iQIYI, Inc. (IQ) Q1 2019 Earnings Report, Transcript and Summary

Ladies and gentlemen thank you for standing by and welcome to iQIYI First Quarter 2019 Earnings Conference Call. Over this time, all participants are in a listen-only mode. [Operator Instructions] I must advise you that this conference is being recorded today, Friday, 17 of May, 2019. I would now like to hand the conference over to your first speaker today, Ms. Dahlia Wei, Investor Relations Director. Thank you. Please go ahead.

Thank you, operator. Hello everyone and thank you all for joining iQIYI's first quarter 2019 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 Dr. Yu Gong, our Founder, Director and CEO; and Mr. Xiaodong Wang, our CFO. Dr. Gong will give a brief overview of the Company's business operations and highlights followed by Xiaodong who will go through the financials and guidance. After their prepared remarks, we'll hold a 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 US 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 Dr. Gong. Please go ahead.

Hello, everyone and thank you for joining us for first quarter 2019 earnings call. We achieved another solid quarter of results. Total revenues were RMB7.0 billion, up 43% year-over-year. Total subscribing members reached 96.8 million as of the end of March. This number does not include any sports subscribers, and it represents a 58% growth from a year ago. We continue to strengthen our platform, attract new users and increase user stickiness. During the first quarter, average DAU of mobile app and the total user time spent both achieved double digit growth year-over-year. iQIYI continued to rank number one among online video platforms in China, in terms of mobile MAU, mobile DAU and the total time spent according to third party tracking data of iResearch and Quest Mobile. Let me start my review with our membership business. During the first quarter, total revenues for our membership business increased by 64% to RMB3.4 billion. Total subscribers reached 96.8 million at quarter end, representing a net addition of 9.4 million from last quarter. This was mainly attributable to our premium content and targeted marketing campaigns. In terms of premium content, we released several high-quality original drama during the quarter such as The Legend of Haolan, The Golden Eyes and The Legend, all of which quickly drove subscriber growth. Licensed dramas such as The story of Minglan, All is Well and I Will Never Let You Go also contributed to subscribers convention as we granted subscribers early access to watch. In addition, our variety shows such as Idol Producer 2, our self-produced youth inspirational variety show and Wife’s Romantic Travel Season 2, a licensed reality show. We offer extra episodes, voting privileges and other value-added services to members, which helped further to add subscriber growth. On the marketing side, we took advantage of the winter vacation and Chinese New Year holiday, when many young people returned from big cities to their hometowns and rolled out marketing campaign to increase user penetration into low-tier cities and older age groups. Moving to our advertising business, during the first quarter, ad revenues remained largely flat compared to a year ago. Looking ahead, we maintain a cautious outlook on advertising due to the soft macroeconomic environment in China and lower-than-expected recovery of our in-feed advertising. We believe our premium content and innovative ad solution will continue to serve as a key driver of future performance for our advertising business. During the first quarter, our highly popular self-produced variety show continued to build upon the solid foundation for our advertising business. For example, Idol Producer 2 came in first among online variety show rankings of Baidu and Weibo. As a result, ad revenues generated from this show reached a historical high for all self-produced variety shows on our platform. At the same time, we are also introducing new innovative ad solutions such as immersive marketing which helps convert the show’s highly supportive fans into customers of our advertisers. This demonstrates the value we bring to enhancing brand awareness and increasing advertising ROI. As I mentioned on our last earnings call, we are working to improve advertising monetization of our original dramas in addition to their role in driving subscription growth. During the first quarter, our original dramas The Legend of Haolan, The Golden Eyes, and The Legends all ranked ahead of industry peers in terms of popularity and the traffic according to a third-party statistics from Enlightent -- Chinese name “Yunhe”. This helped to increase ad revenue from our original content to a higher percentage of total ad revenue. During the first quarter, other business continue to gain momentum, with revenue growing 143% year-over-year. This demonstrates the success we have had in diversifying our revenue streams, and in building multiple engines for the company. The growth was