iQIYI, Inc. (NASDAQ:IQ) Q3 2022 Earnings Conference Call November 22, 2022 6:30 AM ET
Company Participants
Chang Yu – IR Director
Yu Gong – Founder, CEO & Director
Jun Wang – CFO
Wang Xiaohui – Chief Content Officer
Conference Call Participants
Thomas Chong – Jefferies
Alicia Yap – Citigroup
Lei Zhang – Bank of America Merrill Lynch
Daniel Chen – JPMorgan Chase & Co.
Operator
Thank you for standing by, and welcome to the iQIYI Third Quarter 2022 Earnings Conference Call. [Operator Instructions].
I would now like to hand the conference over to Ms. Chang Yu, Director of the company. Please go ahead.
Chang Yu
Thank you, operator. Hello everyone and thank you for joining iQIYI’s Third 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. For the call today, our CEO Mr. Yu Gong will give a brief overview of the Company’s business operations and highlights, followed by our CFO, Mr. Jun Wang, who will go through the financials. After the prepared remarks, the senior management team 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 third quarter and share our views on the business.
Through efforts in the first 3 quarters this year, iQIYI has completed an iconic turnaround, with business performance far exceeding the targets we set at the beginning of this year. There are 2 parts to this iconic turnaround: First, we have been growing the non-GAAP operating profit for 4 consecutive quarters, starting from Q4 last year. And for the first 3 quarters this year, we achieved nearly RMB 1.2 billion in non-GAAP operating profit, a sharp reversal from the operating loss of RMB 2.5 billion over the same period last year. This non-GAAP operating profit in Q3 alone exceeded RMB 500 million. Meanwhile, we generated positive operating cash flow for 2 consecutive quarters.
Second, our market leadership remains unchallenged, and our market share in September actually hit historical high on the content side. According to Enlighten data, we remained #1 in terms of effective video views for our exclusive dramas, more than our competitors in the second and the third place combined. As for the mobile user metrics side, we were also #1 across core metrics, including user base, user engagement and user stickiness. Our subscriber base has grown from 95.6 million on June 30th to 106.2 million on September 30th, representing a net addition exceeding 10 million.
How did we largely improve financial performance while gaining market share? The key is our long-term commitment to original content. We are glad to see that the original content has become a main contributor to our content supply. Among the drama, we launched in Q3, 65% were original content, a historic high. Meanwhile, the hit ratio of our original content improved significantly. As many of you know, iQIYI’s popularity index is an influential indicator of content and popularity. Of the 6 blockbuster dramas with a popularity index of over 10,000 in our history, we launched 4 this year, and 2 in Q3, both are original titles.
Hundreds of millions of users binge on our original content blockbusters, which drive up user base and a market share, and translate into the huge improvement in our financial results, from loss to major profitability in a single year. Behind these titles is our unique approach to content production and operation, which is our core competitive edge. As such, our iconic turnaround is very difficult for others to replicate, since it is based on our years of expertise and extensive library of original content.
With original content as the key to our success, we will continue to execute our “Calm Growth†strategy. This means seeking value growth points while ensuring overall operating efficiency, enhancing content investment and marketing spending in an appropriate manner. With this strategy, we will continue to provide users with appealing content and superior services, and further drive the healthy developments of our business
Now let’s go through the detailed performance of our business segments. Starting with membership services.
Membership services have always been our most important business segment. We are determined to roll out strategies and allocate resources to support the continuous growth of our membership business. The average daily number of total subscribers in Q3 was 101 million, a net gain of 2.7 million compared with Q2. September was strong in particular. The number of subscribers at the end of September surpassed 106 million, grew by over 10 million compared to June 30th and over 2.6 million compared to last September.
We are happy to see that even after summer vacation ended, subscribers continued to grow in September for the first time in the past 4 years, and the average daily subscribers of this September also reached its highest level compared to all the past Septembers. Based on our latest subscriber numbers, the strong momentum continues. Such success was mainly driven by premium content, indicating that users still have strong appetite in paying for excellent story telling.
Our core competitive edge lies around the ability of consistently supplying high quality content, discover and produce exceptional original content. Meanwhile, we strategically emphasized on bringing more privileges to members across wider content categories, which led to improved monetization ability of our subscriber base.
