Earnings Call Transcript - IQ Q1 2022

Operator, Operator

Thank you all for standing by, and welcome to the iQIYI First Quarter 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers presentation, there will be a question-and-answer session. I would now like to hand the conference over to IR Director, Mrs. Chang You. Thank you, please go ahead.

Chang You, IR Director

Thank you, operator. Hello, everyone, and thank you for joining iQIYI’s first quarter 2022 earnings conference call. The company’s results were released today and are available on the company’s Investor Relations website. 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. Xiangjun 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, Xiangjun, 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 provisions of the U.S. Private Securities Litigation Reform Act of 1995. Forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from our current expectations. Potential risks and uncertainties include, but are not limited to, those outlined in our public filings with the SEC. iQIYI does not undertake any obligation to update any forward-looking statements, except as required under applicable law. With that, I will now turn the call over to Mr. Gong. Please go ahead.

Yu Gong, CEO

Hello, everyone. We recorded quarterly non-GAAP operating profit for the very first time. This demonstrates the effectiveness of our new strategy and execution. Last quarter, we announced that our goals for this year are to reach non-GAAP operating breakeven for the full year of 2022 and to reach quarterly non-GAAP operating breakeven as early as possible. I’m very pleased to see our performance exceeded our goals. What are the driving forces on our path to profit? I would name four. First, the premium content. The debut of new content such as top-notch dramas solidifies our market leadership and led to healthy growth of both subscriber base and the ARM. The influence of these new dramas was further elevated through our creative content marketing strategy. Meanwhile, the library content also played a crucial role. We used effective operations to drive traffic to our extensive library content and enhanced user stickiness. Secondly, we refined our operations on content scheduling and promotions. Thirdly, we increased operational efficiency, which means delivering superior services based on effective cost and expense control. Lastly, we drove our sales performance through various initiatives to boost our monetization on membership and ad sales. With these four aspects, profitability is a natural result. Therefore, we believe the performance in the first quarter is replicable as we continue to execute this operational methodology in the future quarters. On premium content, we are confident about our future pipeline. On efficiency management, we will continue to focus on driving efficiency by leveraging the power of technology while maintaining the current lean corporate structure. By using the same methodologies, we will continue to achieve desired results in the future. Now, let’s go through the performance of our business segments in the first quarter of 2022. Let’s start with memberships. For the first quarter, we continued to deliver a solid membership performance. Membership revenue was RMB4.5 billion, up 4% annually and 9% sequentially. The average daily number of total subscribing members for Q1 was 101.4 million, a net addition of 4.4 million from the previous quarter. The monthly ARM was RMB14.69 during the quarter, up 8% annually and 4% sequentially. Q1 was the fifth consecutive quarter that we achieved 8% or above annual ARM growth. Our premium new content and our extensive library content were the main drivers behind our positive performance. Our values for members translate into higher member acquisition, retention and ARM. We expect to see solid membership revenue growth on a year-over-year basis for the quarters down the road. Content is king. Among the new releases during the first quarter, 'A Lifelong Journey', 'Under the Skin', and 'Life is A Long Quiet River' were outperformers. 'A Lifelong Journey' became a blockbuster acclaimed by the whole nation and loved by the audience across all age groups and backgrounds. It tells a story of China's transformation in the past 50 years from the perspective of ordinary people. We are happy to see 'A Lifelong Journey' was able to achieve word-of-mouth popularity, social value, and commercial success. It also shows our deep understanding of the industry and the ability to balance our social obligation and user appetite. 'Under the Skin' is a detective drama focusing on social issues that became a dark horse in the market with very high user stickiness. 'Life is A Long Quiet River', an original drama that portray the daily life and stories of Shanghai urban families, also performed very well in terms of traffic and revenue. Its popularity index exceeded 9,200 at its peak. In addition, we are also seeing the sound long tail effect of premium content as they continue to generate solid viewership after series finales. One of our key strategies with popular IPs is serializing its production. The original light comedy 'Vocation of Love Season 2' is an example of our multi-season approach in which we develop new plot lines for additional seasons of our popular content. The revenue sharing drama 'Shining For One Thing' also became a dark horse and set a new record for revenue sharing drama on our platform. To better connect with users, we also created a distinctive brand for our featured vertical content categories, namely iQIYI Theaters. In the first quarter, we launched our third vertical content theater, 'Laugh On Theater', focusing on the comedy genre, where two titles were launched in Q1 and the third