iQIYI, Inc. (IQ) Q3 2023 Earnings Call Transcript

iQIYI, Inc. (NASDAQ:IQ) Q3 2023 Earnings Call Transcript November 21, 2023 6:30 AM ET

Company Participants

Chang You – Director of Investor Relations

Yu Gong – Founder, Director & Chief Executive Officer

Jun Wang – Chief Financial Officer

Youqiao Duan – Senior Vice President, Membership Business

Xiaohui Wang – Chief Content Officer

Wenfeng Liu – Chief Technology Officer

Conference Call Participants

Xueqing Zhang – CICC

Lincoln Kong – Goldman Sachs

Daniel Chen – JPMorgan

Thomas Chong – Jefferies

Maggie Ye – CLSA

Operator

Thank you for standing by and welcome to the iQIYI Third Quarter 2023 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 Chang You, Investor Relations Director of iQIYI. Please go ahead.

Chang You

Thank you, operator. Hello, everyone, and thank you for joining iQIYI third quarter 2023 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. Jun Wang, our CFO; Mr. Xiaohui Wang, our CCO, Chief Content Officer; Mr. Wenfeng Liu, our CTO; Mr. Youqiao Duan, Senior Vice President of our Membership Business and Mr. Xianghua Yang of Senior Vice President of — and Overseas. 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, the management team will participate 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.

I will now pass on to Mr. Gong. Please go ahead.

Yu Gong

Hello everyone. Thank you for joining us today. Our focus of the quarter remains firmly on generating high-quality growth, achieving strong results in both revenues and profits. Our total revenues grew 7% year-on-year, while profit performance was far more remarkable. Gross profit and non-GAAP operating profit had annual growth of 23% and 71%, respectively. The impressive financial results demonstrate the strength of our robust operating leverage occurred by all exceptional content, which took as a whole competitive advantage. iQIYI is natural brand for our top-tier content. According to Enlighten data, we have been leading the industry in drama viewership shell for seven consecutive quarters. Our original dramas remain as a key driver for container supply and revenue contribution.

Meanwhile, but diverse of high-quality titles premiered were highly acclaimed by users. Notably, the Lotus Casebook, was the 10th drama in our history to break the 10,000 Popularity Index score.

During the quarter, membership services revenue grew by 19% annually, mainly driven by a 12% annual increase in ARM. Two key factors contributed to the revenue growth. Firstly, in part by the high appear of our inclusive content. We have reduced the discounts provided for membership purchases well direct on the channel sales. Our content is compelling enough to drive purchasing decisions in its own.

Secondly, we have upgraded our member benefits and alternatives, resulting in an increased value perception among our members and a boosted membership retention rate. The enhanced member benefits encompass a wide range of upgrades. For example, optimizing the viewing experience from mobile devices to large-screen TVs. Members can now enjoy content in funding 4K, 8K, and even indulging proprietary [indiscernible] total enjoy certain quality audio-visual experience.

The audio experience is equally enhanced with a shift from ordinary stereo sound to the immersive and captivating proprietary industry leading IQ similar sound and our member perks don’t stop there. We go beyond the online realm extending our offering to exciting of last experiences such as inclusive concerts.

These upgrades have transformed entertainment, providing users a diversified, personalized, and immersive entertainment experiences. We are very pleased to see users’ appreciation for our content and services translates into our growth. Alongside membership services, advertising revenue was our second growth driving during the quarter. Our premium content and enhanced marketing capability drove up advertising revenue by 34% annually and 12%, sequentially. Both brand ads and the performance ads booked annually and have sequential net growth. Entering into Q4, we are cautiously monitoring the macro environment impact on the advertising market. We will upgrade our marketing capabilities to weather potential challenges as we continue to seek out new growth opportunities in the future.

Now, let’s dive deeper into the performance of our core business segments, starting with membership services. In the third quarter, Membership services revenue exceeded RMB5 billion for the second time in our history, representing a strong annual increase of 19% driven primarily by ARM growth. We would like to reiterate that the primary goal for our membership services is to drive long-term and sustainable revenue growth. Membership revenue is driven by three components, mainly on subscriber lifetime and subscriber base. And subscriber lifetime are our current key focus in driving the long-term economic value of membership services.

