iQIYI, Inc. (IQ) Q4 2019 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by, and welcome to the iQIYI Fourth Quarter and Fiscal Year 2019 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. [Operator Instructions] I must advise you that today’s conference is being recorded. I would now like to hand the conference over to your first speaker today, Investor Relations Director of iQIYI, Dahlia Wei. Thank you. Please go ahead.

Thank you, operator. Hello, everyone and thank you all for joining iQIYI's fourth quarter and full year 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 brief overview of our company's business operations and highlights followed by Xiaodong, who will go through the financials and guidance. After their prepared remarks, we will 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 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 Dr. Gong. Please go ahead.

Hello everyone and thank you for joining us for our fourth quarter and the full year 2019 earnings call. We concluded the year 2019 with a solid ending. Q4 and the full year net revenues reached RMB7.5 billion and RMB29 billion, respectively, backed by the optimized structure of our content costs, which only grew moderately at single-digit percentage on a full year basis. We further solidified our industry-leading position in terms of our user scale, user stickiness, and a number of subscribers. We are pleased with a set of significant progress we made in 2019, including being the first among industry peers to hit the 100 million subscriber milestone, consistently developing innovative original content, pioneering new advertising solutions, and making new breakthroughs in technology development. I'll start my review with our membership business. As of December 31st, 2019, our total subscribers reached 107 million, a net addition of 19.5 million compared to year end 2018. Subscription revenues grew 36% year-over-year to RMB14.4 billion and contributed half of our full year 2019 total revenues. This reflects our dedication in delivering best quality content to our subscribers and our various operating initiatives to expand our subscriber base. In the fourth quarter, the release of a number of highly popular drama series drove subscriber growth, namely Qing Yu Nian, The Listener, Sword Dynasty and Spirit Sword Mountain among others. Typically, drama series have been the main driver of the subscriber growth, but with our portfolio of content expanding, we are beginning to see a wider range of content categories playing an increasingly important role. For example, hit theatrical movies, such as Ne Zha and The Captain, animation serials One Piece, as well as premium variety show, More Than Forever, all helped to drive our subscriber growth. Also if we look at full year 2019, we saw some of our library content demonstrating long-term values. Our legacy blockbuster dramas, Story of Yanxi Palace and The Mystic Nine, which are two years and four years old, respectively, still consistently ranked among the top contributors. This reinforces our belief in the intrinsic value of premium original content, which will become classics over time, and will take up an increasing share of our content library. During the fourth quarter, we introduced a value-added membership service for some of our content, including Spirit Sword Mountain and Qing Yu Nian, whereby, subscribers can enjoy advanced access to additional episodes at a premium level of packaged or unit expenses. This was the first time we offer such service for our subscribers. And so far, we have seen encouraging results. Going forward, we intend to further optimize our membership system, provide premium services and entertainment experiences to subscribers who are willing to pay for extra privileges, hence, improve overall ARPU and monetization. We continued our efforts to penetrate into low-tier cities. We utilized AI and big data technologies to cultivate content offerings that are more appealing to user demographics in these regions. We also rolled out various marketing campaigns to promote brand awareness in low tier cities. Moreover, we are actively working with numerous cross-industry partners to tap into local markets through a wide range of cooperation channels. These partners range from telecom operators, banks, e-commerce platforms to fast food franchises and retail chain stores, among others. Leveraging their strong local presence in hundreds of low-tier cities, we are able to expand our user reach and improve subscriber conversion. Moving on to our advertising business. Overall, 2019 was a tough year for the broader advertising markets due to the challenging macro and competition environment. Nevertheless, we tried to mitigate the impact