iQIYI, Inc. Q1 FY2023 Earnings Call

Thank you for joining us for the iQIYI First Quarter 2023 Earnings Conference Call. I will now turn the call over to Chang You. Please proceed.

Thank you, operator. Hello, everyone and thank you for joining iQIYI's first quarter 2023 earnings conference call. The Company's results were released earlier today and are available on the Company's Investor Relations website at ir.iqiyi.com. On the call today are Mr. Yu Gong, our Founder, Director and CEO; Mr. Jun Wang, our CFO; Mr. Xiaohui Wang, our CCO Chief Content Officer; Mr. Wenfeng Liu, our CTO Chief Technology Officer; and Mr. Youqiao Duan, Senior Vice President of our membership 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 and Youqiao 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 our public filings with the SEC. iQIYI does not undertake any obligation to update any forward-looking statement except as required under applicable law. With that, I will now turn the call over to Mr. Gong. Please go ahead.

Hello everyone. We started 2023 with an exceptionally strong first quarter, entering a new chapter of high-quality growth. Our content flywheel once again demonstrated its power. The exceptional iQIYI originals drove financial performance and market share to new highs. To be specific: iQIYI maintained its dominant leading position in dramas, reaching new highs in market share. Our long-standing original content strategy bore fruit once again. The Knockout became the best-performing drama in our history. In Q1, original content continued to be the main driver of new releases and revenue performance and further reinforced the brand perception that 'iQIYI is the blockbuster powerhouse' and significantly improved subscriber stickiness. Both total revenues and membership services revenue hit quarterly all-time highs. Total revenues recorded double-digit growth both annually and sequentially. In particular, the core membership services revenue reached new highs, up 24% annually and 17% sequentially. High-quality original content drove robust growth in our subscriber base. In Q1, the average daily number of total subscribing members approached 129 million, with a quarterly net addition of over 17 million. This marks the second consecutive quarter with quarterly net additions of over 10 million. As of March 31, the number of subscribing members was 120 million, reflecting the usual seasonality following the Chinese New Year and marking our best-ever end-of-Q1 performance. Non-GAAP operating income exceeded RMB1 billion in Q1, expanding for the sixth consecutive quarter. More importantly, free cash flow also exceeded RMB1 billion this quarter, a critical milestone as we steadily become more self-sustaining. As we mentioned last quarter, we believe these recent solid results are just the start of a phase of high-quality growth. In Q1, we witnessed the power of premium long-form video and its strong appeal to users. Our ability to produce and deliver highly popular original content is our core competence, which is difficult to surpass in the short term. We will continue to evolve to secure our industry-leading position in the long run. Currently, our businesses can be classified into three stages: core, growth, and early stage. Our core businesses include membership services, online advertising services, content distribution, IP licensing, etc. Our growth businesses include iQIYI Lite and Suike. Our early-stage businesses include our overseas business and cloud cinema business. Now, let's go through the performance of our business segments in detail, starting with membership services. Both membership services revenue and the number of subscribers hit record highs in Q1. Membership services revenue surpassed RMB5.5 billion, up 24% annually and 17% sequentially. The average daily number of subscribing members reached 128.9 million in Q1, a sequential net addition of over 17 million, marking the second consecutive quarter with a net addition of over 10 million. ARM was RMB14.3 in Q1, up 1% sequentially. I'd like to reiterate that the goal of our membership business is maximizing user experience and, in return, strengthening and optimizing our financial performance. The economics of our membership business are driven by three factors, namely, subscriber base, subscriber lifetime, and ARM. We take a dynamic and balanced approach to our membership business based on many factors, including content supply, user demand, and the market environment. This allows us to drive continuous improvements in both membership revenue and user experience. The above-mentioned strategy has helped us build stronger, longer, and broader relationships with our users. We saw further optimization of our membership structure and stronger user engagement in Q1. The proportion of annual subscribers increased significantly year-over-year, while the lifetime value and long-term retention rates also improved. In addition, our membership products reached even broader user cohorts in Q1. We saw strong growth from both subscribers with large-screen privileges and iQIYI Lite’s ad-supported basic subscription package, which targets differentiated user demographics. So what drove the strong growth in Q1? First, the diversified premium content we released drove new subscribers and improved user retention. Among the strong content offerings, The Knockout broke several records and is the best-performing drama that generated the highest membership revenue during the new release window. In addition, dramas such as Unchained Love, Homesick, Every Day and Night, Under the Microscope, and Road Home were all well-received by users. Second, we continued to refine our membership business operations, increasing members’ value perception with enhanced benefits. For example, we improved subscriber conversion and monetization efficiency through sophisticated user analysis, content- and scenario-based marketing initiatives, and in-depth research into user growth strategies. In addition, we upgraded our membership center, introducing various high-quality benefits, which drove a significant increase in member benefit consumption in Q1. Looking forward to 2023, we will continue to focus on driving high-quality growth and pursue further growth in revenue, subscribers, and ARM. Moving on to content. During the quarter, our content methodology remained highly effective, and our brand image as 'a diversified and high-quality premium content powerhouse' reached new heights. Not only did our market share for dramas reach new highs, we remained number 1 in terms of effective video views for both overall and exclusive dramas categories for the fifth consecutive quarter. Original content continued to account for the majority of drama supply and revenue. Original content accounted for 70% of the key dramas we released in Q1, the highest in our history. The revenue contribution ratio of original content also reached new highs. As the best-performing drama in iQIYI history, The Knockout was a true mega hit that broke records across multiple key metrics and generated phenomenal social buzz. Meanwhile, iQIYI originals have become a major source of content supply for domestic TV networks, including CCTV and provincial satellite channels, with whom we have built long-term partnerships. We are the clear industry leader in this area. In Q1 alone, we distributed around 20 premium dramas to CCTV and provincial satellite TV stations, including The Knockout, Every Day and Night, and Miles to Go. Both the volume and revenue of distributed content reached record highs. The Knockout also became the highest-rated show of the past three years on the major domestic drama channel CCTV-8. As an online media entertainment service provider, our goal is to systematically increase the hit ratio of our premium content. Our long-term commitment to original content has provided us with a structural advantage in the industry. Through the years, we have successfully built three strong pillars that support our premium content offerings, namely optimized content production mechanisms, strong operating and technical capabilities, and top talents. These capabilities will empower us to steadily grow the volume of high-quality content to further enrich our premium content offerings. For content production, we significantly