In the third quarter, ARM reached RMB15.54 up to percent annually and 5% sequentially. The average daily subscriber increased by 6% annually to 107.5 million. The current ARM level in our view, it’s still very affordable compared with the price of other consumer products. We will continue to drive sustainable ARM growth over the long term backed by several factors.

First, as we just mentioned, membership purchase decisions are increasingly being made based on content and the membership and the member benefits rather than discounts. Very importantly, our ability in consistently delivering high-quality premium content will be further improved. Second, our member experience offers a compelling value for the menu. We will continue enhancing our offering with new value-added services that increase members’ value, perception, and willingness to pay, such as express package, concepts and merchandise offers.

Finally, we see significance and the potential to further upgrade existing gold members to Platin and Star Diamond membership tiers, which command a higher price yet offer more privilege.

Our member privileges and benefits have proven high attractive and we expect their appeal to remain strong. For example, the used products packages, it’s one of the content privileges we have developed for members, which enable subscribers to redeem their member points to unlock early access to finally episodes of hit drama service This model was applied to two of dramas in the third quarter attracted over 10 million participating members, demonstrating the significant value of perception attached to these benefits, inline with our strategy to foster deeper connections between our loyal members and all premium content from IP derivatives.

Cloud concerts are another important component of membership offering. We have the materials The Lotus Casebook theme concert, which created immersive excitement. Lastly, we have developed a dedicated e-commerce platform for merchandise related to our IPs. Members can use their member points to pay for this — in full or in part.

As discussed repeatedly, our primary focus is on enhancing member loyalty retention and lifetime value through our membership privilege and benefits. Our loyalty program is closely tied to the duration of membership, and we strive to improve the service experience and value perception, especially for our long-term members. For instance, users who after two auto renewals of long-term plans or become premium members are greater elevated benefits, including faster accumulation of member points that can be redeemed for content-related perks and merchandise. As a result, we observed meaningful year-over-year growth in both the quality and proportion of annual plan subscriptions in the third quarter.

Moving on to content. Content is our core competitive advantage. iQIYI original dramas continue to be the main driver in terms of content supply and revenue contribution accounted for over 68% of the key drama launched in the third quarter. For this year summer season, our drama line of coverage, diverse genres such as Asian customs, reality, and suspense, the Asian customs detective drama, The Lotus Casebook become the dark horse hit of the summer. It was our 10th drama to break of 10,000 popularity index score, and the drama’s theme concert we have generated over 230 trending search topics and attracted over 320 million likes.

We are happy to see the significant long-lasting impact with sales, as it continues to dominate the Enlightent list even after its serial’s finale. Other key drivers, such as Asian Customs Suspense serials, My Journey to You Intelligent in perfect victim, I will make sure higher serial focus on social issues and criminal suspense serials, The Lost 11th Floor [indiscernible] were all well received by audiences and reflect the quality and depth of our drama lineup.

For various shows, sequels to all classic IPs, such as the 3rd season of the Big Band and Housework Talent [indiscernible] made strong compacts. The Big Band 3 achieved the outstanding performance in both advertising and the membership revenue. We also launched diverse innovative new IPs, including our very first variety show and the drama crossover As You Wish Love You Seven Times [indiscernible].

Our cultural variety show glory is back Beijing and the increasing show, Let’s Barbecue, which attract a wide variety of users. On a separate note, we are also making good progress in realizing the commercial potential of our printing IPs. Notably, sales of The Lotus Casebook merchandise exceeded RMB18 billion. We have also introduced merchandise based on our original children’s IPs are spanning the full range of children’s products, including daily life, learning for an offline entertainment.

