iQIYI, Inc. Q2 FY2023 Earnings Call

Thank you for joining us for the iQIYI Second Quarter 2023 Earnings Conference Call. All participants will be in listen-only mode during the presentation, which will be followed by a question-and-answer session. I now want to turn the call over to Chang You, the IR Director of the Company. Please proceed.

Thank you, operator. Hello, everyone and thank you for joining iQIYI's second 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; Mr. Youqiao Duan, Senior Vice President of our Membership 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, the management team will participate 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. I will now pass the floor to Mr. Gong. Please go ahead.

Hello everyone. Thank you for joining us today. Our focus for the quarter remains firmly on generating high-quality growth. Our original company strategy continues to deliver top-notch titles, which, in turn, brought the strongest second quarter performance in our history in terms of key metrics such as total revenues, profits, free cash flow, and average daily subscribers during the quarter. Also, we maintain our industry-leading position in market share for six consecutive quarters. According to our analysis, our long-term drivers continue to play a major role in terms of company supply and revenue contribution. In addition, our recent content releases, like our 13-year anniversary show, have generated highly positive reviews, reinforcing our brand image as a provider of high-quality premium content. Second, from a financial perspective, we have the best second quarter revenue performance in our history, up 17% year-over-year. We recorded double-digit annual revenue growth across all key business lines. Membership services revenue grew by 15% annually, and advertising revenue grew by 25% annually. Meanwhile, our non-GAAP operating income hit RMB786 million, which grew by 129% annually, marking the sixth consecutive quarter of profitability. Furthermore, our ability to generate cash strengthened with free cash flow reaching RMB872 million, positive for four consecutive quarters. Our performance in the second quarter represents another solid step in our pursuit of high-quality growth. We expect the market conditions for iQIYI to continue to transform positively due to rationalized competition, improving return on investment in the streaming industry. As an industry leader, we aim to enhance original content capabilities that drive overall industry advancements. Now let’s dive deeper into the performance of our core business segment, starting with membership services. During the quarter, both membership revenue and the number of subscribers hit all-time highs for a second quarter. Membership revenue reached RMB4.9 billion, up 15% year-over-year. Looking at the key drivers behind this growth, the monthly average revenue per member for the quarter reached RMB1,482, increasing both annually and sequentially. This was driven by our refined operating strategy. For example, we optimized our pricing strategy, which effectively narrowed the gap between listing and actual rates. The average daily number of total subscribers in Q2 reached 111.2 million, up 13% year-over-year, primarily driven by our stable supply of content that continues to attract new members. Our subscriber base declined on a sequential basis primarily due to: one, the impact of seasonality; and two, the high base effect after the release of net income and the natural attrition of members. Despite that, we are encouraged by the continuous optimization of our membership structure, as both the absolute number and the proportion of annual subscribers have shown meaningful growth year-over-year. I would like to reiterate that the goal of our membership business is to maximize user experience, which in turn drives our membership services revenue. Going forward, we are more focused on the overall economics, not just pure subscriber growth. We will adjust and balance the number of subscribers and average revenue per member based on multiple factors, including company supply, user demand, and market conditions. Importantly, we strive to enhance the overall health mix and revenue growth around our membership business by providing exceptional user experiences. We established a variety program that includes diverse privileges and benefits. Long-term loyal members can enjoy more favorable pricing and privileges, reinforcing user protection and encouraging longer subscriptions for greater benefits. Recently, we rolled out the express package program, which grants full access to the finale of our hit drama. Over 6 million subscribers have used their membership plans to access the prep package. Our first express package event received positive feedback from subscribers. As membership points are linked to the duration and number of continuous subscriptions, these loyal subscribers are entitled to greater rewards and can accumulate points at a faster rate. We expect this initiative will further strengthen subscriber loyalty and drive member retention rates. Moving on to content, we continue to execute our original company strategy and reinforce our brand image as a provider of high-quality premium content. In the first half of 2023, we released two dramas that achieved high popularity scores. As mentioned earlier, we maintained our leading position in the drama market share for six consecutive quarters. Our original content remains the primary driver of our content supply and revenue, accounting for 67% of all major dramas released during the second quarter. We are excited about our upcoming summer releases, which include high-profile dramas that have generated significant market interest. We believe the continued focus on premium content aligns with our strategy to meet the evolving demands of our audience. Overall, our strength lies in the content business and our commitment to continuous innovation and high-quality production.

