IQIYI Inc. (IQ) Q1 2021 Earnings Call Transcript

IQIYI Inc. (NASDAQ: IQ) Q1 2021 earnings call dated May. 18, 2021

Corporate Participants:

Fan Liu — Head of Investor Relations

Xiaodong Wang — Chief Financial Officer

Yu Gong — Founder, Chief Executive Officer and Director

Xiaohui Wang — Chief Content Officer

Xianghua Yang — Senior Vice President

Analysts:

Thomas Chong — Jefferies — Analyst

Piyush Mubayi — Goldman Sachs — Analyst

Zhijing Liu — UBS — Analyst

Eddie Leung — Bank of America Merrill Lynch — Analyst

Alex Xie — Credit Suisse — Analyst

Presentation:

Operator

Good day, and thank you for standing by. Welcome to the iQIYI First Quarter 2021 Earnings Conference Call. [Operator Instructions]

I would now like to hand the conference over to your speaker today, Ms. Fan Liu, Investor Relations Director of iQIYI. Please go ahead.

Fan Liu — Head of Investor Relations

Thank you, operator. Hello, everyone, and thank you for joining iQIYI’s first quarter 2021 earnings conference call. The company’s results were released earlier today, and are available on the company’s Investor Relations website, at ir.iqiyi.com.

On the call today are Mr. Yu Gong, our Founder, Director and CEO; Mr. Xiaodong Wang, our CFO; Mr. Xiaohui Wang, our CCO, Chief Content Officer; and Mr. Xianghua Yang, Senior Vice President of our Membership Business. On behalf of Mr. Gong, I will give a brief summary of the shareholder letter we sent out earlier today, followed by Xiaodong, who will go through the financials and guidance. After our prepared remarks, Xiaohui and Xianghua will join Mr. Gong and Xiaodong in the Q&A session.

Before we proceed, please note that, the discussion today will contain forward-looking statements made under the Safe Harbor provisions of the U.S. Private Securities Litigation Reform Act of 1995. Forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from our current expectations. Potential risks and uncertainties include, but are not limited to, those outlined in our public filings with the SEC. iQIYI does not undertake any obligation to update any forward-looking statements, except as required under applicable law.

With that, I will kick-start the call with a brief summary of our shareholder letter. As you may have noticed, we have sent out a shareholder letter earlier today. This is the first time since our IPO for Mr. Gong to communicate with our shareholders with this format. In this letter, Mr. Gong shared some of his thoughts on the online video industry, its competitive landscape and our content strategy.

To start with the industry dynamics and our competitive advantage, from the perspective of users’ mindset, video content can be defined as the leisures, entertainment and the interest-based video, of which iQIYI mainly focus on the latter two. Our iQIYI app focuses on entertainment videos and our Suike app on interest-based videos. The entertainment video market has extremely high entry barriers, including the economics of scale, the overall understanding of the industry and its talent as well as the industry’s capital-intensive nature. Empowered by our technology and the database, our knowledge on the industry and our affiliation with the key content talents, iQIYI has established a solid leadership. For interest-based videos, we will continue to invest in Suike and expand that. It will contribute to our core entertainment business.

Next, about our approach to current challenges. Though, we are currently facing some challenges in our membership business, we still firmly believe that this business has huge potential. Two supporting data. First, as of the end of the first quarter 2021, the number of accumulative paid accounts has exceeded 490 million. And two, in first quarter 2021, the monthly average number of subscribing members who have membership benefits for any given day has reached nearly 160 million. For the volatility of membership business, we believe lack of high quality content is the primary reason. We believe the solution lies in the increase of our in-house production capacity and the industrialization of video production. To establish enough and highly productive in-house studios is an important prerequisite for the improvement of our content quality.

We have now established over 50 in-house studios within two years. Most of these internal studios are focusing our original dramas and the variety shows and a few are concentrating on movies and animations. As the capacity of our in-house studios is still far from enough, we will continue to expand our in-house production capacity and diversify the dramas of our in-house studios. Through these in-house studios, we have amass outstanding talent in the content production industry and obtain more premium IPs and productions.

The industrialization of video production includes the restructuring of the industry rules and intelligent production techniques. Thanks to the development of new technologies, our intelligence production system and the tools are gradually improving. This enables us to enhance the controlability of production schedules, content quality and the financial risks, and further reduce costs and improving efficiencies.

