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Operator: Thank you for standing by and welcome to the iQIYI Second 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, IR Director of the Company. Please go ahead.

Chang You: Thank you, operator. Hello, everyone and thank you for joining iQIYI second 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, Chief Technology Officer; Mr. Youqiao Duan, Senior Vice President of our Membership Business and Mr. Gang Wu of Senior Vice President of Brand Advertising Business. 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, 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 the floor 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. Our original company strategy continues to deliver top-notch titles, which in turn brought the strongest second quarter performance in our history in terms of key metrics, such as total revenues, profits, free cash flow, and average daily subscribers during the quarter. Also, we maintain our industry-leading position of long run, key aspects the exception of quarterly results clearly demonstrates the resilient unmet demand, a long-term growth potential of our business. Now let me walk you soon to key developments in the second quarter. Firstly, we maintain our industry-leading position in dominant market share for six consecutive quarters according to enlighten our long-term drivers continue to pay major role in terms of company supply and the revenue contribution, both of which expecting [indiscernible] in them with record by excluding the 10,000 square in the shopping time.

In addition, [indiscernible] such as 13 years of that [indiscernible] generated highly positive water of month reviews, really enforcing our brand image diversify on the high-quality premium content profile. Second, on our financial perspective, we have the best second quarter revenue performance in our history, up 17% year-over-year. We recorded double-digit annual revenue growth across all key business lines, membership services revenue grew 15% annually and advertising revenue grew 25% annually. Meanwhile non-GAAP operating income hit RMB786 million, grew by 129% annually, marking the six consecutive quarter of profitability. Furthermore, our ability to generate cash further strength with free cash flow reaching RMB872 million, positive for our consecutive quarters.

Our performance in the second quarter represents another solid impact in our pursuit of high-quality growth. As we progress [indiscernible] iQIYI under the [indiscernible] industry have been completely transformed with rationalized competition, we have seen improving return on investment for the NPL streaming industry. And as an industry leader, iQIYI likely enhanced original contender ability to financial performance than a new market standard that drive up overall industry advancements. In light of this, we aim to enhance the long-term health of our company production and operations so that we can consistently perform the industry. Now let’s dive deeper into the performance of our core business segment, starting with membership services. During the quarter, both membership revenue and the number of subscribers hit all-time high for a second quarter.

Membership revenue decreased RMB4.9 billion, up 15% year-over-year. Looking at the key drivers behind, monthly ARM for the quarter reached RMB1,482 increasing both annually and sequentially. This was driven by our refined operating strategy. For example, we optimized our pricing strategy, which effectively narrows the gap between listing and actual rates. Average daily number of total subscribers in Q2 reached 111.2 million, up 13% year-over-year, primarily driven by our stable supply of content that continues to attract and increasing members. Our subscriber base declined on sequential business primarily due to: one, the impact of seasonality; and two, the high base effect after the release of the net income and the natural attrition of members.

Despite that, we are encouraged by the continuous optimization of membership structure as an absolute number and proportion of annual subscribers both have meaningful growth year-over-year. I would like to reiterate that the goal of our membership business is to maximize user experience, which in turn — which in return strategy our membership services revenue. Going forward, we are more focused on the overall economics, not just pure subscriber growth with standard adjusted and calculate balance the number of subscribers and ARM based on multiple factors, including company supply, user demand and market conditions. More importantly, we strive to enhance the overall health mix and revenue growth, the dependability of our membership business providing exceptional user determine is key to do so.

We establish a variety program that includes diversified, privilege and benefits. The long-term loan numbers can enjoy more favorable pricing and the privilege reinforcing user protection that earlier in enrollment and a long-term subscription of greater benefits. Just recently, we roll out the express package program, which ran fully accessed to the finale of our hit drama, the latter case work. Within the adjusted event over 6 million subscribers have used their membership plan to access the prep package. Our first express package event received very positive feedback among numbers. As membership points are linked to the duration and the continuous subscription numbers with [indiscernible] subscription [indiscernible] are entitled to higher reward front and also accumulate points at a faster speed.

We expect this initiative will further strengthen subscriber loyalty and drive member retention rate. Moving on to content, we continue to execute our original company strategy and reinforce our brand image as a diversifier and a high-quality premium content powerhouse. In the first half of 2023, we have already released two dramas that broke the tens of popularity index score. As I mentioned earlier, we maintained the top position in the drama market share for six quarters in a row. Original content remains the primary driver to our content supply and revenue among all major dramas released during the second quarter. Our original content accounted for 67%. We think the share of revenue contribution remaining high. We crossed our summer 2023 via with the release of acting [indiscernible] which was the fastest drama in our history to [indiscernible].

