iQIYI, Inc. (IQ) Q4 2022 Earnings Report, Transcript and Summary

Thank you for standing by, and welcome to the iQIYI Fourth Quarter and Fiscal Year 2022 Earnings Conference Call. All participants are in a listen-only mode. There will be a presentation followed by a question-and-answer session. [Operator Instructions]. I would now like to hand the conference over to Ms. Chang You, Investor Relations Director. Please go ahead.

Thank you, operator. Hello everyone and thank you for joining iQIYI's Fourth Quarter and Fiscal Year 2022 earnings conference call. The Company's results were released 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; and Mr. Jun Wang, our CFO; Mr. Xiaohui Wang, our CCO, Chief Content Officer and Mr. Wenfeng Liu, our CTO, Chief Technology Officer; Mr. Youqiao Duan, Senior Vice President of our Membership business; and Mr. Xianghua Yang, Senior Vice President of Movie and Overseas business; and Mr. Gang Wu, Senior Vice President of Brand Advertising business. Mr. Gong will give a brief overview of the company's business operations and highlights followed by Jun who will go through the financials. After the prepared remarks, Xiaohui, Wenfeng, Youqiao, Xianghua and Gang will join Mr. Gong and Jun in the Q&A session. Before we proceed, please note that the discussion today will contain forward-looking statements, made under the safe harbor provisions of the U.S. Private Securities Litigation Reform Act of 1995. Forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from our current expectations. Potential risks and uncertainties include, but are not limited to, those outlined in the public filings with the SEC. iQIYI does not undertake any obligation to update any forward-looking statements except as required under applicable law. With that, I will now turn the call over to Mr. Gong. Please go ahead.