One important point to note is that the original content has become a major contributor to our membership revenue. In Q3, the top 3 revenue contributors were all original dramas, namely: Love Between Fairy and Devil, Chasing the Undercurrent and The Heart of Genius. Our multi-season variety show, The Rap of China 2022 also adopted earlier access for subscribers, and ranked among the top 5 revenue contributors for the quarter.
On a separate note, membership services revenue was slightly below our expectation in the third quarter. This was mainly driven by 3 factors: first, the temporary decline in consumer sentiment in May, June and July due to pandemic resurgence; second, the delay of certain key dramas; and third, the significant reduction of marketing spending as part of our business stress test.
Starting from the second half of August, we successfully reversed the trend with a series of premium content releases including Love Between Fairy and Devil, Chasing the Undercurrent, and Thousand Years For You. Also the reasonable increase in marketing spending and recovery in consumer sentiment also contributed positively to strong growth in subscriber numbers.
As a result, this September marked as the strongest September in our history. This means, the strong performance of our membership business was not fully reflected in our Q3 results. In Q3, our monthly ARM continued to grow annually, but had small dip sequentially. We offered promotional discounts during summer season to encourage more users to experience our service at a relatively lower price point. We believe the value created by these subscribers will be reflected in the future.
Moving on to content strategy and performance. In the past 3 quarters, we achieved significant results in improving both quality and efficiency. Even though we launched fewer titles than last year, we were able to generate more premium works. The performance of our dramas was outstanding in Q3, especially for original dramas, as we had big improvement in areas such as content supply, revenue contribution, success rate, and word of mouth.
One of the best ways to understand the success of our content is to understand our commitment to the original content strategy that we set long ago. So, our performance during the quarter was no accident, and is replicable. Our investments in original content over the past years have been productive and bearing fruits. I’d like to share some data: among major dramas launched in Q3, original dramas accounted for 65%, the highest in our history.
Meanwhile, the success rate for original content have also increased. Two dramas broke the popularity index of 10,000 in Q3, with 2 more dramas breaking 9,000 score. All 4 were original content.
This breakthrough in original content was driven by the unique and effective content methodology we established, which runs through processes from content creation and production to post-broadcasting, powered by a strong team of professionals and supported by a mature and highly efficient operating mechanism
First, we focused on improving the content creation and production qualities of our in-house studios. We also have sophisticated supporting teams with highly experienced professionals across different functions backing these studios through the entire process.
Second, we have established a mature and highly efficient mechanism running through the whole process, enabling highly efficient decision-making, strict quality controls and optimal content scheduling. The key to this mechanism is a profound understanding of the content industry as a whole, based on over a decade of experiences in the industry. This forms a high barrier that is had to breakthrough in the short term.
The breakthroughs in original content have improved the overall quality and influence of our content, giving us absolute advantages as the industry leader. In terms of market share, in September, effective views of our dramas ranked #1, with the greatest lead in our history. Effective views of our exclusive dramas took an absolute lead, more than the sum of competitors in the second and third positions, according to Enlighten.
In terms of popularity, we launched the iQIYI popularity index back in 2018, and since then, only 6 titles received a score above 10,000; and 22 titles received score above 9,000. In other words, titles with a popularity index of over 10,000 are considered potential franchise titles, and over 9,000 are household blockbusters. Among the top 6 popular dramas, 4 were released this year, and 2 in Q3. For the first 9 months, a total of 7 dramas broke 9,000.
Our content has also received great word of mouth. Users actively discuss, rate and recommend our content on social platforms. On the third-party platform douban.com, 9 of our dramas launched in Q3 received a rating of over 7, the best quarterly performance in our history. The performance was driven by our carefully refined content scheduling based on our content reserve and user demand. For the 2 dramas breaking a popularity index of 10,000 in Q3, Love Between Fairy and Devil tapped into the demand of young generation audience during the summer vacation, it’s creative story telling set it apart from other titles in the same genre.
Chasing the Undercurrent, although the storyline is oriented to relatively matured users, but well-liked by a wide range of age groups, and with high viewing completion rate. In addition to dramas, we maintained our output of premium content in other categories. For variety shows, the effective views of the multi-season show The Rap of China 2022 was leading the online variety show market in Q3. The second season of The Super Sketch Show has attracted the largest advertising budget among the variety shows we launched this year. In addition, our original animations recorded solid growth in both the number of titles launched and revenues.