title will be released soon. These comedies are good leisure and entertainment choices that provide users a new outlet to relieve daily pressures. Now with 'Mist Theater', 'Sweet On Theater', and 'Laugh On Theater', our platform successfully covered the three most loved genres by our core users, namely suspense, romance, and comedy. Going forward, we will continue to explore other content genres under iQIYI Theaters that bring targeted and diversified experience to users. In summary, we attract users through premium new releases and retain users through our extensive and diversified library content. We employ various operational initiatives to increase user loyalty and brand awareness. All of this will contribute to a solid base of subscribers and lay a good foundation for future growth. We focus on a systematic approach in building our content business from production to operations. Our goal is under the premise of maintaining iQIYI’s overall competitiveness and leadership, which means we would acquire the most appropriate content with optimal ROI and maximize monetization with a reasonable number of titles. As we continue to enhance our in-house production capabilities, enrich our premium content inventory, and refine our content operations, we will be able to expand our advantage as an integrated platform and improve our overall efficiency across various aspects, including content production, content scheduling, and promotion. Meanwhile, we utilized technology to further improve our production capability and increase our efficiency. Investment in content is our biggest organizational focus, which makes it the key in achieving our goal of optimizing cost and efficiency. We have placed stringent control over the full content production process from script development, preproduction to shooting and post-production. We also emphasize efficiency in content production, content release, and fund utilization. As for our content reserves, we have dedicated ourselves to building our original content offering and enhancing production capability in the past few years. We have established one of the largest and most professional teams of producers in the industry. We also want to highlight that despite the recent resurgence of COVID in some regions in China, we are relatively comfortable with our content reserve, especially in the core drama category as we have a diversified pipeline of dramas for this year benefited from our solid reserve of original content and the experiences gained from operating under COVID in the past two years. Therefore, we currently expect to see limited impact from COVID in our future drama pipelines. Looking ahead to the second quarter and the full year 2022, our key focus is to improve the overall content quality. We will continue to introduce premium content to our users, increase the quality of our offering, and leverage the platform’s advantage to build iQIYI’s content ecosystem. Meanwhile, we will enforce our brand awareness by making multi-season productions for our long series and utilize our successful theater model to enforce our advantage in some vertical genres. Benefiting from our rich content reserve, we will be able to launch a series of titles in the second quarter. For dramas, the key titles we have released in Q2 include 'Left Right', 'My Sassy Princess', 'The Wind Flows from Longxi', and 'Day Breaker', all of which have been well received by users. For the rest of the second quarter, key dramas to be released include highly anticipated original titles, 'A Love Never Lost' and 'Ordinary Greatness'. 'The Lord of Losers', the third drama under the 'Laugh On Theater', will also be premiered. For this year’s 'Sweet On Theater', five new series will be launched. For variety shows, we will launch the second season for last year’s hit show, 'The Detectives’ Adventures'. For animation and children’s content, we will continue to launch new titles under our multi-season strategy. Also, we have prepared a rich and diversified slate of premium content for this year’s summer season, covering all major genres that target different user cohorts. We continue to produce and release original movies to enrich our content ecosystem. 'Man On The Edge' was released in theatres on April 15, and the cumulative box office has surpassed RMB130 million. On April 1, we upgraded the online film distribution collaboration model with our partners, the revenue-sharing model is now based on user viewing time instead of video views in the past. Promotional resources will be allocated based on audience participation and content performance such as view time, membership conversion rates, and user reviews. The new model enables high-quality films to stand out and may significantly improve our operational efficiency, providing a win-win solution for both producers and our platform. Now I'd like to quickly talk about our progress in IP development. Premium content also translates into additional monetization opportunities as we continue to push our strategy of building our IP franchise and increasing monetization capability. In last December, we launched the first title of the iQIYI Chinese Historic City Universe franchise, 'Feng Qi Luoyang', and we have signed with over 20 partners to franchise this popular IP in various formats, including toys, jewelry, apparel, food, and beverages. Moving on to advertising. For Q1, the total advertising revenue declined both annually and sequentially due to the current macro headwinds. The soft ad demand negatively impacted our brand ad business to some extent. Despite the challenging macro environment, premium content continued to draw strong attraction from advertisers. For example, 'A Lifelong Journey' and 'Life Is A Long Quiet River', both had very good advertising