iQIYI, Inc. (IQ) Q2 2020 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by, and welcome to the iQIYI Second Quarter 2020 Earnings Conference Call. [Operator Instructions] Please be advised 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, Lei Zhang. Thank you. Please go ahead.

Thank you, operator. Hello, everyone, and thank you for joining iQIYI's Second Quarter 2020 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. Xiaodong Wang, our CFO; Mr. Xiaohui Wang, our Chief Content Officer, and Mr. Xianghua Yang, Senior Vice President of our Membership business. Mr. Gong will give a brief overview of company's business operations and highlights, followed by Xiaodong, who will go through the financials and guidance. After their prepared remarks, Xiaohui and Xianghua will join Mr. Gong and Xiaodong 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 not limited to those outlined in our public filings with the SEC. iQIYI does not undertake any obligation to update any forward-looking statement except as required under applicable law. With that, I would now turn the call over to Mr. Gong. Please go ahead.

Hi, everyone. Thank you for joining us today. It's obvious that much has changed around the world since our last earnings call. Like many other companies and industries, we have experienced unusual user behavior, fluctuating numbers and great challenges. Clearly, the pandemic is the most influential factor to us and other business in the first half of this year. Our subscribers, MAU and user time spent all peaked during the first quarter because of home confinement. With pandemic gradually being controlled in Q2 earlier than most of other countries, people went back to work, and students in China started to study online and prepare for critical exams, such as the national entrance examination for college and high school, and the final term exams, all of which took place in June and July. As a result, we saw a decline in both people's video-viewing time and frequency in Q2. The pandemic also influenced our content supply. Movies especially theatrical movies, have served as one of our most important content categories in user acquisition and membership attraction. Due to the shutdown of cinemas, no new movies were released offline. Online video platforms, which act as the second window for theatrical movies under SVOD model, are also facing supply shortage and adverse effect to subscriber retention and acquisition. Fortunately, the cinemas in China were permitted to reopen on July 20, with limitation of 30% attendance rate though. Considering the average attendance rate of last year was lower than 30%, we believe that even with limitation, the offline movie industry will be normalized step by step. We expect more movies will be released in cinemas, and the amount will possibly peak during October national holiday. These movies could be aired on Internet in 2 to 8 weeks after the offline window. The supply recovery will somehow improve our subscriber growth and stickiness in late 2020. The pandemic also delayed the new episode airing of Japanese animation, which normally generates half of the traffic in our animation channel. Good news is that the release has been resuming since June end. By late July, almost all Japanese animations have come back, and our paying members' growth and retention will benefit from it gradually. As for variety show, the pandemic somehow affected the production, and thus, resulted in release delay. On the other hand, our pipeline needs to be adjusted according to the postponement of advertisers' sales promotions, considering brand advertising acts as the key driver for variety show revenue. Currently, the good news is that, this delay situation is being eased and all these delayed variety shows will be released gradually. Therefore, it will have a positive effect on advertising business, though will take time for financials to reflect. Same as variety show, the drama series' production has also been delayed for 1 to 3 months in general due to pandemic. But considering the much longer production cycle for drama, this kind of delay will not influence much on the releasing time. We will also take all measures we can to mitigate the possible risk on drama title release next year. Now let's go through the specifics of this quarter, starting with our membership business. As of June 30, our total subscribers were 104.9 million. Subscription revenues grew by 19% year-over-year to RMB 4 billion. Because of weaker content slate of exclusive dramas in Q2, together with the above-mentioned reasons, our subscriber number decreased. Having said that, we believe the second quarter membership slowdown is temporary as our subscribers are already rebounding from the end of June. We are also encouraged by all the positive signs we are seeing. As just said, the adverse effects on content supply are receding along with the pandemic containment in China, although it may take some time to fully recover. With our content and service getting better, we believe these new users will stay in or come back later to our platform. Additionally, our user data proved the large demand potential for long-form videos in lower-tier cities. Most importantly, we are steadily improving our original production capabilities. Our 40-plus in-house studios keep working on projects across various genres, including dramas, variety shows, movies, animations and more. Many of the original titles launched have shown extreme popularity, and more exciting titles will be on air in succession soon. In a word, despite the temporary volatility, we are still confident that our membership business will show healthy and sustainable growth over the long run. In the second quarter, our high-quality content continuously drives subscriber growth. As an innovative operational strategy, we launched the Mist Theater, a new content library, offers a rich collection of 12-episode suspense dramas. It shows strong appeal to users and enhances user retention and stickiness to our platform instead of to just a specific title. For variety shows, we grant subscribers privilege of advanced viewing and exclusive derived content with a wider range of titles, such as Idol Producer 3 and I'm CZR 2. We also keep exploring new movie releasing strategy. For example, we launched more movies via the Premium Video on Demand mode, PVOD mode, including the action-adventure fantasy movie, Double World; action movie, Knockout [Foreign Language]; art-house movie, Spring Tide [Foreign Language]; and the Oscar-winning movie, Marriage Story. Double World became an instant hit on our platform with its cinema-quality audio-visual experience via online screens, demonstrating promising potential of PVOD mode. In the future, we will release more high-quality movies via this mode. Top dramas, such as our hit title, The Bad Kids [Foreign Language], generated immense traffic and acted as key drivers for subscriber growth. Meanwhile, some content titles especially those high-quality original ones that have been available online for over 1 year still come frequently in and out of the top content list in terms of new subscriber attraction and retention. There is a noticeable increase in the lifetime value of our library content, as our premium original titles are accumulating. As our subscriber base tops the 