iQiyi (NASDAQ:IQ) reported second-quarter results after market close on July 31. This was only the streaming-video provider's second quarterly report since splitting off from parent-company Baidu (NASDAQ:BIDU) in March. It also marked the company's first go at hosting its own earnings call.
Sales for the period climbed 51% year over year to reach roughly $932.5 million, with the company's premium member rolls hitting 67.1 million -- up from roughly 61 million at the end of the previous quarter. Sales from premium membership services jumped 66% compared to the prior-year period, while advertising revenue (the company's other main sales pillar) increased 45%. iQiyi also issued guidance for sales to grow between 43% and 49% year over year in the current quarter.
Overall, the Chinese streaming platform delivered strong results, even in light of rising content costs and expanding losses. Read on for a deeper look at the company's quarterly report and the conference call it held following the release -- with transcript quotes courtesy of S&P Global Market Intelligence.
Paid subscriber growth is strong
iQiyi's revenue from advertising is currently its biggest source of sales (42% in the most recent quarter compared to 40% for membership services), but paid subscriber growth is the metric investors are most focused on. Results have been encouraging on that front, with nearly 6 million subscribers added in the quarter and more than 60 million subscribers added since May 2015.
iQiyi introduced a feature last quarter that allows users to watch six episodes of a given drama per week on the free, ad-supported model while offering users on the premium service unlimited access. Management indicates that this played a significant role in subscriber additions. The other big paid-membership driver in the June-ended quarter was the company's cross-promotion membership drive with JD.com. Here's Chief Financial Officer Xiaodong Wang discussing the subscription growth picture:
That's why [in] the second quarter ... the net adds and new members is quite good. And those are actually the key drivers for the second quarter. ... we see the trend and we believe the trend will continue. ... the number of subscriber will continue to grow very fast. ... the revenue of the membership service, definitely, I think it will be better, maybe much better than we expect before.
Xiaodong made it clear that average revenue per user (ARPU) isn't the company's chief focus at this point. Instead, iQiyi is prioritizing membership growth for its premium services and sees opportunities to focus more on increasing ARPU down the line.
iQiyi continues to make content strides
Continuing to deliver rapid sales growth hinges on adding appealing content to the platform, and iQiyi management was eager to highlight recent successes and upcoming projects during the call. Chief Executive Officer Tim Gong Yu touted the company's strength in the variety-show genre, highlighting impressive performance for Idol Producer and noting that the latest edition of the company's series The Rap of China had proven to be a huge hit since its release on July 14. Here's Gong discussing iQiyi's efforts in the drama genre:
We continue to enhance our self-production capability by expanding drama studios and focusing resources on original dramas, especially those appealing to young viewers.
The CEO also noted the company's strong showing at the Shanghai International Film and TV Festival in June, which saw iQiyi-produced content and affiliated talent bring home 11 awards. The company believes a strong lineup in the second half of the year will help it continue to drive premium membership and overall sales on its platform.
Operating costs will remain high
The flip side to the big sales gains in the quarter was that heavy spending on content, advertising, and branding pushed the company's operating loss to roughly $200.7 million from $149.7 million in the prior-year period. iQiyi isn't taking its foot off the gas when it comes to content acquisition and production, and this means operating costs will continue to climb. Here's Xiaodong outlining the cost side of the content equation:
We see I think it's the right schedule, so we'll continue to invest on the content in the next few years at least. So I would expect content cost as a percentage of revenues to be a little bit higher than what you are seeing in the first half. ... now you see the content cost is somewhere between 70% to 80% of the total revenue. I would expect it close to 80% for the rest of the year. ... definitely we need to invest more on the content to attract more user traffic and to build a more solid user base.
iQiyi is building its multimedia business
iQiyi announced that it had purchased Chinese game developer Chengdu Skymoons on July 17 in a deal valued at up to $300 million when performance-based incentives over the next two years are factored in. The two companies had previously worked together on a video-game adaptation of iQiyi's series The Journey of Flower in 2015, with Skymoons releasing a title with content that evolved in tandem with the the show's story line as it aired. The game went on to be a big hit, and it points to the potential that multimedia crossovers have for iQiyi. Gong comments on the value of the acquisition in the quote below:
Finally, our most recent update is that in July, we completed the acquisition of Skymoons, a developer and a global publisher of mobile games. Through this acquisition we expect to fully have the potential of video adaptation from gaming IP and also game development based on video content, which I believe is the natural synergy between iQIYI and Skymoons, that will enhance iQIYI's overall ecosystem.
The company also recently signed deals with anime specialist Toei Animation and children's television network Nickelodeon (a division of Viacom), and it continues to expand the content offerings of its online literature data base.
iQiyi's others segment could grow rapidly
Sales for the others segment climbed 62% year over year to reach $81.4 million -- or roughly 9% of total sales in the period. iQiyi's video business rightly attracts most of the focus, but the company could have underappreciated growth engines in other areas of the business. Xiaodong sheds some light on the role that licensing will play in growing sales:
Membership, I believe, will be key driver of ... revenue growth ... the third quarter. And also, as I just mentioned concerning earnings, and because of our execution of diversified monetization model ... I would have expected other revenue to continue to grow very fast because we have more diversified revenue source, especially for the so-called licensing, we are going to launch the very popular variety show The Rap of China. And so along with revenue and membership revenue, definitely we will see some IP licensing-related revenue or other related revenues from those like hot variety shows or even content.
In addition to its licensing business, the company's others segment includes its literature, comics, and gaming divisions, its live-streaming service, an entertainment news feed, an entertainment-focused e-commerce platform, and a social media platform. In response to being called "the Netflix of China," iQiyi management has sometimes stated that it is pursuing a "Netflix Plus" model -- one that will have more sources of revenue than the American company to which it is often compared. iQiyi has also said that it aims to create a Disney-like multimedia business.
Consumer products is routinely Disney's highest-margin business segment because the company doesn't have to manufacture most of the goods that feature its classic characters. Instead, The House of Mouse collects revenue by licensing the properties out to partners like Hasbro, Electronic Arts, and Mattel. iQiyi's collection of valuable franchises doesn't come close to Disney's at present, but licensing is going to play a crucial role in getting the business to regular profitability.
Keith Noonan owns shares of iQiyi and Walt Disney. The Motley Fool owns shares of and recommends Baidu, Hasbro, JD.com, Netflix, and Walt Disney. The Motley Fool recommends Electronic Arts and iQiyi. The Motley Fool has a disclosure policy.