improved our industrialized video content production capability through our sophisticated content management mechanism and content production tools. We believe these create effective competitive barriers that are difficult for others to surpass. For content management mechanism, we have established an efficient and comprehensive mechanism running through the full process from project incubation to assessment, production, promotion, operation, and distribution. For content production tools, we built in-house developed systems to support industrialized video production based on AI, big data, and cloud computing. Through these methods, we can further improve our content production and operational efficiency and set a new standard for the Chinese video industry. Regarding industry talent, we have a compelling creator culture and a talent cultivation mechanism that's highly valued and appreciated by our in-house talents and industry content partners. Our approach is reflected in two aspects: first, in addition to providing competitive economic incentives, we give creators sufficient freedom, allowing them to take initiative and unlock their creativity within our disciplined framework. Second, we have always been committed to encouraging fresh young talents. In addition to working with well-known and experienced creators, we also nurture young and emerging talents and help them develop their potential. In 2023, we will continue to launch diversified content across all genres. For dramas in Q2, Echo directed by renowned Chinese director Feng Xiaogang, Thirteen Years under our Mist Theater, and The Ingenious One have generated positive word-of-mouth. Also starting from Q2, a number of key costume dramas will be released, including Story of Kunning Palace, The Lotus Casebook, Destined, and Love You Seven Times. A diverse lineup of dramas in other categories will also be released. A number of original variety shows will also be launched in Q2, including both returning seasons of hit shows and the debut of new titles. In addition to the already-aired Believe in the Land, HAHAHAHAHA 3, Yes, I Do, and The Detectives' Adventures 3. Please also anticipate the launch of our flagship titles such as The Rap of China 2023. Looking ahead, we plan to increase our investment in variety shows in step with the gradual recovery of the advertising market. For Q2, please also anticipate new releases in other categories, including original children’s cartoons Tuktak Man 7 and The Roofus, and original animations The Guardian Legend and Are You OK? 2. Moving on to Advertising. We are pleased to see that advertising revenue reached RMB1.4 billion in Q1, up 5% year-over-year. For performance advertising, revenue grew 75% annually and its revenue contribution reached new quarterly high. We successfully acquired a higher share of advertising budgets from key industries, including internet services, e-commerce, and games, and made full use of ad slots to effectively improve monetization. In addition, we optimized our algorithms to strengthen user targeting and improve ad effectiveness. For brand advertising, Q1 was soft due to typical seasonality. The year-over-year decline was due to the relatively high base in Q1 last year, and the ad market back then was not impacted by the pandemic lockdown in Shanghai, which is the main hub for the domestic advertising market. Despite that, we observed a growing preference among advertisers driven by our premium drama, variety shows, and diversified ad products. The launch of a number of variety shows in Q2 is likely to drive the recovery of the brand advertising business. We are cautiously optimistic about the overall brand advertising market this year. Consumption is still recovering in the first half of this year, and we expect to see further recovery in the second half. Overall, we are positive about the long-term development of the brand advertising market. Meanwhile, iQIYI’s brand influence and user base are highly valued by advertisers. In terms of ad sectors, we are optimistic about the FMCG sector, which includes food and beverage, travel, domestic, cosmetic brands, smart home appliances, and healthcare. Moving on to Technology & Products. Technical innovation is one of our core values and is critical in driving video industrialization and improving content production efficiency. For virtual production, the technology has been applied in two of our key original dramas. Film sets that adopted this technology saw efficiency improvements of over 30% and reduced the required crew members by one-third. The iQIYI Video Production Management System is a data-driven and highly efficient decision-making system that captures every critical moment in the entire content production process. For example, the system can complete AI-powered revenue projection in just a few minutes. It can also generate estimated content-related cost ratios, a key measure that we use in our original content’s decision-making and efficiency monitoring process. Management can utilize these tools to monitor production progress, ROI, fund usage, and manage the overall production in real-time. We continuously optimize our products with the aim of bringing the ultimate entertainment experience to every user. iQIYI APP was honored by the Ministry of Industry and Information Technology for providing user-friendly access tailored for the elderly and disabled. We also upgraded iQIYI’s semantic search capability to better understand users’ search intentions. The 'search by character' feature launched in Q1 helps users quickly find videos based on characters, providing a highly efficient way to search for videos. We are actively exploring how generative AI applications, built upon Large Language Model (LLM), can improve content production and promotion efficiency in the long-form video industry. Our internal assessment indicates that generative AI technology can be implemented in multiple business scenarios, including streamlining script brainstorming, creation, and review processes. We have initiated the integration of generative AI technologies into our intelligent production systems and expect that the resulting LLM-empowered intelligent production systems will achieve higher performance and better outcomes. By combining LLM applications with computer vision and audio models, we can gain deeper insights into video content, resulting in significantly improved quality and production efficiency of promotional images and videos for use in advertising and content marketing. Text-to-image and text-to-video applications are also valuable tools for generating pre-visualization during production preparation and for use in comic and animation production processes. Next, I’d like to discuss the progress of iQIYI Lite and our overseas business. In Q1, iQIYI Lite maintained high-quality growth and once again recorded operating profits. For the ad-supported basic subscription package, the number of subscribers grew by over 70% sequentially and revenue grew by over 80% sequentially. For the overseas business, driven by the outstanding performance of premium content, the membership revenue achieved solid growth in the quarter. The membership revenue growth rate exceeded 90% annually in regions including the U.S., Hong Kong, Japan, and Mexico. The influence of original Chinese dramas continued to grow, with revenue growth of 54% annually. The Knockout topped viewership rankings in multiple markets in Southeast Asia and North America, generating outstanding word-of-mouth and huge social buzz. Heading into Q2, we have a solid pipeline of premium titles, including key costume dramas and original Chinese dramas that will drive the growth in both subscriber numbers and revenues. In summary, Q1 represents our solid first step into the new stage of high-quality growth. After 13 years of development, our industry-leading brand influence is deeply embedded in the minds of users and industry peers. We are confident about the future prospects of the industry. And as a market leader, our business has strong resilience and promising growth potential. We treasure the trust and support of our stakeholders and will keep pushing ourselves to unleash more potential and achieve high-quality growth over the long term. Now, let me pass on to Jun to go through our financial performance.

