iQIYI, Inc. (IQ) Q2 2021 Earnings Report, Transcript and Summary

Good day and thank you for standing by. Welcome to iQIYI Second Quarter 2021 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 would now like to hand the conference over to Ms. Fan Liu, Head of Capital Market of iQIYI to read the opening remarks and Safe harbor statement. Please go ahead.

Thank you Operator, and thank you for joining iQIYI Second Quarter 2021 earnings conference call. The Company's readout was released today and is 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 CCO, Chief Content Officer; and Mr. Wenfeng Liu, our CTO, Chief Technology Officer. Mr. Yu Gong will give a brief overview of the Company's business operations and highlights followed by Xiaodong who will go through the financials and the guidance. After their prepared remarks, Xiaohui and Wenfeng, we're joined the mid-term goal and Xiaodong in the Q and 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 and are not limited to those outlined in our public filings with the SEC. SEC undertakes 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.

Hello, everyone. For the second quarter we maintained favorable momentum from the first quarter, with total revenue approaching the high end of our previous guidance. Our operating loss narrowed for 5 consecutive quarters on a year-over-year basis due to our effective cost and expense control. During the quarter, we continued to lead the market in multiple operating metrics. According to the third-party data, we ranked at the top of the long/mid-form video industry in terms of mobile MAUs, mobile DAUs and the total user time spent. First, let's start with our membership business. As of June 30, our total number of subscribers reached 106.2 million. This represented 0.9 million net add sequentially despite the heightened uncertainty of content launch during the second quarter. Our membership growth was mainly due to three factors; 1, our premium content, especially dramas, performed well, which helped to drive the number of subscribers to increase. For example, dramas launched in June, including: My Dear Guardian [Foreign Language] and The Rebel [Foreign Language] were well received by audience. In addition, films such as Detective Chinatown 3 and Break Through the Darkness [Foreign Language] also did well. Second, we saw strong membership growth on TV devices as we approach summer vacation. Three, we further deepened our overseas expansion, driven by our premium content and efficient operation, we consistently improved the conversion of our subscribers. The number of our overseas subscribers at the end of quarter exceeded 1 million. Apart from bringing our domestic produced content to the overseas users, we also made breakthrough in the local original content. For example, we launched our first original Korean drama series: My Roommate Is a Gumiho, in May, which was remarkable success. In addition, the Sweet On Theater was launched for the first time in overseas market, [Foreign Language], keeping pace with the domestic success of theater scheduling mode and improving the retention of specific user cohorts with a sequence of genre-specific content. The slightly sequential decline of membership services revenue was mainly due to the volatility of subscriber number during the quarter, which was mainly attributable to: one, lack of blockbusters to continue the popularity from Q1, which causes the volatility of subscriber number, particularly in the first half of Q2. Two, delayed launch of premium content to the end of Q2. Despite the volatility of our membership services business, our ARPU grew nicely. Average monthly ARPU saw high single-digit growth year-over-year during the quarter, mainly due to the price adjustment we launched in November last year. With more premium and diversified content portfolio to be launched since the second half of the year, we remain confident in our mid- and long-term subscribers and ARPU growth. Furthermore, we also expanded new market space for paid online videos. During the quarter, we launched our Cloud Cinema brand. The brand includes three major categories: theatrical movies launched under our PVOD mode, S-rated online movies, and our original movies. The revenue-sharing ratio of PVOD movies to content partners increased to 42%, which is higher than theatrical releases. By doing this, we hope to explore a new area for growth and establish a new online distribution ecosystem for movies. Moving over to our advertising business, our total advertising revenue increased by 15% year-over-year, but declined slightly quarter-over-quarter. The year-over-year growth was mainly attributable to the peak season for food and beverage advertising partially offset by a decline in revenue due to our content delay. We expect both brand and performance ads to increase in the third quarter due to our ad inventory increased during the summer vacation. Brand ads recorded significant growth year-over-year during the quarter, mainly due to an improvement in ARPU. Our major dramas during the quarter such as A Love for Dilemma [Foreign Language], The Rebel, My Dear Guardian and Sweet On Theater, all performed well in terms of popularity, word of mouth and video views, which helped to drive our client ARPU to the peak level over the past few years. Performance ads regained year-over-year growth during the quarter, mainly driven by the contribution of key industries such as internet movies, e-commerce platforms, and internet service apps. We also enhanced our monetization capabilities with our products and technologies, which helped to significantly improve our effective CPM. Meanwhile, new resources from connected TVs and ad alliances both performed well. Moving over to content. Although we experienced certain challenges in content scheduling during the second quarter, we maintained our leading position in terms of the total number and video views of top content across categories, from dramas and variety shows, to animation and children's content. According to third party data, video views of our dramas and variety shows accounted for nearly 40% and over 30%, respectively, of the overall market viewership. Our animation content, including children's cartoons, had over 40% market share. During the quarter, we launched a series of classic titles. The content perfectly catered to user demand and further serialized the development and innovation for top IPs. To give you some examples: One, for dramas, we launched the exclusive title The Rebel, which was a hit among a wide range of users. The dramas topped a number of ranking lists since its launch and were rated 8.3 on average by over 220,000 accounts on Douban, a widely used user rating platform. Other exclusive dramas, such as A Love for Dilemma, My Dear Guardian, My Treasure and others were well received on our platform. In addition, A Love for Dilemma also aired on CCTV-8 and the Dragon TV, which helped to attract a lot of TV audience back to the iQIYI platform. Following the