Ladies and gentlemen, thank you for standing by, and welcome to the iQIYI's Third Quarter 2018 Earnings Conference Call. At this time, all participants are in a listen-only mode. [Operator Instructions] I must advise you that this conference is being recorded today, Wednesday, the October 31, 2018. I would now like to hand the conference over to your first speaker today, Mr. Dahlia Wei, Investor Relations Director for iQIYI. Thank you. Please go ahead.

Thank you, operator. Hello, everyone, and thank you all for joining iQIYI's third quarter 2018 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 Dr. Yu Gong, our Founder, Director and Chief Executive Officer; and Mr. Xiaodong Wang, our Chief Financial Officer. Dr. Gong will give a brief overview of the Company's business operations and highlights; followed by Xiaodong, who will go through the financials and guidance. After their prepared remarks, we'll hold a Q&A session. Before we proceed, please note that 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 statements except as required under applicable law. With that, I will now turn the call over to Dr. Gong. Please go ahead.

Hello, everyone, and thank you for joining us for the third quarter earning call. We continued to deliver solid results during the third quarter. Total revenue were RMB 6.9 billion, up 48% year-over-year. The performance was primarily driven by robust growth in the number of subscribers which reached RMB 80.7 million at the end of September, representing a record high of quality net addition of RMB 13.5 million. This quarter, we also observed further enhanced user reach engagement level and the time spent as summertime is a peak season for us during the year. We ranked number one across a number of operating metrics among our peers according to independent data tracking by major research firms. This, again, reaffirms our industry-leading position and the competitive strength. We will start this quarter's business review with membership services which has become our biggest revenue contributor. Membership revenue was RMB 2.9 billion, representing a 78% year-over-year growth. Premium content continues to be the mostly important driver for the membership growth. We released the most popular drama of this year in China, Story of Yanxi Palace, during the quarter. The mega-hit costume drama that we originally produced has set several records in the entertainment industry in China. It harvested over 20 billion total video views and has become the single most successful title in terms of subscriber conversions in our history. Along with our variety of other premium content, it greatly boosted our subscriber numbers. Our joint membership program with JD.com continued to progress nicely in the third quarter, attracting a steady inflow of annual subscribers who wish to enjoy benefits from both companies. In addition, to JD.com, we continue to pursue opportunities to develop other cross-industry partnerships, including telecom carriers and commercial banks. During the third quarter, we established a new cooperation with…

Good morning, everyone. Let me go through our financial highlights. Starting on January 1, 2018, iQIYI adopted ASC 606, a new revenue accounting standard that nets value added tax from the revenue and cost of revenue line items. To increase the comparability with Q3 2018 numbers, 2017 revenue numbers for today's discussion have been adjusted net of VAT. For the third quarter of 2018, iQIYI's total revenues were RMB 6.9 billion, up 48% year-over-year. The increase was primarily driven by strong growth of our membership services. Membership services revenue was RMB 2.9 billion, up 78% year-over-year. The strong growth was driven by robust growth of number of subscribers, which reached 80.7 million, with a record net addition of 13.5 million during the quarter. Online advertising service revenue was RMB 2.4 billion, down 4% year-over-year. As Dr. Gong just mentioned the decrease in advertising was primarily due to the FIFA World Cup impact as well as recent regulatory headwinds. Content distribution revenue was RMB 834.6 million, up 220% [ph] year-over-year, primarily due to a number of premium content titles that are distributed during the quarter. Other revenue were RMB 831.1 million, up 157% year-over-year. Other revenue was generated from live broadcasting, online game, online literature, IP licensing and talent agency. The growth in other revenue reflects a strong performance across our various vertical business lines, but we continue to pursue a diversified business model that fully leverages the content value and the massive field traffic of our platform. In particular, we started consolidating Skymoons into our financial since the deal was closed in mid-July. Moving on to the cost of revenue. Our cost of revenue were RMB 7.7 billion, up 66% year-over-year after deducting the value added tax in the same period in 2017. This increase was primarily driven by the…

Thank you. Ladies and gentlemen, we will now begin the question-and-answer session. [Operator Instructions] Your first question today comes from the line of Ella Ji from China Renaissance. Please ask your question.

Good morning, management. Thank you taking my question. My question is about your online ad revenue line. So first of all, can you give us some outlook expectation for the fourth quarter? Do you expect that this World Cup and the regulatory impact will continue in 4Q? And sequentially, how does 4Q ad revenue looking comparing to 3Q? And then I also wonder if you can also provide more colors into the line. So for example, between KA and SME advertisers, could you share more colors which are getting more hit? And what categories? And what's the exposure to these categories as a percentage of the revenue? Thank you.

