Ladies and gentlemen, thank you for standing by, and welcome to the iQIYI Second Quarter 2018 Earnings Conference Call. (Operator Instructions) I must advise you that this conference is being recorded today, August 1, 2018. I would now like to hand the conference over to your first speaker today, Ms. Dahlia Wei, Investor Relations Director. Thank you. Please go ahead.

Thank you, operator. Hello, everyone, and thank you for joining iQIYI's second 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 today for the earnings call. I'm pleased that we delivered another strong quarter for financial and operational results. Total revenues were RMB 6.2 billion, up 51% year-over-year. All major business lines recorded solid growth across the board, highlighted by the strong performance from our membership and advertising services. Let me start with our membership business. Membership services continued to generate strong growth momentum, with the revenue growing 66% year-over-year to RMB 2.5 billion during the quarter. We recorded a net addition of 5.8 million subscribers from the previous quarter, with the total number of subscribers at 67.1 million as of June 30, 2018. By far, the most important driver of membership growth is our premium content. In the second quarter, we also adopted a new releasing format for some of our latest and most popular content, namely My Story for You and The Legend of Yun Xi. VIP members are able to watch all 48 episodes of these drama series all at once, while non-VIP users are only able to access 6 episodes per week. This strategy has been very successful as we saw a significant influx of first-timer, renewing and returning subscribers. Our joint membership program with JD.com has also been very effective in terms of driving growth of annual subscribers as it broadened both party's targeted subscriber bases. We also have a number of other cross-industry collaborations in place besides the JD partnership, such as partnerships with mobile carriers and commercial banks, among others. VIP privileges and benefits are also important factors when users consider becoming paying subscribers. During the second quarter, we introduced customized VIP cards and special voting privileges on variety shows. Such features embedded in shows like "Idol Producer" and "Clash Bots" have been particularly popular and…

Good morning, everyone. I am pleased that we delivered a solid second quarter. Let me go through our financial highlights. Starting on January 1, 2018, iQIYI adopts ASC 606, a new revenue accounting standard that nets value added tax from revenue and cost of revenue line items. To increase comparability with Q2 2018 numbers, 2017 revenue numbers for today's discussion have been adjusted net of VAT. For the second quarter of the year 2018, iQIYI's total revenues were RMB 6.2 billion, up 51% year-over-year. The increase was primarily driven by strong growth of our membership services and advertising services. Membership services revenue was RMB 2.5 billion, up 66% year-over-year. We continue to see strong growth in subscribing member benefiting from our premium content as well as our solid progress of various operational initiatives during the quarter. Online advertising services revenue was RMB 2.6 billion, up 45% year-over-year. The increase was primarily due to the higher monetization efficiency of brand advertising business, driven by the growing popularity of our self-produced content, especially the hit variety shows we launched, as well as the strong performance of our in-feed advertising business. Content distribution revenue was RMB 539.4 million, up 18% year-over-year, primarily due to several major film titles that we sub-licensed during the quarter. Other revenue was RMB 538.9 million, up 62% year-over-year. Other revenues were generated from live broadcasting, online games, online literature, IP licensing, and talent agency, etc. The strong growth in other revenues reflects our effective execution of our diversified business model or Netflix Plus model, to fully leverage the content value and massive user traffic on our platform. Moving on to the cost of revenues. Our cost of revenue was RMB 6.1 billion, up 47% year-over-year, after deducting the value added tax in the same period in 2017. The…

Operator?

(Operator Instructions) Your first question is from Eddie Leung from Merrill Lynch.

Hi Gong Yu, Xiaodong and Dahlia, good morning. Congratulations on the very good quarter. Could you comment on the content cost trend for the rest of the year? It seems like you guys mentioned that we will have more high-profile dramas in the rest of the year. Will that change the level of content cost versus first half of the year, in which we had more original variety shows? Thank you.

Morning. This is Xiaodong. I think we talked a lot about our strategy on content, especially on original content. We still think it's the right strategy, 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. And I would expect now you see the content cost is somewhere between 70% to 80% of the total revenue. I would expect it close to the 80% for the rest of the year. And because we believe that invest on the content can bring us much better benefits in the long run. And also, we talked about the third quarter is the peak season of the traffic in the year, within the year. So during the peak season, definitely we need to invest more on the content to attract more user traffic and to build a more solid user base. Operator Your next question comes from the line of Thomas Chong from Crédit Suisse.

Thanks management for picking my questions. I have a couple of questions. The first one is about on the paying subscribers. Can management comment about the long-term trend? And my second question is about the advertising outlook in the second half. And the third is about the foreign exchange loss of RMB 778 million. Can management explain a bit more details about the nature and is it recurring in future quarters? And finally is about Skymoons revenue that we booked in Q3. Can management talk about the revenue and the earnings for this M&A?