Now I would like to turn over to Xiaodong for first quarter update.

Xiaodong Wang — Chief Financial Officer

Hello, everyone. We kicked off the year with a solid quarter. Our revenue increased both sequentially and year-over-year in the first quarter, which is above our previous guidance. Besides, in recent quarters, when revenues have been relatively stable, our content costs have been effectively controlled and losses have continued to narrow. We continue to lead the market by launching a consistent stream of premium content. According to QuestMobile, our MAU, DAU and monthly time spent all ranked first in the industry in the first quarter of 2021.

For our membership business, as of March 31, 2021, we had 105.3 million subscribers with 3.6 million net additions during the quarter. Membership services revenue increased by 12% sequentially to RMB4.3 billion. Subscriber growth was driven by several factors. First, our top content, in particular premium dramas, performed very well. For instance, our top drama, My Heroic Husband, was a blockbuster during the Spring Festival. Second, users spent more time on long-form video during major holidays such as Spring Festival, driving up the overall traffic on our platform. Third, we introduced various innovative marketing initiatives during the holiday season.

In addition to overall membership growth, our sequential growth in membership services revenue was also due to two factors, including, first, an increased willingness to pay among users. Second, ARPU growth driven by the headline pricing adjustment in November 2020, which is well accepted among users in the industry. Meanwhile, we strived to expand our total addressable market through launching a new VIP plan iQIYI Lite and expanding our footprint overseas. Though we still expect short-term volatility in our subscriber numbers, we remain confident in the mid and long-term development of our membership business. This is based on our dedication to premium content as well as ongoing improvements to our original content ecosystem and in-house production capabilities.

Moving on to advertising business, during the quarter, the overall advertising market continued to recover. Our online advertising services revenue increased by 25% year-over-year. Even though the first quarter is traditionally a slow season for our advertising business, we were able to achieve decent sequential and year-over-year growth. Like the trend in the fourth quarter of 2020, growth was mainly attributed to strong content marketing revenue. Our content marketing revenue recorded decent growth driven by major variety shows and dramas. The content marketing revenue accounted for around 64% of our brand advertising revenue in the first quarter, which was a peak for the last few quarters. This again validated advertisers’ recognition of our premium content.

Next, for content, we continued to lead the industry in terms of total number of top titles and viewership across the categories, including drama, variety shows, animation, children and other content. For drama, our exclusive customer drama, My Heroic Husband became an instant hit after its launch. Its innovations in theme and style provided a whole new way of creating good costume drama which will have an impact on our future productions.

In original movies, our original movie Underworld Crashed has been screened in theaters, reached a box office of over RMB300 million and has received high ratings from various platforms. For the second quarter, key dramas in our pipeline include A Love for Dilemma, Court Lady, Crossroad Bistro, The Rebel, The Lion’s Secret and others. Love for Dilemma and Court Lady were aired in April and well received by our users. We kept promoting short drama theater brands with a brand featuring romantic content scheduled to launch on May 20 this year. We will also launch new content in Mist Theater later this year.

In animation, new content to be aired including No Choice but to Betray the Earth, The Tales of Wonder Keepers and the light animation Immortal Father As a Son-in-law 3 as well as others. Despite some expected uncertainties in our content schedule in the coming months, we believe that the impact will be mitigated by our diversified content pipeline, especially self-produced dramas.

With over 10 years’ of iQIYI’s growth, we strongly believe that long-form video is irreplaceable as an entertainment format. In the meantime, through continuous technology innovations that empower content production, we will have the capability to increase our hit ratio, generate greater commercial value, and expand the imagination for the next generation of entertainment. As well, we look forward to bringing more good news to all shareholders.

Now let me review our key financial highlights for the first quarter. For the first quarter, total revenue reached RMB8 billion. Membership business continued to be our largest business pillar accounted for 54% of our total revenue. Our advertising business recorded notable rebound of 25% increase on a year-over-year basis. Both content distribution business and other business achieved stronger growth on a year-over-year basis.