Ella, this is Xiaodong. I don't think you've got – you only read one press release. You read up hundreds of press release. Let me just try to make it simple. Okay, I understand your question. So basically, what I can tell you, we don't disclose the detail of like the revenue guidance. But what I can tell you is definitely, the year-over-year decrease is abnormal. So you will expect positive increase next quarter. By the way, as we addressed before, a lot of different facts which have different impact on our revenue in our advertising business. So I think you will have a normal increase in the fourth quarter. But you mixed a lot of facts together. And what I was trying to tell you just now is from a year-over-year perspective, we expect some positive increase. But as we discussed before, the third quarter is a peak season of – has been strong for the whole year. So there will be something there that has impact on revenue in the fourth quarter. And the second part of your question, between like KA and SME, definitely, the FIFA World Cup will have like more impact on the key account as well as brand-new advertisers. But we do have some – let's say, we try to make our revenue of SME more healthy, so we did something in – during the third quarter. So that will have some impact on the revenue of SME. But we expect those will come back in the next few quarters. So definitely, I think we still have confidence that SME ad work will be back to normal in the next few quarters.

Thank you. Dr. Gong just added in that further. On the SME side, some categories that was hit by the regulatory is that one is the game industry because as you all know, there would – there are fewer games launched this year. So accordingly, there will be fewer advertising budget spent from the gaming sectors. And also, in the third quarter, we also cleaned up some not so healthy advertisements on the in-feed side, so that also had some impact on SME clients.

Your next today comes from the line of Thomas Chong from Credit Suisse. Please ask your question.

Hi, good morning. Thanks management for taking my questions. On the membership revenue, how should we think about the subscriber's trend as we go into Q4? Should we expect there will be a normal seasonality there? And how should we think about the outlook in 2019? And my second question is about content cost. As we head probably towards the end of the year, how should we think about the growth momentum for content costs as we go into 2019? Thank you.

For the subscriber, because Q3 is the highest seasonality during the year, so we recorded a net addition of RMB 13.5 million. In Q4, we expect that we will continue to grow but may not be as strong or as big as RMB 13.5 million that we saw in the Q3. That will definitely continue to grow. For the whole year 2019, we also have very positive view, and we expect the net addition for full year 2019 will be no less than the full-year addition in year 2018. Since this summer, we already upload the procurement price for TV series that we purchased from the TV drama series. Netflix already start to decrease. But as you know, there will be a time lag of the purchase to broadcast our platform, nearly six months of timeline. So the impact of content cost will only hit in next year 2019, and the impact will be limited. But in the long run, we believe procurement price for licensed content will be on a downward trend.

Your next question today comes from the line of Eddie Leung from Merrill Lynch. Please ask your question.

Good morning. Thank you for taking my questions. Just one quick follow-up on content costs, probably more about your cash outflow. We've seen quite a bit of cash outflows in the past two quarters. I suppose those will be related to content costs. I'm just wondering is there any seasonality? And how should we think about the cash outflow in the upcoming above quarters? Thanks.

This is Xiaodong. Actually, I think I said it’s a very good question. We don don't see any seasonality for the cash flow because, actually, it's more related to the content cost investment we made in the, let's say, quarter before – two quarters before. I think that is actually depending the extra cash status of the company. So basically, what I can tell you is the membership service continued to grow. The mix impact between membership and ad revenue will help us on the cash inflow. And – but with more investment on the self-produced content you would expect like see what situation are the cash outflows. So net-net, I will say it will impact almost the similar cash burn rate in the next few quarters.

Your next question today comes from the line of Piyush Mubayi from Goldman Sachs. Please ask your question.

Thank you, Dr. Yu. Thank you, Xiaodong. I have got two related questions. And when I look at your subscriber revenues, they've done exceptionally well and your customers have been – you've been able to retain the customers that you're adding, which leads me to believe, how do you think of the ratio of your paying customers to either DAU or MAU? And if you could remind us how DAU/MAU have been progressing while the customer numbers have been growing rapidly? And related to that is if you could just revisit your pricing – how you think about pricing for the next two or three years because it appears the subscription business is doing a lot better than initially thought. And also your success with Yanxi Palace is so powerful that it will give you the ability to price up. I assume you've got more shows like that coming through. And second, if you could us take us through the economics of the one successful show; we'd love to hear the details. Thank you.

Good morning. I think I can do the first questions. Actually, as we've discussed before several months ago, I think we expect that we will consider the price change once we see steady growth of the membership service. And now I think – in fact, this probably seems to be much bigger than we expected with still the very fast growth. And again, we still think that the strategy, it appears to be still correct. So – and let's say, we'll still be very cautious in the price change in the next few quarters at least until we see the slowdown trend of the membership growth. And we don't think it's done yet. As probably we will see something else to increase our ARPU of our memberships business. For example, we continue to extend the paying period of our subscribers around the year. I think I'll tell you something about like around six months. And now, I think we see very good trend that we increase the paying period to like additional two or three months. So I think that's the basic strategy were going to carry in the next few quarters, at least. I think I will let Dr. Gong to comment on the second one.

