IQIYI, Inc. (NASDAQ:IQ) Q3 2020 Earnings Conference Call November 16, 2020 7:00 PM ET

Company Participants

Lei Zhang – IR

Yu Gong – Founder, CEO & Director

Xiaodong Wang – CFO

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Xianghua Yang – President, Membership & Overseas Business Group

Conference Call Participants

Eddie Leung – Bank of America Merrill Lynch

Yiwen Zhang – Citigroup

Thomas Chong – Jefferies

Gary Yu – Morgan Stanley

Alex Xie – Crédit Suisse

Zhijing Liu – UBS Investment Bank

Bo Pei – Oppenheimer

Binnie Wong – HSBC

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the iQIYI Third Quarter 2020 Earnings Conference Call. [Operator Instructions].

I would now like to hand the conference over to your first speaker today, Investor Relations Director of iQIYI, Lei Zhang. Thank you. Please go ahead.

Lei Zhang

Thank you, operator. Hello, everyone, and thank you for joining iQIYI’s Third Quarter 2020 Earnings Conference Call. The company’s results were released earlier today and 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; and Mr. Xianghua Yang, Senior Vice President of our Membership business. Mr. Gong will give a brief overview of our company’s business operations and highlights, followed by Xiaodong who will go through the financials and guidance. After their prepared remarks, 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 provision of the United States Private Securities Litigation Reform Act of 1995. Forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from our current expectations. Potential risks and uncertainties include but not limited to those outlined in our public filings with the SEC. iQIYI does not undertake any obligation to update any forward-looking statements except as required under applicable law.

With that, I will now turn the call over to Mr. Gong. Please go ahead.

Yu Gong

Good morning. As we know — as we all know, with the alleviation of the COVID-19 epidemic in this abnormal year of 2020, we see both the users’ behavior and the macro economy gradually back to normal. Despite the negative impact in the first half of year, the content production industry is trying to catch up. In the third and the fourth quarter, we are taking a variety of measures to speed up this recovery process and prepare for next year’s growth.

Now let’s go through our business segments. First, I’ll talk about our membership business. As of September 30, our total subscribers reached 104.8 million, and the paying ratio reached 99.5%. Membership services revenue grew by 7% year-over-year to RMB3.98 billion. Although total subscribers remained flat this quarter, the membership revenue still increased compared with last year.

There are a few factors we observed regarding membership business trend. First, there was some lack of new content on our platform due to the content release delay and new theatrical movie shortage. The fact that fewer new movies were released in cinemas this year accordingly affected the movie supply. As a result, we launched fewer movies in Q3 compared to the same period last year.

In Q4, we expect some sequential rebound of new movie supply although still not as much as Q4 last year. Specifically, we are very happy to see that one of the most expected movies this year, The Eight Hundred just started streaming on our platform from November 1 and became hit immediately. We expect more and more theatrical movies coming online gradually for our subscribers.

Second, we see the users are spending more time on short-form videos. However, we also noticed that larger screens such as smart TV and set-top box also became more popular. More users prefer watching the content on large screen for better home entertainment experience.

Our platform, the time spend via TV devices is growing for the past several years, and recently, total time spend on TV surpassed that on the mobile devices. Accordingly, we will take more initiatives on large screen-related business and develop monetization ability of them. We believe, with appropriate operation tactics, larger screens can be an important monetization driver for us in the mid/long term.

Lastly, the summer vacation this year was shorter than usual, which lead to softer traffic and time spend on our platform compared with last year. We believe the membership growth slowdown is temporary. As content is always the key to attract subscribers, we have high confidence in our premium original content and in-house production capabilities. Most of our over 50 in-house studios will go into full production from the second half of next year. These studios are expected to largely improve both the originality and the diversification of content on our platform and ultimately drive continued growth in our membership business.

In addition, we are targeting different user groups by focusing on diversified content categories. Considering the movie diverse user need and our large group members, we have invested in a variety of content verticals and already seen some great initial results. iQIYI Mist Theater, which features 12-episode suspense dramas, has been watched by over 68 million subscribers as of the launch of its finale. We are happy to see that these shorter dramas are attracting new subscribers as strong as the longer series and with even better ROI.

Also, we continue to explore more monetization models. We have provided early access to premium content for extra charge to our users and launched the premium video-on-demand mode for a few movies. In addition, the S-diamond membership, our premium membership package with plenty of privileges and high charges, was well received by a part of our users since launch.

Looking ahead to the rest of the year, we expect there might be some uncertainties on our membership due to our recent pricing adjustment. As you know — as you may know, we just launched our new subscription pricing plan, which was effective on November 13.