performance. The drama 'A Lifelong Journey' itself attracted 25 advertisers to our platform. For Q1, the sequential growth of our performance ad business was benefited by our growth in ad inventory, but partially offset by the weak macro environment. iQIYI Lite contributed to the increase in ad inventory, with its monthly average DAUs reaching 5 million in Q1 and surpassing 5 million starting in April. Given that the major monetization methods for iQIYI Lite are performance ads, it effectively supplemented our ad inventory and mitigated the adverse impact of the macro environment. In Q1, we upgraded our ad placement platform, which was widely adopted by advertisers. The new version is more user-friendly and increased monetization efficiency by nearly 20% compared to the previous version. The upgraded ad placement platform helped advertisers to cover more ad slots, get more exposure to their products, and improve ROI by leveraging smart algorithms. Moving on to technology. Technology is fundamental to support our development. We continue to use AI technology to improve content production efficiency and promote the industrialization of the online video industry. Technology helps us optimize costs, promote information security and copyright protection, and improve the entertainment experience for users. In the first quarter, our proprietary AI dubbing technology, iQIYI dubbing, was widely used in our film offerings. For our movie channel, more than 20 foreign movies used this technology to complete dubbing in Mandarin before launching on our platform, saving costs while increasing revenues for both new and library films. iQIYI dubbing was also used in our overseas business; for example, we launched a few films in Thailand using iQIYI dubbing, which received very strong user feedback and generated strong revenue performance. AI dubbing is effective in optimizing costs and driving revenues for long-tail content. Technology also safeguards our system architecture and provides data security and enables antipiracy protection of our platform. In the quarter, our proprietary digital rights management, DRM solution completed in the Farncombe Security Audit, which is recognized worldwide as an in-depth measure of a solution’s ability to protect premium content. So far, we are the only domestic streaming platform in Mainland China that completed such certification, reflecting our strong ability in digital media security protection. Moving on to our new business initiatives. We are also exploring growth opportunities through new business initiatives. We are delighted to see continued strong momentum for our overseas business and iQIYI Lite. For our overseas business, driven by our continued efforts in enhanced products and user experience, the membership revenue and advertising revenue for our overseas business both recorded solid annual growth during the first quarter. iQIYI Lite is a great supplement to our main iQIYI app and continues to achieve strong performance across various operating metrics in the quarter. iQIYI Lite is mainly focused on the performance ad monetization model, which is significantly different from the subscription-centered monetization model of our main app. Overall, the user demographics, monetization model, and content consumption behavior on iQIYI Lite are largely different from our main app. The user overlap between iQIYI Lite and the main app further declined in the quarter, with the DAU overlap around 4% in March. Meanwhile, we observed that the consumption of library content on iQIYI Lite was significantly higher than on the main app, which largely enhanced realization of long-tail library value. We believe iQIYI Lite has ample potential for growth in both user scale and monetization abilities. In summary, Q1 was a breakthrough quarter for the company. We delivered what we have promised, reaching non-GAAP operating profit earlier than anticipated. This demonstrated our outstanding execution, professionalism, and strong unity of everyone within iQIYI. The encouraging first quarter results also demonstrated that the long-form video industry can generate sustainable operating profit. We have a clear value proposition for our users. Not only do we offer the latest premium content available in the market, but we also have an extensive and diversified content library that every user can find their favorite. This value proposition is unique, and the happiness we offer to users far exceeds the price we demand. Looking forward, the pandemic situation in Shanghai and Beijing does create additional challenges, and the time for full recovery remains unknown as of today, which could impact our Q2 performance. Regardless, we still strive to deliver another quarter of non-GAAP operating breakeven after the first quarter success. We would like to wrap up by thanking all our stakeholders, including our shareholders, business partners, and employees who share our belief in the positive prospects of long-form video. We understand that many of our stakeholders follow our business development closely and pay close attention to areas such as whether blockbuster content can be delivered every quarter or if our business would be impacted by some short-term market headwinds. Honestly, we would not worry about what will change. We focus on what will not change in the next five years or ten years, and we will invest heavily in these areas to meet user demands, that is possessing a collection of highly differentiated premium content and a highly effective platform that delivers sustainable value to our users. Meanwhile, we will continue to seek new opportunities through innovation and expand our values in the ever-changing market. With that, I’ll hand over to Wang Jun to go through our financials.