(Foreign Language)

So for the first question, we expect the subscription business will continue to enjoy decent growth for the mid to long term. And for the second question, actually, the advertising business, we have 2 components. One is brand ad, the other is in-feed ad. The in-feed ad actually are growing very nicely. But for the brand ad side, we will take a cautious, optimistic view for the second half of the year. The main reason is because, as everybody knows, there is World-cup in this summer, and the total budget for advertising usually is relatively fixed. And we observed CCTV actually attracts more advertising dollars than we -- expected . So that will have a kind of short-term impact on our advertising. We remain cautiously optimistic of the business.

This is Xiaodong. I'll answer the remaining 2 questions. Question 1 is about like -- sorry this is Thomas', not Eddie's.. And upon the exchange loss we recognized in the quarter, we recognize more than RMB 700 million exchange loss, but a majority, or over 95% of the exchange loss actually are unrealized exchange loss, it-- had no economic action, economic impact. Because you know in China, we have to follow the currency regulation and we have to use kind of what we call intercompany loan to transfer the money we raised overseas and to bring it onshore for operational purpose. So we still have intercompany loan because it's RMB denominated and during last quarter RMB depreciated a lot, over 5%. This depreciation cost the assets of overseas entity a huge loss. But on a consolidated basis because we still use RMB as the currency, so it has accounting impact of over 700 million exchange loss but actually there's no economic impact. So it's a purely accounting matter. And actually, I think you can see it seems like a very big exchange gain during the first quarter is actually same reason. And that's what's on your third question, and then the last one is also the acquisition of Skymoons. Actually, in fact we believe in the long run, the company will bring us like better benefits because I think it fits the -- what we call Netflix Plus model, where help us monetize the traffic and IP we have through our content. But I think during the third quarter, because we just acquired the company, it will take some time to let the figure happen. So yes, you're right. Definitely, there will be some impact on our top line or the bottom line but it's not material, it's already prepared in the forecast guidance we gave.

Your next question is from Piyush Mubayi from Goldman Sachs.

Thank you for taking my question and congratulations on Dr. Gong Yu and Xiaodong for a very strong set of numbers. I've got 2 questions. First, when I look at the membership services revenue, which is done very strong-- which has done very well in the quarter, your subscriber growth numbers for the last 2 quarters have held up very well. I wonder if you could generally talk about whether you're surprised positively or negatively by the performance in the first half and what you think it means for the rest of the year when it comes to membership services revenue. And if you could touch upon the ARPU numbers, which have held up and done better in the second quarter versus the first quarter, and what it means for the rest of the year. And the second is related to your guidance, which is very strong, between 43% and 49% up year-on-year. Would you be able to break it down between membership services revenue, online advertising, content distribution, so we can get a better color of what the driver is into the second -- into the third quarter and we can then predict 4Q also?

Good morning, [Kirk] (sic) [Piyush], this is Xiaodong. And I think I can start with the first question about the membership growth. And I think we talked something about the seasonality of membership services. So typically we see the first is a very strong quarter and the result is actually match the expectation. For the second quarter, actually, frankly speaking, the result is a little bit better than we expected. And there are 2 key drivers for the second quarter's membership growth. The first one is we try something new on how we're going to publish those content, especially for the original content. Dr. Gong just introduced, I don't want to repeat here. So those, like the innovative way to publish the content, it helps a lot. We've generated a lot of members during the -- in later -- second half of June because of this slightly innovative method of publishing content. Also, the cooperation with JD and other partners, it helped us in the short term during the second quarter. That's why the second quarter, actually, the net adds and new members is quite good. And those are actually the key drivers for the second quarter. And for the trend for the remaining year, as Dr. Gong just said that we're still -- I believe, the members, the subscribers will continue to grow very fast. And we see the trend and we believe the trend will continue. And so I -- definitely, I will see the subscriber -- the number of subscriber will continue to grow very fast. And however -- and I think actually, the revenue of the membership service, definitely, I think it will be better, maybe much better than we expect before. And -- but as I've said it before, for now ARPU is not the…

Your next question comes from the line of Alicia Yap from Citigroup.

Good morning management, thanks for taking my questions, and congrats on the solid numbers. Just follow-up on the content distribution revenues a little bit. Since the management comment during the prepared remarks, this seems to be potentially -- it could repeat, right, in the future quarters in terms of the faster growth. Should we actually assume the change of the strategy will continue to drive the content distribution revenue to grow faster than historically? And then related to the revenues is that, on the -- regarding the online ads revenue growth, I understand you mentioned about the brand ads under World Cup. But then, given some of the reasons, regulatory ad content crackdown, should we expect any impact at all on our ad revenue growth in the third quarter? And then just quickly on the Skymoons acquisition, so when should we actually expect a finished game product to be available to the market? Will that be this year or will that actually be sometime next year?