Moving over to advertising. Despite all of the recent macro headwinds, the domestic advertising market is recovering. While the industry remains under pressure in the second half of the year, we are already seeing some positive signs. The successful launch of our hit content, including The Rap of China 2020, The Big Band 2, and all of the new series in Mist Theater, coupled with a gradual recovery of advertisers’ confidence during the third quarter, both our brand ads and performance ads rebounded compared with the second quarter.

Our brand ads revenue was recorded a sequential increase for two consecutive quarters. The sequential growth quarter — the sequential growth during the third quarter was mainly attributable to the increase in the number of advertisers. In terms of industry, the revenue increase was mainly from food and beverage, online games and transportation. Besides, education and consumer electronics recovered faster sequentially.

During the quarter, we continue to innovate the advertising campaigns with our theater. Mist Theater has sparked new ideas and provided a template for advertising across shorter series. So far, we’ve already attracted Volkswagen and Yili, and over 30 other advertisers have also joined. As a result, Mist Theater has generated decent advertising revenue in addition to word-of-mouth buzz. In the future, we plan to launch more theaters in categories such as romance and comedy, providing advertisers more choices.

Moving on to the content. During the quarter, we accurately identified our users’ demand for entertainment post the pandemic and during the summer vacation and released a number of hit dramas, variety shows and animations with innovative scheduling. We are trying to establish our self-branded content vertical. The Mist Theater was our first trial and achieved phenomenal success. We will continue to launch other different self-branded content verticals in the coming quarters. We believe the self-branded content verticals can raise our user stickiness to our platform rather than just to a single title.

As mentioned under the Mist Theater banner, we have released a total 5 high-quality short suspense dramas, namely Kidnapping Game, The Bad Kids, Crimson River, Sisyphus, The Long Night. Because of its high quality and widespread popularity, Mist Theater has drawn global attention. Recently, The Bad Kids became the first Chinese drama series to win the Best Creative award in the second Asia Contents Awards in the 2020 Busan International Film Festival.

In addition, Reunion: The Sound of the Providence Season 2, rapidly broke the 9,500 mark on our content popularity index after its exclusive launch on our platform. Meanwhile, we also released a number of dramas that featured a theme of female personal growth story, including Love Yourself, My Unicorn Girl, and Love is Sweet, to cater to the demand of female user group who are contributing most on drama viewing. Besides, another our original drama, The Thunder, has recently been honored Outstanding Television Series at the 30th China TV Golden Eagle Award and the 26th Shanghai TV Festival Magnolia Awards.

For our top original varieties, such as The Big Band Season 2, The Rap of China 2020 and Mr. Housework Season 2, aired and performed nicely during the quarter. Also, shows catering to diversified user group such as Summer Surf Shop for athletic people; Dear Little Desk for parents; and Let’s Party for fans of girl idol THE9 were also well received during the quarter.

In addition, our self-produced animation, including Are You OK, and Deer Squad were released during the quarter and became quite popular among ACG fans and children.

For the fourth quarter, we plan to release more high-quality dramas, including My Best Friend’s Story, Dear Missy, Spirit Realm, and The Duke of Mount Deer. Upcoming key variety shows, including Hahahahaha; FOURTRY Season 2, Qipa Talk Season 7, and Dimension Nova.

In conclusion, despite the unprecedented, volatile and difficult situation we and many others are facing, we have made a considerable progress with a variety of operational initiatives. Our Mist Theater has been a success. In the future, we will continue to innovate and develop new production and operational strategies in running our business to achieve sustainable growth over the long term.

With that, I’ll turn it over to Xiaodong to talk about our financials.

Xiaodong Wang

Morning, everyone. Let me review our key financial highlights for the September quarter. Total revenue reached RMB7.2 billion. Membership business continued to be our largest business pillar, with revenue up 7% year-over-year, accounting for 55% of our total revenue. Our advertising business recorded notable rebound with 16% year — increase on a Q-over-Q basis.

Our cost of revenue decreased 22% year-over-year mainly due to 24% year-over-year decline of the content cost. SG&A expenses were only up 1% year-over-year. As a result, our operating loss margin narrowed to 17% from 38% in the same period last year.

As of September 30, 2020, the company had cash, cash equivalents, restricted cash and short-term investments of RMB7.4 billion. For detailed financial data, please refer to our press release on our website. For the fourth quarter of 2020, we expect total revenue to be between RMB7.28 billion and RMB7.73 billion, a 3% increase — decrease to a 3% increase year-over-year. This forecast reflects iQIYI’s current and preliminary view subject to change.