success of the Mist Theater, we continue to broaden our content offering via theater mode. We are working to meet the diversified needs of users through this new mode, enhancing their user experience while attracting the fans in the niche segment. In May, we launched the Sweet On Theater in which Moonlight [Foreign Language] and The Day of Becoming You successfully gained the popularity and the word of mouth. For variety shows, we continued to innovate new original content across various genres. Original titles, such as The Detectives' Adventures [Foreign Language], Mr. Housework season 3 and Working Mom [Foreign Language] were especially hot shows during the quarter. Three, for animation, our self-produced animation Immortal Demon Species [Foreign Language] maintained its popularities throughout the quarter. Other titles launched include No Choice But to Betray Earth! and our self-produced cartoon The Tales of Wonder Keepers [Foreign Language]. Four, for online movies, in April, we exclusively released Raid [Foreign Language], which up to now, its box office is about to break RMB 30 million and well received by audience. For original films, Break Through the Darkness [Foreign Language] which was produced by iQIYI Pictures, was released in theaters during the quarter. The cumulative box office has surpassed RMB400 million so far. It has received great reviews and commercial returns. At the same time, another two movies produced by iQIYI Pictures started shooting in the second quarter, and another four are in post-production and expected to be released soon. In addition, iQIYI Original Films has 14 films under development. For the second half of the year, we have a better pipeline than either the first half of the year or the second half of last year in terms of numbers of titles, quality and genres. Meanwhile, we will continue to push to launch our scheduled content on time. For the second half, key drama include traditional dramas with regular numbers of episodes such as Ace Troops [Foreign Language], The Ideal City [Foreign Language], and Fengqi Luoyang as well as vertical theater brands, such as Who is the Murderer, Gold Panning, [Foreign Language] and The Pavilion [Foreign Language] in Mist Theater. For variety shows, we are focused on developing innovative new content across a number of themes such as the already launched Game of Shark [Foreign Language], and New Generation Hip-hop Project, upgraded version of the Rap of China as well as What's Your Name and Born to Dance [Foreign Language]. For animation and the children's content, while expanding our content library, we are also exploring the area of in-house production. A couple of exciting titles included the already released self-produced 3D animation Immortals of the Godless Age [Foreign Language], Princess Doremi and Tuktak Man 5. In addition on sports content, after successfully broadcasting the Euro 2020, we will present full competitions of Premier League for the next 4 seasons. 2022 FIFA World Cup qualification games in Asia as well as La Liga and other top sports events. Moving over to technology, advanced technology is the cornerstone of our business. Among other things, it allows us to continuously develop innovative content, enhance the user experience, and improve our operating efficiency. During the quarter, we were pleased to see that iQIYI lite that targets users in lower-tier cities had rapid take up. The peak DAU exceeded 1.3 million, and the average user time spent exceeded the same metrics on our iQIYI mobile app, the number is as at the end of last quarter. In terms of demographic, users on iQIYI Lite consist mainly of elderly and young people, groups that tend to have more spare time, mainly in lower-tier cities. In June, the average DAU overlap between iQIYI lite and our main app is around 7%. In addition, we constantly work hard to improve the technology of our recommendation engine so that users are effectively matched with the most appropriate content from our vast library. We believe nearly 30% of our DAUs were driven by our content library during the second quarter. Recently, we also made progress in industrialization of video production by utilizing our intelligent production tool set. For example, we currently launched the Production Business Intelligence System, PBIS, internally. PBIS is a professional data system for our content production teams. As a BI, business intelligence, product designed and developed centering content producers, PBIS offers producers one-stop data inquiry, acquisition, analysis and evaluation to support their decision-making. On the first day of its launch, dozens of our producers tried out the system. In the near future, PBIS will be widely promoted internally and then cover all our in-house studios within a year, promoting the industrialization of video production within iQIYI as well as in our partner ecosystem. In general, we are still in early stage of industrialization of video production. The supply of high-quality content especially of hit vertical content needs to be amplified. Our core content strategy is to focus on high-quality content across selective verticals while providing more premium mass market hits so that we can optimize subscribers penetration and conversion. We admit that there is still large gap between us and our global peers. In the future, leveraging our deep understanding of users, our highly innovative in-house production teams as well as our advanced technologies for industrialization production, we believe we are well positioned to address current challenge to narrow the gap with our global peers and capture the future market opportunities. With that, I will turn it over to Xiaodong to talk about our financials. Xiaodong Wang^ Good evening, everyone. Let me review our key financial highlights for the second quarter. Our total revenues reached RMB 7.6 billion. Membership business continued to be our largest business pillar, accounting for 52% of our total revenues. Our advertising business continued to rebound with 15% increase on year-over-year basis. Our other revenues achieved 20% growth on year-over-year basis as we continue to diversify our monetization channels. Our cost of revenues was flat compared with the same period last year, among which content cost was also remained stable. Our operating loss margin on GAAP basis narrowed to 15% from 17% in the same period last year, and our net loss narrowed for the fifth consecutive quarters on a year-over-year basis driven by our disciplined investment strategy. As of June 30, 2021, the company had cash, cash equivalents, restricted cash and short-term investments of RMB 12.3 billion. For detailed financial data, please refer to our press release on our IR website. For the third quarter of 2021, we expect total revenues to be between RMB 7.62 billion and RMB 8.05 billion, a 6% to 12% increase year-over-year. This forecast reflects iQIYI's current and preliminary view, subject to change. I will now open the floor for Q&A. Thank you.