Okay. Maybe a little -- I think I will probably answer the first several questions and Dr. Gong will follow up on the regulatory and maybe I will come back with the Skymoons strategy. Actually there are too many questions, I almost forgot what's the first one. I think about the content, I think there's some miscommunication. We don't say a lot about the content distribution. Actually, what Dr. Gong mentioned is how we're going to publish content. We try to let the member access the content first to have some privilege, to enhance their experience, and then release to the free users. We don't see a lot about like content distribution. And actually, the content distribution revenue increased. I think the percentage is okay. It's now- as fast as [18%], it's just a moderate increase. So I don't quite understand what your question on the content distribution. But definitely, you're right, content distribution will be a very important part of the revenue source in the next few quarters because we have a lot of content now in hand. We are trying to manage the efficiency of the content library. We're trying to utilize all the content that we have in hand, no matter it's like the directories for our user or try to have some financial returns in a very cautious way to swap to other platform, especially some TV channels or other media platforms. That's the strategy that we have here. So I don't know whether I answered your question on the content distribution. So if not clear, please clarify.

Yes. I think it's -- actually, I was asking whether the licensing to the domestic TV station, is it more one-off? Or is it -- actually could repeat in the future quarters?

Well, definitely, you will still see a meaningful size of content distribution revenue in the next few quarters, it's normal. Because -- actually, if you do it right, to some extent, distribution content to the TV channel actually will help us on the traffic and to attract more users on the platform because expanding to the TV channels will help us to increase the influence of the content actually. But you have to do it right. You have to pick the right timing, right window to do it. So -- and somehow, actually, it's part of the strategy. So you just need to know when is the right timing to do so. So it will be some like technical here. But -- and you're right, definitely, you will see the content distribution will be the very important revenue source in the next few quarters. So I think I will let Dr. Gong answer your question about the regulatory accident recently.

(Foreign Language)

(Foreign Language)

We already see much severer regulation in the first half of the year, so we don't expect any further impact from this side in the second half of the year.

Okay. I will put something. Okay, Alicia, please?

Oh no, sorry. Just on the Skymoons and any follow-up that you wanted [to talk about].

Yes. Actually, what I'm trying to say -- I also have something to say about Skymoons. Actually, Skymoons is an established company. So actually, it now has some product already online. So that's why when Thomas asked the question about, like Skymoons, I said there will be some impact on top line, but it's not material. They have some products already online and they have some DAUs and paying users, or whatever metrics. I would expect they will have like more and more successful products I think maybe later this year or next year. There will be right timing. For second -- third quarter and there will be some impact, but not a material impact on the revenue side. Operator Your next question is from Yanyan Xiao from Citic Securities.

(Foreign Language)

Sorry to interrupt -- so sorry to interrupt. I think it's better to speak in English because, otherwise, we have to translate the question. It would take more time.

Okay, I have 2 questions. And firstly, it's about the membership. And we have seen some strong sales, promotion activity for membership, especially into July, like RMB 89 for 1 year, and also JD Plus membership. And do you see any strength in the membership growth in the near term? And so -- and also, how many paying members iQIYI will able to reach in the long run? And the second question is about the recent policy from the government, especially for the high price for the star or the performers. And recently, there were news about the 3 major online video platforms, like iQIYI, Youku and Tencent Video formed alliance to put a threshold to the price per episode, like 9 million for custom dramas and 6 million per episode for modern dramas. Do you deeply -- give us more color about that kind of policy? And how do you view the government policies about the high price for the stars?

Okay. I will answer the first one. Dr. Gong will comment on the second one. On the membership, I think the accuracy on the promotion of the -- on membership service, actually, it's a very short-period promotion. It only lasts for 3 days. And I don't think it will have like a huge impact on the final results. But it's a very, like, a meaningful experiment we are going to have in the next few quarters. Because most of the cooperation -- promotion on the JD program and the [related] is like the annual members, as Dr. Gong just mentioned. Anyway, it helps us to increase the annual members, but -- and because the percentage of annual members is very small, compared to others like monthly auto-renewal subscribers, it's quite, quite very small. So basically -- and I don't think those promotions will have like significant impact on the final results, whether it's financial or the numbers. Plus, it's just -- the reason why we did it is just trying to understand a different way to explore the future opportunities to increase our members. It's just kind of like, say, how we explore and expand the subscriber base. And we will see some trend reflect some data. We understand what users want and we know what we are going to do in a few quarters to further strengthen the subscriber base as to where to increase the revenue of membership service. And let's say, that's what my thoughts on the membership. And Dr. Gong will answer the other question on the government's policy.