I will now open the floor for Q&A.

Lei Zhang

Operator, I think we can open the floor for the Q&A.

Question-and-Answer Session

Operator

[Operator Instructions]. Your first question comes from Eddie Leung from Bank of America Merrill Lynch.

Eddie Leung

So my question is about what Dr. Gong just mentioned about the potential uncertainty in the subscriber number after the price hike. So just wondering if you could add some color on that, whether we are seeing some weakness in the subscriber growth after the price hike.

Yu Gong

As our new pricing plan was effective on November 13, and this time, the pricing plan was targeted to the Android terminal, meaning that we increased Android terminal price to balance to the iPhone — or iOS terminals, that the monthly subscription fee has increased from RMB19.8 to RMB25 per month. And auto renewals monthly fee was to come from RMB15 per month to RMB19 per month.

Now it’s only 4 days that we — since we launched our new pricing plan. And meaning that last Friday and Saturday and Sunday that we have the 3 days of the data. It is not long. But so far, all the data shows that not much of the change on the new subscriber increasing. And — but this single fee for the per new subscribers, of course, have increased. And there’s not much of time so that we cannot say that so far whether it is positive or negative. But based on the experience from our analysis before and also our peers’ experience that we will see that maybe there will be some negative impact in the coming 1 or 2 quarters.

But overall, in the long term speaking, we think the negative impact will vanish and that the user behavior will come back to normal. Thank you.

Yu Gong

One point added that we all know that the main motivation the user has to attract them to subscribe is the exclusive premium content which is — that’s based on our strong original content production abilities. So if you’re looking at our pipeline forward that our pipeline is quite rich. So we do believe that our reach — the pipeline of the self — exclusive content released will definitely help us to mitigate of our negative of the new pricing plan, in the long term and midterm speaking, that our subscriber trends will back to normal. Thank you.

Operator

[Operator Instructions]. Your next question comes from Yiwen Zhang from Citi.

Yiwen Zhang

So I translate into English. I’m asking on behalf of Alicia. So the question is also regarding subscription price hike. So notice Dr. Gong previously talked about the rationale behind the RMB19.8 price set 9 years ago. So can you talk about the rationale behind the 25% rise of the new price? And then in the future, when we do the periodical review of the price, what factors will you consider?

Yu Gong

Thank you for the question. And Mr. Gong thinks that it’s more appropriate just for Mr. Yang Xianghua, who is in charge of our membership business, who will answer the question. Thank you.

Xianghua Yang

As to the evidence that we collected for this new pricing adjustment plan, that’s based on the first days the user suite we launched and we executed. Actually that we executed this user suite from the second half of 2018 that we collected the data on the user behavior and the user in content and also their acceptance of the new pricing. And based on this that we think that the new price of the auto renewal of the — from the RMB15 to the RMB19 per month would be quite reasonable. Thank you.

Operator

Your next question comes from Thomas Chong from Jefferies.

Thomas Chong

My question is about the advertising outlook. Can management comment about how we should think about the trend coming into 2021 and also with regard to any special events that we need to pay attention for next year?

Yu Gong

Yes. I think that for this year, our brand advertisement is our main driver of our advertising business that was quite significantly impacted by the pandemic.

Of course, for next year, we think, along with the pandemic largely under control globally, that the outlook of the next year would be much better than this year. But based on this year is really abnormal and unprecedented, so it’s like of the systematic patterns that we can trace from this year’s experience. So it will take more time for us to give the more accurate prediction of the next year.

So we think that there are a lot of factors that drive our business. The first one is definitely that the original content production abilities that for the next year and in more of the future, that we will focus on the drama series selection, variety show and animation, including adult — animation for adults and animation for kids. And also the movies, the movies we talk about is not only Internet movies but also the theatrical movies which the budget is higher.

And also that how to drive the development, the content production ability that we are going to take measures to increase our self-studio productionality and numbers. We also will improve our cooperation with our content partners.

And secondly that we will invest more on the technology and to execute applied new technology on the content distribution and also the content production. We will leverage the 5G artificial intelligence and even the blockchain technologies into our content production and distribution process.

And the third one is that we definitely will invest to develop and invest more on our mid-form video platform, Suike, and so that after 1-year trial of the Suike, we find out the business position of our Suike platform, that it is that we will build up a video interest community for the video creators and fans that a few weeks before, that we have held a Suike event that gather around the creators and the fans that was quite received very well by our fans and customers. That also further strengthens our confidence to build up a video interest community.