[Operator Instructions] Please ask your question in Chinese first and then translate your questions into English. Participate and restrict to one question at each time. Please standby while we compile the Q&A work form. Your first question comes from Ella Ji from, China Renassaince. You start your questions.

And thank you for taking my question. My first question is, actually, I would love to hear [Indiscernible] So my first question is, for management you could elaborate on the latest regulatory environment, especially overall directions regarding the content. Thank you.

[Indiscernible]

Hello, Ella. [Interpreted] So it contains four major parts. So firstly, because we are a video platform, so the content censorship is the main area we look at. So actually, the basic principle for content censorship hasn't been changed over the past several years. So for this year, because the key events on the July 1 key events, there is a tightened censorship environment in the second quarter. After that, it will actually return to the normalized regulation pace. And the second area is for actually, we see the tightened regulation for the overall internet industries, not only for us. So this area mainly focuses on the 2 parts. One is the anti-monopoly regulation. But for us, the video industry, particularly for the long-form video industry is actually fully competitive industry, so we -- actually for the limited impact from the anti-monopoly regulation. And two -- second part is on the data security. So we observed that the government has implemented more tightened and specific guidelines for this part. Internally, we already enhanced our management and also technology part to follow it and implemented a more specific approach on this area. And last 1 for the education industry because this is an area people ask frequently. Education is not our main area, business area we are looking at. But just because of the tightened regulation on this area, we foresee that the students or the kids -- might have more time and then other things apart from the study. So the entertainment is 1 of the key areas that they might spend more time on.

Thank you.

Thank you.