Thanks, Mr. Gong. And hello, everyone. Q1 was another record-setting quarter for us. We achieved historical highs across all key aspects. Not only did we achieve all-time highs in total revenues and membership services revenue, but we also further improved our profitability, cash flow, and balance sheet. The exceptional Q1 result was once again driven by the success of our original content strategy. To be more specific, we booked RMB8.3 billion in total revenues, hitting a quarterly all-time high, up 15% annually and 10% sequentially. Membership services revenue continued to serve as the biggest growth driver, with revenue exceeding RMB5.5 billion, up 24% annually and 17% sequentially. Meanwhile, our advertising revenue and content distribution revenue grew by 5% and 16% respectively on an annual basis. Moving on to costs and expenses, our cost of revenues increased by 10% sequentially, among which content costs increased by 7% sequentially. We launched more diversified premium original content in the first quarter, as Q1 is a typical high season with the Chinese New Year holidays. Total operating expenses increased both annually and sequentially, mainly due to an increase in SG&A expenses. We devoted more resources to marketing as we believe this could amplify our content influence, increase user penetration, and enhance the strong momentum generated by our slate of original content. For Q1, we continued to strengthen our profit and cash flow generating capability. Non-GAAP operating income exceeded RMB1 billion, expanding for the sixth consecutive quarter. More importantly, free cash flow also exceeded RMB1 billion. In Q1, we raised approximately US$1.1 billion through follow-on and convertible notes offerings. We also repurchased approximately US$340 million principal amount of the convertible notes due 2026. As of the end of Q1, the company had cash, cash equivalents, restricted cash, short-term investments, and long-term restricted cash included in prepayments and other assets of RMB6.3 billion. This RMB6.3 billion cash balance does not include the payment of around US$1.2 billion to the paying agent to meet the Company's repurchase obligation on April 1, 2023, for the convertible notes due 2025, which was classified as 'prepayments and other assets' on the balance sheet. The repurchase has been completed in April 2023. To conclude, the first quarter results demonstrated the success of our high-quality growth strategy. We will continue to focus on execution and are confident in our ability to generate more value for our stakeholders in the long run. For detailed financial data for the first quarter, please refer to our press release on our IR website. I will now open the floor for Q&A.