Hello everyone. We wrapped up a remarkable year of turnaround, with outstanding performance in 4Q '22, our market share reached historical high , so were our membership revenue, operating profits and a free cash flow. To be specific: in Q4, we launched 6 blockbuster dramas with subscribing members, time spent growing by over 40% annually and 30% sequentially, which is unprecedented. As a result, we continue to gain market share. Our leadership in terms of effective video views in the drama category remained unchallenged, according to Enlightent data. Strong content performance brought the highest quarterly membership revenue in our history up 15% annually and 13% sequentially. In Q4. Our average daily number of total subscribing members was 111.6 million, and represents a sequential net addition of more than 10 million. The number of subscribing members as of the end of December was 119.7 million represents a net addition of over 13 million compared with end of September. In the meantime, our advertising business continue to recover with sequential growth rate of 25%. Now move on to profit. We had a record-setting quarter of RMB979 million non-GAAP operating profit, up 87% compared with last quarter. The non-GAAP operating margin continues to expand for the fifth consecutive quarter and reached 13% in Q4, a showcase of operating leverage embedded in our business model. In Q4, free cash flow reached over RMB840 million grow by 4.7 times compared with Q3. We have been generating positive free cash flow for two consecutive quarters. The outstanding Q4 performance is not a surprise. In fact, our Q4 performance may just be the start if we look ahead for one or two years. The driving force behind our current and the future success is our ability to produce and deliver high quality, popular original content, which is our unique core competence. iQIYI Original now is the ‘synonym to the “MUST-SEE SHOW”, iQIYI brand perception has been elevated from iQIYI is capable of creating blockbusters to iQIYI is THE blockbuster powerhouse. As a perfect footnote to our statement, right after the closing of 4Q '22 we launched original drama, The Knockout. It has become another magic hit, broke records across every key metrics, the fastest to break iQIYI popularity index of 10,000 highest peak popularity index, highest daily user time spent, largest daily audience and the highest membership revenue. The Knockout also generated tremendous social buzz and become a true nationwide phenomenon. The success of the show demonstrates that the production and the operation of our original content had entered into a virtuous cycle, the flywheel effect have been released. The stable premium content supply drive user growth, improves cost efficiency and profitability, which supports the company to create more premium content. Therefore, we firmly believe the success is replicable and we could exceed our past performance in the future. Why do we believe that our original drama production capability is unique and cannot be easily copied? Because creating Blockbuster has no short cuts. To get where we are today, we invested numerous resources including time, capital, talent and technology. We initiated our original content strategy back in 2014 and made substantial breakthroughs in 2022 after almost a decade of persistent efforts. In the most recent two years, our investment in original content almost reached RMB20 billion. With time and money, we have established in-house studios that bring together the industry's most creative talent. We have also gradually established our complex data driven and highly efficient, decision-making system that can capture every critical moment in the entire lifecycle of content production. As a result we have witnessed the gradual ramp-up of high quality original dramas. Among the key dramas we launched each year, the proportion of original productions increased from 20% in 2018 to over 50% in 2022. For 2022, the original content accounted for over 60% of blockbuster dramas and also contributed over 60% of the revenue during the new release window. In Q. the total subscribing members time spent on original content doubled year-over-year. Hence we conclude that we enjoyed the structure advantage that are very difficult for others to imitate. The entry barrier is extremely high. In the past 12 months, we have completed three rounds of capital raising with proceeds totaling around $1.3 billion to remove debt overhang. We truly appreciate the generous support of our investors who are as confidence as we are in the future of iQIYI. With a healthier balance sheet and cash generating business, the management will be able to focus entirely on accelerating the company's growth, creating more value for our investors. Looking ahead to 2023, we will start a brand new journey. We have upgraded our 2023 annual goal to achieve high-quality growth. Under this strategy , our goal is to achieve growth in revenue and operating profit to realize high-quality growth. We will continue to invest in our core business, while remain cautious when assessing material new business opportunities.. We will continue to invest in top premium content to maintain a high-quality, yet diversified content pipeline and to invest in high ROI marketing and the members benefits. Also, we keep a close eye on industry opportunities powered by technical advancement such as artificial intelligence generated content, AIGC and other innovative technologies. We will explore AIGC application scenarios in the long-form video industry together with our strategic partner Baidu in the areas such as improving content production efficiency, content distribution and promotion. We believe the AIGC strategy will help iQIYI to unlock even more potential, further improve our overall business efficiency and generate greater value. Now let’s go through the detailed performance of our business segments. Starting with membership services. Membership services revenue was RMB4.7 billion, the highest in our corporate history, representing an increase of 15% annually and 13% sequentially. As we had a very strong quarter of blockbuster content, we utilized the opportunity to attract and grow our subscriber base with a marginal increase in ARM. Our subscriber base have a strong growth in Q4, the average daily number of total subscribing members was 111.6 million, a net addition of 10.6 million compared with Q3. The total number of subscribing member was 119.7 million as of the end of December, a net addition of 13.5 million compared with the end of September. Very importantly, we are glad to see the improvement in membership structure with the proportion of annual subscribers increasing significantly in Q4 compared to the same period last year. We believe the higher subscription rate for annual packages will help to improve stickiness and the long-term monetization. In Q4 our monthly ARM was RMB14.17 up 2% sequentially. We further increase of our membership pricing in December, which will drive ARM increase in the future. For our membership business, we are committed to grow revenue. In the long-term, we believe our ARM will have plenty of room to grow when we continue to upgrade content quality and bringing more value to our users. In the short-term we strategically choose to optimize the growth of subscriber base and the membership duration so that more people can enjoy our content and the relationship between the platform and user becomes more enduring. A good example is that as the monthly ARM of the annual package is lower than the monthly package, when we enroll more annual subscribers, our average ARM might be impacted in the short-term. However, we value the relationship with subscribers and we believe the long-term trust we built with subscribers will bring more strategic value. In Q4 we continue to expand our exclusive membership benefits package, including exclusive IP-based souvenirs, and limited time discounted offers, exclusive fans events. Moving onto content in Q4, we continue to lead the market with dominant market share. According to Enlightent data, we remain number one in terms of effective video views for both overall dramas and exclusive dramas categories, reaching quarterly new highs in the past two years. For variety shows, we also ranked number one in terms of effective video views, with launch of popular original programs, including Super Sketch Show 2, Memoon Player and Folk 2022. 