Our cost of revenue decreased 10% year-over-year, mainly due to the 9% year-over-year decline of content cost. The decrease was primarily due to the decline of licensed content costs. Our operating loss margin on a GAAP basis continued to narrow by 16% year-over-year to 13% for the fourth consecutive quarter. As of March 31, 2021, the company had cash, cash equivalents, restricted cash and the short-term investments of RMB13.3 billion. For detailed financial details, please refer to our press release on our website.

For the second quarter of 2021, we expect that total revenue to be between RMB7.21 billion and RMB7.65 billion, a 3% decrease and a 3% increase year-over-year. This forecast reflect iQIYI’s current and preliminary view, subject to change.

I will now open the floor for Q&A.

Questions and Answers:

Operator

[Operator Instructions] Your first question comes from Thomas Chong from Jefferies. Please ask your question.

Thomas Chong — Jefferies — Analyst

[Foreign Speech]

Thanks management for taking my questions. My question is about the regulatory environment in China. How should we think about the regulations regarding the long-form video? And on the other hand, how we should think about our short-form video strategy? I mean, the mid-form video strategies for Suike? And any KPI data can be shared that would be great. Thank you.

Yu Gong — Founder, Chief Executive Officer and Director

[Foreign Speech]

Okay. Over the past two years, as you may have observed, that the regulation intensity is almost stable. You can observe that before some kind of a season, for example, and the upcoming July 1 day, they will be intensified all in-house regulation policy guidelines and management. It will directly impact our content pipeline in the short-term and of course some uncertainties.

[Foreign Speech]

Okay. For Suike app, we right now don’t have a very quantitative KPI. Over the past one year, we have been able to find it as the good value proposition, which is based on the interest-based video community. All the things, including the user interaction, for some, it’s still in the progress of the upgrading. And in terms of the content community ecosystem, it’s still far from satisfactory. We still need to work hard on this. Until it has been quite satisfactory before the year end, we won’t have a very big promotion. In terms of the user data, it won’t be grow very rapidly in the near-term. We will still have a very elaborated evaluation internally.

Thomas Chong — Jefferies — Analyst

Thank you.

Yu Gong — Founder, Chief Executive Officer and Director

Thank you.

Operator

Your next question comes from Piyush Mubayi from Goldman Sachs. Please ask your question.

Piyush Mubayi — Goldman Sachs — Analyst

Thank you for taking my question. My first question concerns the content cost spending, which is — look solid in this quarter in terms of control. I wondered if you could talk through the expectation for the rest of the year and whether these levels can be continued to improve on as we look forward for the rest of the year? That’s the first.

The second is, as we look at ARPU at this stage, following the competitions joining you with raising pricing or raising effective ARPUs, what is the outlook for where this number could go through for the rest of the year as you roll that higher price through? And where can you think — where do you expect this to go? And the third is, you’ve spoken in the past about your move into the international markets. Could you just give us a brief feel for the scale that you are likely to be able to attain and where you are at this stage? Thank you.

Xiaodong Wang — Chief Financial Officer

This is Xiaodong. I will answer the first question about the content cost and then I will let Xiaohui comment on ARPU trend on the overseas business. For the content cost, I believe the total content cost we’ll spend this year will continue to be optimized in the next few quarters, which means as a percentage of revenue our — definitely you will continue to see the trend of decreasing of the content cost. That, by the way is discussed before.

I think we are thinking about like the — in short-term, we are thinking about like expand to original content to a different category, including movies and animations, which could have unlike the short-term volatility of the total content cost. For a lot of period, the future ratio improved. I think as we discussed before, the total spending of content cost even from legacy absolute dollar amount perspective, I believe will continue to be optimized in the next few years. Thank you.

Xiaohui Wang — Chief Content Officer

[Foreign Speech]

We actually very welcome our peers to follow our suit. For the detailed information, I will turn over to Xianghua for the detailed information.

Xianghua Yang — Senior Vice President

[Foreign Speech]

Okay. So as you know, we actually adjusted our pricing last November. For this quarter, in terms of ARPU growth on the sequential basis and also on a year-on-year basis, it’s around the 10%, and we expect this trend will continue.

[Foreign Speech]

Our international business is still in a very early stage and it’s definitely it’s still in a very rapid growth stage. In terms of the future direction for the business, I think ASEAN region will be major location we are looking at.