And the fourth one is definitely that we will develop our overseas business. And with that, the content for the overseas business is definitely to be focused on the Asian-oriented content, which including that, the Chinese content and Korean content and Japanese content and so on. And the overseas business will based on the Asian — South Asian — Southeast Asian and maybe explore globally.

And certain for our overseas membership that to be emphasized that the membership — the subscriber numbers that we announced does not include our sports members, but it definitely include our business overseas members. The overseas members is not as much as to mention compared to our domestic members number. It is less than 1% of our overall subscriber numbers. But all of our overseas subscription members comes from the organic growth and just driven by our Asian-oriented content we released. And we think that it is our approach to drive these subscribers organically and not unlike that our peers to improve the subscription numbers and/or take the aggressive and extreme members, such as acquisition and just to increase subscriber numbers quite rapidly. Thank you.

Operator

[Operator Instructions]. Your next question comes from Gary Yu from Morgan Stanley.

Gary Yu

Let me translate the questions as well. I have two questions. The first question is related to competition. So after our recent announcement of price changes, do we expect our competitors or other players in the market to also increase? And how should we look at membership business market share going forward?

The second question is related to the recent announcement of Baidu on acquisition of YY domestic business. And how should we look at the potential synergy with iQIYI business?

Yu Gong

As for the pricing plan for our peers that we don’t know, we have no idea about their plans — about their pricing plan. And — but that’s — we’re also not in the position to provide any predictions on other peers on their plans.

But based on the overview of the whole industry, clearly, as I mentioned from our last earnings call that after 9 years, the original price — the subscription fee, there is a big gap between content supply of cost and the subscription fee in China. So we think that is quite unreasonable to keep the situation as it used to be. So looking at the overall industry, we think that the adjusted pricing plan is quite reasonable for our business.

And for the second question that regarding that — the business acquisition from Baidu, we think that the YY business is quite different from our business from its nature. So that it’s no direct or significant influence on iQIYI. Thank you.

Operator

Your next question comes from Alex Xie from Crédit Suisse.

Alex Xie

My first question was about content cost. So the content cost just decreased quarter-over-quarter. What’s your view on the outlook of content costs in the next quarters?

And the second question is about Mist Theater. So you mentioned these potential series received quite good feedback from customers. So what’s the impact on the subscriber growth for the Mist Theater? And how do you compare the ROI with previous original dramas and original variety shows?

Yu Gong

So there are two reasons behind of the content cost decreasing for the recent 1 or 2 quarters. The first one is definitely that the content release delay caused by the first pandemic influence, and the second one is lead time for the regulation audit. So that the second one is that the titles we purchased only at the high end of the first half of 2018 are gradually released that from 2018 and the second half of 2019 and even the first half of this year. So that after that, they gradually released on the high price of the titles and that the content cost is also gradually — it decreased from this year. In the; long term speaking, we don’t think that it will be sharp decrease on the content cost. But it may have the fluctuation for the content cost-wise. Thank you.

Plus, our Mist Theater consists of 5 series of the 12-episode short drama. So why we call it short? You have to look at the experience on our older television period of the drama series that it used to be long episodes, meaning it has an average episode for each title cost increased from 38 to 45 per title. It is because first, the television, their revenue was driving by the advertising. The advertising is driving by the user time. So the longer series are, the television station will derive more money. And of course, the content producers, they are also intentionally to — they produce dramas to be longer to also earn more money because their trading pattern is based on the cost per episode. The more episode they produce, the more money they’ll earn.

But it’s quite different for the Internet platform like us. So we are key on the subscription business, that’s our main driver. And more attraction to our users is our content. And we derive our subscription method from the user attraction and the stickiness. That also considering the tight schedule of the modern people, they have less time on the entertainment, and they may much more favor on the short drama that it’s maybe only 12 episodes for this month that they will verify and attracted by the one title. And the next month, they will find new drama titles that they are — is quite interesting to them. They will also keep the subscription — their subscription service on.

And so that is the main driver for us. And so if we will develop more short dramas with the total cost is quite low but with quite much better ROI, that is very wise strategy for us. So we definitely will produce more short dramas. [Thank you.]

Operator

Your next question comes from Zhijing Liu from UBS.

Zhijing Liu

My question is as we see that Focus Media has seen some very good recovery in the past two quarters, so can we see that advertising — branded advertising is still very attractive for many advertisers?

Yu Gong

As for brand advertising method for the domestic Internet platform, the first one is the content target as to that advertising is targeted to one single specific content. Because of the pandemic, the content released — some of the content release were delayed, and definitely, that influenced our brand advertising.