2022 was a harvest year for our dramas. We had the most number of blockbusters that covered diverse themes, and evenly released across the year. First we launched five dramas with popularity index over 10,000 in a single year, while four of them are originals. Not only we brought our content quality to the next level. We significantly improved our financial performance and generated profitability at large scale. Second, our content releases covered diverse themes, including modern themed A Lifelong Journey Ordinary Greatness and Wild Bloom; the ancient costume epics Love Between Fairy and Devil and New Life Begins; the suspenseful Strange Tales of Tang Dynasty; and the fantasy and youth Inspiration, The Heart of Genius. Third the timing of our releases was evenly throughout the year. The five blockbusters with popularity index over 10,000 were released at the beginning of year during summer vacation and during winter. Other high quality dramas were released at regular intervals during the year. Users can turn to iQIYI and watch the most current hit shows at any time. We also maintained the best of the word of mouth in the industry. Among the top 10 highest rated Chinese dramas on douban.com in 2022, seven were iQIYI's exclusive dramas and four were original production. Our original title Ordinary Greatness and Wild Bloom ranked first and the third respectively. As we move on to 2023, we will maintain our strong momentum and plan to launch a number of highly anticipated dramas. Original production Unchained Love and The Knockout were launched in Q1 and highly acclaimed by users.. The Knockout become another MEGA hit, a true nationwide phenomenon. Just to name a few highlight: first, it has the highest popularity index score and is the 8th drama that broke the popularity index of 10000, generated a huge social buzz and high word of mouth, , its peak Douban score was 9.1, only very selective Chinese dramas have such high score. The dramas was broadcasted on leading national TV network including CCTVs and BRTV, all of which had outstanding viewership. Just on CCTV network alone, The Knockout has been watched by over 300 million audience so far. During 2023, a variety of key dramas will be launched such as the ancient costume epics, The Demon Hunter’s Romance，Story of Kunning Palace, Destined, and Fox Spirit Matchmaker. Modern-themed dramas such as Miles to Go, Take us Home and We Are Criminal Police et cetera, for original variety shows, we will continue to launch multi-season shows and introduce new programs. We will focus on building franchise values and enhancing synergy between dramas and the variety shows. Please also anticipate to see a slate of well craft original movies, children content and animations. And our advertising business recovered sequentially in Q4, total ad revenue was RMB1.6 billion in Q4, up 25% sequentially and down 7% annually, which was significantly narrowed from the 25% annual decline in Q3 exceeding our expectations at the beginning of the quarter in particular for Q4, brand ads return to double-digit sequential growth and year-over-year decline continues to narrow better than our expectation. The sequential growth was benefited from first, hit dramas and variety shows attract ad budgets;, second, the domestic reopening boosted advertisers confidence and increased ad demand; three, growth in sectors such as the Internet services, telecommunications and healthcare. Heading into 2023, we believe reopening would support economy recovery. We are positive about brand ads for the full-year 2023 and expect to see healthy growth compared with 2022. For performance ads, we achieved strong revenue growth both sequentially and annually, driven by algorithm optimization and tailored operational initiatives for advertisers from e-commerce, internet services and online game sectors. We believe that iQIYI’s core user group is highly attractive for advertisers and with our appealing content and advanced technology, we will be able to effectively help advertisers to increase their brand influence. In the future, we will adopt multiple strategies to improve our ads business. We will focus on growing our revenue scale and offer tailored campaigns on large screens. Meanwhile, we will continue to develop the ad-supported basic subscription package on ]iQIYI Lite, which is similar to Netflix, low-priced ad-supported initiative. We believe the solid growth in iQIYI Lite basic subscription package will drive ad inventory on our platform and leads to ad revenue growth. Moving onto technology and the products, technical innovation is one of our core values. We continuously promote video industrialization and improve efficiency in content production and distribution through innovative technologies, we start to explore AIGC related opportunities since mid-2022 and have seen promising results. We believe our rich video entertainment resources, combined with cutting edge technologies will empower iQIYI to further improve efficiency in content production, distribution and other areas. On February 15th, we announced the strategic cooperation with Baidu, and both company will jointly explore the AIGC application scenario through Baidu's Ernie Bot, we anticipate that content distribution and promotion are one of the earliest areas to be implemented and this cooperation will further accelerate our progress in AIGC related areas. We look forward to implement more applications as we strengthen our technology advancement in the future. Moving on to new business first, iQIYI Lite. in Q4, iQIYI Lite reached breakeven for the first time and recorded solid revenue growth both annually and sequentially. We continued to develop monetization model of iQIYI Lite and the new ad supported basic subscription package was well received by user. Moving onto overseas business. In Q4, overseas membership revenue increased 30% year-over-year and the growth rate in America and Canada exceeded 70%, original content, especially original dramas performed quite well, our original Chinese dramas, New Life Begins achieved the top ranking in Thailand, Philippines, Indonesia and South Korea only three days after its launch. We are also delighted that our original dramas released in Q4 attract advertising budgets. In 2022, we successfully completed an iconic turnaround with substantial improvement in financial performance, business operations and market share. Meanwhile, our unique content production methodology helped us to produce a continual stream of blockbusters, enhancing our core barrier. Our industry leading original content production ability and superior operational capability are our core competitive strengths and the key to our rapid growth in the long-term. As we move through 2023, we are committed to delivering high quality growth. We firmly believe our best days are yet to come. We will further release the flywheel effects of our business and bring higher value to our users, partners, and stakeholders. Now let me pass on to Jun to go through our financial performance.