For a show, we internally look at two metrics to measure the success of a drama or a show. One is the time, the time – viewing time of the show consumed by our users versus the total time spent in that specific timeframe. And secondly, we also look at the first actual payment that we collected from the users who become a – converted to a subscriber on these dramas. Although those two metrics might not be exactly precise to measure the subscription revenue, we think altogether, this will help us to gauge a rough amount of how the subscription revenue performed for this drama.

Your next question today comes from the line of Alicia Yap from Citi. Please ask your question.

Hi, good morning, Yu Gong, Xiaodong, and Dahlia. Thanks for taking my questions. I have a follow-up question on the advertising revenue. Wondering management can clarify what are the not so healthy categories that you have cleaned up during the quarter and are these revenue gone and not recovered in the future? And then other than specific sector impact, have you seen any impact from the macro softness that is affecting the advertising budget sentiments especially into your 4Q guidance as well as into the 2019? Just quickly on housekeeping, if you could share revenues and the total expense as related to the Skymoons consolidation would be helpful. Thank you.

Okay. You've got a lot of questions. The first one, I think those – so we're calling not so healthy segment is actually – we have some customers which do not have the related license needed to put their ads on the Internet. So we don't know whether they are like say a good customer and a bad customer. But from our perspective, because they don't have like I said, related documents to prove they are qualified advertisers so we just let them go. I think that's a major reason why we see something like a decline on our customers numbers in this sort of quarter in our SME business. And everybody is talking about like the macro impact on ad spend, it's definitely, I think we will see some impact. We don't know how long and how soon it will be, but what I can tell you as we said before, it's kind of like a spread we put on the normal business. We still have the confidence, we can do better than the other competitors or players in the market. So you can still expect – as I told Ella just now, you will still see some positive increase in the next few quarters on our entire ad business. And the third question for the detail on Skymoons, because it's not material. So we don't disclose the details, but you can just imagine because it's not material, so it does not like – impact on our total revenue.

One more category that might be impact from the cleanup was some advertisement related to the franchise related category and also 2019 we expect kind of having revenue, we'll continue to grow, but the growth rate might be somewhat decelerated from the previous year's high growth rate.

Your next question today comes from the line of Karen Chan from Jefferies. Please ask your question.

Thank you management for taking my question. Just a bit follow-up on the advertising revenue, just wondering how much of that third quarter decline is attributable to one-off World Cup and also your practice of cleanup of SME ad customers. In other words, should we be seeing third quarter as kind of a trough and a sequential recovery in the following quarters? Also a quick follow-up on the content cost, how should we think about content cost going into rest of the year in 2019, taking into consideration our content pipeline? And from a longer-term perspective, the pay cap control on celebrities on both the drama and variety show trend?

So first, I cannot give you the exact number of the impact of FIFA World Cup because it's more of like, say, budget impact on our major advertisers. We expected the revenue – ad revenue to be like say, increased during the third quarter, but actually we see a decrease trend. So as I just said, it's definitely abnormal. So we will do have like very high confidence we will see healthy growth in the next quarter. But as I just said, you have to consider seasonality. Third quarter, actually, typically is a strong quarter throughout the year, and the fourth quarter definitely is weak quarter of the year. So I don't think you will see like say a sequential growth, like strong growth in the first quarter. But from year-over-year perspective, definitely, we'll see some growth and a very healthy growth of the ad business. And I think let's first – okay, for the content cost and for the rest of years, the content cost, actually, we amortize the content cost throughout the year or even a little longer. So what I can tell you is that you wouldn't see any decrease in absolute dollar amount of content cost in the remaining of the year because – maybe like the titles we launched in the fourth quarter is about the same for the third quarter, but still, there will be some remaining impact of the content amortization in the fourth quarter. So I would expect you will see some slightly increased but maybe not that big in the fourth quarter.

Your next question comes from the line of Xueru Zhang from 86Research Ltd. Please ask your question.

Good morning, management. Thanks for taking my question. I have question regarding to the Dolphin project, Haitun Jihua. As we know, the format of the drama in this project is very similar to the TV series in U.S., which will be divided into seasons. I wonder, will this become the mainstream in your original content portfolio, and what is the early feedback from users? And what is the implication on content cost going forward? Thanks.

The traditional TV drama series have a long in terms of episodes, its many, many episodes, very long. It's mostly fitful for the advertising monetization model. As for project Dolphin, we follow the – North American drama pattern, which is more high-quality and also shorter length in terms of episodes. For example, The City of Chaos is a drama we produced from the Dolphin project. This is very short in terms of episodes and also very high-quality. It's more fitful for the fee-based monetization model, which means we can attract more subscribers for this show.