broad-based, and that to a large extent driven by our gaming business, which perform better than it’s expected. Now our content strategy, quality and innovation form the core of our content production criteria. We remain committed to incorporating Chinese culture values into our content and pay great attention to detail. Our content library is getting enriched everyday as we continually deliver a high-quality content covering youth, fashion, suspense, realistic and historic themes among others. Entering Q2, we have released some original content, such as New Legend of White Snake, a remake of the classics drama based on a well-known Chinese folktale. The Thunder, an anti-drug police and detective series and I AM CZR, a singer songwriter music reality show. In particular, our original drama series, The Thunder, has not only been well received by all users but also highly acknowledged by government officials. And it becomes the first original series aired during prime time on drama channel of CCTV. Furthermore, it is expected to hit international market to through RED by HBO, which acquired by the Southeast Asia licensing right of the show. For the rest of the year our content pipeline remain very strong as many of you may have discovered at our IQIYI World Conference last week. In addition to the upcoming slate of high-quality drama serials and variety show, we are also making efforts to tap into original theatrical movies through IQIYI original film plan. For the first time in the industry, we officially announced a standard named the Interactive video guideline along with an interactive video platform, the standard and authoring tools were designed to empower our company partners to produce more interactive drama or variety shows with lower cost and less time. We are constantly enhancing our IP centered ecosystem. As a leading content distribution platform and IP powerhouse, we have incubated various types of content in the form of literature, light novels, cartoons and comics, as well as dramas, movies variety shows, animation and even online games. This allows us to fully leverage the value of our IP-based productions, and monetizing them through diversified channels, for example, through project Yunteng, we released 12 drama and movie titles adapted from literature IP last year, and we expect to adapt roughly another 80 literature titles into video content this year. Our self-produced variety show, Idol Producer, not only allowed us to expand our business territory to talent agency, but also led to the creation of IP adjacent products with more than 200 SKUs. Another more recent example is our game business. Our subsidiary, Skymoons, launched a 3D turn-based mobile game The Croods, which is based on a famous IP licensed from DreamWorks Animation’s 2013 popular animated feature film, The Croods. The game has performed exceptionally well since it was launched in February, exceeding our expectations. This is another good showcase of our ability to adapt IP into online games. And lastly, I'd like to finish my discussion with technology. As a technology-based entertainment company, our business development relies on the continual innovation of both technology and products. Recently on the 5G front we began collaboration with various carriers such as China Unicom to explore the commercial application of 5G technology to Internet media. On March 18, we launched our 8K VR visual experience center at China Unicom’s 5G innovation Showroom in Beijing. In addition, we launched an innovative service “Qisubo”(which integrates CDN technology with 5G Mobile Edge Computing). It leverages ample bandwidth and minimal latency of 5G to effectively ensure a high frame rates, when watching videos and a greater interactive experience. In the future, our “Qisubo” service can be used in hotels, airports, high-speed trains, universities, shopping malls and other location which will allow users to enjoy a smoother experience when watching our extensive selection of high-quality video content. As the commercialization of 5G terminology rolls out. We will continue to expand our usage scenarios and ensure premium entertainment experience for users. To sum up, we had a strong start to the year of 2019 with a set of solid results during the first quarter, especially in our membership business. As the subscriber base continues to scale, benefiting from China's growing GDP per capita, which exceeded USD9,000 in 2018, we believe Chinese online entertainment industry has entered a new growth phase with enormous opportunities for the years to come. We are at the forefront of the right industry at the right time, and will continue to leverage our platform advantages, advance our technology innovations, and attract top talent, in order to capture the tremendous growth potentials ahead. We remain committed to our vision of becoming a technology-based entertainment giant and driving sustainable long-term value for our shareholders. With that, I will now pass the call to Xiaodong to go over our financials.