100-million mark, we need to innovate in membership services and products to cater to users' diverse demands. We further optimized our membership system by launching the S-diamond Membership package on May 23. This S-diamond Membership integrates content offerings of our Gold Membership, our Cartoon Membership, Literature Membership, VR Membership and Sports Membership and grants access through multiple devices including mobile devices, PC, smart TV, and VR devices. The advertising business continued to be soft in the second quarter due to the advertisers' budget cuts, traffic decline after people went back to normal life and some variety show production delays. However, we are seeing a slow rebound of the business in the turbulent macro-economic environment. Ad revenue grew slightly compared to the first quarter and the average customer spending also improved sequentially. In terms of advertising verticals, food and beverage, bathroom accessories, telecom services and consumer electronics are showing a relative rapid recovery. We are also exploring new initiatives for ad monetization. For example, top players from our original blockbuster show, Idol Producer 3, hosted a live commerce with the famous KOL, Li Jiaqi, attracting nearly 20 brands to advertise with us. This kind of e-commerce show further enhances iQIYI's IP value, while directly drives brand awareness and sales conversion. Meanwhile, THE9, the girl group from Idol Producer 3, has received commercial endorsements from more than 15 top brands including DIOR, Mengniu, Nongfu Spring in just the last 2 months. Leveraging the popularity of the girl team, we will continue to conduct commercial cooperation to drive long-term business value. Our advertising business is also empowered by technology innovation. We utilize AI to place ads more properly, as viewers' acceptance for AI advertising placements is as high as 75% according to third party data. We also upgraded our video-in ad format, enabling auto-insert of ads that seamlessly matches the scenes and the plots. Looking ahead to the second half of the year, we expect the advertising business to remain under pressure. We believe it will recover but might take some time. We are seeing some resuming of advertiser confidence as the pandemic became under control and our content production has returned to normal. Going forward, we will further strengthen our content library and experiment more innovative ad formats to better mitigate risks from the changing macro environment. Content. Moving on to the content, in the second quarter, our premium content aroused widespread attention domestically and abroad. Starting with dramas, a number of our original titles gained public visibility and social media excitement. In Q2, we launched the finales of Winter Begonia [Foreign Language], a romance drama, and We Are All Alone [Foreign Language], a realistic title reflecting the situation in the entertainment industry, which both became trending topics on social platform. The Bad Kids [Foreign Language], the second drama aired under Mist Theater, became an overnight sensation after its release. It is called as the best drama title in the first half of the year, with an initial rating of 9.2 on Douban. From iconic Story of Yanxi Palace in 2018, to phenomenal The Thunder in 2019, to the highly-praised short dramas in Mist Theater this year, we have built records with our diversified original blockbusters for these 3 years, leading the online drama market. For variety shows, we cater to diversified demands from our users by analyzing their watching habits and likes. As an extension of our top original variety show, Idol Producer 3 turned out to be another success in the first half of the year, domestically and internationally. In addition, exclusive shows like I'm CZR 2, It's My Life and Amazing Dinner also received positive feedback during the quarter. Our original CG animation series, Deer Squad, that premiered on July 15 on our platform will air on Nickelodeon Asia channel from this August. Additionally, there will be 3 original movies under post-production, more movies are under shooting or to start shooting within this year. All of these will further strengthen our content supply. At the 26th Shanghai TV Festival Magnolia Awards-- [Foreign Language], our original title The Thunder won the Best Drama Award and the Best Screenplay Award. It is the first Internet drama series that wins the Magnolia Awards. Moreover, at the 23rd Shanghai International Film & TV Festival Internet summit, our self-produced drama series, including The Thunder, Detective Chinatown and Waiting For You In The Future, won the Annual Online Drama Award, while our original variety shows, such as The Big Band and I'm CZR were honored the Annual Variety Show Award. Additionally, our original documentary film, Touch Out [Foreign Language], won the Best Documentary and Audience Award at the 14th FIRST International Film Festival. Looking at the second half of 2020, there have been and will be more hit content superior in quality, including Reunion: The Sound of the Providence, one of The Lost Tomb series, Twenty Your Life On, Ping Pong, Love in Shanghai, The Blooms at Ruyi Pavilion and Hikaru no Go. As the market recognized Mist Theater for its innovative model and special category, over the next 2 years, we will gradually launch more of these distinctive themed theaters to cover diversified categories. In addition, the third quarter is the hot season for variety shows. Our pipeline consists of creative titles including Summer Surf Shop and Dimension Nova as well as multi-season hits such as The Big Band 2, Mr. Housework Season 2 and the Rap of China 2020. We believe these shows will bring us young, vibrant and positive energy especially under the pandemic existing period, building up an emotional and a lasting connection with our audience. Our R&D capabilities are one of our core competencies. In this quarter, we launched the technology support for the AV1, AOMedia Video Codec 1.0 video coding format. This is available on both PC and Android devices, boosting significant advantage in transmitting higher quality video content with saving almost 20% bandwidth. From user perspective, it allows viewers to enjoy ultra-HD video using less data without losing the quality. In facing adversities, our employees have risen to the challenge and demonstrated incredible creativity and commitment to our company and our mission, and we couldn't be more proud of them. While it is hard to predict precisely when there will be full resuming of all business segments, we have already discovered a silver lining in the fact that our users have demonstrated their tremendous appreciation and affinity to our original content, and our content partners and advertising customers always show us their strong support. All of these have solidified our confidence and determination to further develop our strategic vision for our business and deliver an exceptional entertainment service. With the substantial collection of IP assets, the outstanding content from our creative engines and our robust technology platform, we will emerge from this challenging period in a strong position and continue to drive greater long term value for our shareholders. With that, I'll turn it over to Xiaodong to talk about financials.