Turning into Q4 and next year, we are committed to deliver diversified and high-quality content on a continuous basis. We have a highly anticipated slate of dramas aside from the already launched hit titles such as Long Run of [indiscernible] Story of Kunning Palace, Zhu Ruibin [indiscernible]. We also held a stellar drama pipeline to be released. This includes major Asian customer titles Journey to Love [indiscernible] and the Chinese Palatine for as well as modern-day theme dramas like Detective Chinatown Season 2 Tania, and lack of flowing River Season [indiscernible] and The Lonely War for variety shows, our pipeline covers a wide range of themes, including our first original physical competition show we never stop and our hit show, become a Farmer, will introduce its first spin offshore. Hi, Young Farmers.

We also have an exciting lineup of children’s cartoon animation. For original children’s cartoon, we are going to debut the second half of Deer Squad Season 3. Deer Squad Season 3 and our brand-new title, MEGA Mail [indiscernible] for original animation, The Great Ruler of Natura, and against the [indiscernible]. After trading trending, while new athletes such as the sci-fi series, the 5th game [indiscernible], and the upcoming adaption, like Magic, groceries are set for release.

Moving on to advertising business, we are delighted to see accelerated recovery during the third quarter. Total advertising revenue reached RMB1.7 billion, up 34% annually and 12% sequentially. Revenue from brand ads recorded double-digit growth both annually and sequentially driven by several factors, notably our premium original content such as Big Bands Season 3 and Love You Seven Times attracted stronger advertising demand. Advertising budgets are located towards where they show and the drama increased by 67% and 28% year-on-year, respectively.

Breaking it down by sector, we saw increased ad budget from food and beverage, while sectors like internet services, transportation, and healthcare also recovered. Revenue from performance apps recorded strong annual revenue growth of over 78%, mainly due to two factors. First, targeted and efficient operations gained higher budget share from sectors such as Internet so is that e-commerce, and the games. Second, the effective use of generative AI-enhanced ad creation and ROI.

Looking ahead to Q4, we are cautiously monitoring the overall advertising market. We acknowledge that the consumption segment takes time to fully bounce back operating a lagging effect on brand advertising business. Nevertheless, less based on our unparalleled content quality and extensive user profile, we are the of to platform for advertisers seeking optimal advertising opportunities.

For performance apps, we are optimistic on sectors such as internet services, e-commerce, and the shop drivers. And we will continue to fine-tune our algorithm and leverage generative AI to enhance ad creation and maximize efficiency.

Moving on to the technology and products. Our commitment is centered around the fostering technology innovation to empower the entertainment ecosystem, creating value for our users and content creators. Firstly, we harness the power of technology to elevate the entertainment experience for our users. And secondly, we empowered our content creators by equipping them with the latest tools and resources to improve the quality and efficiency of their creation.

Our focus on leveraging AI to enhance the user experience has yielded significant progress. Notably, we have pioneered the use of generative AI in three key search categories: character search, AI plus search, and actual search. By applying advanced content analysis, we are now capable of automatically generating video clips and drama highlights. This cutting-edge technology has been in play mandate across hundreds of core dramas on our platform, greatly improving such accuracy and user engagement. User directed to a drama from AI plus search spend an average of 40% more time viewing the content.

One more exciting user experience optimization is the introduction of Karaoke mode in the Big Band 3. This innovative and interactive feature seamlessly integrates some lyrics into the, on-screen display during band performance sessions, allowing viewers to sing along and creating a more immersive experience, with meaningful viewer engagement and the time spent increased by users activating this feature. In terms of content production and operation, we are promoting the application of generative AI in various user cases, during the rapid technology development of the video industry.

Now the role of generative AI is involving from mail embedded to co-pilot made in every phase of workflow. By leveraging this transformative technology, we are empowering creators in every aspect of their work, from planning and development to production and the promotion of content. This approach not only enhances efficiency but also unlocks new potentials. We are seeing great initial results. For example, we use generative AI producing low-cost, high-quality posters and visuals to showcase our content. We have applied this technology in promoting our key programs, such as, testing Chengdu, The Big Band Season 3, as a platform. In addition, we are expanding the reach and influence of apps by using generative AI

Finally, for our business performance in regions outside of Mainland China. Our premium content continues to win acclaims from overseas users and drove steady growth in overseas membership revenue. In the third quarter, membership revenue in Japan, Korea, the U.S., and Hong Kong all increased by over 50% annually. The solid performance was driven by the rising influence of our high-quality CPAP powered by a number of popular titles, the total viewing time for C dramas on our overseas platform increased by 23% annually and 33% sequentially in the quarter.