Good morning, everyone. Let me go through our financial highlights. For the first quarter of the year 2019, iQIYI total revenues was RMB7 billion, up 43% year over year. The increase was primarily driven by the strong growth of our membership services thanks to our premium content as well as our various operational initiatives. Membership services revenue was RMB3.4 billion, up 64% year-over-year. This was driven by the strong growth in the number of subscribers, which reached 96.8 million at the end of the first quarter. Online advertising services revenue was RMB2.1 billion, flat year over year due to macro softness and slower-than-expected recovery of our in-feed advertising. Content distribution revenue was RMB442.6 million, up 66% year over year. This increase was driven by a number of premium content titles we distributed. Other revenues were RMB982.5 million, up 143% year over year. The increase was driven by strong performance across various business lines, especially the robust growth of our game business after the acquisition of Skymoons, which launched several successful games during the quarter. Moving to the cost of revenues Our cost of revenues was RMB7.3 billion, up 50% year over year. The increase was primarily driven by higher content costs as well as other cost items. Content costs were RMB5.3 billion, up 38% year over year. Turning to the operating expenses. SG&A expenses were RMB1.1 billion, up 62% year over year, primarily due to the increased share-based compensation expenses and higher marketing spending on games after the consolidation of Skymoons. Our R&D expenses were RMB598.1 million, up 54% year-over-year. The increase was primarily due to our continued investment in R&D personnel. Operating loss was RMB2.0 billion, compared with operating loss of RMB1.1 billion in the same period last year. Operating loss margin was 29%, compared to operating loss margin of 22% in the same period of last year. Total other income was RMB211.1 million, compared with total other income of RMB666.2 million during the same period last year. The year-over-year variance was mainly due to the fair value gain we recognized in the first quarter last year arising from our private company equity investments, lower foreign exchange gain we recognized in the first quarter of 2019 due to exchange rate fluctuation, as well as increased interest expenses associated with our financing activities. Loss before income taxes was RMB1.8 billion, compared with a loss of RMB396.2 million in the same period last year. Income tax expenses was RMB7.4 million, compared to the income tax expenses of RMB0.5 million in the same period in the year 2018. Net loss attributable to iQIYI was RMB1.8 billion, compared with a loss of RMB395.7 million during the same period of year 2018. Diluted net loss attributable to iQIYI per ADS was RMB2.52. As of March 31, 2019, the Company had cash, cash equivalents, restricted cash and short-term investments of RMB17.9 billion. In March 2019, we closed the offering of USD1.2 billion in aggregate principal amount of convertible senior notes. Turing to the second quarter 2019 guidance, we expect total net revenue to be between RMB6.91 billion to RMB7.29 billion, representing an increase of 12% to 18% year-over-year. This forecast reflects iQIYI’s current and preliminary view, subject to change. This concludes our prepared remarks. I will now turn the call to the operator and open the floor for Q&A.

[Operator Instructions] Your first question comes from the line of Ella Ji from China Renaissance.

Thank you for taking my questions. My first question is regarding your content cost in the first quarter. It was a nice surprise. It's down almost 20% sequentially. So can you talk about your content cost trend? Is this something one-off or should we expect to see your content cost continue to trend down in the coming quarters? And then also relating to the content, this year, it's quite an important year. There are a lot of anniversaries for our political events. So relating to that, can you just give us an update of the regulation approval? Is there any change that you're seeing and how should we think about the impact on your revenue and cost respectively? Thank you.

[Foreign Language] So, for your question, the major reason for the content cost coming down in this quarter is primarily due to delay of some – certain of our content. The delay is related to several reasons. One could be the policy changes and regulatory censorship, but more I think, in addition there's something related to the process of our content production. And talking about regulation side, I think overall this year, will be relatively stable compared to the level of last year. But entering into Q2 and Q3, there will be some anniversaries of political events. So Q2 and Q3 will be a little bit stricter than before.

Your next question comes from the line of Alicia Yap from Citigroup.

I have questions on your second quarter guidance. If the subscription remains solid, it would suggest that the advertising revenue will phase quite meaningful year-over-year end sequential decline. Is that the correct assumption? And could you help us understand the dynamics and the shift of the landscape? So what are you seeing now from the app demand versus three months ago in February when you report 4Q results? Was that a change of the advertiser tone to be even more cautious than you are seeing in the beginning of the year? Thank you.

Alicia, first, yes, you're right. We are more cautious about the advertising revenue in the second quarter as I explained before. We had expected infeed ads recovery could be done in like two or three weeks last year, but unfortunately, it seemed to take a longer time to get it to the normal level. So which means we will have some challenges on the ad side, and really big challenge on the ad revenue side. But back to the membership services, I think we can still make like a bit of a long-term positive trend of the membership business. Certainly, Dr. Gong just introduced due to some delay of the content, will have some impact on the subscriber business also as well as the online advertising service, but in general speaking, we still have confidence on the membership services.