This was a nice show that such core in our history and the second title that is sold this year. In addition, 13 years of that under our meet [indiscernible] brand and the beauty of [indiscernible] also received critical acclaim for their appearing areas. And at the same time, our original revenue showed [indiscernible] in their strong returns and their popularity remain as strong as ever. Our market share for total market shows was the highest in the industry according to enlightened. Even more impressive was the market share for our [indiscernible] shows, which doubled sequentially. The highly anticipated show launched in Q2 included our flagship, The Detectives’ Adventure Season 3 [indiscernible], The Rap of China 2023, HAHAHAHAHA Season 3, [indiscernible] and innovative new shows such as become [indiscernible].

This is season of The Rap of China was a true hit and scored the highest popularity index score over additions. Moreover, we have completed a holistic commercialization of the show, which expanded its culture influence — interest into other verticals, including concerts, arts agency, and merchandise. Some from the show were also related on leading streaming music platform such as Tencent Music and the NetEase Cloud Music driving RevPAR high music revenue for this IP. The first release of the adventure receive generated the highest popularity index called of any reason. Additionally, become summer wrapped up in the second quarter gained critical acclaimed with a nomination for the best variety show. As we all know 28th Shanghai TV Festival Mongolia Award.

We are also excited to see original content as widely recognized across TV stations in China. In Q2, we distributed 30 dramas to brought TV network including CCTV and the provincial supply the channels with whom we have built a long-term partnership. So this partnership, we are able to expand our content which and grow as influence among different demographics. Heading into the second half of the year, we have a value range of effecting and diversified premium content in the pipeline. On summer 2023 have been bolstered by highly anticipated Asian custom dramas including the latter case book, which was the latest and the 10th drama that build the 10,000 popularity index. Now seven times [indiscernible] also was launched and the Demon Hunter’s Romance, Wu You Du, will do follow.

Moreover, we are broadening of presence in the prime drama general this popular titles such as the last 11 as well [indiscernible] and imperfect victim will make sure higher. Both of which were generated significant user traction and exceeded of Popularity Index of 9,000. Our offering will be further enriched by the wide eyes in the dark [indiscernible]. For this summer season, we have been abundant high-quality new releases in both online drama serials and offline the article movie as media companies carefully compete for user’s attention, our topnotch content offerings have allowed us to maintain our leading position in the drama category. This, once again, proves our strength in the content business. For royalty shows or pipeline in the second half will consist of both to classic and innovative new IPs, [indiscernible] of the big [indiscernible] makes a strong comeback and other key program includes less [indiscernible] household talents [indiscernible] and as you wish, which integrates across orders from our fee dramas.

Our pipeline also includes other numerous exciting releases including sales such as fine against [indiscernible] and come back in [indiscernible] cash performance such as new seasons of price set and also as well as [indiscernible] including the [indiscernible]. Moving on to advertising business, we are delighted to see an accelerated recovery. Total asset revenue recovered to RMB1.5 billion, up 25% annually and 7% sequentially. Both brand apps and the performance as recorded annual and sequential growth in Q2. Performance added revenue doubled year-over-year and reached its no long high and its growth accelerated on a sequential basis. This solid performance was driven by a combination of factors, but the current higher share of ad budgets during the strong 18th shopping festival to target and efficient operations brought higher budget from key sectors such as Internet services, e-commerce and games, three, optimizing algorithm for beta performance and monetization efficiencies and therefore, applying generative AI as we have ad creation and ROI.

Brand and revenue also grew annually and not sequentially, benefiting from several factors; one, Q2 in the high season for food and beverage factors; two, increase ad budgets during the [indiscernible] shopping best compound with last year; three, more robust pipeline of morning shows contributing to us and expanded ad inventory; and four, and a low base effect when compared to the same period of last year. We also observed increasing demand for apps related to key dramas with improving quality of iQIYI originals, the number of units in annual contracts and the contract rate both increased meaningfully as compared to the same period last year. Few dramas attracted over [indiscernible] brand advertisers generated highest ad revenue among all dramas launched this year.

Heading into the second half, we remain cautiously optimistic about the outlook of overall advertising market. Well, we noticed a study respond in consumption assessment. We do aware that the macroeconomic recovery will have a lagging effect on the brand and the advertising business. That said, we still hold a positive view of the long-term growth of brand advertising. Brand advertising market in China, we expect certain cyclical sector including food and beverage as well as those that benefit from reopening policy and a recovery on a relative faster pace. Moving on to technology and products, technical innovation is one of our core areas. We keep improving content production and operation efficiency by driving technology innovation such as generated AI.