Jun Wang, CFO

Thanks, Mr. Gong, and hello, everyone. Now let me walk you through our key financials for the first quarter 2022. Starting with the revenues, in the first quarter, our total revenues reached RMB7.3 billion. We booked healthy growth on our membership services with RMB4.5 billion, which was our largest revenue contributor. Our membership services revenue increased by 4% annually and 9% sequentially, primarily driven by ARM, or average revenue per membership, which achieved positive annual growth for nine quarters in a row. Our subscriber base also grew by 4.4 million as our premium shows attracted more paying members. The solid performance of membership services was partially offset by the relatively weaker advertising services revenue due to macro headwinds. Now move to the cost and expenses. The first quarter cost of revenue was RMB6 billion, representing a cost savings of RMB1.1 billion compared with the same period last year. This leads to consistent gross margin expansion in the past three quarters, from 7% in the third quarter of 2021 to 12% in the fourth quarter of 2021, and to 18% in the first quarter of 2022 on a GAAP basis. In the meantime, our total operating expenses decreased 35% annually and 34% sequentially after we completed our organizational realignment in the second half of last year. Our Q1 was also the third quarter in a row that we saw the decrease in total OpEx. The expanded gross margin and decreased expenses combined contributed to our first profitable quarter. Behind this profit is not magic, but science, and it took three quarters to get where we are. Our non-GAAP operating loss was RMB1 billion two quarters ago, which shrank to RMB516 million last quarter and then turned to a profit of RMB327 million in the first quarter of 2022. The trend is clear, what is driving this trend is our consistent efforts in improving our operational efficiency and scalability. We have become nimbler and more focused, which helps us in better adapting to the changing environment and best positions us to capture long-term growth opportunities in the future. In March 2022, the company completed a private round of $285 million. At the end of the first quarter, the company had cash, cash equivalents, restricted cash, and short-term investments of RMB5.2 billion. We believe we have sufficient funding to satisfy our operational needs in the foreseeable future. For detailed financial data, please refer to our press release on our IR website.

Operator, Operator

Thank you. We will now begin the question-and-answer session. Your first question comes from the line of Thomas Chong from Jefferies. Please ask your question.

Thomas Chong, Analyst

Thanks management for taking my questions. My question is about our overall strategy. How do we execute and reflect in our financials? And in particular, we are making profitability on a quarterly basis in Q1. On the other hand, how should we think about the outlook in the next couple of quarters? Thank you.

Yu Gong, CEO

Thank you. The answer comes from five aspects. First, we have many years of accumulation of head premium content. For example, the key TV drama series and also variety shows, movies, children’s content, and animation. And second, we refined our operations including content scheduling and promotions to increase overall operational efficiency. Third, we also improved the content operations in many different areas and have stringent control over the full content production process. Fourth, we’re also driving the sales capability and efficiency, including boosting our monetization through our membership and ad sales. And fifth, we work to increase the overall ROI. We will terminate the business that has poor ROI and low future potential.

Chang You, IR Director

The earlier mentioned five aspects are the continuous efforts that we’ll be focusing on, and that will drive profitability in the mid to long term. We’re also focusing on new business initiatives. For example, overseas business and iQIYI Lite that will help the overall development and growth of our mid to long term.

Operator, Operator

Thank you. Your next question comes from the line of Lei Zhang from Bank of America. Please ask your question.

Lei Zhang, Analyst

Thanks management for taking my question and congrats on breakeven. We have seen many cost-saving initiatives resulting in breakeven in the first quarter. So wondering, do you see any impact of our cost control on our operating metrics, like user time spent and revenue? Secondly, can you give us some updates on your content strategy going forward? Thank you.

Yu Gong, CEO

Okay. For overall speaking, our control of costs and also expenses are for the purpose of increasing overall efficiency for our business. Content is our biggest cost item and investment. So for very important premium head content, we will not lower our investment in this area at all. We will probably decrease the investment in the low ROI content genre and content categories. Based on our many years of internal studies, user data, and also our reference to the overseas streaming business, we can tell that the top line, the revenue upside depends on the head premium content. So overall, the low-performing content is really dragging our whole performance down and also creating loss. These are the areas we will continue to put efforts on going forward.