My journey to you [indiscernible] achieved that the highest revenue on our overseas platform during its broadcasting period. Meanwhile, the Lotus Casebook’s popularity in remain as Mainland China, at the top of our overseas platform in both total video viewer and viewing time in the fourth quarter, and remarked number one in total video views in Southeast Asia East Asia, and North American market.

For the fourth quarter, we will continue to drive high-quality growth in addition to enhancing platform, cooperation, and the channel expansion. We are dedicated to bolster our content pipeline to copy relies on the strong momentum of Chinese drama while introducing localized drivers in Thailand, Malaysia, and Taiwan to further expand our influence.

In summary, we have accomplished strong results in the third quarter with other emphasis on delivering high quality growth. As we look ahead, our dedication to enhancing user experience strengthening competitive edge in original content, maximizing member value, and harnessing the power of advanced AI technology remains that fast. Going into next year, we will cautiously increase investments in both our core and innovative business establish a solid foundation for sustainable long-term growth.

Now, let me pass to Wang June to go through our financial performance.

Jun Wang

Thanks, Mr. Gong, and hello, everyone. We have delivered a strong Q3 result as you can see. The growth of ARM drove the growth of the membership services revenue, profits, and the free cash flow, and our operating leverage led to margin expansion on a year-over-year basis. This demonstrates the dependability and scalability of our business model. Now, let me walk you through the key numbers.

The total revenue increased by 7% annually to RMB8 billion, driven by growth in both membership services revenue and online advertising services revenue. The membership services revenue exceeded RMB5 billion, up 19% annually, primarily driven by the increase in ARM. Online advertising revenues reached RMB1.7 billion with an annual growth rate of 34%. This was fueled by the growth in both brand and performance ad with performance ad showing stronger growth momentum.

Now moving to the costs. Our quality costs and expenses remained relatively stable year-on-year. Total cost of revenue was RMB5.8 billion, up 2% annually. Content cost as a component of cost of revenues was RMB4.2 billion, down 3% annually. Total operating expenses were RMB1.4 billion, down 2% annually.

Turning to profits and cash flow, the non-GAAP operating income reached RMB895 million up 71% annually, positive for seven consecutive quarters. The free cash flow reached RMB826 million and has been positive for five consecutive quarters, representing our enhanced cash-generating capabilities.

At the end of Q3, the company had cash, cash equivalents, restricted cash, short-term investments, and long-term restricted cash included in the prepayments and other assets, the total of RMB7.2 billion. To conclude, our Q3 results reflected a strong execution of our strategy and steady progress in driving high-quality growth. We are dedicated to delivering long-term value to all of our stakeholders. For detailed financials, please refer to our press release on our IR website.

Now we will open the floor for Q&A.

Question-and-Answer Session

Operator

[Operator Instructions]. Your first question comes from Xueqing Zhang of CICC. Please go ahead.

Xueqing Zhang

Thanks, management for taking my question, and congratulations on another strong quarter. My question is about ARM and ARM has quite a solid growth for this quarter. So, what’s your outlook for ARM in the first half and next year? Also, could you ask for more color on how to improve your perceived value and the loyalty of membership? Thank you.

Yu Gong

Thank you. Youqiao will answer this question.

Chang You

VP of Membership Business, Duan Youqiao, will answer this question. Please go ahead.

Youqiao Duan

Yes. For Q3, the ARM exceeded RMB15 within our expectations. And then this is because our progress in content quality and also membership privilege for the long-term perspective. The result of that has been promising, and more users have been willing to pay at a reasonable price for premium content and also quality services.

We expect healthy growth in ARM to continue in Q4 with significant room for further improvement in the long-term. Our confidence comes from four aspects.

Content quality remains, the primary determinant for our members’ purchase decision, and ability to consistently provide high-quality and diversified content is strengthening continuously.