We have been applying generative AI in content production, marketing user interaction and received encouraging initial results. For example through large language model scripts and can drastically be processed to extract key information effectively accelerating the assessment process and improving budgeting and results management. Our internal data shows that the accurate rate of theme and the character breaks down and by generative AI has exceeded 90% so far. Besides generative AI can quickly assess intricate the storage clouds to enhance the user experience by improving search results recommendation and payback interactive experience. Moreover, the generative AI has also been helping us in creating advertising ideas and the boosting monetization performance.

To give you an example, performance as using generative AI to produce had content increased ROI by 20 percentage points. Next, I’d like to give you some updates on our growth and early-stage business. I will start iQIYI, which continues to generate high-quality and healthy growth. This is being driven by our improving monetization capabilities. Impressively, iQIYI has already been profitable at the operating level for three consecutive quarters. Our total revenue reached historical high in Q2, up 35% year-over-year, with membership revenue increased by 87% annually, primarily driven by the ad supported basic members package. Let’s talk about business performance in regions outside of Mainland China. Our premium content continued to grow in popularity, and we saw solid membership revenue growth in particular, Hong Kong, the U.S. and Canada had annual growth of more than 50%.

The corporate influence of high-quality growth overall Chinese dram has grown rapidly. Revenue generated by our video production increased by 116% year-over-year, and our original Chinese drama or note [indiscernible] became the top revenue title in Taiwan, Asian costuming dramas acting and built it of related the top broadcasting this in area markets, including Southeast Asia, East Asia and North America. With plenty of premium titles in pipeline for the third quarter, we will continue to fortify our competitive edge for the marketing premium Chinese video content. We will also continue to develop closed a loop in terms of content marketing and promotion, user growth and subscriber acquisition promoting Chinese content to a wider range of audience in the overseas market.

In summary, we are pleased with this solid progress in our pursuit of high-quality growth looking forward to the second half of this year with our focus in the long-term sustainability and the health of business with strengthening our competitive position in the long run. Our robust premium content pipeline will continue to create the flywheel effect, reinforcing the online improvement of our business fundamentals. On top of exceptional results with our auto growth and monitor the right opportunities and make elective strategic investments to further fit the next fit of growth. We appreciate all your support and look forward to building great value together. Now, let me pass to Jun to go through our financial conformance.

Jun Wang: Thanks, Mr. Gong, and hello, everyone. As Mr. Gong mentioned earlier, we recorded our best ever second quarter results across multiple key financial metrics, such as total revenues and current membership services revenue, while the profit and the free cash flow remained robust. In addition, our balance sheet healthiness was further improved. Now, let me walk you through key numbers. Total revenues increased by 17% annually to RMB 7.8 billion, setting an all-time high for second quarter performance. We secured double-digit annual revenue growth across all business segments. Membership services revenue continued to serve as the most powerful growth engine with revenue exceeding RMB4.9 billion, up 15% annually. Online advertising span up its growth as revenues reached RMB1.5 billion with an accelerated annual growth rate of 25%, which was filled by the growth in both brand and performance ads with performance ads being the key driver and to a lesser extent from brand advertisement.

The content distribution revenue and other revenues rose by 15% and 16% respectively on annual basis as well. Moving on to cost and expenses, our cost of revenues increased by 10% annually among which content costs increased by 7% annually. This was primarily driven by an increase in number of original drama and variety shows launched during the quarter. Total operating expenses grew by 11% annually, largely due to the increase in SG&A expenses. We devoted more resources in marketing as we believe this could amplify our content influence, increase subscriber attraction and enhance the strong momentum generated by our original content offerings. Turning to profit and cash flow. Non-GAAP operating income reached RMB786 million, up 129% annually, positive for 6 consecutive quarters.

Free cash flow reached RMB872 million positive for 4 consecutive quarters. During the quarter, as part of our liability management initiatives, we repurchased a total principal amount of $133.6 million, above our convertible senior notes due 2026. In addition, the total interest-bearing debt decreased significantly quarter-over-quarter. As of the annual second quarter, the Company has cash, cash equivalents, restricted cash, short-term investments and long-term restricted cash included in the prepayments and our assets totaling of RMB6.1 billion. To conclude, the second quarter results, once again, demonstrated that we are making solid progress in delivering high-quality growth, and we are well positioned to generate greater value for our stakeholders in the long run.

For detailed financial data for the second quarter, please refer to our press release on our IR website. Now, we will open the floor for Q&A.