Chang You, IR Director

So even though reaching the market #1 is not our primary goal, according to our third-party data and Enlightent data, it shows that iQIYI was still number one in terms of the market effective video views for the top TV drama category. Our original content also had excellent performance for viewing time for dramas, movies, and children’s content, which consistently improved on an annual basis.

Yu Gong, CEO

For going forward, this year, our very important key focus is to drive efficiency, which will allow us to focus on investment in head premium content as well as increase overall ROI and focus on content that generates high ROI. In the next two years, we will continue to focus on premium head content, which will bring profit and also provide good returns to our business.

Chang You, IR Director

Thank you. I think our CFO also has some points to add.

Jun Wang, CFO

I would just quickly translate myself. Supplementing to what Mr. Gong has shared, I would say that people care about the new releases each quarter. On the other hand, we also need to notice that our new releases are also in the form of the investment, after the debut, it will flow into our library, which will generate lifelong traffic over time. Our business model combines new releases and library, which is very much defensible and manageable.

Alicia Yap, Analyst

Hi, thank you. My question is related to the membership subscription business. How does management see the future longer-term growth trend for the membership revenue? Will that mainly be driven by the increased penetration rate for paying users, or is that increase from ARPU? How much room can we further increase our paying ratio? In terms of near-term, can management share how has the demand for the membership service been trending given the prolonged lockdown in Shanghai and other cities? Have you seen any uptick in the subscription from the lockdown, or is the membership demand driven more by content? Thank you.

Yu Gong, CEO

Okay, based on our experiences with COVID in the past two years, the first wave came from 2020 and then the second wave came from this year. We found the pattern in terms of dealing with the pandemic. In the short term, there are some uplifts in terms of consumption of digital entertainment and digital content online. Over the long term, there might be some impacts in terms of entertainment opportunities or choices from offline options, which might push the popularity and penetration of online media entertainment. However, very importantly, we believe the success of our membership business really depends on the premium content. This is what drives our membership growth in both revenue and subscriber growth, also contributing positively to our business.

Chang You, IR Director

Overall, we are still very confident and optimistic about the long-term growth of our membership business. Our premium content really drives positive membership growth in terms of subscribers, revenues, and ARM.

Yu Gong, CEO

Our main goal is really trying to keep growing our membership services revenue. We don’t set the goal in terms of growing the absolute number of subscribers or the ARM.

Chang You, IR Director

I would like to first talk about ARM that’s driving our business. We’re very happy to see that among our industry peers, there are some price adjustments on that front as well. They are sending really positive signals and also guiding the whole industry moving in a positive direction.

Yu Gong, CEO

Also, a very important point we should raise is that we think premium content is driving the whole membership growth as well. We are working on improving the quality of the premium content and building a stable supply reserve of premium content, which is really supporting our future membership growth.

Chang You, IR Director

The recognition from users for IP is very important for future growth as well. We’re happy to see the whole industry, as well as users and the government, are sending positive signals of recognizing the power of IP. We are focusing on IP protection and really driving the antipiracy issues of the company.

Yu Gong, CEO

Users are upgrading their consumption behaviors. In terms of content offerings, whether it’s long-form video or short-form videos, the consumption is driven by paid content as well as long-tail content that brings users together. We see more users developing the habit of buying subscriber memberships, which sends a very positive signal to our business.

Chang You, IR Director

The overlap of content is pretty high among our peers, meaning there are fewer exclusive content offerings for each platform, which somewhat pulls back the willingness to pay for subscriptions. In Mainland China, the average user subscribes to 1.2 platforms, which is lower than many overseas streaming services.

Yu Gong, CEO

Several reasons contribute to the high overlap of content among our competitive peers. One is the economic aspect; selecting non-exclusive content tends to lower content costs. The second point is that the original content production capability is relatively low currently among industry peers. Going forward, if we could increase production capabilities, especially for head original content, that will reduce content overlap among competitors.

Chang You, IR Director

Thank you. In the interest of time, I would now like to hand the conference back to management for any closing remarks. Thank you, everyone, for participating in our call today. Feel free to reach out to the IR team if you have further questions. Thank you, and see you next quarter.

Yu Gong, CEO

Thank you.

Chang You, IR Director

Thank you, bye-bye.

Operator, Operator

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