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..

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..

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..

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..

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

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. .

Thank you. Youqiao will answer this question..

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

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..

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

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..

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. .

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

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..

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

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. .

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

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

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

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. .

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

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. .

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

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..

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

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..

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