Ladies and gentlemen, thank you for standing by, and welcome to the iQIYI Third Quarter 2020 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. [Operator Instructions] I must advice you that today's conference is being recorded.

I would now like to hand the conference over to your first speaker today, Investor Relations Director of iQIYI, Lei Zhang. Thank you. Please go ahead.

Lei Zhang - Investor Relations Director

Thank you, operator. Hello everyone and thank you for joining iQIYI third quarter 2020 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. Xiaodong Wang, our CFO, and Mr. Xianghua Yang, Senior Vice President of our Membership Business. Mr. Gong will give a brief overview of our company's business operations and highlights, followed by Xiaodong, who will go through the financials and guidance. After their prepared remarks, Xianghua will join Mr. Gong and Xiaodong in the Q&A session.

Before we proceed, please note that the discussion today will contain forward-looking statements made under the Safe Harbor Provision of the United States 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 not limited to those applied in our public filings with the SEC. iQIYI does not undertake any obligations to update any forward-looking statement except as required under applicable law.

With that, I will now turn the call over to Mr. Gong. Please go ahead.

Yu Gong - Founder, Chief Executive Officer and Director

Good morning. As we all know, with the evolution of the COVID-19 epidemic in this abnormal year of 2020, we see both users' behavior and the macro economy gradually back to normal. Despite the massive impact in the first half of the year, now content production industry is trying to catch up in the third and the fourth quarters. We are taking a variety of measures to speed up this recovery process and prepare for next year's growth.

Now let's go through our business segments. First, I will talk about our membership business. As of September 30, our total subscribers reached 104.8 million and the paying ratio reached 99.5%. Membership services revenue grew by 7% year-over-year to RMB3.98 billion. Although total subscribers remained flat this quarter, the membership revenue still increased compared with last year. There are a few factors we observed regarding membership business trend. First, there was some lack of new content on our platform due to the company's release delay on the new theatrical movies shortage. The fact that fewer new movies were released in cinemas this year, accordingly affected the movie supply. As a result, we launched fewer movies in Q3 compared to the same period last year. In Q4, we impacted some sequential rebound of new movies supply, although still not as much as Q4 last year. We are very happy to see that one of the most expected movies this year, The Eight Hundred just started streaming on our platform from the member first and became hit immediately. We expect more and more theatrical movies coming online gradually for our subscribers.

Second, we see the users are spending more time on short-form videos. However, we also noticed that larger screens such as smart TV and set-top box also become more popular. More users prefer watching the content on large screen for better home entertainment experience. On our platform, the time spent by our TV devices is growing for the past several years and reasonably total time spent on TVs surpassed that on the mobile devices. Accordingly, we will take more initiatives on large screens related business and develop the monetization ability of them. We believe with appropriate operation tactics, larger screens can be an important monetization driver for us in the mid, long term. Lastly, the summer vacation this year was shorter than usual, which led to softer traffic and the time spent on our platform compared with last year. We believe the membership growth slowdown is temporary.

As content is always the key to attract subscriber, we have high confidence in our premium original content and the in-house production capabilities. Most of our over 50 in-house studios will go into full production from the second half of next year. These studios are expected to largely improve both the originality and the diversification of content on our platform and ultimately drive continued growth in our membership business. In addition, we are targeting different user groups by focusing on diversified content category. Considering the movie diverse user need and our large numbers, we have invested in a variety of content verticals and have already seen some great initial results. iQIYI Mist Theater which features 12 episode suspense dramas have been watched by over 68 [Phonetic] million subscribers as of the launch of its finale. We are happy to see that these dramas are attracting new subscribers as strong as longer serials and make even better ROI.

Although we continue to evolve more monetization models, we have provided early access to premium content for extra charge to our users and launched the premium video-on-demand mode for few movies in addition to the S-diamond Membership [Foreign Speech], a premium membership package with plenty of privileges and high charges was well received by a part of our users since launch. Looking ahead to the rest of the year, we expect there might be some uncertainties on our membership trend due to our recent pricing adjustment. As you may know, we just launched our new subscription pricing plan, which was effective on November 13th.

Moving over to advertising, despite all of the recent macro headwinds, the domestic advertising market is recovering while the industry remains under pressure in the second half of the year, we are already seeing some positive signs. The successful launch of our hit content including the Rap of China 2020 [Foreign Speech] The Big Band 2 [Foreign Speech] and all of the new serials in mid-September coupled with a gradual recovery of advertisers confidence during the third quarter. Both our brand ads and the performance ads rebounded compared with the second quarter. Our brand ads revenue recorded sequential increase for two consecutive periods. The sequential growth during the third quarter was mainly attributable to the increase in the number of advertisers. In terms of industry, the revenue increase was mainly from food and beverage, online kits and transportation, besides allocation on consumer electronics recovered faster sequentially.