[Foreign Speech]

Our current strategy for our international business is still very disciplined. We are cautiously looking at opportunities. The major concern here is that we don’t have enough in-house or original content, particularly in TV dramas and also variety shows. The capacity is far from enough. It’s more the case for overseas expansion because in terms of the content, it has actually very strong characteristics for the regions. It’s more also more the case that in terms of the production capacity for the films and animations is also far from enough in terms of the capacity and the diversity. So we will continue to increase expanded capacity for our in-house production, particularly when — in terms of the acquisition content. The marginal cost for the acquisition content is still too high. And so it’s the major approach is still in-house, but in-house production capacity.

Yu Gong — Founder, Chief Executive Officer and Director

[Foreign Speech]

I want to add one point that overlap — since the IPO, our earnings call is mainly focusing on this quarter and next quarter. It’s quite short-term. We haven’t been able to have a chance to talk about our long-term strategy or the schematic view. And so this time it’s our — it’s the first time since our IPO to use the shareholder letter to communicate with our shareholders. I understand that most of our analysts haven’t been able to got some time to really read the shareholder letter. I want to stress that the major challenge in here is actually not that short-form video or other incoming format to grabbing our time spent. Our biggest challenge for us is still the content itself.

[Foreign Speech]

In terms of the licensed content, on the TV drama categories, as you may know, the content for satellite TVs, content has been roughly free. This has caused some issue for the content we can get on our platform. On the films category, because of the COVID-19 pandemic outbreak and also because of the change of the broadcasting rules of Hollywood films, we also have a scarcity in terms of the films content supply in our target.

[Foreign Speech]

Because of the shrinking TV drama content for satellite TV, we need to focus on our in-house production capacity to more mass audience in this market just because they need more content from our category.

[Foreign Speech]

So as a result, we need to enhance the investments in terms of the numbers of the in-house studios we have. And in addition, we need to increase our budget or the investments on the films and also animation categories.

[Foreign Speech]

We want to share some data with you guys. In terms of the memberships time spent, 60% of the time spent are on the drama, TV drama. In terms of the video viewership or the user traffic, the first category is drama, second is film, and for animation and variety shows it’s much less than former two.

[Foreign Speech]

In addition to increase the numbers of in-house studios, we also needed to improve the industrialization magnitude of the video production. This — the solution is mainly to take advantage of the technology. This includes three parts. First, we need to increase the forecast correctiveness [Phonetic] of the financials and also user traffic while add certain business intelligence techniques. Second, we need to take advantage of the AI or other technologies to systemize the video production system in terms of reducing the cost and improving efficiency. And third, we need to take advantage of the intelligent tools to reduce the cost and also improve the efficiency online.

[Foreign Speech]

Over the past several years, we have already developed certain functions or certain tools in terms of the industrialization of video production. We haven’t been able to systemize this work. We want to improve this over the next one or three years.

[Foreign Speech]

So put it in a word, our increasing numbers of the in-house studios is the most important supporting pillar for us.

Piyush Mubayi — Goldman Sachs — Analyst

Thank you.

Operator

Your next question comes from Zhijing Liu from UBS. Please go ahead.

Zhijing Liu — UBS — Analyst

[Foreign Speech]

Thank you management for taking my question. I have two questions. We have seen greater fluctuation of subscriber growth since last year. How can we mitigate such volatility? And secondly, we are supposed to see more original content launch in second half. Can we expect the prominent improvement of content quality in short-term? Thank you.

Yu Gong — Founder, Chief Executive Officer and Director

[Foreign Speech]

The primary reason behind the volatility of our member — subscribing members is that of the content on our platform. We have observed clearly that if we have good content, we will have incoming users falling to our platform. If we don’t have the good content, the users will leave a lot more. So this is a very clear phenomenon. So the key solution here is that improve the content quality which will be main thing in the second half.

[Foreign Speech]

I recommend that you look at our app. We have a new feature here which is called the upcoming new content, which included the content which have already specify launching date and also including some content with the uncertain launching date. If you look at our feature right now, you will find that we have 78 new titles which will be launched in the coming quarters.

Zhijing Liu — UBS — Analyst

Thank you.

Yu Gong — Founder, Chief Executive Officer and Director

Thank you.