Your next question comes from the line of Binnie Wong from HSBC.

[Foreign Language] I have two questions here. One is that in terms of your strong total subscriber growth here, in the past quarter, industry subs growth has been growing very good. And now this quarter, it seems that the competitor has been participating in sub growth. How do you see the competitive landscape going forward? And how do you see that, you still have been gaining -- growing the market share in your total sub. Despite that, probably towards like the end of the year, we'll even have a better, stronger pipeline. But then this quarter, despite not very strong yet, but we still have a very, very good growth in our sub growth. Your strategy, you think we have been doing much better than our competitor this quarter. And then second is that, what is your sense in terms of second half in terms of advertising growth that you think second half besides is easy comp in our advertising revenue, you still see potential better drivers in our company in advertising or maybe the industry? How do you see has been turning better to give us confidence into the rest of the year? Thank you so much.

[Foreign Language] Okay. For the subscriber growth, yes, you are correct, we outperformed our peers in terms of subscriber growth in the first quarter. I think that’s mostly attributable to a very strong original content we offer in the first quarter, especially some serial, drama series we launched. And also some variety shows we produced originally such as Idol Producer, they all contributed to the strong growth. And I’m quite confident that this trend will continue into the rest of the year because our pipeline, as you mentioned, is quite strong in the second half. So, on the content side, we are quite confident. Secondly, also there is something related to scheduling the content, how to balance the mix of what kind of content to be aired and also benchmarking to what our peers or other companies are offering on that platform. So it’s overall strategy to scheduling the content launch schedule. But overall, I think we are quite confident and something I wouldn’t elaborate, we although have some initial – operational initiatives and marketing efforts on the sidelines.

This is Xiaodong. I will answer your second question. Actually, one of the very important reason why we see a very weak performance on the ad business is relatively we have a high base last year. So entering to the third quarter and the fourth quarter, there won’t be that usual, it’s more like to some extent more apple to apple comparison for the year over year growth. So I believe you won’t see, that kind of like a deterioration on the year-over-year growth coming to the second half of the year. But however, as I just said, we remain very cautious on the forecast of the entire advertising business in the next few quarters or even next two years, because of the relative weak macro environment.

Your next question comes from the line of Piyush Mubayi from Goldman Sachs.

Thank you for taking my question. I have two related questions with advertising. The first is, do you think in the longer term, your advertising business and your subscription business can run simultaneously. Or do you think that success in the subscription business would mean that the advertising business would be a very different business from the sort of numbers we saw in 2018? The second is, if you could dissect the advertising business between the performance brand advertising as well as the accounts, the major verticals that you're seeing and how each of those verticals are performing, that would be great. Thanks.

Piyush, can you repeat the second question? We kind of lost you for the second part.

Could you dissect the advertising business performance in the first quarter, what you've seen so far that has led you to a more bearish view on the advertising business in the second quarter, and a general cautious commentary around advertising for the next one year? Could you break it down between the different components and drivers of advertising business? Thank you.

[Foreign Language] To answer the question, I think we have three major revenue pillars for the company. The first one is membership business, which performed quite well in the first quarter and we continue to see the paying habit is forming for Chinese users and their willingness to pay is getting better than before. And second revenue source is advertising as you asked. I think there are two factors impacted our advertising revenue. One is, as we mentioned, there is some content delay in this quarter, and also, there'll be some further delay probably in Q2 and Q3 as well, that will definitely impact our brand advertising. And also another is, as everybody knows, there is some softness in our macro environment. As a result, certain advertising verticals, they lower your advertising budget, and that's another impact. And in advertising business, we also have in-feed advertising and we did some cleanup starting later half of last year. So that's another drag on the revenue side. And in addition, because on the in-feed ad inventory side, the overall inventory is coming up from all over the industry, but on the other hand, demand is not so upbeat as a result the CPM level is on a downward trend, but I believe in the second half and in Q2, Q3, I think the industry will eventually warming up and CPM can on a return trends to a normal level. And I also want to mention the third driver for our business, which is other business. Other business contains a lot of IP derivative revenues, including games and other IP related revenue, which can be potentially a long-term driver for us. [Foreign Language] I also want to add some commentary on the management of our business. For our membership business, I think seasonality wise, Q3 is the strongest demand from our users and followed by Q1, Q4, Q2; Q2 being the weakest. And also there's another factor, which is supply of content. The content was determined by the content procurement, content production, as well as the schedule of regulatory censorship of the content. So that schedule might not perfectly match the demand pattern of the user need. And also for our advertising business, there is also seasonality pattern, which is a little bit different than a membership, typically in Q3, it’s the stronger quarter in the year and Q2 or Q4, probably Q1 in the weakest.