[Foreign Language] So just a quick follow-up for just regarding your content because we have seen some regulatory directions regarding the short video industry that they are promoting more positive -- kind of the positive content. So I just wondered if that could also affect the long-form video content in both the drama as well as the variety shows.

[Foreign Language] m Gong Yu: [Foreign Language]

This is Xiaodong. I think probably, you mentioned like recently released regulation regarding the enhanced censorship on the short-form videos, I think Dr. Gong just said, for long-form videos, they have always been to kind of important for us. So -- if anything we have like indirect or direct impact, on our business should be positive because those short-form videos, they haven't go through all this kind of process before. Now I think kind of we are on the same track right now, we have more experience on how to handle this and we have let's say or they go through all these kind of things for past decade.

Thank you for addressing that question. So if I may, I have a second one regarding the lite version. [Foreign Language] So could management elaborate on the recent progress of iQIYI lite because we see that iQIYI lite app has quite impressive user growth in the recent months?

[Indiscernible]

[Interpreted] I will introduce iQIYI lite app briefly, and then I will turn over to our CTO, Wenfeng, to elaborate. So we have developed iQIYI lite app for around half a year. So behind this project, we are actually trying to target the nonmajor users we are targeting right now. So our core users right now are actually the users aging between 25 to 35 years old users. And we covered some young generation and elder people, but that is not enough. So over the past 1 or 2 years recently, we observed that more and more new users, they are actually not -- haven't formulated a habit to use iQIYI app. So we tried to develop a new product that can target this kind of new users and incentivize this kind of new users to use our product and watch our content. Right now, up till now the app satisfy our expectation. So I will turn over to our CTO, Wenfeng, to elaborate more.

[indiscernible]

[Foreign Language]

[Interpreted] iQIYI lite app, it's a personalized product targeting lower-tier city users. Since the launch, we observed a very solid user growth. As of the end of second quarter, the weekly DAU has surpassed 1 million -- 100 -- sorry, 1 million milestone. And the user overlap between iQIYI lite app and iQIYI main app is extremely low. So as we just mentioned in the CEO prepared remarks, it's only 7%, and this ratio continues to go down. And we observed that the users for our iQIYI lite app preferred to consume more content library rather than new content. And in terms of the user time spend performed also very well. And we try to acquire the new users through an advertising on the channel with relatively high penetration into lower-tier cities and also through the user sharing approach. And also, we try to improve the user retention through the personalized recommendation and also the -- and convenient interaction and also improving the adoption capability to the low-functional smartphones. So right now, the user retention for our iQIYI lite app is also very good.

[Indiscernible]

[Interpreted] So our CEO has something to add. So this kind of initiatives, I mean, iQIYI lite app is also consistent with our idea that we believe there would be a consumption upgrade in terms of the content for the Chinese users.

Thank you.

Thank you. So basically, we expect those kinds of users, they previously they don't watch the TV dramas, or the films and this kind of entertainment content. When they have a chance to access to the high-quality entertainment content, they will be spend more time on this kind of entertainment content. So from our initial data set, it seems that our thesis got demonstrated through this kind of user retention rate and also the user growth.

Thank you.

[Indiscernible]

Your next question comes from Eddie Leung from Bank of America, Merrill Lynch. Please go ahead,

[Foreign Language] So my question is about content costs. We have seen a pretty good cost control in the past, several quarters. While the company has always been pretty conservative in guiding the content costs going forward. So I'm wondering, when we look at the cost control in content, for example, in the past 1 or 2 quarters, how much was due to the delay of some of the hot content? And how much was coming from the benefits of lower production and licensing costs?

This is Xiaodong. I think if you're talking about like 1 or 2 quarters content cost, it could be caused by the delay of certain content. But if you look at the past few quarters numbers, you see the consecutive optimize our content costs, which actually is more driven by the efficiency improvement on the content investment. We see the price stabilize since year 2018. And given the fact, we have more original content launched in the past few quarters. So basically, we have more control on the quality and the efficiency of the content investment. But of course, it's -- I don't think conservative is the right word here because in fact we are going to expand the category of our content investment, including original movies and overseas content. That's why we see the potential slightly increase on the dollar amount of content cost but the percentage of revenue, definitely, I think you will continue to see the optimized trend in the next few quarters.

