IQ 爱奇艺

Presentation

Operator

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

Chang You

Thank you, operator. Hello everyone and thank you for joining iQIYI’s second quarter 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; Mr. Jun Wang, our CFO; Mr. Xiaohui Wang, our CCO, Chief Content Officer; Mr. Wenfeng Liu, our CTO, Chief Technology Officer; Ms. Vivian Wang, our CMO, Chief Marketing Officer; Mr. Youqiao Duan, Senior Vice President of our membership business; and Mr. Xianghua Yang, Senior Vice President of movies and overseas 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, Vivian, Youqiao and Xianghua 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 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 will now turn the call over to Mr. Gong. Please go ahead.

Yu Gong

Hello, everyone. I’m very pleased to take this opportunity to report on our progress in the second quarter, but more importantly, share our views on the future. In the second quarter, the Company made breakthroughs once again. As we all know, the weak macro economy and COVID resurgence in Q2 had great impact on business of most of media companies. Despite an extremely challenging environment, we still made achievements in the following three aspects: one, our membership business continued to grow year-over-year; two, we generated non-GAAP operating profit for two consecutive quarters and achieved sequential growth in Q2; three, our cash flow improved significantly, and we achieved positive operating cash flow for the very first time. These were the results of strong execution of the strategy that centered around cost optimization and efficiency improvements. Such strong results also fully demonstrated the resilience of our business. For two consecutive quarters, we reached our operational targets while drastically improved our financial healthiness, enabling us to face the ever-changing market environment with ease. Our solid performance in the second quarter demonstrated that iQIYI has completed its self- transformation and successfully sailed out of the storm. It also gives us the confidence to upgrade our strategy starting from the third quarter this year, a strategy which will fuel our business growth and improve our financial healthiness at the same time. We would like to call it the Calm Growth, which has the following features: one, to pursue growth, but not at the expense of significant cash burn. We will stay cautious about the growth opportunities with long investment cycle and high cash investment. Rather, we would actively invest more resources in iQIYI’s core business and projects with higher degree of certainty and high ROIs. Two, pursue growth for both profit and revenue, but profit should grow faster than revenue. Capitalizing revenue growth opportunity will not result in higher operating expenses. We would maintain the current lean organizational structure, embrace challenges with passion, and improve operational efficiency. Three, the value we have provided to our users and customers would grow even faster than the profit. We will produce and stream more and better premium content. We will create greater value for our users and customers, and all financial returns should follow. The Calm Growth strategy can better motivate us and align the interests of our users, customers, and stakeholders. We hope that the Calm Growth strategy can help us further improve the healthiness of our business and drive our profit and revenue growth in the future. Now, let’s go through the performance of each business segments in the second quarter of this year. Starting with membership services. Membership business is the most important business segment for us. We are determined to roll out strategies and allocate resources to support and guarantee the continuous business growth. In the second quarter, membership revenues were RMB 4.3 billion, up 7% year-over-year. The average daily number of total subscribing members for the second quarter was 98.3 million, and monthly ARM was RMB 14.53, up 8% year-over-year. ARM has maintained a healthy annual growth rate at or above 8% for six consecutive quarters. The positive outcome was contributed to our newly-launched membership package targeting TV devices, consistent and diversified premium content offerings, and the execution of our refined operating strategy that increased the value perception of our members. First, we actively drove acquisition of new members on TV devices. Targeting the growing demand of TV users, we launched platinum membership plan in May emphasizing benefits on TV side. By strengthening member experience and value on TV, the monthly active members on TV devices increased by around 15% annually in the second quarter. Secondly, we continued to refine our operating strategy based on viewing and paying preferences to increase member retention, drive new member growth and win back churn users. Another driver during the quarter was premium content as we continued to launch diversified high-quality content that caters to the varied demands of different user cohorts. For example, Ordinary Greatness tells stories about the daily life of policemen in heart-warming and humorous ways. The drama harvested positive public reaction as well as revenue performance. It topped the Douban list for domestic dramas in the first half of 2022 with a score of 8.6 while generating the highest membership revenue on our platform during its