(Foreign Language)

The major content -- or the cost is -- come from our content cost, and content cost has 2 major components, one from drama series, the other comes from variety shows. For the variety shows, actually, the SARFT has published some regulations to limit the high payment -- compensation that we can pay for the celebrities and stars. And we have been in compliance with this regulation already and then this has been in place in the company and it helps us to be more controllable content costs for us. And for the variety -- for the drama series, there's no regulatory -- formal regulations in place yet and the government is in talks with online video players, including iQIYI, and we are mutually in contemplation and the thinking -- do some thinking about this. And a few months ago, iQIYI and Youku and Tencent, we published a joint declaration to call on for certain limitations for the compensation for the actors and actresses. That's not formal, that's not official. So I believe, in the future, in the near future, actually, the government may consider to publish formal regulation in this regard. Operator (Operator Instructions)

Operator, if there's no more additional questions, we can conclude the call. Operator Ladies and gentlemen, presenters, please continue.

Okay. We can take another question, maybe from JPMorgan.

Okay. Alex Yao from JPMorgan.

A couple of follow-up questions. Number one is for the content cost. Can you give us an update of your in-house or original content production cost in relation to the TV drama? Because this is apparently one of the areas or capability you guys are incubating. Just want to understand how important is it from cost perspective in the first half financial results. And can you also give us an update in terms of the progress in producing original TV drama by yourself. And then secondly, can you talk about the top drama price inflation this year versus last year? And how do you think about the price inflation -- the implication on price inflation from the recent Fan Bingbing incident, i.e. a very famous actress was found to have 2 contracts, one is for tax purpose, the other is for real income purpose. Do you see ripple effect that such famous actors and actresses will see limited room for increase their income for participating in TV dramas? And is that going to be a key industry benefit in the next few years?

I think I will comment on the first one, Dr. Gong will say something about like this recent news I cannot call it accident. And about like the content cost, we've said a lot about how we value the original content and then we said we are going to invest heavily on the original content. And since for the first half year, you'll see -- we made some progress. Actually in the second quarter, the original content as a percentage of total, like content cost, actually, we've reached a historical high. We feel something about like the original content account for somewhere between [10% or 20%] before of the total professional produced content. For the second quarter, I think that number is pretty high. I -- see high end of the range. And as you know, for those like a content company, it's not as smooth as the manufacturing line. So sometimes this week, it's higher; sometimes next week, it's lower. And we expect to continue to increase this percentage in the long run. But I cannot guarantee for every quarter you will see like a steady increase on this. It's not a smooth, linear progress because it's content business. It's not like the manufacturing business. So that's why we didn't disclose the detailed numbers of this number. But I can tell you -- what I can tell you is we made some progress for the second quarter. It's in the high end of the range and we'll continue -- we believe we will continue to see the percentage to increase in the long run, and we will definitely invest heavily on that. That's why, actually the reason why I said I would expect the content cost as a percentage of revenue to increase in the second half of the year because we will continue to invest on the original content. That's the reason why you will see higher content cost in the next few quarters.

(Foreign Language)

For the content cost, actually the procurement costs for drama series is a big component of content costs. In the first half of the year, we are -- we've observed very different directions for the licensed copyright. For the very top level, the premium content, we continue to see inflation, price inflation of this top-quality content. As for some other mediocre level of drama series, we actually have seen that has been stabilized. The reason is, in the past three to four years, there are many emerging companies in this entertainment industry. They produced a lot of -- in terms of quantity, many, many drama series were produced. And we have seen the supply side has gradually surpassed the demand side. That's why I think, going forward, the price inflation, as well as the patent increase will be gradually eased. And we observe for our iQIYI's case, our license budget or our procurement costs start to saturate for the time being. So I think those trend will be eased gradually.

(Foreign Language)

For the event that the debate between Cui Yongyuan and Fan Bingbing actually, there'll have -- not be any official conclusion or official comment from the government. There are some -- just some market speculation or discussion about this issue. So we are not in a position to comment on this. But more of influential kind of sentiment is this discussion will be one of the catalysts of the trend that I discussed just now. That is not the main reason or main driver, but will be one of the catalysts.

Ladies and gentlemen, due to time restraint, I will hand the call back to today's presenters. Presenters, please continue.

I would like to conclude the call.

Thank you for joining us. If you have any more questions, please feel free to contact us.