Your first question comes from Xueqing Zhang from CICC.

I now will translate myself. Congratulations on the results. My question is related to content and content costs. What's the trend of the company's investment for this year and in the longer term? And what is the level of this year's production compared to previous years? Also regarding the income statement, how does management think about the growth rate for this year and in the future? I'll ask if management could share with us the highlights of the pipeline this year.

I would like to invite our CCO, Xiaohui, to answer the content-related question.

For this year and over the next ones, overall content costs will remain stable with a marginal increase. And in the long run, we will maintain a reasonable content launch schedule and also a relatively stable content cost level. Secondly, we'll continue to invest in high-quality original content; the numbers and proportion of high-quality original content will increase in the future. Compared with last year, the number of titles going into production this year will also increase in order to meet the demand for head premium content inventory and the launch schedule. For dramas, starting from Q2, we will start to launch this year's key costume dramas, including, for example, Story of Kunning Palace, Destined, The Lotus Casebook, Love You Seven Times, etc. We will also launch modern dramas, including Bright Eyes in the Dark, We Are Criminals, Police, Imperfect Victim, Hello Life, etc. For our variety shows, Q2 will mark a strong return of original variety shows, including both returning seasons of hit shows and the debut of new titles. Investors may refer to the detailed content headline list released last week during our iQIYI World Conference for more detail. Thank you.

I will add on to what Xiaohui just mentioned and explain from the finance perspective. He mentioned that content investment for content costs will remain stable with a marginal increase. Over the past year, including Q1 in 2023, we can see the portion of our original content has been increasing steadily and has been the main driver of high-quality growth over the past period. Right now, because the original content proportion is relatively at a high percentage, we anticipate that going forward, this percentage will remain relatively stable. For our original content, especially now we are entering into a very high-quality stage, we have deployed a very systematic content launch schedule. Because of this, we can launch the content more at ease and at our own pace. Currently, we have a full system from producing the original content to broadcasting, and this is a very systematic programmatic approach in managing our original content. Therefore, our funding needs are relatively stable as well. From financial aspects, we anticipate to see the continued performance of the above-mentioned two points going forward.

Your next question comes from Lincoln Kong from Goldman Sachs.

The question is about the competition. So how do we see the competitive landscape has changed or evolved in the current market? And over the next 2 to 3 years, do we expect any of the other peers to increase their investment in order to grab more market share in the space? And how can iQIYI maintain the competitive edge in the industry?