During the quarter, we continued to innovate the advertising campaigns with theaters which have packed new ideas and provided content for advertising of shorter serials. So far we have already attracted Volkswagen and Yili and over 30 other advertisers have also tried. As a result, Mist Theater has generated decent advertising revenue in addition to word-of-mouth buzz. In the future, we plan to launch more theaters in categories such as romance and comedy, providing advertisers more prices.

Moving on to the content. During the quarter, we accurately identified our users' demand for entertainment products in pandemic and during the summer vacation and released a number of hit dramas, variety shows, and animations with innovative scheduling. We are trying to establish our self-funded content vertical. The Mist Theater was our first of trial and achieved phenomenal effect. We will continue to launch other different self-funded content verticals in the coming quarters. We believe our self-funded content verticals can increase our users' stickiness to our platform rather than just through single-handle.

As mentioned, under the Mist Theater banner, we have released a total of five high-quality short suspense dramas, namely Kidnapping Game, [Foreign Speech], The Bad Kids [Foreign Speech], Crimson River [Foreign Speech]; Sisyphus [Foreign Speech], The Long Night, [Foreign Speech]. Because of its high quality and widespread popularity, Mist Theater has strong global attention. Recently The Bad Kids became the first Chinese drama serial to win the best creative award in the second Asia Contents Awards in the 2020 Busan International Film Festival.

In addition, Reunion: The Sound of the Providence Season 2 rapidly broke the 9,500 mark on our content popularity in that after its exclusive launch on our platform. Meanwhile, we also released a number of dramas that feature of female personal growth story including Love Yourself, [Foreign Speech]; My Unicorn Girl [Foreign Speech]; and Love is Sweet, [Foreign Speech] to cater the demand of female user group who are contributing most on drama viewing. Besides, another of our original drama, The Thunder, [Foreign Speech] has recently been honored Outstanding Television Series at the 30th China TV Golden Eagle Award [Foreign Speech] and the 26th Shanghai TV Festival, Magnolia Awards [Foreign Speech].

For our original varieties such as The Big Band Season 2, The Rap of China 2020 and Mr. Housework Season 2, [Foreign Speech] performed nicely during the quarter, also shows catering the diversified user group such as Summer Surf Shop [Foreign Speech] for athletic people, Dear Little Desk [Foreign Speech] for parents and Let's Party [Foreign Speech] for fans of go out all the night were also well received during the quarter. In addition, our self-produced animation including Are You OK, [Foreign Speech] Deer Squad [Foreign Speech] were released during the quarter and became quite popular among ACT fans and children.

For the fourth [Phonetic] quarter, we plan to release more high-quality dramas, including My Best Friend's Story, Dear Missy, Spirit Realm and The Duke of Mount Deer [Foreign Speech] upcoming key variety shows including HAHAHAHAHA, FOURTRY Season 2, Qipa Talk Season 7, [Foreign Speech] and Dimension Nova [Foreign Speech].

In conclusion, despite the unprecedented, volatile and difficult situation we and many others are facing, we have made a considerable progress with a variety of operational initiative, Our Mist Theater has been a success. In the future, we will continue to innovate and develop new production and operational strategies in planning our business to achieve sustainable growth over the long-term.

With that, I will turn it over to Xiaodong to talk about our financials.

Xiaodong Wang - Chief Financial Officer

Good morning, everyone. Let me review our key financial highlights for the September quarter. Total revenue reached RMB7.2 billion. Membership business continued to be our largest business with revenue up 7% year-over-year, accounting for 55% of our total revenue. Our advertising business recorded notable rebound with 16% increase on a Q-over-Q basis. Our cost of revenue decreased 22% year-on-year, mainly due to 24% year-over-year decline of the content cost. SG&A expenses were only up 1% year-over-year. As a result, our operating loss margin narrowed to 17% from 38% in the same period last year. As of September 30, 2020, the company had cash, cash equivalents, restricted cash and short-term investment of RMB7.4 billion. For detailed financial data, please refer to our press release on our website.

For the first quarter of 2020, we expect total revenue to be between RMB7.28 billion and RMB7.73 billion, a 3% increase - decrease to a 3% increase year-over-year. This forecast reflects iQIYI's current and preliminary view, subject to changes.

I will now open the floor for Q&A.

Lei Zhang - Investor Relations Director

Operator, I think we can open the floor for the Q&A.