Operator

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

Eddie Leung — Bank of America Merrill Lynch — Analyst

[Foreign Speech]

Just a three quick questions. The first one is a follow-up question on Dr. Gong’s comment about original content. So just wondering, in the upcoming years’ spending, how much of the budget is for the original content? And then the second question is about the so-called large screen strategy. Wondering if there is any update on the user metrics from Smart TV? And then finally, we noticed that there was an acquisition of a chocolate brand like two months ago. So wondering any rationale behind it? Thank you.

Yu Gong — Founder, Chief Executive Officer and Director

[Foreign Speech]

Okay. So I will turn over to Xiaodong for the question of the content cost. I will answer the connected TV question first. Well, connected TV, if we rule out the seasonal volatility, our user time spent and also user traffic on the connected TV is still stable and increasing. In terms of the user time spent, the connected TV is already surpassing the mobile side. When I say mobile side, it includes both cell phone and the tablet. Right now we don’t have a very authorized third-party data, but I believe that in terms of the DAU and MAU on the connected TV, it’s still smaller than mobile side. But in terms of the average — daily time spent on the TV side is higher than the mobile side, and we believe this kind of a trend to continue. And in the long run, the TV side in terms of the user time spent, it might contribute 60% to 70% of our total user time spent.

[Foreign Speech]

And I need to add one point that the connected TV has — will be — has more ample potential in terms of the membership and also PVOD taxation, just because of the connected TV has a much better user experience and it’s easier for users, although in terms of the willingness for paying for the users is much higher.

[Foreign Speech]

In terms of the chocolate company, you have mentioned previously, it’s called a [Indecipherable] It’s not a merger or it’s not a consolidation business investment, it’s just a minority equity investment. And since our investment, the total valuation of [Indecipherable] has settled, more than doubled. Thank you.

Xiaodong Wang — Chief Financial Officer

I think for original content and the total content cost, it’s around like 30%, but if you look at across different categories, it varies. For drama category, it’s over 40%. For virtuous, it is higher, over — I think 90%. So we’re not going to increase [Indecipherable] in the next few quarters. But I think the focus will be the quality. We are going to improve the quality of this original content in these two categories.

And in the coming year, I think we will try to understand how we are going to expand our original content strategy to other categories, including drama — including movies and animations. As we said before, we are going to do some small experiments in these two categories. So overall, I think you will still see some increase of the original content and the total content cost next year. But I think our idea of stable level of original content, as we talked before, will be around like say 40% to 60%, if you look at the penetration mix between original content versus licensed copyrights. Thank you.

Operator

Your last question comes from Alex Xie from Credit Suisse. Please ask your question.

Alex Xie — Credit Suisse — Analyst

[Foreign Speech]

My first question will be — thank you management for taking my questions. My first question will be about the new VIP program for iQIYI Lite. Would you please share with us the differences from the original VIP program and how should it help you penetrate into low-tier cities? And secondly, would you please share with us the impact of the new regulation on the reality shows after the events of Youth With You 3? Did it impact your advertising revenue from reality shows in the future? Thank you.

Yu Gong — Founder, Chief Executive Officer and Director

[Foreign Speech]

We are sorry that we haven’t been able to broadcast the last episode of Youth With You. And as you have already observed that the Beijing Municipal Bureau of Video and Television have issued a new guidance that we cannot vote through the purchasing goods or buy-in membership plans. So this means that the voting in the future would be only for free. And in terms of the impact, in terms of our advertising revenues, we are still evaluating internally.

[Foreign Speech]

Okay. So for iQIYI Lite app, as you know, it’s mainly catered to lower tier city — lower tier city users. It’s much more simplified in terms of the user interface versus our main app. In terms of the membership plans on iQIYI Lite app, for these kind of members, they need to watch certain advertising format. But in terms of the membership pricing, it’s much lower than our main app membership just because for this kind of subscribers, their willingness to paying for the content is not that high. And so we want to leverage some certain kind of operation tactics to penetrate that.

Alex Xie — Credit Suisse — Analyst

Thank you.

Yu Gong — Founder, Chief Executive Officer and Director

Thank you.

Operator

I will now pass the call back to management for closing remarks.

Fan Liu — Head of Investor Relations

Okay. So thank you for joining our call. We look forward to talk with you guys in the next quarter. Thank you.

Xiaodong Wang — Chief Financial Officer

Thank you. Bye, bye.

Operator

[Operator Closing Remarks]