[Operator Instructions] Your next question comes from the line of Wendy Huang from Macquarie. Please ask your question.

Can you provide your top advertising industry categories and also what are the new categories you mentioned earlier that you are planning to add. And also on the – given the revenue and also the content cost trend you mentioned, so should we expect the Q4's loss margin at a growth level to why didn't narrow. Lastly, on the content distribution revenue that has a very tremendous growth this quarter. What's the detailed reason behind that and how should we expect going forward? Thank you.

Okay. I will let Gong to comment on the first part of the question and we didn't provide guidance on margins and but I already gave you some colors on the revenue and the major part of the cost – the content cost. So I think you can have some rough idea of margin picture in the fourth quarter. And I would like let Gong Yu comment on the first part of the question.

On the advertising side, we saw some softness from the FMCG side, but we are actively looking for new clients for the advertising, for example we saw the Internet services that is a very interesting sector and growing very fast. Although, it already enjoyed several years of growth already but we continue to see more innovative is this model than the new emerging companies coming into this sector, so that will be a new sector that add to our – to our client pool.

[Operator Instructions] Your next question comes from the line of Binnie Wong from HSBC. Please ask your question.

Hi, management. Thank you for taking my questions today. So I was wondering that like for IQIYI certainly a big success, right? And then how should we think about in terms of the subscriber number in terms of their retention ratios staying on the platform. And then, can you just reiterate in terms of our strategy in terms of thinking about like selecting this good high quality content generating of course very high investment for us, but then also high return for us in terms of the strong effort the advertising despite external factors affecting us. How should we think about in terms of the – into the fourth quarter, any other like promotions or any other things that we should think about – when we think about like the growth in subscriber number, that would be very helpful? Thank you.

I think and that is – let's say and for the last part of your question, I don't think we will have say additional promotion or like the very unusual promotion. You will see our offer actually is quite steady. And also U.S. is similar trend when we look at like the single effect of single content like Yanxi Palace. We don't see any deterioration on the churn rate, but definitely you are right, well, there will be subscriber that come for the content only and but we don't see any like see deterioration on churn rate this year. We believe our platform has become like, say, quite healthy attracting the new subscribers.

First, the most important driver for the quick ramp up of our subscriber numbers to premium content, we added more than 13 million net additions of subscribers in this quarter, mostly driven by the paid content we launched. And we do see some users – some subscribers stop subscribing after our hit show Yanxi Palace come to an end in August. So the number we announced is as of end of September, it's not our peak number in August. Still, as I said, it's really the important – very important driver comes from premium content. And secondly, we also have multiple cooperation with a lot of industry partners, for example, telecom operators, cable TV partners as well as JD.com and so on and so forth. Those are also very important to expand our user coverage and reach. Thirdly, it's not so important, but still, we do occasionally launch some holiday-related promotions to attract new users. Even that's not so important as the first two factors, but still contributed to the growth. With the Chinese Internet users become more sophisticated and the evolvement of Internet business coming into the stage, we observed the people are more willing to pay for intangible like knowledge or entertainment like video content. So that's more than we previously thought. So this next year, 2019 I think will be better than this year.

Your next question today comes from the line of Yanyan Xiao from Citic. Please ask your question.

Thank you, management. My question is about the – your PGC content specifically for the mobile device, also the vertical video or [indiscernible] you will may be publish in the November. So how do you think this kind of content will differentiate from the former PGC content and you think, can you give us more color about these kind of specific kind of content? Thank you.

PGC content has been a very important component of our platform. In terms of video view, the percentage of PGC increased from 40% at the beginning of the year to almost 40% – 60% by now. So it's very important. And vertical format of content is also a trend that we observed appealed to our users. So we launched some PGC in vertical content, a PGC relatively is lower quality and shorter in terms of length. But in Q4, we are trying to do some innovation and try to – trying to the development of format into our PPC more professionally produced higher quality content. So in Q4, we will launch some vertical content to see – to do some experiment to see how that applied to our subscription business and also our advertising business.

Your next question today comes from the line of Natalie Wu from CICC. Please ask your question.

Hi, good morning. Thanks for taking my question. I've got a simple one. Just given your current cash position in last run rate, just wondering any plan for financing or controlling content cost in the future? Thank you.

Xiaodong here, I think we proved from last quarters, we feel okay, right now and – but I said last time, we will consider all kinds of different alternatives for the future financing, but probably not necessarily equity with other solutions, probably I don't know convertible bonds straight at it or the bank facility whatever, but definitely, we'll consider other one's potential. End of Q&A

Operator, I think it's time probably to conclude the call.

Thank you. Ladies and gentlemen, that does conclude the conference for today. We thank you all for your participation. You may now disconnect.