of these headwinds by adapting and upgrading our advertising products, better leveraging the strength of our content and expanding our advertiser base. For brand advertising, by converging our content strengths and advertising creativeness, we have launched numerous new formats of embedded ads, innovative ads, sponsorship ads and so on to better cater to advertisers' need. For example, in the fourth quarter, our original fashion-themed reality show FOURTRY attracted over 10 leading brands, including Vivo, Lancôme, Pepsi and the e-commerce platform Aomygod.com to advertise with us, which not only enhanced their brand awareness, but also boosted their sales volume. For performance ads, we saw continued revenue rebound in the fourth quarter, although, from a relatively small base. Leveraging our massive user traffic, abundant data and AI algorithms, true-view ads and in-feed ads continued to serve as dual engines for growth. In 2020, we will dive deeper into the more resilient and promising advertising sectors, such as e-commerce, education, finance, and Internet services to seize potential growth opportunities. Aside from our membership and advertising revenues, our other revenues on a combined basis grew 30% year-over-year and accounted for a record 13% of total revenues in 2019 compared to 11.5% in 2018. This illustrated the continued progress we are making towards building a diversified business model. Our game business performed particularly well with the launch of a number of successful new games, such as The Croods and the Death of Love throughout the year, which drove strong organic revenue growth. Our new mobile game, Re: Life in a Different World from Zero-Infinity, which was adapted from a popular animation series, was launched last month and has attracted a large number of ACG users. Other smaller business that we are incubating such as live broadcasting, talent agency, digital literature and IP licensing, have all benefited from the significant synergies created by our content ecosystem and are natural expansion of our IP-based development value chain, which leads to the next part of my discussion, our content. During the fourth quarter, we continued to focus on delivering high-quality content and achieved a number of breakthroughs in the creation of original content. According to Enlightent [ph], the third-party marketing survey, we outperformed industry peers once again in terms of video views for both dramas series and variety shows during the quarter. For full year 2019, we released quite a number of blockbuster dramas, covering themes that vary from suspense, romance and family life, to military, reality and many more. The best performers of the year include The Thunder, Go Go Squid! and A Little Reunion, as well as aforementioned Qing Yu Nian and Spirit Sword Mountain. The popularity of these titles demonstrates our growing ability to identify and deliver a premium content across numerous verticals. We replicated the success with the recent launch of the exclusive hit drama iPartment Season 5, which attracted over 38 million subscribers to watch -- to watch it within the first week of debut. Together with The Great Ruler, an original costume drama launched in late January, these popular content will help drive subscriber growth. For variety shows, in the fourth quarter, we released season six of our flagship talk show, Qipa Talk, which is our longest-lasting web show in the industry. I'm proud that we now have a proven track record of consistently releasing sequels of our top variety shows, including Qipa Talk, The Rap of China, as well as highly anticipated return of Idol Producer Season 3, which will take place this quarter. We are continuously building strong IPs of multi-generation shows and drives significant long-term value for us. On the other hand, we would like to highlight our consistent innovation around developing new themes and new formats of variety show content. Our 2019 new shows, The Big Band and FOURTRY have both garnered overwhelming success. Let me take FOURTRY, the star-studded original fashion reality show, as an example. Leveraging its pop culture appeal and growing influence on fashion trends, we launched our own fashion brand FOURTRY and developed over 270 co-branded SKUs to embrace the new consumption trends in the market. This multi-dimensional development process will help us maximize IP commercial value and will act as an incremental driver for long-term growth. Looking ahead to 2020, we have forged a robust pipeline of premium content, including over 100 major dramas, over 30 variety shows as well as 20 original animations and comics. This pipeline not only covers highly popular mainstream shows, but also expands to various new content