Question & Answers

Operator

Thank you. Ladies and gentlemen, we will now begin the question-and-answer session. [Operator Instructions] Your first question comes from Eddie Leung from Bank of America Merrill Lynch. Please ask your question.

Eddie Leung - Bank of America Merrill Lynch - Analyst

[Foreign Speech] Good morning. So my question is about what Dr. Gong just mentioned about the potential uncertainty in the subscriber number after the price hike. So just wondering if you could add some color on that. Whether we are seeing some weakness in the subscriber growth after the price hike. [Foreign Speech]

Yu Gong - Founder, Chief Executive Officer and Director

[Foreign Speech] As our new pricing plan was effected on November 13 and this time the pricing plan was targeted to the Android terminal, meaning that we increased Android terminal price balanced to the iPhone or iOs terminals that the monthly subscription fee has increased from RMB19.8 per month to RMB25 per month and auto renewable monthly fee was - come from RMB50 per month to the RMB90 per month. Now it's only four days that we - since we launched our new pricing plan and meaning that last Friday and Saturday and Sunday that we had three days of the data. It is not long, but so far, all the data shows not much of the change on the new subscriber increasing and - but the single fee for the new subscribers of course has increased. And there is not much of time so that we cannot say that so far whether it is positive or negative, but based on the experience from our analysis before and also our peers' experience, we will see that maybe there will be some negative impact in the coming one or two quarters, but overall, in long-term speaking, we think the negative impact will vanish and the user behavior will come back to normal. Thank you.

[Foreign Speech] One point added that we all know that the main motivation the user has, to attract them to subscribe, is the exclusive premium content, which is that based on our strong original content production abilities. So if you're looking at our pipeline forward, our pipeline is quite rich. So we do believe that our rich pipeline of exclusive content release will definitely - to help us to mitigate of our - that negative of the new pricing plan. In the long-term and mid-term speaking, that our subscriber trend will back to normal. Thank you.

Eddie Leung - Bank of America Merrill Lynch - Analyst

[Foreign Speech] Thank you.

Lei Zhang - Investor Relations Director

Next question please.

Operator

Thank you. Once again, please state your questions in Chinese first, then translate your questions to English. Your next question comes from Yiwen Zhang from Citi. Please ask your question.

Yiwen Zhang - Citigroup - Analyst

[Foreign Speech] So I will translate into English. I am asking on behalf of Alicia. So the question is also regarding subscription price hike. So noticed dot-com previously told about the rationale behind the RMB19.8 [Phonetic] price set nine years ago. So can you talk about the rationale behind the 25% of rise of the new price? And then in the future, when we do the periodical review of the price, what factors will you consider? Thank you.

Yu Gong - Founder, Chief Executive Officer and Director

[Foreign Speech]

Lei Zhang - Investor Relations Director

Thank you for the question. And Mr. Gong thinks that it's more appropriate to - for Mr. Xianghua who is in charge of our membership business will answer the question. Thank you.

Xianghua Yang - Senior Vice President

[Foreign Speech] The evidence that we collected for this new pricing adjustment plan is based on the first days of the users read we launched and we executed. Actually we executed this users read from the second half of 2018 that we collected data on the user behavior and user income - the income chat and also the acceptance of the new pricing. And based on this, we think the new price of the auto renewal from the RMB15 to the RMB19 per month would be quite reasonable. Thank you.

Yiwen Zhang - Citigroup - Analyst

[Foreign Speech]

Lei Zhang - Investor Relations Director

Next question please.

Operator

Thank you. Your next question comes from Thomas Chong from Jefferies. Please ask your question.

Thomas Chong - Jefferies LLC - Analyst

Hi, good morning. Thank you management for taking my questions. My question is about the advertising outlook. Can management comment about how we should think about the trend coming into 2021? And also with regard to any special events that we need to pay attention for next year? Thank you. [Foreign Speech]

Yu Gong - Founder, Chief Executive Officer and Director

[Foreign Speech] Yes. I think that for this year, our brand advertisement, which is our main driver for advertising business, was quite a significant impact by the pandemic. Of course for next year, we think along with the pandemic largely under control globally, the outlook of the next year would much better than this year. But based on this year, it's really abnormal and unprecedented. So it's like of the systematic patterns that we can trace from this year's experience. So it will take more time for us to give the more accurate prediction of the next year.