We have been maintaining our market leadership for the past period. Right now, we think the entire long-form video industry has gone through a structural change. The irrational investment style and wild growth are no longer applicable. Our goal is to pursue profitability and high-quality growth. This is also the consensus of the entire industry and we all think is a very key indicator. In our 13 years of history, we have never been the biggest player in terms of capital in the market. So we actually put more focus on original content and have seen promising results, maintaining a definite market leadership on this front and building competitive strength in this area. Going forward, we will continue to reinforce our competitive strength to ensure our leadership in the long run. We also utilize technology to improve our overall content production process. For example, from screening scripts to invitations, incubation, content launch, and the entire cycle of original production can be covered through our technology-driven tools. Using these tools, we can manage and forecast our original content effectively. To secure a stable supply of our original content and increase the likelihood of producing blockbuster content going forward, we will also utilize AIGC to improve our production efficiency and enhance overall original content quality while also decreasing content costs.

Your next question comes from Daniel Chen with JPMorgan.

So my question is related to the membership business. Could management provide some color on the outlook of the subscriber number in the second quarter and also longer-term? Also, how should we think about the overall growth for the membership service this year and in the long term? And what is our major strategy for the membership business in 2023?

For Q1, driven by strong original content, the Q1 membership services revenue and subscriber base both hit record highs. It is expected that the Q2 membership services revenue and subscriber base will still show significant year-on-year growth. We have estimated that for Q2, the subscriber base and the revenue will be the best-performing second quarter in our history. From a quarter-on-quarter perspective, it is expected that the subscriber base and revenue in Q2 will have some sequential dip, mainly reflecting the seasonal pattern after the Chinese New Year holiday. However, overall, we remain optimistic about the subscriber base and revenue outlook for this year, mainly because of two factors. The first reason is that we are still very confident about the company's headlines and the content launch schedule for this year, especially during major windows such as summer vacations. Our highly efficient content production mechanism, strong operating and technical capabilities, and top talent will enable us to steadily grow the number of high-quality content compared to last year. The second factor is we are seeing the proportion of annual subscribers increase significantly year-over-year. Although it might not have the short-term uplift effect on ARM, the long-term benefit is significant as it represents a longer and closer relationship with our subscribers. This will drive annual revenue performance and also improve cash flow healthiness. Additionally, the lifetime value and long-term retention rate of our various membership packages have also increased; we also saw strong growth from both subscribers with large-screen privileges and iQIYI Lite's ad-supported basic subscriber packages. The main strategy for our membership business this year is to reach high-quality growth, which means maximizing user experience and, in return, strengthening our subscriber base, LTV, and ARM.

The next question comes from Alicia Yap with Citigroup.

Can management share with us your view on the brand advertising outlook this year? And what does the ad demand for each major stock vertical industry look like? In addition, have you seen any meaningful difference in terms of demand sentiment between brand ads and performance ads?

I will talk about brand ads and performance ads separately. For brand advertising, the performance of that is very closely correlated with macroeconomic development. We are seeing the overall ad market recover with the gradual recovery of China's economy, especially in the post-COVID period, but the reflection in the advertising market will lag by 1 or 2 quarters. After April, we are seeing a gradual recovery of brand advertising and we are still very cautiously optimistic about the overall brand advertising market for this year. In the first half of the year, consumption is still gradually recovering, so we expect to see more evidence of recovery in the second half of this year. Overall, we are still very confident in the long-term development of the brand advertising market, as iQIYI is one of the platforms with the highest user quality, the strongest willingness, and ability to pay in the Chinese Internet industry, which can effectively help advertisers enhance brand influence and sales conversion. Looking at the subsectors, the FMCG, retail, travel, entertainment, and health industries have recovered the fastest so far. Since Q2 is the peak season for FMCG and food and beverages and toiletries industry, we expect Q2 should have positive growth, both annually and sequentially. Additionally, Q2 also has key marketing campaigns such as June 18; therefore, the ad budget of some e-commerce platforms should also expect to see some increase to some extent. We are optimistic about the long-term prospects of the new energy vehicle sector and the home furnishing sector. The performance ad market will gradually recover in 2023 with moderate recovery in Q2 in the domestic market, particularly for iQIYI, especially because we have optimized our algorithm and increased our sales efforts. In Q1, our quarter performance was actually above the market industry, and also looking into the future quarters, we expect to see strong growth in Q3 as well. Overall, the performance ad market is currently showing pretty big budget growth in areas such as online services, game launches, e-commerce, travel, and localized advertising.

I'll now hand the conference back to Ms. Yu for closing remarks. Over to you, ma'am.

Thank you. And please note that the previous discussion on Q2 is forward-looking and only represents our current view based on current data points. I would like to thank again for everyone's participation in the call today and please do not hesitate to contact us if you have further questions. Thank you, everyone, and we'll see you next quarter.

Thank you.

Thank you.

Thank you. Bye-bye.

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