Second, in comparison to other domestic daily consumer goods and similar products abroad, our current prices are relatively low.

Third, with the growing demand for watching content on large TV screens, an increasing number of Gold members are upgrading to platinum and diamond membership levels.

fourth, the introduction of more member privileges and benefits such as loyalty points, express package, cloud performances, member exclusive e-commerce items and also IP merchandise will continuously enhance the attractiveness and the long-term value for members.

All of the above four items I just mentioned, gives us confidence that the ARM will continue to have healthy growth in the future.

Further, due to our relatively low pricing base, the absolute impact of ARM growth on user perception is relatively small. What users care about the most is still the quality of content and the user experience. We have seen rapid increase in member conversions with the launch of recent premium content. This indicates that our strategy of leveraging quality content and user experience to enhance ARM and long-term member value is correct and has gained user recognition. Leading to sustainable growth in membership revenue. We will continue to pursue this direction.

Operator

The next question will come from Lincoln Kong of Goldman Sachs. Please go ahead.

Lincoln Kong

So, my question is at this time juncture of the year, when we think about the next how is our overall business plan strategy outlook and the focus area for next year? Thank you.

Yu Gong

For next year, for 2024, based on the current macro environment and also our current performance so far, our goal for next year is still aiming for high-quality growth. High-quality growth, meaning the revenue and profit will both grow and profit will go at a faster pace.

Secondly, we will cautiously appropriate an increased investment in core business to promote long-term growth. Specifically, we will reasonably allocate more investment in top premium content to enhance our core membership business performance in ARM, member lifeline, and sub base and also will drives the performance in advertising business.

Okay. And thirdly, we will continue to explore the implementation of innovative technologies centered around generative AI. So, there are two sides that’s going to benefit from this. On the B2B side, we’ll increase investments in intelligent production to improve the industrialization and efficiency of the video industry. And on the B2C side, we’ll explore new services and even new business models to cater to the consumer needs. And hopefully, this will become the second or third growth new growth pillars going forward in the long-term.

And for the other two innovative and new growing business such as overseas business and iQIYI Light, if we can maintain profitability of these two businesses, we will hopefully to grow the revenue performance for these segments next year.

Operator

The next question comes from Daniel Chen of JPMorgan. Please go ahead.

Daniel Chen

Thanks management for giving me the opportunity to ask questions. My question is on the content cost and also content strategy. Could management please elaborate on what’s our content strategy going forward and also the content spend outlook? Thank you.

Chang You

Yes, our Chief Content Officer, Mr. Xiaohui Wang, will answer this question. Please go ahead.

Xiaohui Wang

Our goal for in the future remains to consistently deliver high-quality and diverse content, solidifying our core advantage in drama genre, while seeking breakthroughs in other content categories.

For 2024, in terms of the drama category, while maintaining a stable overall number of releases, we will focus on increasing investment in top-tier projects, which we normally call the S and eight plus ratings. Continue to produce high-quality content is our number one goal. In Q1 of next year, we will launch a new season of Ms. Theater, a highly anticipated S Grade production, strengthening our competitive advantage and making a strong kickoff for the year. Based on the iQIYI’s Popularity Index Score, we have already seen four dramas this year that have exceeded a significant milestone of 10,000 scores for this year. And we anticipate the performance for next year will be better than this year.

Regarding variety shows, while keeping content costs relatively stable, we will increase the number of programs and upgrade our production team. In addition to the already market-proven, multi-season variety shows, several Innovative projects will be gradually introduced starting from Q4 this year, such as our original physical competition show We Never Stop, which will be launched at the end of November, and we have internally high expectations for that. In terms of business models, we will explore monetization models beyond advertising, membership, and IP derivatives as well as explore more IP development opportunities throughout its lifecycle.

For movies, we will increase investment in films made for online distribution and top-tier content feature films, while further optimizing the operating models for online films, theatrical releases, and our ITE cloud cinema.

For tourist content, we will appropriately increase investments, strengthen the influence of our multi-season IPs, and increase commercially-oriented original content as well as expand PUGC content. Our primary objective will be increasing the revenue growth potential, and expanding IP licensing, and exploring additional revenue potential such as toy licensing, and et cetera.