During the quarter, our IP franchise format also achieved great performance. We launched both the original drama and animation based on the same IP, The Love Between Fairy and Devil, and saw great synergies. Membership revenue of this original animation stayed as #2 on the animation channel during the entire summer vacation, just behind the Japanese animation One Piece. Entering into Q4, we will maintain the strong momentum of Q3 by launching a number of highly-anticipated dramas, including New Life Begins, Wild Bloom featuring top leading actress Zhao Liying, and Unchained Love featured the leading actor from our blockbuster drama Love between Fairy and Devil this summer.
We continued to explore new content themes that cater to diversified user demand, such as the recently launched drama series selections targeting female audience. Please also anticipate a good selection of variety shows, children’s animations and movies slated for release.
Moving on to advertising. Similar to our peers, we fought against macro headwinds and increased advertising revenue by 4% sequentially. For brand advertising, the revenue recovered sequentially and the year-over-year decline narrowed compared with last quarter, reflecting the attractions of hit dramas and variety shows in the peak summer vacation season. We saw sequential recovery in the number of brand ad clients in Q3, as well as recovery of ad demand for international brand advertisers. For performance ads, we saw revenue increases both annually and sequentially.
Heading into Q4 and next year, we face the same challenges as our peers, as Q4 is a traditional off season for advertising, and macro recovery takes time to be reflected in advertising budgets. Currently, we expect continuous sequential recovery in advertising business for Q4. For next year, if macro economy recovers and with absence of pandemic resurgence, we shall anticipate to see year-over-year recovery also.
Technical innovation has always been part of our core values. We are committed to bringing the best entertainment experience to every user. At the same time, we hope to promote the industrialization of long-form videos to drive the robust development of the Chinese video industry. This ambition is reflected in our daily work as our engineering team focuses on every product detail. A recent example of our approach to product improvement was the optimization of the bullet chat quality and distribution algorithm, which improved the user interaction and stickiness.
Average daily number of users that activated the bullet chat feature increased year-over-year in Q3, and the daily average number of bullet chat interaction increased by 50% year-over-year. We also continue to utilize in-house developed tools to improve content production efficiency. The iQIYI video production management system acts as an efficient tool to help production teams. By the end of Q3, the system have been applied to 5 iQIYI original dramas. In addition to improving efficiency and production quality, the system also saves costs and effectively controls budgets.
For overseas business, in Q3, we saw healthy growth in membership revenue both annually and sequentially, reflecting the popularity of our premium content and improved operating capability. Premium content launched during the quarter had solid results both in terms of monetization and word of mouth. Hit Chinese dramas on our domestic main app also performed very well overseas, further extending the IP value on a larger scale. Top dramas under our Sweet On Theater brand, including The Love Between Fairy and Devil and Thousand Years For You, had sound performance. Premium content also drove improvements in monetization. For example, advertisers recognized the value of our theater model, and we attracted partners such as Lazada and Realme as title sponsors for Sweet On theater in Thailand.
In the first 3 quarters of 2022, we again demonstrated the powerful execution abilities, professionalism, and strong unity of everyone within iQIYI. For 3 consecutive quarters, we outperformed by continuously improving fundamentals, demonstrating our value to everyone. We achieved growth in market share while significantly improving our financial performance. As content is our core competency, we are confident that we will be able to deliver blockbusters on a continuing basis as we have worked out replicable methodologies for both original content production and operations. These methodologies lay a solid foundation for healthy growth.
We believe that we have achieved an iconic turnaround in the context of an extremely challenging macro environment this year, and we will continue to deliver values both to users who love our content and stakeholders who are as confident as we are in the prospects of long-form video. Now, I will hand over to Wang Jun for financial details.
Jun Wang
Thanks, Mr. Gong, and hello, everyone. In Q3, we booked RMB 7.5 billion in total revenues, up 12% sequentially. Our non-GAAP operating profit reached RMB 524 million, increased 53% sequentially. Meanwhile, we have been generating positive operating cash flow for 2 consecutive quarters, and recorded nearly 200 million operating cash flow in the third quarter. These encouraging results demonstrated the resilience of our business under extremely challenging macro environment and the pandemic resurgence.