Thanks, Mr. Gong, and hello, everyone. As Mr. Gong mentioned earlier, we recorded our best-ever second quarter results across multiple key financial metrics, such as total revenues and current membership services revenue, while profit and free cash flow remained robust. In addition, our balance sheet healthiness has further improved. Now, let me walk you through some of the key numbers. Total revenues increased by 17% annually to RMB 7.8 billion, setting an all-time high for second-quarter performance. We secured double-digit annual revenue growth across all business segments. Membership services revenue continued to serve as the most powerful growth engine, with revenue exceeding RMB4.9 billion, up 15% annually. Online advertising revenue experienced significant growth, reaching RMB1.5 billion with an accelerated annual growth rate of 25%, primarily driven by both brand and performance ads. Content distribution revenue and other revenues rose by 15% and 16% respectively on an annual basis as well. Now, moving on to costs and expenses, our cost of revenues increased by 10% annually. Among these, content costs increased by 7% annually, primarily due to the increase in the number of original dramas and variety shows launched during the quarter. Total operating expenses grew by 11% annually, largely due to the increase in SG&A expenses as we devoted more resources to marketing to amplify our content influence, increase subscriber attraction, and enhance strong momentum generated by our original content offerings. Turning to profits and cash flow, non-GAAP operating income reached RMB786 million, up 129% annually, positive for six consecutive quarters. Free cash flow reached RMB872 million, positive for four consecutive quarters. During the quarter, as part of our liability management initiatives, we repurchased a total principal amount of $133.6 million of our convertible senior notes due 2026. In addition, the total interest-bearing debt decreased significantly quarter-over-quarter. As of the end of the second quarter, the Company had cash, cash equivalents, restricted cash, short-term investments, and long-term restricted cash totaling RMB6.1 billion. To conclude, the second quarter results once again demonstrated that we are making solid progress in delivering high-quality growth, and we are well positioned to generate greater value for our stakeholders in the long run. For detailed financial data for the second quarter, please refer to our press release on our IR website. Now, we will open the floor for Q&A.

Your first question comes from Xueqing Zhang of CICC. Please go ahead.

My question is related to the membership business. We've seen stable growth in the past two quarters. So, what's the longer-term outlook for this segment? Also, how should we think about the outlook for the membership service in the second half of this year and longer-term?

Thank you. We will invite Mr. Gong, who's responsible for the membership business, to answer the question.

Our membership business developments have different focuses and strategies at different stages. In the initial establishment and rapid growth phase, the primary goal was to maximize the number of subscribers, focusing on growing the subscriber base. Once our subscriber base reached a significant size, for example, when our subscriber base first exceeded RMB 100 million in 2019, our objective shifted to maximizing membership revenue based on market conditions and our strategic adjustments. Therefore, we no longer focus solely on increasing the number of members. Our membership revenue is determined by subscriber base, subscriber lifetime, and average revenue per member. Our goal is to achieve long-term and substantial growth in membership revenue while taking a more long-term perspective in business planning and improving the overall health of our membership business. In the future, we will continue to adhere to the strategies I mentioned earlier. First, we will encourage subscribers to commit for a longer duration, thereby increasing the proportion of long-term subscribers. We have already observed continuous annual growth in both the scale and percentage of annual subscribers, and we hope this trend will continue. Secondly, we will systematically promote membership loyalty, particularly by enhancing the value perception of long-term subscribers. We have already implemented measures such as discounted pricing and privileges for long-term subscribers, reinforcing our members' understanding that early and sustained subscriptions lead to greater benefits. For example, we recently rolled out the express package program, which was a meaningful upgrade in our membership point system. During the 8-day event, over 6 million subscribers used their membership points to access the express package. Overall, we believe that improving membership value perception will naturally increase loyalty and retention, driving long-term growth in both ARM and membership revenue.

Our next question will come from Lei Zhang of Bank of America Securities. Please go ahead.

We've seen that a key long-form video player launched several contents this summer with good performance. How should we view the current competitive landscape in the content domain? Additionally, we noticed that offline entertainment, especially movies, has shown strong recovery. Do we see any impact or benefit to our business from this?

We will invite our CCO, Mr. Xiaohui Wang, to answer this question.