broadcasting. With top exclusive content, we adopted an early access viewing model for members. We launched our original multi-season exclusive variety show The Rap of China 2022 in late June. Members were given the privilege of early access, and the show successfully attracted over 1.3 million members on the first day of launch. In addition, we are devoted to strengthen membership benefits in addition to the exquisite video viewing experience. For example, we launched marketing campaigns such as Member Benefits Day, Super Brand Day, to provide members with various benefits and deals across a wide variety of brands. In the second quarter, our member benefits were accessed over 60 million times. Looking ahead, we will continue to launch high quality premium content, optimize sales channels within and outside our platform, effectively leverage various content promotion channels such as our partner Douyin to expand the reach of our premium content. Meanwhile, we will continue to improve our operational initiatives to increase member value, user loyalty, and brand awareness, and last but not least, continue to improve the experience and monetization capabilities on large screens. Moving onto content. We insist on providing users with high quality premium content that caters to differentiated viewing demands. As improving operating efficiency and emphasizing content quality became industry-wide key words, we took that initiative to adjust our content pipeline so that head premium content makes up the majority of new releases. During the second quarter, we maintained our leadership position across key operating metrics. On user traffic front, according to QuestMobile, our mobile MAU ranked number one in the industry. Meanwhile, on content related measures, according to Enlightent data, we maintained the highest market share for the drama category in terms of effective video views, despite the number of new releases were not the highest in the market. Our market share for animations, including children animation, also ranked first in the industry. Meanwhile, thanks to our long-term commitment to premium content, our high-quality content library continued to show positive long-tail effects as the viewership market share of our library content also ranked number one in the industry. I’m pleased to see strong user engagement via sufficient supply of high-quality content while improving content-related cost ratios for key content categories. The ROI performance for drama, variety show, animation, and children’s content channels all improved, both annually and sequentially. During the second quarter, we continued to launch premium original content across key genres. Acclaimed original dramas included Ordinary Greatness, My Sassy Princess and The Fight. The box office for our original movie Man on the Edge were over RMB 160 million, and it was one of the main contributors to the domestic movie box office in the second quarter. For children’s content, the sequel to our original animation Princess Doremi Season 2 made solid revenue contribution to our membership business. For original content, one of our key strategies focuses on taking a multi-season approach for our established IPs to drive long-term value. Building on the success from previous seasons, we saw strong user attractions of these returning titles. During the second quarter, four of our popular original variety shows released their latest season, including The Rap of China 2022, The Detectives’ Adventures Season 2, and et cetera. Among which, our original music show The Rap of China 2022 maintained its high popularity from previous seasons, and a good number of songs from the show topped the chart on various music platforms. The second season of The Detectives’ Adventures also ranked number one on multiple third-party data platforms. Meanwhile, vertical content theater model continued to meet differentiated user demands. The Lord of Losers, the third drama under the Laugh On Theater, introduced an innovative interactive viewing feature that provides an immersive experience and brought increased audience participation. Its Douban score started at 7.1 and went up to 7.6 given its interactive features. The SWEET ON Theater returned in June with five new titles, satisfying the viewing preference of young generation audience during summer vacation. Over the years, we have definitely seen solid improvement in the quality of our premium content offerings. For example, iQIYI’s popularity index is an influential measure that indicates the popularity of a content, and any titles with over 10,000 popularity index score are clear blockbusters, such measure is highly recognized by the industry and users. Among our content offerings, there have only been four titles that broke the 10,000 popularity index score, and two of them were launched this year. Namely, drama, A Lifelong Journey, tailored to a relatively more matured audience group. The other one is our recently launched original drama Love Between Fairy and Devil from SWEET ON Theater, catering to younger generations. This drama is the first original drama that broke such landmark score, demonstrating the exceptional quality of our original content is highly recognized by our users. We are now even more confident with our original content production abilities and our future pipelines, especially for the original drama category. We look forward to bring a diverse selection of