As a reminder, please restrict to one question at each time. Your next question comes from Alicia Yap from Citigroup. Please, go ahead.

Hi. Thank you. [Indiscernible] My question is can management give us the longer-term prospect of the long-form video industry in China. Will the current model between the membership subscriptions and the advertising model remain in place? Any breakthroughs in terms of content production for monetization model, especially I think management talking about the industrialization in the video production, so how would that actually transform future monetization model for the video industry?

[Indiscernible]

Okay. So Alicia, my -- I actually have a very positive view for this industry personally. My positive view is still down these 2 parts. One is that in terms of the penetration, we still have very -- still have a very low penetration in terms of the paying users. So our pay ratio -- paying ratio is also low. So in China, there is only a small percentage of people that are willing to pay for professional and high-end entertainment content. And we expect that more and more people will actually join this kind of iQIYI users when -- with the trend of the consumption upgrade of the content we just mentioned before. And in terms of the monetization, our -- right now, our core users are the people aged between 20 to 40. But we don't have sufficient content for the people aging higher than 40 years old. And also for the younger generation, we also don't have sufficiently do the content for them. So right now, we are trying to amplify our content supply and to satisfy this kind of users' needs. So based on that, we expect the penetration ratio and also the paying ratio will continue to improve. And in terms of the monetization model for -- in China, for most of the internet verticals, when the new users join the platform, they often time are free users. So they will consume their advertising, if they more and more enjoy our content, they will start to pay for our content, and there will be no advertising for them. But these kind of users will turn into -- will convert into the high-ARPU users through our membership package and also PVOD methods.

[Foreign Language]

[Interpreted] As you have observed, we went through some kind of volatility or the uncertainty in terms of the content launch. I think that the more fundamental reason behind that is that we haven't been able to offer sufficient supply, content supply and a more diversified content supply. So as we mentioned in the shareholder letter in the past -- in the last quarter, we believe the industrialization of video content production is the key to solve this issue. The key thing is that we try to enhance the forecast -- enhance the certainty or improve the forecast accuracy for the full cycle of the content production, so that we can lower risk and lower the cost accordingly. So from the -- since the first quarter, we have enhanced our investment in this kind of industrialization of video content production. As we have mentioned previously, in this quarter, we start to roll out the Production Business Intelligence System, PBIS, this kind of tool can enable our producers to forecast in the traffic and the monetization of the revenue for the project.

Yes. Thank you.

Thank you. Your last question comes from Piyush Mubayi from Goldman Sachs.

Thank you for taking my question. When I look at your content cost as an indication of how you are industrializing content production, your content spend was about, at its peak, 84% of revenue, and it's come down gradually, and it's looking like it is about 67% of revenue. With the industrialization, where does that content spend come down to? And how long do you think it will come down to that trough level that you think it can get to? That's my first question. And related to that, if I may, you've got -- you've moved into iQIYI Sports in the major world with the EPL at a price point that looks like it's RMB 19 or RMB 20 per month on a headline basis based on the price I've seen. What has been the initial indication of demand for EPL on your platform?

This is Xiaodong. I will comment on the first question. I think the industrialization of the content production is mainly to increase the supply and the quality of the content. Definitely, as a percentage of revenue, it will continue to contribute, it's positive. In fact, because of the, let's say, better monetizing ability of this content. But I think in the past few years, the main driver of the content is more like the slight increase of the hit ratio and the quality of the content. And the more diversified content strategies like the Mist Theater and so on. But I think within the next 3 to 5 years, definitely, you will see significant improvement on the efficiency of the content production given the progress we expect to achieve for the industrialization of the content production. And for the sports, I'm not quite following your question regarding the CPM because sports is not like we charge the user directly for the nominal price you saw on the website. Actually, it's more like the revenue share between iQIYI and our JV who actually run sports business. So it has very little impact on the ARPU of the membership business or the revenue of iQIYI because they only have a -- I think a very, very low percentage of the total membership or subscription business.

This concludes the question-and-answer session. I will now pass the line to the management for closing remarks. Thank you.

Thank you, everyone, to joining our call today. So please feel free -- if you have any questions, please feel free to reach us. So let's speak next quarter. Thank you.

Thank you.

This concludes today's conference call. Thank you for participating. You may now disconnect.