runways that appeal to even more diversified user groups. Content innovation is at the core of our strategy and the talent is the key to content creation. In 2019, we entered into partnership with highly-specialized academic institutions, including Beijing Film Academy and Shanghai Theater Academy, among others, to cooperate on educational programs, which will expand our talent reserves and nurture their creativity. And at present, we have over 40 internal studios focused on different content genres and are also contributing to the industry content production ecosystem. Moving on to the technology. Technological innovation has always been a cornerstone for our business. Driven by AI-based technologies, we were able to continually enhance our user-oriented entertainment service platform and explore new and innovative ways to improve content creation, distribution and monetization. In the fourth quarter, we launched an innovative AI application called AI Radar, which supports the realtime recognition and search of information from video images and also provide users with an interactive feature to directly buy a product while watching a video. This technology has been applied to various content across our platform, including fashion show FOURTRY this quarter. Cyber security continues to be very important for leading digital entertainment companies like us. We are committed to ensuring robust user data protection. Recently, our user information security management and privacy protection technology was recognized by leading international authorities with the grant of verification certificates ISO 27001 and ISO 29151. With the growing user demand for diverse – diverse entertainment formats, we plan to launch a YouTube-mode app named Suike. To-date, the YouTube model has not grown to scale in China due to a mixture of complex factors, but we believe that with the growing deployment of 5G and AI technology, the market potential for a similar app will grow significantly in the next two to three years. In order to capitalize on this opportunity, we have started to make initial efforts and investments into building this model to scale -- model to building -- into building this model to scale. To lead this new and important initiative, we are pleased to have Mr. Hong Ge [ph] on board, who brings with him extensive experience in technology and management. Mr. Ge has held key positions in the industry-leading companies, such as Facebook and Airbnb. He received his Master's Degree in Computer Science from Yale University and his Bachelor's Degree in Computer Science and Technology from Tsinghua University. In conclusion, 2019 was a challenging yet a fruitful year. We further strengthened our IP-centered content ecosystem while growing and diversifying our revenue streams. I'm proud of what we have achieved during the year and then look forward to 2020, which marks 11th year since our founding. As 2020 unfolds, we believe the industry will continue to trend towards a healthier and more rationalized competition landscape, with increasingly newer and richer format of video content emerging in the market. We now have more than 40 in-house studios that are dedicated to content production of drama, variety show, animation, children's content and many more, allowing us to provide more exclusive and original content for iQIYI users going award. The rising willingness of Chinese users to pay more for premiums content creates significant potential for our business. Following of initial steps in overseas expansion last year, we are planning to add more local in local contents and international contents this year. All-in-all, we are more confident than ever in our future growth prospects. Before I conclude my prepared remarks, I would like to quickly comment on the recent outbreak of coronavirus. During the outbreak, we prioritized the health of our employees by taking care of their needs and offering flexibility to work from home. So far, there's zero infection among all of our employees around the country. In addition, we have always been committed to maintaining high standards of corporate social responsibility. We produced various relevant video content that help increased public awareness and support as the nation fight the outbreak. We are also the very first online entertainment company that invited over 200 celebrities to shoot for music videos for the charity song, Let the world be filled with love, which were released on our platform, various TV stations and many other media platforms. We believe we will eventually overcome the coronavirus and get back to our path toward future growth prospects which remains intact. With that, I will turn the call over to Xiaodong to go through the financials.