Within the revenue lines, we recorded membership services revenue of RMB 4.2 billion. As Mr. Gong mentioned in his opening remarks, the performance of our membership business was back-loaded and the current Q3 result is not a full reflection of the strong momentum we observed. During the quarter, the number of subscribing members grew from 95.6 million as of June 30, 2022 to 106.2 million as of September 30, 2022, representing a net addition of over 10 million during the quarter.
Now move on to the cost and expenses. The third quarter cost of revenues was RMB 5.7 billion, representing a cost saving of RMB 1.3 billion compared with the same period last year, or down 19% annually. Content cost, a significant component of cost of revenues, decreased 18% annually, and up 12% sequentially. The sequential increase is the result of operational initiatives under our calm growth strategy. We launched more hits during the quarter, bringing more subscribers, and generating more profits, which forms a virtuous cycle.
Our gross profit margin, which is a direct metric to reflect the ROI of our content business, consistently expanded in the past 4 quarters and reached historical high of 24% in Q3, compared with 7% in the same period last year. Meanwhile, with the continuous optimization of our business operations, our total operating expenses decreased by 470 million year over year. The expanded gross margin and disciplined operating expenses combined contributed to our non-GAAP profit expansion.
For Q3, non-GAAP operating profit was RMB 524 million, compared with the non-GAAP operating loss of RMB 1.1 billion for the same period last year, and it’s up 53% quarter-over-quarter. At the end of the third quarter, the company had cash, cash equivalents, restricted cash and short-term investments of RMB 5.0 billion, compared with RMB 4.9 billion in the previous quarter. Our operating cash inflow reached a 196 million during the quarter.
Going forward, we will continue to execute the Calm Growth strategy and our commitment to achieve healthy business growth remains unchanged. We are confident in our ability to generate value for our stakeholders in the long run. For detailed financial data, please refer to our press release on our IR website.
Now, I will now open the floor for Q&A
Question-and-Answer Session
Operator
[Operator Instructions]. And the first question will come from Thomas Chong of Jefferies.
Thomas Chong
My question is about the membership business. Can management talks about the Q3 overall membership business performance as well as the growth driver. Is it coming more from the number of subs or from the ARM side and also what are the key drivers going forward?
Yu Gong
The slight decline in membership revenue was due to 3 factors mainly. First, the temporary decline in consumer sentiment in May, June and July due to the pandemic resurgence in the first half of the year. Second, the delay of certain key dramas during June and July. And third, the significant reduction of marketing spending as part of our business stress test. And starting from the second half of August, we successfully reversed the trend with a series of premium content releases, including Love Between Fairy and Devil, Chasing the Undercurrent and Thousand Years For You. And also, the reasonable increase in marketing spending and recovery in consumer sentiment also contributed positively to strong and continuous growth in subscriber numbers.
As such, our membership services revenue grew from a relatively lower base of the sub number in July. The strong subscriber number growth started to pick up in August. As a result, the performance of our membership business was back loaded and the current Q3 result is not a full reflection of the strong momentum we observed.
In Q3, there are 2 months left for the summer vacation. And among our user base, there are a large number of students in this group so that they are the potential users for us. So therefore, we offered promotional discounts during the summer season to encourage more users to expand our services at a relatively lower price point. That’s why it caused some of the fluctuations during the third quarter.
And for our entire membership business going forward, our main goal is to grow the membership services revenue while achieving healthy performance on the subscriber numbers and ARM. And in terms of growing the sub numbers in the future, it comes from 2 aspects. One is the continuous investment in content, namely especially for the head of premium content. And also the second point is continued investment in marketing spending.
For the ARM growth, it comes from 2 reasons. One is the lowering of the discount in the past years and also that increase in the listing price of our member business. Thank you.
Operator
The next question comes from Alicia Yap of Citigroup.
Alicia Yap
Congrats on the strong results. My question is related to the video content. So IT has successfully released the numbers of heat drama this quarter this year that received very good feedback. So can management share with us how will IT ensure in the future that you will also have a very high hit ratio for your drama?