Thanks Mr. Gong, and hello everyone. Q4 was a record-setting quarter for our membership revenue, operating profits, operating cash flow and free cash flow. The operating margin continued to expand driven by operating leverage. In addition, we raised around $1.3 billion over the past 12 months to remove the debt overhang. With operational and financial performances in great conditions, and significant capital structure enhancement, the management will be able to focus on delivering high quality growth in the long run. Now I will also like to take this opportunity to review the overall performance for the year 2022 for iQIYI. First, we delivered what we promised earlier in the year. We set a goal of reaching non-GAAP operating breakeven for the full-year of 2022 and ended up with non-GAAP operating profit of RMB2.2 billion far exceeding our expectation. Then we shifted our operational focus from cost down in Q1, Q2 to scale up in Q3 and Q4 and roll out our calm growth strategy in the middle of the year, which resulted in healthy expansion of market share, membership services revenue and profit in the second half. The momentum continues beyond the December 31, 2022. And in addition, we also promised to protect the interest of all the stakeholders and fixed the immense challenge of debt overhang despite the extremely volatile market and then we made that as well. Secondly, we humbly ask our investors to look beyond iQIYI-specific achievement and revalue the long-form video industry as a whole. iQIYI continued to outperform to deliver alpha, but the ROI for the entire industry was quickly recovering for the entire 2022 as well to deliver beta driven by the structural change on the supply side, less quantity, more quality, more concentrated supply of platform originated content leads to higher hit ratio and more efficient cost control. On the demand side, as Mr. Gong mentioned, long-form video remains the fundamental entertainment need for the mass market. Over time, the higher quality of content naturally lead to the higher willingness to pay, hence the higher ARM. And we are in a virtuous cycle and we'll see a more promising future. Third, we would like to thank everyone who supported us in a very dramatic 2022, including our users, employees, content partners, our shareholders, and supportive bondholders and creditors. Our commitment in achieving healthy business growth remains unchanged and we are more confident than ever in ability to generate value for all stakeholders in the long run. For detailed financial data for Q4 and fiscal year 2022, please refer to our press release on our IR website. Now we will open the floor for Q&A.