high-quality titles to our users. For the second half of 2022 and especially for the summer season, our content pipeline for dramas is focused on capturing young generation audience while maintaining premium content for mainstream audiences. This includes: The Heart of Genius, Twenty Your Life On Season 2, Sweet On Theater 2022, and et cetera. A new season of Mist Theater will return in the fourth quarter. For variety shows, we will serialize established IPs while continuing to innovate new genres. For the second half of the year, a greater number of variety shows will be launched compared to first half of the year, including our original Super Sketch Show Season 2, Mr. Housework Season 4 and Folk. For animation and children’s content, we will continue to execute multi-season and diversified IP monetization strategies. Not only many of our popular titles will release their new seasons, during our summer season, we also launched the animation version of Love Between Fairy and Devil, which was adapted from the same novel as the blockbuster drama. The high popularity of the drama has also brought stronger revenue performance of the animation. Apart from that, we have seen clear pickup in the overall consumer demand during the summer season. We hope such momentum will continue and the consumer demand will return to the pre-pandemic level soon. Moving on to advertising. The macro softness and the pandemic resurgence in top-tier cities including Shanghai and Beijing put pressure on the overall ad business, particularly on brand ads. All the players in the market faced similar challenges. However, we quickly engaged in pushing forward our ad sales process after these cities began to resume normal course of business operations starting mid-June and managed to grow our ad revenue for our original variety shows by 53% sequentially, despite such challenging environment. Performance ad revenue increased by 12% annually during the quarter. This was mainly benefited from accurate identification of user groups and customized ad solution for key accounts. Technical innovation is among our core values. Technical innovation makes it possible to bring wonderful viewing experiences to our users. For example, cooperation between our content creative team and product R&D team led to the production of brand new open interactive episodes for drama The Lord of Losers. Such innovative and creative story telling formats significantly drove user engagement. The average time spent for the interactive episodes increased by 20% as compared to conventional episodes. Moving onto new business and products. Both the overseas and iQIYI Lite business maintained sound momentum, continued to increase our long-term value, grow and enrich our ecosystem. The overseas membership revenue recorded significant annual growth, benefiting from a large increase in paid subscribers. During the quarter, we launched hit titles including KinnPorsche The Series and 7 Hari Season 3. These hit titles appeared on the Twitter’s top search list, and attracted a large number of viewers and advertisers, especially in Thailand and Malaysia. For the second half of the year, we will work to expand the paid user base and monetization capabilities to ensure stable growth and market position in key markets. iQIYI Lite saw rapid annual growth in both membership and ad revenues. Average DAU for the second quarter was over 5 million, and the user engagement rate increased both annually and sequentially. iQIYI Lite focuses on lower-tier cities to differentiate from the user base of our main app. The overlap between iQIYI Lite and our main app remained at a very low level in the second quarter, with the DAU overlap less than 4% in June. With a distinctive user group, consumption behavior and revenue model, iQIYI Lite serves as a great complement to the main app and is expected to reach greater monetization potential in the future. As you know, we announced content licensing cooperation with Douyin in July, in which we will license select content to Douyin that enables distribution and recreation of iQIYI’s existing content. It demonstrates both platforms are working collectively to create win-win for both platforms and users, and setting rules for the industry. More importantly, the cooperation showcased the value recognition of our exceptional content portfolio, as well as the strength and longevity of our premium long-form video content. The arrangement will unlock new opportunities that will help us penetrate into larger user base, enrich the online video ecosystem, broaden monetization opportunities, and increase the value of our IPs. We will roll out cooperation from both product and content sides starting in Q3. Overall, results in the second quarter were certainly encouraging. In the face of special challenges from the macro environment, we significantly improved our financial results over two consecutive quarters while maintaining our industry-leading position. This was a result of our strong professionalism and team cohesion and execution, as well as our strategy focusing on cost optimization and efficiency improvement. In the future, under our upgraded Calm Growth strategy, we aim to generate sustainable growth of non-GAAP operating profit. We are committed in providing more premium content to our users, satisfying growing spiritual and cultural demands, driving content value, and creating long-term value for our stakeholders.