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

Xueqing Zhang: My question is related to the membership business. [indiscernible] stable growth in the past two quarters. So, what’s the longer-term market for also how should we think about the outlook for the membership service in the second half of this year and longer term?

Chang You: Thank you. We will invite Mr. Gong who’s responsible for the [indiscernible] business to answer the question.

Yu Gong: Our membership business developments have different focuses and strategies at different stages. In the initial establishment and rapid growth phase, the primary goal was to maximize the number of subscribers, which was focusing on growing the sub-base. When sub-base reached a significant size, for example, when our sub-base was first in the market that exceeded RMB 100 million in 2019, our objective shifted to membership revenue based on the market condition and our own strategy adjustment. So no longer purely just focus on some members. Our membership revenue is determined by the sub-base, subscriber lifetime and ARM. Our goal is not only to focus on the current quarter revenue but to achieve long-term and substantial growth in membership revenue, taking a more long-term perspective in business planning and improving the overall health of our membership business.

In the future, we’ll continue to adhere to the strategy we mentioned earlier. So first, we will continue to encourage subscribers to subscribe for a long period. Increasing the proportion of long-term subscribers, we have already seen continuous annual growth in the scale and also the percentage of annual subscribers, and we hope this trend will continue. Secondly, we will continue to systematically promote membership loyalty, particularly by enhancing the value perception of long-term subscribers. We have already implemented a series of measures for example. First, we provided discounted price and privileges for long-term subscribers, reinforcing our members understanding that the earlier and longer you subscribe the better. We introduced a membership loyalty program that contains membership point system, which favors long-term loyal subscribers.

We believe this will improve user retention rate and enables the platform to generate mid- to long-term revenue from extended subscribing lifecycles. For example, we wrote out the recent the Lotus case for express package program, which was a meaningful application upgrade of our membership point. During the 8-day event, over 6 million subscribers have used their membership points to access that express package. Overall, we believe with the improvement in membership value perception, we believe that the membership of loyalty and retention will naturally increase, driving the long-term growth in ARM and also membership revenue.

Operator: Our next question will come from Lei Zhang of Bank of America Securities. Please go ahead.

Lei Zhang: We have seen that a key long form review player launched the several contents this summer with good performance. So, I want to see how should we look at the changing enrollment? And how should I see the competitive advantage in content perspective? On the same time, we noticed that offline entertainment actually saw strong recovery, especially movie. Do we see any impact or benefit to our business?

Chang You: We will invite our CCO, Mr. Xiaohui Wang to answer this question.

Xiaohui Wang: For this summer, we’ve seen the industry have a better supply of it public content whether it’s online dramas or offline theatrical whole movies. All of these are actually competing for users’ attention. We are also pleased to see the flourishing of the long-form video industry. We believe with the improved content quality, the industry vitality has been activated, and we believe the market prosperity is beneficial for everyone. Under this backdrop, we have maintained our leading position in online drama driven by our high-quality original content. We have been leading the industry for six consecutive quarters in terms of the overall drama market share and also the exclusive market shares. Once again, we have with the test in Q2, which demonstrated our advantage and sustainability in the content business.

Everyone knows the content industry is a long-term business. And the key to long-term success lies in the ability to continuously produce and supply high-quality content. In the core drama category, due to the nature of longer production cycle performance, our competitive advantage in this area is difficult to surpass in this quarter. Additionally, core market players are establishing different differentiated advantages, focusing on original content and exclusive content. As such, the content differentiation has been gracefully improved and the competition environment has been more benign and rational. We believe that our advantage in the content business are foreseeable and sustainable, supported by four strong pillars are mature and continuously improving content production mechanism, strong operating capabilities, leading technology capabilities and our top industry talent.

In the future, we will continue to firmly adhere to innovation, premium content, diversification and continuously seeking new bits through innovation and research. Also, while ensuring the quality of projects, we will carefully plan our production to ensure a long-term entity sustainable supply of diverse premium content. Regarding the recovery of offline entertainment, on one hand, we will continue to focus on our strength, concentrating on the production and operation of our content online. On the other hand, the recovery of online theoretical movies will benefit online video platforms. The second window movie supply will recover and increase.

Operator: Our next question today will come from Alicia Yap of Citigroup. Please go ahead.

Alicia Yap: Wonder, if management could share with us what’s your view on the overall brand advertising market outlook for the second half this year? Have you observed any major shift of budget sentiment from advertiser and will IT modify any of your advertising strategy?

Chang You: We’ll invite our Senior VP of Brand Ad Business, Wu Gang to answer the question.

