingness to pay among audiences, thus creating a positive feedback loop for content production. We also see potential for users to subscribe to multiple membership packages from different video providers. We are proud of our turnaround last year and continue to lead the industry. Our aim for next year is to achieve high-quality growth, meaning we plan to grow in terms of both revenue and profit. I recognize that this may put pressure on others in the industry, but as a leader, we view it as a good sign. The increasing returns on investment will facilitate a swift recovery for the industry, benefiting all players eventually.

Thank you. Your next question comes from Lincoln Kong from Goldman Sachs. Please go ahead.

My question is about AIGC-generated content, particularly its application in video. How does management view the potential total addressable market and possible applications in this area? Additionally, we've noticed the company has formed a partnership with Baidu. What specific developments should we anticipate from this collaboration?

Our iQIYI corporate vision is to be a technology-based entertainment giant. We believe that technological innovation is always a key factor in promoting the evolution of the video industry. We have been investing in artificial intelligence for computing, audio and video technology, among others, to enhance the efficiency and quality of content production and improve viewer experience. AIGC serves as a powerful engine for data processing and content production using AI technology. By leveraging AIGC technology, we aim to expand iQIYI's capabilities in content creativity, enhance production efficiency, and improve quality and user experience. Since mid-2022, we have been exploring applications of AIGC in the video space. Currently, we are investigating several aspects: In the scripting stage, content creators can utilize iQIYI's intelligent production system, which sparks more creative ideas while enhancing efficiency and reducing costs. During the production stage, this system can intelligently analyze and process scripts, effectively extract story outlines, and provide valuable information throughout project planning, post-production, and marketing, thereby improving overall efficiency and quality in video content production. Regarding content marketing and promotion, AIGC can generate numerous marketing videos and materials, enhancing the efficiency and impact of our marketing efforts. In the future, content creators will also be able to use AI to automatically generate video commentary scripts, further enhancing efficiency and quality in video recreation. This will greatly enrich short-form video content that promotes our dramas, variety shows, and films, attracting more users to engage with our content. It will also effectively promote our extensive library content, extending its lifecycle. AIGC can create personalized poster images for any content, helping it reach the right audience and improving the content recommendation experience for users. The video search experience will be enhanced as well; through conversational AI capabilities, users will be able to search for plots, discover stories of specific themes, or receive binge-watching recommendations, making it easier for them to find relevant content. We believe that combining AIGC technology with iQIYI's abundant online video entertainment resources will further drive industry development and enhance user experience. We plan to continue increasing our investment in this area. On February 15, 2023, we announced a strategic cooperation with Baidu, with both companies set to explore AIGC application scenarios through Baidu's ERNIE Bot in various areas such as content creation tools, content distribution and promotions, content search, and novel creation. We believe this partnership will further enhance iQIYI's production capabilities in creativity, efficiency, and user experience. Thank you.

Thank you. This is the last question for today. I'll now hand back to iQIYI management for closing remarks.

Thanks to everyone for joining the call today, and please do not hesitate to reach out to us if you have further questions. Thank you.

Thank you. Bye-bye.

Thank you. That does conclude our conference for today. Thank you for participating. You may now disconnect.