Jun Wang

Thanks Mr. Gong and hello everyone. This is Jun. To start the financial section, I would like to highlight four key items that we have delivered. First is the profit growth; second is the operating cash flow breakeven; third, it’s $500 million bond raising; and fourth is the optimistic growth outlook based on our calm growth strategy, as Mr. Gong just mentioned. Now, with these four items in mind, I would like to move into the details. In the second quarter, we booked RMB 6.7 billion revenues and RMB 344 million non-GAAP operating profit, and at the same time achieved quarterly operating cash flow breakeven. As Mr. Gong mentioned, this is remarkable result as we fight against the gravity of macro downturn throughout the quarter. Within revenue line, the membership services revenue was RMB 4.3 billion, up 7% year-over-year, mainly driven by ARM, or average revenue per membership. The solid performance of membership revenues was partially offset by the weaker non-membership services revenues due to challenging macro environment. Now move to the cost and expenses. The second quarter cost of revenues was RMB 5.2 billion, representing a cost saving of RMB 1.6 billion, down 24% annually and 12% sequentially. Content cost, a significant component of cost of revenues, decreased 24% year-over-year, when we delayed several top shows to the third quarter. The net result is that our gross profit margin reached 21% in the second quarter and consistently expanded in the past three quarters, namely, from 7% to 12% to 18% then to the 21% in the latest quarter, reflecting ongoing gains in the ROI of our content business. Meanwhile, we kept our spending disciplined and stabilized total operating expenses in the second quarter. As a result, the expanded gross margin and disciplined expenses control combined contributed to our non-GAAP profit expansion. For the second quarter, non-GAAP operating profit was RMB 344 million, grew 5% quarter-over-quarter. At the end of the second quarter, the Company had cash, cash equivalents, restricted cash and short-term investments of RMB 4.9 billion, compared with RMB 5.2 billion in the previous quarter. We managed our operating cash flow well, achieving operating cash flow breakeven for the first time in Q2. Today we also entered into an agreement with PAG, the leading investment firm in Asia Pacific to raise $500 million through convertible bond issuance. We would like to thank our new investor’s trust; and we are confident about our future performances under Calm Growth strategy, aiming to achieve both revenue and profit growth and business healthiness at the same time; and we will continue to create value to all the stakeholders. In summary, again, to recap quarterly results that we have presented for investors: the first is profit growth; the second is operating cash flow breakeven; the third is the debt fundraising; and the fourth one is the optimistic growth outlook based on Calm Growth strategy. For the detailed financial information, please refer to our press release on our IR website. Now, we will open the floor for Q&A.

Operator

Thank you. [Operator Instructions] Today’s first question comes from Alicia Yap with Citigroup. Please go ahead.

Alicia Yap

[Foreign Language] My question is related to the membership business. Can management elaborate a little bit more the trend that we are seeing for the second quarter in terms of the membership performance? And how is membership subscription and the revenue trending in the third quarter? And also, can management share your thoughts on how you view the membership business longer term, and what are your future strategies? Thank you.

Yu Gong

[Foreign Language]

Chang You

Okay. Let me answer the question into two parts. First, I would like to explain the trend of membership business in Q2 and Q3. First of all, for Q2, overall, the revenue performance met our expectations. The ARM for our membership continues to grow in the past quarters. However, there are some relative frustrations in the absolute subscriber numbers, which is to our expectations. There are a few reasons that contributed to that outcome. First, typically Q2 is the low season for the year. Second, Q2, because of the pandemic resurgence, there are a limited number of theatrical movies that were released online, which triggered a lower number of movies that we can broadcast on platform. And third, to some extent, there are some relatively content delays of our offerings on the platform also attributed to the resurgence of COVID in China. And entering into Q3, we’re seeing a significant improvement in the membership business, also because Q3 is traditionally the summer peak season. So, starting from August, we’ve seen a lot of the major titles released online, including The Heart of Genius, the very blockbuster of Cang Lan Jue, which is the Love Between Fairy and Devil. So currently, overall, we are optimistic of the Q3 revenue performance for the sub business as well as the absolute subscriber base for Q3.