Gang Wu: IT is overall advertising business has been in a continuous recovery rate with brand advertising rebounded in Q2, growing both year-on-year and also quarter-on-quarter. After economy recovery takes time to reflect in the brand advertising market, we hold us cautiously optimistic attitude towards the brand advertising market for the second half of this year. Because we think IT is one of the platforms in the Chinese Internet industry that has the highest user quality as well as strong consumption power and a user’s willingness to pay. So we are an indispensable choice for advertisers in enhancing their brand influence. We have being seen in increasing recognition from advertisers for our content and also innovative products.

The content prime amount of content marketing overstatement has been driven by topnotch drama and variety shows and there have been a strong preference and acceptance from advertising for advertisers for our innovative ad products. Under the current macro environment, the advertisers from different factors are formulating corresponding advertising strategies based on the strategic vision, also the long-term market view among which certain brand advertisers with forward-looking strategic vision may increase their app spending, seizing marketing opportunities by opening the market. Looking at the specific sectors, we are optimistic for the food and beverage industry, cosmetic and personal care industries as well as the transportation industry, which also includes the new energy vehicle.

Operator: Our next question today will come from Lincoln Kong of Goldman Sachs. Please go ahead.

Lincoln Kong: So, thank you management for taking my question. So my question is about performance at a pricing here. We have been seeing continued [indiscernible] for performance as in the first half, how do we think about the second half outlook of this set of business?

Chang You: Thank you, Lincoln. I will invite our CTO, Wenfeng to answer this question.

Wenfeng Liu: For performance ad revenue has maintained its annual growth for five consecutive quarters, with the growth rate continues with actually the growth rate that continuously accelerating and its contribution in total ad revenue has continued to increase, reaching a historical high in Q2. It is expected that the performance ad structure will continue to experience strong growth in second half of this year, benefiting from our improved market capability, attracting more advertising budget from key industries such as internet services, e-commerce and gaming. Now also, we believe with the algorithm optimization and the support of generated AI performance app results will bring the outperformance and also monetization efficiency to improve.

In the future, we think the performance app advertisers will pay more attention to cost effectiveness and also the advertising performance striving to achieve additional conversion and also to maximize returns on investment. Going forward, we will continue to strengthen app creativity, content personalization and interactivity. We will also leverage new technologies like generated AI to lower app production costs and also enhance and add delivery efficiency, adapting to the averaging market and user demand. From the ad sectors perspective, for the second half of this year, we think we have a positive outlook different sector, for example, the traditional e-commerce platform, live streaming e-commerce, culture and entertainment, harbor and tourism and also the lifestyle food industry.

Operator: Our next question will come from Maggie Ye of CLSA. Please go ahead.

Maggie Ye: Thank you management for taking my question. Noted the Company has generated very strong operating cash flow and free cash flow this quarter and has also repurchased convertible notes. Please, could you share with us more about your thoughts on the Company’s debt level management and plans for financial resources in the coming quarters?

Chang You: We will invite Mr. Jun, our CFO, to answer this question.

Jun Wang: I think for the interest of time, I’ll just answer the question English directly. So, I think this is a question that we constantly receive and the inquiry that we continue received from the investor community as well and our answer is very straightforward. First and foremost, we are in a productive continuously improving our capital structure. We are still making, trying every effort to make our balance sheet more healthier and more robust and this is what we do. And secondly, I think within our framework, doing that, there are two things that really matters. The first and the most important thing is actually to continuously generate sizable free cash flow. Just to remember, generating sizable cash flow means natural deleverage regardless of whether we will contact the debt buyback or not.

And this is really a key and this is what we have been very proud to see our progress in the past couple of quarters. And the second thing is to develop a serious and comprehensive set of the choices to see what we can do to benefit our shareholders best. And these set of choices won’t include, for example, the debt buyback, but it will also include to explore the opportunity to invest for safe returns. And as we all know, the external environment has been extremely dynamic with a rise in interest rate and actually provide return opportunities for the Company with free cash flow. So with that being said, I think our overall principle revenues remains the same. We explore every opportunity to create value for our stakeholders, including our shareholders and our supporting debt holders but without compromising the safety of our business for sure.

Operator: This will conclude our question-and-answer session. At this time, I’d like to hand back to management for closing remarks.

Chang You: Thank you, everyone, for participating in the call today, and please do not hesitate to ask us if you have any further questions. Thank you and we will see you next quarter.

Operator: The conference has now concluded. Thank you for attending today’s presentation, and you may now disconnect your lines.