Thank you. [Operator Instructions]. The first question is from Xueqing Zhang from CICC. Please go ahead.

[Foreign Language] And I'll translate it myself. Thanks for taking my question. And congratulations to your remarkable performance, which means that The Knockout were a mega-hit in January. So how management think about overall content trend in the first quarter. And as you mentioned in the letter to investors, people know iQIYI as a blockbuster powerhouse. Can management show us that how to make more and more original blockbusters in the future? And last how should we think about the number of subscribing members in the longer term? Thank you.

[Foreign Language] First of all, the Q1 content was excellent, exceeded our expectations and for the overall content performance, I will invite our CCO, Xiaohui, to answer the question. And in regards to the membership business, we will invite our Senior Vice President, A - Youqiao Duan, to answer the question.

[Foreign Language] As a media platform, one of the main goals for iQIYI, in the past 10 years is to systematically improve the success rate of operating blockbusters. Looking at the content, our performance in the past year, whether it's the drama Love Between Fairy and Devil, Wild Bloom, New Life Begins, Chasing the Undercurrent, Homesick and the recent The Knockout. We can see the continuity and diversity of iQIYI blockbuster content. [Foreign Language] The first core competitiveness is talent. Under our in-house studio strategy, we have established a number of diverse and distinctive in-house studios, which gathered the most creative talents in this industry. These talents are also in line with the distinctive characteristics of the creative industry. At the same time, we have also established a strong supporting mid platform, which provides a sophisticated mechanism that is conductive to improving the efficiency in content production and increasing the probability of hit ratios. [Foreign Language] The second is our internal development content management system. We have established complex data driven and efficient decision making content production management system, which covers every critical moment in the entire cycle of content production. [Foreign Language] The third one is operations. We have one strong content operation capability, which runs through content creation, production, scheduling, promotion, and et cetera. [Foreign Language] The fourth is innovative and intelligent technology, we use intelligent production technology to effectively improve production efficiency and save cost, which provides strong guarantee for our content production. [Foreign Language] The fifth is industry insight. After years of experiences in the industry, we have clear insights in terms of the content creation and accurate grasp of the appetite of the Chinese entertainment consumer market. These are definitely our core competitive advantages. [Foreign Language] Therefore, our current content production mechanism and strong operational capabilities will guarantee us with a stable and continuous supply of top premium content in the future. Thank you.

[Foreign Language] In 2022, we continued to develop our membership business operations, membership sales and subscriber base and have achieved healthy growth momentum. In 2022, Q4 the subscriber base made a breakthrough of the fluctuating subscriber range of the past two years, we are optimistic that the subscriber base will continue to grow in 2023. [Foreign Language] Our number of subscribers reached nearly 120 million by the end of December. Thanks to the high quality content, our subscriber base continue to maintain a high level and continued growth since the beginning of the year. [Foreign Language] The structure of our subscriber base is optimized, the annual membership, membership package and the large screen subscribers are growing well, which will help improving the platform's membership stickiness and long-term monetization ability.. [Foreign Language] In the long run, the ceiling of domestic subscriber base depends on the number of people consuming the long-form video content, the number of families, and the industry's competitive landscape. Currently, the number of subscribers still have a lot of room for growth compared with the number of Internet population and the number of families in China. [Foreign Language] In the future, the membership business has good prospects in both direct-to-consumer sales, and also channel sales market. In the direct-to-consumer sales market, there's a fundamental demand for long form video membership in the mass entertainment market. In the channel sales market, video membership package has also become one of the preferred products favored by our partners, the telecommunication Internet services and financial sectors. [Foreign Language] Last but not least, as our content quality continues to improve, it will definitely increase subscribers’ willingness to pay and the improvement of our monetization ability in the future. Thank you.

Thank you. Your next question comes from Q - Lei Zhang from Bank of America Merrill Lynch. Please go ahead.

[Foreign Language] Thank you management for taking my question and congrats on the strong results. My question is mainly on the online industry, we notice that the major player have focusing on ROI and content quality in 2022. Wondering how should we see the industry development in the future? Thank you.