Yu Gong

[Foreign Language]

Chang You

Sure. In the past 2.5 or 3 years, the membership business experienced abnormal performance because of the COVID situation in China. For short-term speaking, there were some positive impacts. For example, we have seen sub base increase because of the COVID but that situation probably will last a shorter period of term from 2 to 3 months. Overall speaking, I think the COVID situation was more on the negative side of our membership business that trigger to the abnormal -- pretty volatile and unhealthy development of the business. And from the operational side, the content offering, we have seen that has also negatively impacted our content offerings in the last two or three years. The approval process of our content business also has some impact as well and also the consumer spending motivations were also impacted with the COVID situation in China and negatively impacted by the macro environment. So, overall speaking, I would reiterate, or I will summarize the past two, three years as more on the negative side rather than the positive side for our membership business. But currently, because of the whole pandemic situation is gradually improving -- and you’ve seen the negative impact is gradually decreasing over the recent period, especially since summer, we’ve seen a significant pickup in the consumption of the consumer spending and the sentiment is positive on that side. So overall, speaking mid to long term of our membership business, we are still very optimistic of our membership business.

Yu Gong

[Foreign Language]

Chang You

Okay. Earlier, I touched on the negative impact because of the pandemic situation, in the past 2 to 3 years. But starting in Q3, especially the second half of Q3 and to the future we are seeing a gradual decrease of the negative impact because of COVID, and we’re seeing a pickup in the overall business for our membership business. There are two points. First, we anticipate the sub base will continue to grow in the future. And secondly, for our ARM, that continued to grow in the past six quarters and we anticipate this positive trend will continue in the future as well.

Operator

And our next question today comes from Thomas Chong at Jefferies. Please go ahead.

Thomas Chong

[Foreign Language] Just now the prepared remarks here, you talked about calm growth, why is that our profit growth will be faster than the revenue growth? Thank you.

Yu Gong

[Foreign Language]

Chang You

For the Calm Growth strategy, let me explain a little how we arrived to this strategy. Towards the end of last year, we built out a strategy that will increase our efficiency and optimize cost; we built out the different measures and plans to execute this strategy. After the past two quarters, we successfully kind of figured out what’s the minimum that we can do to achieve this result. And we also figured out the pattern that will guide us or enable us to achieve better efficiency and improvement in the future. For example, we now can know after we have the increasing investments in some of the content that would generate high ROI, then that will positively lead to the higher margin growth towards profit, because we think a lot of the investment that we can gain from the past experiences, we know the content with higher ROI that we can invest in that will produce the same results or even better results from the user front. So, that’s why we think overall speaking, going forward, the profit will grow faster than revenue. And also, we think, even under the reasonable amount of increasing investment that will expedite the process even further. And looking back to the first half of this year, we actually controlled some of our investment in content and that we also see some fluctuations in the user growth that negatively impacted due to such reason. But going forward, we know if we increase the investment for these two areas, we will gain higher returns in the future, which means we will gain higher efficiency for any of the investment we put in going forward.

Operator

And our next question today comes from Xueqing Zhang with CICC. Please go ahead.

Xueqing Zhang

[Foreign Language] Today, we have announced the $500 million profit placement of convertible notes with PAG. So could management share more details about this? And in terms of financing activities what’s the plan for the future? Thank you.

Jun Wang

As I just mentioned, this afternoon actually, the company has announced to enter into the agreement with PAG for $500 million convertible issuance. And as you know, PAG is a leading investment firm in Asia Pacific with approximately, I think, $50 billion AUM and with accumulated investment over 70 billion. And they are very active, very seasoned investors with real know-how in the digital media space with strong historical track record. So, this is the general background. I think this financing illustrates PAG’s recognition on companies improved fundamentals, and we do have improved competitiveness. We have margin expansion with an improved financial healthiness. And with all being said, I think most importantly, both sides have conviction that the iQIYI’s media business to help future has great future, I think, growth potential, and this is one of the most important thing. Then another consensus, I would say that between two parties is iQIYI’s value has been heavily underestimated. And one of the catalysts for value recovery probably is to find a way to solve the current debt overhang as the market pick up. And this $500 million financing is a joint cooperation, I think the first step on company’s liability management, although it’s not enough to solve all the problems. And we are clear that $500 million is only a step stone, and we still have a journey to go to solve our problems. And during this process, we do need collaboration and efforts from all the partners, including the company, including our employees, including the company’s stakeholders and note holders as well. And it’s still with the completion, I would say with the signing of this $500 million financing, we are still not in a position to sit back and relax mode. We are still going to work hard on that. And of course, we are very confident that if we can solve these technical issues with all collaborations from all parties if we can recover the company’s value, all the value unlocked can help the investors -- whoever help the company, can help investors to gain, I would say, satisfying reward and returns going forward. So, this is all that I will share regarding the -- our private placement as well as the future -- some of the future thinking.