Morning everyone. Let me comment on our financial highlights. Despite the volatile macro-environment in China, we delivered another quarter of growth, with total revenues increasing 4% year over year. Our membership business continued to be the main business pillar, with revenues up 19% year over year, accounting for 55% of our total revenues. Our advertising business continued to be soft with revenue declined year over year, due to the advertisers' budget cuts, traffic decline after the pandemic containment and the delay of certain variety shows. Both our cost of revenues and operating expenses decreased year over year, and our content costs were only up 2%. We kept spending strategically on original content to drive in-house production capability while making wise and disciplined investment across the board. As a result, our operating loss margin narrowed to 17% from 26% in the same period last year. Our net loss decreased to RMB 1.4 billion from RMB 2.3 billion in the same period last year. As of June 30, 2020, the company had cash, cash equivalents, restricted cash and short-term investments of RMB 9.5 billion. For detailed financial data, please refer to our press release on our IR website. For the third quarter of year 2020, iQIYI expects total net revenues to be between RMB 6.95 billion and RMB 7.4 billion, representing a 6% decrease to flat year over year. This forecast reflects iQIYI's current and preliminary view, which may be subject to change. I will now open the floor to Q&A.

[Operator Instructions] Your first question comes from the line of Wendy Chen from Goldman Sachs.

[Foreign Language] So my question is about the subscriber growth outlook. You mentioned that the subs growth momentum has come back since the end of June. So wondering how do we see the subscriber growth so far for the -- and also for the second half of the year as the college entrance exam ended and the summer peak season started? And also how do we see the subscriber level reaching in the medium to longer term?

[Foreign Language]

Thank you, Wendy. You're correct that the examination for the entrance to college already ended on July. But to consider in this situation, this summer break is different from normal seasons that, for example, the exams were delayed 1 month, and also the other that with the shortened holiday -- summer break for the high school and maybe junior high school students as well, so that we cannot predict precisely on the net add numbers, but we are seeing the very clear trend on the rebounding of our traffic and the subscribers. Thank you.

Your next questions come from the line of Thomas Chong from Jefferies.

My question is about the advertising outlook in the second half. Given that we are seeing some kind of recovery in Q3, how should we think about the momentum for KA as well as SME? And my second part of the question is about our mid-form video strategies in the second half. Should we expect there will be a step-up in sales and marketing and any KPI that can share would be great.