And also another one is auto distributed. But considering that the content — the delay is quite recovering after the pandemic is controlled and also that our advertising supply is quite abundant, so it’s that we keep very positive on the trend and outlook for our brand advertising. Thank you.

Operator

Your next question comes from Bo Pei from Oppenheimer.

Bo Pei

And then I will translate for myself. So first question on the short video platforms, we noticed there are many people watching dramas and movies on short video platforms now. And I was just wondering, what is the net impact on us? Because on one side, they service a promotional channel, but on the other side, they actually attract some potential paying users for us. And then so on a net basis, is this impact good or bad for us? And is there any licensing deals? Or how do we handle the copyright on short video platforms?

And then the second question is about our theater model. So in the long term, what percentage of dramas can come from these theater models? And then does that mean if we achieve this percentage does mean we can further lower our content cost given the total number of ads also will decrease?

Yu Gong

As there is a lot of clicks of the long-form videos on the short video platform, it has a huge negative impact on the long-form video platform. We are imposing that legal actions and negotiations with short-form videos. And also, there is — yes, there are some positive impact on the — such attraction to new users that like you said. But overall, we think that the negative impact definitely surpass the positive ones.

Yes. To that, after saying about the very good things about the short form — short-episode drama, so we — I want to talk about advantages of the theater. So that normally that after a title was fully released that the audience passion will also go away with that. But with the theater as to our paying users or our audience, that will keep more on the theater and the older users accumulated and with attracted and stick to the theater, so not to just — to address the single title. As to in another word, they will stick to our platform in that so that we will see that this is definitely a very good way for us to maintain our paying users.

In the future, I think that roughly speaking, we may have half and half between the short-episode dramas to long dramas. And of course, the waiting time of the long dramas will be longer. So we are seeing that right now that the average waiting times per title is dropping down on our platform recently because of those shorter dramas. But definitely that the short drama is the right way approach to improve both the monetization and the user stickiness to our platform. Thank you.

Operator

Our final question comes from Binnie Wong from HSBC.

Binnie Wong

So I’ll just quickly translate. So I guess the first question here is that if you look at the content spend, right, Tencent has around — announced that in the next 3 years, they are going to step up to CNY 100 billion in the next 3 years versus CNY 50 billion in the last 3 years in terms of content spend. So how do we affect — how does this affect our content — iQIYI’s content strategy?

And then in terms of the mix versus like in the split in terms of self-production, licensing, how do we see the split now? And then what is our optimal structure? Can you remind us that?

And then very lastly is just on the advertising growth. It’s still on a double-digit decline. But then if we look at, say, Tencent, right, their media advertising, in terms of the magnitude of the decline has narrowed down from a double digit in the last several quarters down to only almost like a flattish type of growth, right? It’s only down like 1%. So I just want to understand, is it just a matter of timing for iQIYI, and then down the road, we should probably be able to see a better advertising growth? Or is there something structural in our advertising business that should — we should be reminded of?

Yu Gong

Yes. When talking about the total content spending, it definitely will be our main and biggest investment in the coming years, that if you look at it in the coming 3 years, that it can easily calculated based on the spending for our past experiences.

So this today is the earnings call. It’s not a new press event or that we can tell stories like the million or billions of the spending. This is not a new story. So that I think that it won’t really amount to a number if you look at the spending for the past few years that it will not much of a big change.

And if you think about the ratio between original content versus the licensed content, generally speaking, we definitely see the trend on the increasing from our original content.

If you take — if you talk about detailed ratios, that is quite different based on the content categories. You look at the variety shows that almost most operating content cost goes to the original variety shows and our self-produced ones. And if you look at the drama, if you look at the contract or the future titles that we are about to produce or are producing, that over half are our original content. But if you look at the release time of this year, the license content cost may be higher. And if you talk about the movies, definitely that almost all the movies — the theatrical movies or licensed movies still take the lead. And for this year, we only launched one self-produced movie, and also the quality and investment scale is still have distance to the mainstream release.

So we did some internal analysis that — or that the analysis or research about our advertisers and versus our peers’ advertisers that we think is comparable to our business. And we see a bit higher or better recovering of our advertiser business. And for the overall industries, we think that the worst time has already passed. And definitely, this year is quite tough, and we think that it will get better. Thank you.

Lei Zhang

Thank you. Operator, I think that is all for us today.

Operator

Thank you. Ladies and gentlemen, we have reached the end of our conference call. Thank you for participating. You may all disconnect.

Lei Zhang

Thank you very much. Have a good day.

Yu Gong

Thank you.

Lei Zhang

Bye, bye.