Yu Gong
This question is content related. So I will invite our Chief Content Officer, Wang Xiaohui, to answer this question.
Wang Xiaohui
We launched the ITE popularity index back in 2018. And since then, only 6 titles received a score above 10,000, 4 were released this year and 2 in Q3. And this perfectly demonstrates that there are a long-term commitment to original content. The original content has become one of the main contributors to our blockbuster content.
The success was mainly contributed from 3 factors. First was mainly attributable to the powerful production team that we have built through our in-house studios, which contains highly experienced professionals with various creative styles. We also have very sophisticated supporting teams across different functions to support these studios through the entire process, which runs through processes from creative ideas development, content production, broadcasting and marketing.
At the script level, we rely on the professional teams and get them relative flexibility in screening the creative ideas, emphasize on polishing scripts, which build a solid foundation for the content creation process.
At the production level, once we have the solid content creation foundation in place, we will follow by rigorous process before projects entering into the billing process. In addition, we will collaborate with highly professional, creative and reliable partners in the production process, select the most suitable actors based on our comprehensive forecasting mechanism. All of the above will safeguard the continuous creativeness and the high quality of our original production.
The second factor was contributed by we have established a mature and highly efficient mechanism running through the entire process from developing an idea into original drama series to broadcasting and marketing it. This mechanism enables highly efficient decision-making, strict quality controls and optimal content scheduling based on user preferences. And going forward, we will continue to seek an effective balance between embracing the diversity of content creativeness and efficiency in the production process.
The third effect is that our intelligence reduction system is getting more sophisticated, which also helps in terms of increasing the possibilities of creating blockbuster content and improving efficiency.
Operator
The next question comes from Lei Zhang of Bank of America Securities.
Lei Zhang
My question is mainly regarding cash flow. I noted that we have a meaningful improvement in free cash flow and operating cash flow with a positive free cash flow this quarter. So can you give us more color on the driver behind it and how should we look at the trend going forward?
Yu Gong
So I think that to answer the second part of the question first, yes, we are very confident that this trend could continue in the future. And behind that, we do see if we can review the entire process of the turnaround, we will say that the starting point of the turnaround is a very disciplined expense management. It’s a very ROI-focused talent strategy, and we have continued to do that throughout the 3 quarters.
But on top of that, in the third quarter, we do see some new catalysts coming in and these UCAs including a virtuous cycle, which starts with our investment in the content. Then our investment content generate more hits, more hit titles and give users more value proposition, which in turn attracted more members than creating possibility for generating derivative revenues. Then on top of that we will cover into the profit then in turn, bring us more free cash flow. And we will certainly continue to do that, and we do believe this success is reputable, which support the trend — which supports the positive free cash flow trend. So that’s point number one.
So on top of that, we also like to comment that because we have been very much focused on original content, as you guys have been asking questions around that. Now original content means IP value and IP value can generate derivative revenues with higher margin and this is consistent with our experience and observation of the media conglomerates globally. So this if not — this creates the whole new opportunities for the company in the future.
Operator
The next question comes from Daniel Chen of JPMorgan.
Daniel Chen
Congratulations on the really solid result. My question is on the content regulation overall environment for the long-form video. Could management share some color on this?
Yu Gong
About 2021, is last year in the 2021, there are different authorities that roll out different policies that kind of tightened the photograph regulatory environment for the online video space. But as we entered into 2022, until now the regulatory environment seems to be relatively stable, and we haven’t seen major changes in such process.
The main current focus for us is to increase quality and optimize content quantity which not only applies to us and our peers, and we are glad to see that coincidently also applies to the various government authorities and then they would roll out policies that’s actually positive to such process.
After the three quarters of time for ITE, we now figure out a perfect balance between the quantity that we show for content and also the amount of marketing spending into this market to promote our content. So going forward, based on the success of our past 3 quarters and under the comp growth strategy, we believe that we can have healthy and sustainable growth for our business going forward.
Operator
There are no further questions at this time. I’ll now hand back to management for closing remarks.
Chang Yu
Thank you, everyone, for joining our call today. Please do not hesitate to contact the IR team for the management if you have further questions, and see you next time. Thank you. Bye, bye.
Operator
That does conclude our conference for today. Thank you for participating, and you may now disconnect.
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