[Foreign Language]

For the first question, and yes, that I think our most of ad revenue comes from the brand advertisement. So KA reflects a large proportion of our ad revenue. That as we can see that the KA brand advertisers said that their budget is coming back after our variety show is gradually to be on air. But it will take some time to reflect in the financials. Because that, I think that some of our new variety shows will be on air on August and some maybe on September and possibly peak on October. So that it will take some time to reflect in financials. For the in-feed advertisers and for the SME advertisers that -- since it's not account for so much of our advertising revenues, even that there's some rebound, it will not reflect too much on the financials. Regarding the Suike that we did variety of the activities on the market promotion and the technology platform building and also, after that, we put efforts on the community setup for the fans. But there is -- there has been some progress already, but we need some time to build it into the large scale. And I think that the most of the advertisement in the Suike will come to the form of the in-feed advertisement and the ad inventory will thus be not that much. So that we don't see much of the reflection on the ad revenues from the Suike perspective.

And now we have Alicia Yap from Citigroup.

[Foreign Language]

[Foreign Language]

I will answer the first question, then we'll leave Xiaodong to answer the second one. We have different scheduling strategies regarding the different content category. I'll start with the dramas. For example, the drama there are a few influential factors regarding the scheduling. There are -- the first 2 are most important ones, including the production cycle and our license cycle. The second one is the regulation cycle. And also that it may have some influence from the advertisers but not much. For the variety shows that seems that most of the revenue comes from advertisers, so it will be determined mostly by the advertisers budget and their promotion activity schedule. So most of them, the variety shows needs to be aired or produced or scheduled based on the contract agreement with the major advertisers or that the appropriate ROI assessment, so that only very few of variety shows that we decided to schedule anyway, it's because they have -- there has something more meaningful to our platform or that we expect that their revenue will gradually increase after -- as long as it is broadcasting. So that meaning, in that case, we may schedule it on air that even without agreement with advertisers. Now Xiaodong, you have...

No, go ahead.

Sorry that Mr. Gong wants to add some points on this question. Please, later.

[Foreign Language]

Also for the scheduling on other 2 content category, animation and theatrical movies that, thinks that the Japanese animation generates half of our traffic in our animation channel. Since the break up -- the pause of the Japanese animation, new episode releasing somehow influenced our animation traffic as well. And -- but in the future to cope well with this kind of possible risk, we will invest more on the domestic animation production. For the theatrical movies that we can -- everybody can see that for the half of the year, there is no theatrical movies release offline. That's also because of the we ranked #1 on the movie traffic compared to other platforms that this kind of shortage on the content supply that somehow influence us most regarding the theatrical movie. Good news is that the cinema already reopened from July 21. We expect that more and more movies will be released offline and possibly after 2 to 8 weeks, that it will be aired on the Internet as well. Possibly the national holiday will be the peak time for the theatrical movies' release. Also that to further better coordinate with the kind of the possible risk that we will invest more original movies, and the quality will to the same as the theatrical movies, and we will do more to cooperate with this kind of risk and build up our own self-produced movie confidence and independence as well.

This is Xiaodong. I think a couple of weeks after the short seller report, we received inquiry from both Nasdaq and SEC, the inquiry on a confidential basis. However, we still voluntarily to disclose this inquiry at this time because we want to be transparent to all investors. That's basically the logic behind. Thank you.

Your next question comes from the line of Ella Ji from China Renaissance.

[Foreign Language] So two questions relating to the membership services revenue. One is due to the delayed launch of some key drama shows and variety shows, in the later half of the summer break, I just wonder the seasonality for the rest of the year, so are we going to see a more balanced membership growth between 3Q and 4Q this year versus the prior year? And secondarily, management mentioned a few areas to increase the ARPU of your members. So just wonder what's the organic ARPU growth for your members.

[Foreign Language]

As our SVP of the Membership business, Mr. Yang Xianghua just answered the question that, yes, you're right. The Q3, normally the peak season for our traffic and the same as our subscriber additions. But normally, that it's also highly depending on our content supply as well. Some of the summer with really heat, blockbusters will have the higher traffic and subscriber additions, some are not. But for this year, that with the influence of the pandemic and also relatively shorter summer break that we cannot predict or anticipate precisely about the number of the net adds of the subscribers. But it's very clear that we are already seeing some rebound from the Q2 end. And we hope that the trend will continue for the increase. But again, this may some -- have some uncertainties on that. Thank you.

And now we have Billy Leung from Haitong International.

[Foreign Language]

[Foreign Language]

Thank you for the question regarding S-diamond membership. And yes, that from the May 23 that we launched our new membership package [Foreign Language] S-diamond membership to cater that -- our diversified membership proposition. It has -- since it has only launched for more than 1 month that until Q2, and we didn't see it account for too much on our relative very big massive user bases. So -- but it did meet our expectations, and we have the expectations on this to further improve our subscriber monetization. Thank you. Xiaodong will follow with the next questions.