Okay. Piyush, if you want more details about our advertising service, we can talk later during our conference. Thank you.

Your next question comes from the line of Ribery Gu from Credit Suisse.

I have a follow up question on the subscription growth. As the subscriber has already reached around 100 million level, I just want to understand the next step for a growing strategy for our subscription. I understand that our major focus will still be the content, but at the same time, will the management also focus on, like the upgrades for the subscription model, or anything like the further cooperation like we did with JD before.

[Foreign Language] Yes, you're correct that exclusive content is the most important driver in our subscription growth, especially the original high-quality content, because the licensed content, most of that is not exclusive. So the exclusive content really mainly comes from our original pipelines, especially drama series and to a lesser extent, variety shows and movies, but mostly drama series. And in addition, yes, we have some operational initiatives like a joint membership with certain standards like JD and some other Internet services and we also do some targeted marketing and promotions, but compared to content, those are not so meaningful drivers. [Foreign Language] I also want to add that, compared to Netflix, our model is a bit different because we have both free users and paying users. And now our efforts are mainly focused on convert those free users into paying users. And now on average basis, our paying users pay approximately 8 months during a 12-month period, and compared to several year ago, that number is only four months. And so we will continue to offer more and more high-quality content to drive those users to become paying users that paying a longer period of time. So as a result, at each time, we reported the quarter end number, that number will continue to grow.

Your next question comes from the line of Karen Chan from Jefferies.

[Foreign Language] My first question is related to the paying subscribers. So given some of the scheduled delay in dramas, how should we think about the full year paying subscriber target? And secondly, on content cost, can you provide us a rough breakdown between license and self-produced content this quarter? And how should we think about full year content costs budget and any more color on how license content procurement cost has been trending in the industry? That would be great. Thank you very much.

[Foreign Language] The first question, yes, our target does not change. We still remained the net addition target with that earlier in the year.

[Technical Difficulty]I think we disclosed before about the percentage and all mix of content cost and mix between original content versus licensed content. I think the percentage in this year remains about the same because there we won’t change the number like in 1 or 2 quarters. As I said before, it will be a long-term target, long-term task. So basically, it’s still between 10-20%. And if we are talking about, let's say, from VV perspective, or time-spend perspective, I can tell you the number is a little bit bigger than the kind of [Technical Difficulty]. Thank you.

Your next question comes from the line of Tian Hou from TH Capital.

Yeah, thank you for taking the question. So, last earning calls, I remember, you guys gave the guidance for the paying members for the full year. I wonder if there's a new guidance for the paying members on a full year basis. The second one is regarding the content cost. So what's the trend of the content cost for the full year? That's the second question.

[Foreign Language] Our full year guidance for the membership growth doesn’t change. Maybe, because of the content delay I just mentioned earlier, this target become challenging, but we would like to maintain this target for the full year growth.

Yeah. As I said before, this year, content cost our target tends to between 70% to 80% of revenue and seeing that it will remain the same.

Your next question comes from the line of Yanyan Xiao from Citic Securities.

My question is about a drop in recent drama [Foreign Language]. So can you share us more details about this drama and like the performing numbers right now or the projection numbers and also how does the numbers compared to the previously hit show like [Foreign Language] and how does this drama will influence your second quarter results.

[Foreign Language] Yes. The Thunder is a very good show and very good quality drama series. It’s a 48 episode-long series and now it’s in the 20th episode now. I think according to our AI system, we have a forecast system that e – we forecast that – this show airing and viewership behavior members will be better than in the name of people, but compared to the Yanxi Palace that might not be that level, because that’s the most important show and best performing show in the history of the video platform.