As for Animation, third quarter was the best quarter we have had for original animations. We are confident in further increasing investment in original content next year expect a moderate increase in the number of original titles. Thank you.

Operator

The next question comes from Thomas Chong of Jefferies. Please go ahead.

Thomas Chong

Thanks management for taking my questions. May I ask about our overseas outlook as well as our strategies? Thank you.

Chang You

Our Senior Vice President, [indiscernible] will answer this question. Thank you.

Unidentified Company Representative

Our overseas business started in 2019 and encountered the outbreak of COVID, which led us to adjust and slow down our progress over these three years. However, through these three years of exploration, we have also achieved fruitful results.

Firstly, we have validated our business model. Although our overseas business is still small in scale, in 2023, we forecast to achieve revenue growth and profitability. We have experimented in different markets and identified the methods for growth and profitability that can be gradually replicated, in other markets.

And secondly, we have validated the influence of iQIYI’s original content overseas, establishing our core competitiveness. Our goal is to establish our overseas platform as the home of beloved Asian content, and iQIYI’s original Chinese dramas are a most evident advantage. Over the past years, Chinese dramas have witnessed significant viewership growth in certain markets, we have seen the potential of CPP.

Lastly, we began to build a comprehensive ecosystem in key countries, including cooperation with local regulatory agencies, content partners, and channel partners. Through these collaborations, we have already launched exceptional local drama content. We can bring outstanding content and culture from all over the world to iQIYI users in China and also around the world through our global network. These advancements have inspired us, largely.

Building on these three achievements, we aim to strengthen collaboration with partners around the world using content as a medium and leveraging technology platforms to facilitate cultural exchange and also, explore new commercial opportunities. We will continuously empower and add value to everyone in our ecosystem.

Operator

The next question comes from Maggie Ye of CLSA. Please go ahead.

Maggie Ye

Thank you, management for taking my question. My question is about advancement we made in the application of generative AI technologies at iQIYI. And I’m particularly interested in understanding the results we have already achieved in terms of improvement in business efficiency as well as cost structure. And also want to learn more about management’s perspective on the long-term impact of these technologies. Thank you.

Chang You

Sure. Thank you, Maggie. And then we will have Wenfeng, our CTO to answer this question.

Wenfeng Liu

Okay. We believe the generative AI will have significant impact on the entire video industry in the next three years to five years, bringing significant changes in production methods, cost structure and personnel structure. So currently, iQIYI has already started implementing generative AI in core areas such as content planning, development, production, and promotion.

We have achieved a certain level of productivity in four major application scenarios, namely text, in image, sound, and video. And this has helped, creators to improve quality, optimize efficiency and reduce costs.

For example, in content planning base, we have used generated AI to compress the time required for a short extensive evaluation feedback from project assessment process from several hours to a few minutes. In the development phase, the use of generative AI have assisted reducing the time required for manual reading from three days to four days to about one hour. The accuracy of scene and a character breakdown in spruce have also exceeded 90%.

In the production phase, producers have effectively saved on design and production costs, by using generative AI tools to generate character sketches and concept posters. In the promotion phase, high-quality posters and dynamic videos generated by generative AI have been applied in on-platform operations and off-platform advertising for key projects such as Different and The Big Band 3.

In addition to content production, we also utilize AI-generated creative tools for effective app material production for performance ad. Some industries have seen a 200% increase in app spending compared to before the use of AI while using — while other campaigns using AI-generated materials have also experienced a 60% higher rate of investment compared to non-AI materials.

In the future, we will continue to explore more business scenarios and application opportunities, fully leveraging the capabilities of generative AI to create even greater value. Thank you.

Operator

There are no further questions at this time. I will now hand it back to management for closing remarks.

Chang You

Thank you everyone for participating in today’s call and please do not hesitate to contact us, if you have further information or questions. Thank you. Bye-bye. We will see you next quarter.

Operator

Thank you. The conference has now concluded. Thank you for attending today’s presentation and you may now disconnect.