Operator

And our next question today comes from Lincoln Kong with Goldman Sachs. Please go ahead.

Lincoln Kong

[Foreign Language] So, the question is about the cooperation with Douyin, since we have signed agreements on a copyright of our video contents. So, how should we think about the future potential collaboration formats? And how would they help us in terms of the user acquisition, copyright distribution and other potential commercial efforts to our financials?

Yu Gong

[Foreign Language]

Chang You

Okay. Let me explain or elaborate a little bit more on the Douyin collaboration. We went through the negotiation process in the past months and both parties were very sincere, and we wanted to create a win-win situation for this ecosystem as well as for the video space. I probably won’t go too much into the details of the process, but there are a few aspects I wanted to share with you guys. First, within this collaboration, iQIYI is authorized to authorize Douyin to use some of the content that have the license right to distribute using for creation of short-form videos. But within that framework, we have a specific arrangement for Er Chuang, which means the recreation for the short-from videos. The target is that we won’t hurt the long-form video viewing experience for this collaboration, which also means that we can use this collaboration for many of our very high-quality premium content to reach a broader audience which also means utilize the short-form video to brought the traffic to iQIYI platform for the long-form video. And there’s this one aspect. Another aspect is we’re getting the financials returns for this collaboration. The results you will see starting from the third quarter of this year. It had positive impact for revenue as well as profit as well as cash flow have positive impact because of this collaboration. And thirdly, we also will collaborate in other operational front, for example in products, technology and daily operations of the platform. Because we just signed this agreement in Q3, in July, we are getting things worked out, and we will roll out products and also content starting from, I would say, towards the end of Q3. So, you will anticipate more products and content related to this cooperation with Douyin starting from that period.

Yu Gong

[Foreign Language]

Chang You

Okay. Let me share some of the mid- to long-term views of this collaboration. First, I will share from the industry perspective. First of all, because iQIYI and Douyin are both the leading players in the market, one is for short-form and one is for long-form. So, under this collaboration, very importantly, we’re setting rules for this industry and creating win-win collaboration for both platforms. So basically, this demonstrates the very positive and sustainable development of this video business in the long term, which is very beneficial for both platforms and also for the users as well as for this ecosystem. And second, for creators and the industries we are creating a very, I would say, advanced or better iQIYI solutions which will push the IP protection as well as the legal enforcement of our premium long-form content. And also, it will, to some extent, decrease, I would say, copyright infringement situation in some of the short-form videos. And also very importantly, for the creator’s perspective, I will say they have more time now to be concentrated and more dedicated to bring more creative talent and unleash their creative talent to bring more positive and high-quality content to our users. And this will also be very beneficial for the IP license holders as well. Above were the positive impacts for the video industry, and I will share on some of the views for iQIYI specific. First of all, I will say, this collaboration demonstrated the very premium content of iQIYI are recognized by the industry as well as our users. Also, it demonstrates the monetization potential of our high-quality premium content in the future. Second, through this collaboration, it will help iQIYI’s premium content to reach a broader group of users, and creating bigger impact of our content. That will also draw increasing number of users as well as members to the platform. Thank you.

Operator

Ladies and gentlemen, this concludes our question-and-answer session. I’d like to turn the conference back over to Ms. You for closing remarks.

Chang You

Thanks everyone for joining the call. Please contact us if you have any further questions. See you next quarter. Thank you. Bye, bye.

Operator

Thank you. This concludes today’s conference call. We thank you all for attending today’s presentation. You may now disconnect your lines, and have a wonderful day.