This is Xiaodong. If you’re talking about the impact on the revenue side, I can tell you actually as I explained no single drama titles will have like same material impact on the revenue side, because for most of the drama series, if it’s the original content, its titles have more impact on long run because most of the revenue contribution from the membership service, which will not have a significant difference within a quarter.

[Operator Instructions] Your next question comes from the line of Elinor Leung from CLSA.

Hi, thank you for taking my question. Can you talk a little bit more regarding the content regulation and what type of content has to be delayed? And also how long will be delayed? Is there any risk that we have to write off these content in the future and have we changed our content strategy now to cope with the new regulatory environment.

Okay, this is Xiaodong. Actually, we talked about regulation before, as I explained to your guys, actually this very, very seldom case, which we’re actually like we kill the content or titles, most time is simply delayed because of longer processing time, we need longer time to get approval from authority. So basically, I don't think there will be any risk on the financial side, which will require us write off certain content from bulk. So basically it will take us longer time and more effort to get approval. I think it's not regarding to a certain category of the content of which like the content is forbidden or whatever restricted from the authority, more thorough censor process [indiscernible]

Your next question comes from the line of James Lee from Mizuho Securities.

Thanks for taking my questions. And maybe one more clarification on the regulatory side, is your assumption to -- are you planning, based on your assumption, are you planning to launch any new drama series in 2Q and 3Q? Just curious what you’re thinking there, given the line of sight you can see on the regulatory side? And on the same front, are you expecting to add any subscribers in 2Q and 3Q and is it fair to assume if you launch fewer content out there, we will also see the churn rate go up as well. Thanks.

I think in the short term, probably like one quarter or several months, you will see some impact on – in releasing the content we produce or in the purchase. But generally speaking, we do believe people will do the job right, so gradually, you will see less and less impact in the long run, maybe properly third quarter, fourth quarter, there will be some impact. But we don't see like the significant impact on the business side.

Our last question comes from the line of Wendy Huang from Macquarie.

[Foreign Language] I will just briefly translate. Firstly, the follow-up on the accounting treatment on those delayed TV drama, if those TV dramas never get broadcast in the end, how will you actually deal with this from an accounting perspective where you need to actually write it off? And also what's your content procurement plan this year, i.e., how should we actually expect the content cost increase in 2020. Lastly, what's your plan to actually beef up your in-house production capability? How many number of the in-house studios do you have? Do you have any plans to acquire any good studios from market?

This is Xiaodong. I will answer your first two questions and let Gong Yu comment on the third one. And first, it never happened before and we seriously doubt it will happen in the near future, like certain content cannot get the approval and unreleased forever. Something like that. It never happened before and we do believe it will not happen in the near future. And even let’s hypothetically, we assume that something happened, something bad happened, most of the content are licensed content in our scope. So for licensed content, if it cannot go through the approval process, we do not need to pay for it. So basically, there's nothing like write off. So, for original content, there is only a very small percentage of the total content cost for now. And even that, and I seriously doubt we will see like a big impact on the book, because for most of the original content, it's a bit more like the, you understand the guidance before you launch a program for original content, the risk is even less than licensed content because we choose wisely what kind of type of content we should produce and the way we communicate with authority, upfront, that's how it works basically. And I will pass over to Dr. Gong Yu to answer your third question.

[Foreign Language] We have two types of original content. The first one is internal studio, which the content comes from the in house. We are funding directors and actors that are actually ourselves and also certain element to the external production team. This is mostly applies to our variety show category like Idol Producer and variety shows and for drama series, some earlier studios, the pattern is they pick the script play and established the project, then they outsource the production process to external partners, but some newly established new studios, they have their own production capability and they will be producing their own original content and those content will gradually come up in later half of this year.

Thank you. That's all the time we have for questions today. I'll now hand the conference back to today's presenters for the closing remarks. Please continue.

Thank you all for participating in today's call. If you have any additional questions, please feel free to contact us. Thank you.

Thank you.

Thank you. Ladies and gentlemen, that does conclude our conference for today. Thank you for participating. You may all disconnect.