[Foreign Language] I think right now it is the industry's consensus that we believe there's a fundamental demand for long form video membership in the mass entertainment market. Maybe a few years ago, there are some players who doubted this, but I think right now everybody in this market reached a common consensus on this. [Foreign Language] At the end of 2021, we think we were the first to foresee that there are changes in the online video market that will lead to a new stage of rational development for the entire industry. The focus of the long-form video competition will shift from competing on content quantity to content quality and more players will pursue the improvement in operational efficiency and profitability. And based on the past one year and more experience, we can witness that increasing quality of video content leads to higher ROI. And I think based on that, we think the results in 2022 also prove that our insight of the structural change of the industry is correct. [Foreign Language] Our iconic turnaround of the business performance last year I think was attributable to the improvement in original content production. And the same for the industry peers, I think there are more sufficient supply of content and also a higher hit ratios and better rational cost control and we think the high quality content inevitably will lead to higher willingness to pay which enables us to form a virtuous cycle for content production. And then we also believe eventually there's the chances for one single users to subscribe to multiple membership packages among the video industry peers. [Foreign Language] We believe our -- we achieved iconic turnaround last year as we continue to lead industry. And also at the same time, our goal for next year is achieving high quality growth, meaning that we'll achieve quality growth in terms of revenue and also for profit as well. I understand that this brings some of the pressure for our peers in the industry, but I think as a leader, industry is a good sign. And the increasing ROI will also lead the entire industry to recover better ROI performance quickly and driven by the structural changes as we mentioned earlier. And then I think this will eventually lead to a healthier industry, and eventually every player in the industry will benefit from it.

That's all. Thank you.

Thank you.

Thank you. Your next question comes from Lincoln Kong from Goldman Sachs. Please go ahead.

[Foreign Language] So my question is about AIGC generated content. So especially the application in the video space. So how do management think about the potential TAM and the potential applications are going to operate in this space. Especially we also notice, recently, company has reaching corporation with Baidu. So in that sense, what aspects should we expect more concrete, plan related to this cooperation?

I'd invite our CTO, Wenfeng, to answer this question. Please go ahead.

[Foreign Language] Our iQIYI corporate vision is to be a technology-based entertainment giant. We believe that technology innovation is also -- always one of the key factors to promote the evolution of the video industry. We have been investing in artificial intelligence for computing, audio and video technology and others to improve the efficiency and quality of content production and enhance viewer experience. [Foreign Language] AIGC is powerful engine for data processing and also content production using the AI technology. By applying the AIGC technology, it can further expand iQIYI's capabilities in content creativity, improve content production, efficiency, and quality and user experience. We have been exploring the application of AIGC in the video space since mid-2022. [Foreign Language] We have been exploring in the following aspects. For the scripting stage in the future. Content creators can use iQIYI's intelligent production system during the scripting process. Not only that, it will trigger more creative inspirations, but it will also improve efficiency and reduced cost. In the production stage in the future. iQIYI intelligent production system can intelligently analyze and process the script through the use of AIGC to efficiently analyze the script and extract the story outline. In addition, such technology not only can help the content producers in planning the project, but it could also provide more valuable information regarding, during processes for post-production and marketing, improving the overall efficiency and quality of the video content production. [Foreign Language] In terms of content marketing and promotion, AIGC can produce a large number of marketing videos and marketing materials to improve the efficiency and effect of content marketing. In the future, content recreators can also use AI to automatically generate, video commentary script further improve the efficiency and quality of video recreation. This can greatly enrich short form video content that promote our dramas, variety shows, films, et cetera, attracting more users to watch iQIYI's content. It will also especially benefit in promoting our extensive selection of library content effectively in extending the life cycle of these content. And also, AIGC can produce personalized poster images for any content, help content to find its audience and user will have improved content recommendation experience. The video search experience will also be improved. Through the conversational AI capabilities. Users can search a plot, find out the story of a particular theme or binge watching recommendation, et cetera. Helping the users, they can help the users to find content more effectively. [Foreign Language] We believe that the combination of AIGC technology and iQIYI's rich online video entertainment resources can further promote the development of the video industry and improve user experience. We'll continue to increase our investment in this area. On February 15, 2023, we announced a strategic cooperation with Baidu and both companies were generally explored the AIGC application scenarios through Baidu's ERNIE Bot. In the area such as content creation tools, content distribution and promotions, content search, novel creation, et cetera. We believe it will further expand iQIYI's production capability in content creativity, production, efficiency, and user experience. Thank you.

Thank you. This is the last question for today. I'll now hand back to iQIYI management for closing remarks.

Thanks to everyone for joining the call today, and please do not hesitate to reach out to us if you have further questions. Thank you.

Thank you. Bye-bye.

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