For this summer, we’ve seen the industry improve with a better supply of both online dramas and offline theatrical films, all competing for users' attention. We are pleased to observe the flourishing of the long-form video industry, as we believe that improved content quality has activated industry vitality, benefiting everyone involved. In this context, we have maintained our leading position in online drama, driven by high-quality original content. We have been leading the industry for six consecutive quarters in terms of overall drama market share as well as exclusive market shares. Our strategies, as demonstrated in Q2, reaffirm our advantage and sustainability in the content business. The content industry is a long-term business, and the key to long-term success is the ability to consistently produce and supply high-quality content. In the core drama category, due to longer production cycles, our competitive advantage in this area remains strong and challenging for competitors to surpass this quarter. Each core market player is establishing differentiated advantages, with a focus on original and exclusive content. We believe that content differentiation has been enhanced, creating a more rational competitive environment. Our advantages in the content business are foreseeable and sustainable, based on four strong pillars: a mature and continuously improving content production mechanism, strong operational capabilities, advanced technological capabilities, and top industry talent. Moving forward, we will adhere to the strategies of innovation, premium content diversification, and constantly seeking new opportunities through innovation and research. While ensuring the quality of our projects, we will carefully plan our production to ensure a long-term sustainable supply of diverse, premium content. Regarding the recovery of offline entertainment, we will focus on optimizing our strengths in online content production and operation. However, we do believe that the recovery of offline theatrical releases can also bring benefits to online platforms like ours.

Our next question will come from Alicia Yap of Citigroup. Please go ahead.

Management, could you please share your view on the overall brand advertising market outlook for the second half of this year? Have you noticed any major shifts in advertisers' budget sentiment, and will it modify any of your advertising strategies?

We'll invite our Senior VP of Brand Advertising Business, Mr. Gang Wu, to answer this question.

The overall advertising business has been continuously recovering, with brand advertising rebounding in Q2, growing both year-on-year and quarter-on-quarter. After the economy recovers, it takes time to reflect in the brand advertising market. We hold a cautiously optimistic attitude toward the brand advertising market for the second half of this year, as we believe our platform offers high-quality user engagement along with strong consumer spending power and willingness to pay. Thus, we are an essential choice for advertisers seeking to enhance their brand influence. We have seen increased recognition from advertisers for our content and innovative products. The prime content marketing has been driven by outstanding dramas and variety shows, leading to a strong preference from advertisers for our innovative advertising products. In the current macro environment, advertisers respond to strategic vision and long-term market views, with some brand advertisers seeking to increase their ad spending in order to seize marketing opportunities. Specifically, we are optimistic about sectors like food and beverage, cosmetics and personal care, as well as transportation, including new energy vehicles.

Our next question will come from Lincoln Kong of Goldman Sachs. Please go ahead.

Thank you for taking my question. My question is about the performance of your advertising segment. We have observed consistent growth through the first half of the year. How should we view the outlook for this segment in the second half?

Thank you, Lincoln. I will invite our CTO, Mr. Wenfeng Liu, to answer this question.

Performance advertising revenue has maintained annual growth for five consecutive quarters. The growth rate continues to accelerate, and its contribution to total ad revenue has reached a historical high in Q2. We expect the performance advertising segment to continue its strong growth in the second half of this year, driven by our enhanced market capabilities, which attract more advertising budget from key industries such as internet services, e-commerce, and gaming. Additionally, we believe that with algorithm optimization and the support of generative AI, performance advertising results will improve in terms of outperformance and monetization efficiency. In the future, performance advertisers will prioritize cost-effectiveness and ad performance, striving to achieve better conversion rates and maximize returns on investment. We will enhance ad creativity, content personalization, and interactivity while leveraging new technologies like generative AI to reduce production costs and improve delivery efficiency in line with market trends and user demands. From a sector perspective, we maintain a positive outlook for various industries, including traditional e-commerce platforms, live streaming e-commerce, cultural entertainment, and food lifestyle.

Our next question comes from Maggie Ye of CLSA. Please go ahead.

Thank you, management, for taking my question. Noting that the Company has generated very strong operating cash flow and free cash flow this quarter and has also repurchased convertible notes. Could you share more about your thoughts on the Company's debt management and plans for financial resources in the coming quarters?

We will invite Mr. Jun, our CFO, to answer this question.

For the interest of time, I’ll answer the question directly in English. This question is frequently asked by investors, and our response is straightforward. First and foremost, we are consistently focused on improving our capital structure, aiming to make our balance sheet healthier and more robust. Secondly, two key factors drive this initiative. The most important factor is our continuous generation of sizable free cash flow. Generating significant cash flow facilitates natural deleveraging, regardless of whether debt buybacks occur. We take pride in the progress we've made in this area over the past couple of quarters. The second factor involves developing a comprehensive set of options to create shareholder value, including debt buybacks and the exploration of safe investment opportunities. Given the dynamic external environment and rising interest rates, the Company sees opportunities for returns with free cash flow. Our overall principle remains: we will explore every opportunity to create value for our stakeholders, including shareholders and debt holders, while ensuring the safety of our business.

This will conclude our question-and-answer session. At this time, I'd like to hand back to management for closing remarks. Thank you, everyone, for participating in the call today. Please do not hesitate to ask us if you have any further questions. Thank you, and we will see you next quarter.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect your lines.