Regarding the internal review on the SEC's queries, I think you're right, it's been almost like 4 -- more than 4 months past. But you have to understand, it's internal, independent internal review. So we don't know exactly the result and the status right now. What I can tell you is the voluntary disclosure of this investigation itself actually shows the confidence of the management on the potential results of this internal review. And we do believe due to the solid and disciplined internal control process and the corporate governance we built in the past 10 years, and together with the corporate culture we're promoting in the company, we do believe the results will be quite positive to the company. That's our belief. And also, here, because a lot of people are asking similar questions. I just want everybody, including those non-Chinese speaking investors, I think you have to understand, unlike those short seller or the politicians, we are -- we have some -- we are people who create not destroy. We are someone who [indiscernible] not interest. So I do believe and together under the lead of Dr. Gong Yu, we will be up again. We will show all the investors the quality of the company and the potential of the management. Thank you.

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

So the first question is -- I want to see if the company can give some color on the [Foreign Language]S-diamond member and [Foreign language]. So that's one. Number two is I have to doubt the member -- revenue per member, if that can actually sustain -- steadily support iQIYI, this kind of a market cap, if there are some other ways of accomplish much bigger monetization in addition to the member fee. So what's the thought on that from management? That's 2 questions.

[Foreign Language]

Mr. Xianghua will answer the first question. Yes that, you can see that we developed a variance of the subscriber fees and other monetization methods mostly to cater to different choices, options of our customers. I think that we have a massive user base. And this seems controversial but, fundamentally, it's not conflicted to each other at all. And that also that we will further explore possible monetization method to cater to our users' demand and without any, adverse feelings from our users. As we can see that exploring to -- for the subscribers or paying users that monthly, yearly that there's many exploring in the history. And until now that we can admit the current user change and the user willingness to pay for the content through other entertainment forms, the trend is clearly going up. And we can see not just us long-form videos, for the music and literature as well. People paying willingness is increasing that we are certain that paying is still the clear trend. And Dr. Yu will follow with the next question.

[Foreign Language]

Regarding our business model that we firmly believe that our major source of our revenue is still the subscriber revenue. That the subscriber revenue still cannot cover our cost, it's because the past 9 or 10 years intense competition. Currently, that our monthly fee is RMB 19.8. It is calculated and made by -- in the discussion between me and Xianghua a few years ago. We didn't have much of the benchmark regarding the industry at that moment. That's why we consider things that, reading the data, normal users in China, normal audience in China that normally will watch 4 movies per month. And the unlicensed DVD, they're buying at a price of RMB 5 for 1 disc. So combined together, it is RMB 20 for 1 month. That's why we made our price for the monthly fee at RMB 19.8. So it still is relatively low regarding., because of the competition, it cannot cover our content cost right now. So with other revenues together with advertising revenues because we have the different format of our advertisers, advertisement, some subscriber will -- advertisers, advertisement and also nonsubscriber advertisers as well with other added value, the monetization methods, including animation, literature and so on that we believe combined all of these revenues together, still we can achieve the profitability or cover our content at least. Thank you.

The last question comes from the line of Bo Pei from Oppenheimer.

[Foreign Language] I will translate for myself. I want to know more about the 12 episode summer series like The Bad Kids had very good feedback in 2Q. And then I want to know in terms of ROI, is there any difference between the short drama series and the long one we used to produce more? And then in the future, is that a key area for us to invest?

[Foreign Language]

Our Chief Content Officer, Xiaohui, just answered this question. That since that, we very appreciated that and very happy to receive the very positive feedback regard -- and better ROI on the -- from The Mist Theater since we launched it, and especially the titles you mentioned, The Bad Kids, and we definitely will invest more on this type of the intense suspense dramas and other themed theaters as well. But we will not -- of course, we will not invest less on the long or longer episode dramas as well because they have different expressions and different ways to attract our users. No matter long -- the longer episodes or the short episode, we definitely will continue to improve our capability to provide more high-quality content to our users. Mr. Yu Gong will also add some points on this topic.

[Foreign Language]

This kind of 12-episodes, short drama titles to that, the content cost per episode is a little bit higher than the longer episode drama. But the ability to attract subscribers is as strong as other form of the drama titles so that we can see a little bit better ROI for this kind of 12 episode drama. Thank you.

Thank you. Now I would now like to hand the conference back to the management. Presenter, please continue.

Thank you for joining us today. Thank you very much. Have a good day.

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