Good morning, everyone. Let me go through our financial highlights. For the fourth quarter of 2019, iQIYI total revenues were RMB 7.5 billion, up 7% year-over-year. Total revenues in 2019 were RMB 29 billion, up 16% year-over-year. Membership services revenue for the fourth quarter were RMB 3.9 billion, up 21% year-over-year. Membership service revenue in 2019 was RMB 14.4 billion, up 36% year-over-year. The increase was primarily driven by the growth in the number of subscribing members. Online advertising services revenue for the fourth quarter was RMB 1.9 billion, down 15% year-over-year, primarily due to the challenging macro economic environment in China. Online advertising service revenue in 2019 was RMB 8.3 billion, down 11% year-over-year, primarily due to the macro headwinds, the uncertainty of certain content scheduling and intensified competition in advertising business. Content distribution revenue for the fourth quarter was RMB 878 million, up 68% year-over-year, driven by higher volume and the contractual price of the titles we distributed in the quarter. Content distribution revenue in 2019 was RMB 2.5 billion, up 18% year-over-year, driven by a number of premium content titles that we distributed during the year. Other revenues for the fourth quarter were RMB 874.4 million, down 21% year-over-year, primarily due to the soft performance of certain business lines, partially offset by strong growth in game business. Other revenues in 2019 were RMB 3.7 billion, up 30% from 2018, driven by the growth of number of business verticals, especially robust growth of our games business after the acquisition of Skymoons. Moving on to the cost of revenues. Our cost of revenues for the fourth quarter was RMB 7.9 billion, down 7% year-over-year, primarily due to the lower content costs, partially offset by the increase of other cost items. Content cost for the fourth quarter were RMB 5.7 billion, down 13% year-over-year. This was a combined result of certain major titles being launched later in the quarter as well as the less expenses recorded related to the original content. Cost of revenues in 2019 was RMB 30.3 billion, up 12% of 2018, primarily driven by the high content costs and other cost items. Content cost in 2019 were RMB 22.2 billion, up 6% year-over-year due to our continued investment in our comprehensive and diversified content library. Turning to operating expenses. SG&A expenses in the fourth quarter were RMB1.4 billion, up 15% year-over-year. SG&A expenses in 2019 were RMB5.2 billion, up 26% from year 2018. This was primarily due to the increased sales and marketing expenses related to certain iQIYI apps and our game business. The full year increase was also due to the higher share-based and personnel-related compensation expenses. Our R&D expenses in the fourth quarter were RMB711.3 million, up 17% year-over-year. Research and development expenses in 2019 were RMB2.7 billion, up 34% from the year 2018. The increase was primarily due to our continued investment in R&D personnel. Operating loss in the fourth quarter was RMB2.5 billion, compared with the operating loss of RMB3.3 billion in the same period of 2018. The operating loss margin for the fourth quarter was 34% compared to that of 47% in the same period of year 2018. Operating loss in 2019 was RMB9.3 billion compared to an operating loss of RMB 8.3 billion in 2018. Operating loss margin in 2019 was 32% compared to 33% in 2018. Total other income in the fourth quarter were RMB75.3 million compared with the total other expenses of RMB 34.8 million during the same period year of year 2018. The year-over-year variance was a combined result of foreign exchange gain due to the exchange rate fluctuation between RMB and the U.S. dollar, increased interest expenses associated with our financing activities, as well as the impairment loss for certain private company investments. Total other expenses in 2019 were RMB967.1 million compared to total other expense of RMB676.2 million during 2018. The full year variance was due to the increased interest expense, foreign exchange fluctuations, as well as the impairment loss and lower fair value gain for private company investment. Loss before income taxes for the fourth quarter was RMB2.5 billion compared with a loss of RMB3.4 billion during the same period of 2018. Loss before income taxes in 2019 was RMB10.2 billion compared to a loss of RMB 9 billion in 2018. Income tax expense for the fourth quarter was RMB22.6 million compared to income tax expense of RMB79.5 million during the same period in 2018. Income tax expenses in 2019 was RMB51.9 million compared to income tax expense of RMB78.8 million in 2018. Net loss attributable to iQIYI for the fourth quarter was RMB2.5 billion compared with a loss of RMB3.5 billion during the same period of 2018. Diluted net loss attributable to iQIYI per ADS for the fourth quarter was RMB3.43 compared to a diluted net loss attributable to iQIYI per ADS of RMB4.83 in the same period of 2018. Net loss attributable to iQIYI in 2019 was RMB10.3 billion compared to a net loss of RMB9.1 billion in 2018. Diluted net loss attributable to iQIYI per ADS were RMB14.14 for 2019 compared to a diluted net loss attributable to iQIYI per ADS of RMB 17.01 in 2018. As of December 31, 2019, the company had cash, cash equivalents, restricted cash and short-term investments of RMB 11.5 billion. Turning to our first quarter 2020 guidance. We expect total revenues to be between RMB 7.10 billion and RMB 7.52 billion, representing an increase of 2% to 8% 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 to Q&A.

Thank you, Xiaodong. Ladies and gentlemen, we will now begin the question-and-answer session. [Operator Instructions] Your first question comes from Alicia Yap from Citigroup. Please ask your question.

Your next question comes from Eddie Leung from Bank of America, Merrill Lynch. Please ask the question.

Your next question comes from Thomas Chong from Jefferies. Please ask the question.

Your next question comes from Wendy Chen from Goldman Sachs. Please ask your question.

Your next question comes from Ella Ji from China Renaissance. Please ask your question.

We still got time for one last question. Our final question comes from Tiah Ho from T.H. Capital. Please ask the question.

I would now like to hand the conference back to management. Please continue.

Okay. Thank you, again. And if you have any other questions, please do feel free to contact us. Thank you.

Thank you.

Ladies and gentlemen, we have reached the end of our conference call. Thank you for participating. You may all disconnect.