[Foreign Speech] So we will think about the four factors that drive our business. The first one is definitely that our original content production abilities that for the next year and more the future that we will focus on the drama series production, variety show and animation including adult - animation for adult and animation for kids and also the movies. The movies we talk about is not only Internet movies, but also the theatrical movies, which the budget is higher. And also that how to drive the development of the content production ability that we are going to take measures into increase our self-studio productionality and numbers. We also will improve our cooperation with our content partners. And secondly that we will invest more on the technology and execute it, apply the new technology on the content distribution and also the content production. We will leverage the 5G artificial intelligence and even the blockchain technologies into our content production and distribution process.

And third one is that we definitely will develop and invest more on our mid-form video platform Suike. After one year trial of the Suike, we find out the business position of our Suike platform that it is that we will build a video interested community for the video creators and fans that a few weeks before that we have held a Suike event that gathered around the creators and the fans. That was quite received very well by our fans and customers. That also further strengthens our confidence to build up video interest community.

And the fourth one is definitely that we would develop our overseas business and that the content for overseas business is definitely to be focused on the Asian oriented content, including that the Chinese content and Korean content and the Japanese content and so on. And the overseas business will base on the Asian - South Asian - Southeast Asian and maybe it's more globally. And certain for our overseas membership that - to be emphasized the membership - the subscriber numbers we announced does not include our spot members, but definitely includes our business overseas members. The overseas members is not as much as to mention as compared to our domestic members number. It is less than 1% of our overall subscriber numbers, but all of our overseas subscription members come from organic growth and just driven by our Asian oriented content we released. And we think that it is our approach to drive these subscribers organically and not - unlike our peers to improve the subscriber numbers and take the aggressive and extreme members such as acquisition just to increase the subscriber numbers quite rapidly. Thank you.

Lei Zhang - Investor Relations Director

Next question please.

Operator

Once again, please state your questions in Chinese first and in English. Your next question comes from Gary Yu from Morgan Stanley. Please ask your question.

Gary Yu - Morgan Stanley & Co. - Analyst

[Foreign Speech] I have two questions. The first question is related to competition. So after our recent announcement of price changes, do we expect our competitors or other players in the market to [Technical Issues] and how should we look at membership business market share for [Technical Issues]?

And the second question is related to recent announcement of Baidu on acquisition of YY domestic business and how should we look at the potential synergy with iQIYI business? Thank you.

Yu Gong - Founder, Chief Executive Officer and Director

[Foreign Speech] For the pricing plan of peers, that we don't know. We have no idea about your - plans about their pricing plan, and - but that we are also not in the position to provide any predictions on other peers, on their plans. And - but based on the overview of the whole industry, clearly, as I mentioned from our last earnings call, that after nine years, the price - the subscription fee, there is a big gap between the content supply cost and the subscription fee in China. So we think that is quite unreasonable to keep the situation as it used to be. So looking at the overall industry, we think that the adjusted pricing plan is quite reasonable for our business.

And for the second question that regarding the business acquisition from Baidu, we think that the YY business is quite different from our business, from its nature, so that it has no direct or significant influence to - on iQIYI. Thank you.

Lei Zhang - Investor Relations Director

Next question please.

Operator

Thank you. Your next question comes from Alex Xie from Credit Suisse. Please ask your question.

Alex Xie - Credit Suisse - Analyst

[Foreign Speech] Thank you management for taking my questions. My first question will be about content cost. So the content cost just decreased quarter-on-quarter. What's your view on the outlook of content cost in the next few quarters?

And the second question is about the Mist Theater. So you mentioned the Mist Theater's series received quite good feedback from customers. So what's the impact on the subscriber growth for the Mist Theater and how do you compare the ROI of Mist Theater's original content and original variety shows? Thank you.

Yu Gong - Founder, Chief Executive Officer and Director

[Foreign Speech] So there are two reasons behind the content cost decreasing for the recent one or two quarters. The first one is definitely that the content release delay caused by the, first, pandemic influence and the second one is lead time for the regulation audit. So the second one is that the titles we purchased only at the high end on the first half of 2018 are gradually released that from the 2018 and second half of the 2019 and even the first half of this year. So after that, the gradual release on the high price of the titles and that the content cost also gradually decreased from this year. In long-term speaking, we don't think that it will be sharp decrease on the content cost, but it may have the fluctuation for the content cost-wise. Thank you.

[Foreign Speech] Our Mist Theater consists of five theaters of 12-episode short dramas. Why is it called short? You have to look at the experience of our old television period of the drama series. It used to be long episodes, meaning the average episode for each title comes - increased from 38 to 45 per title. It is because the first - the television, their revenue was driven by advertising, the advertising driven by the user time. So the longer theaters are, the television stations will derive more money. And of course, the content producers, they are also intentionally to produce drama to be longer to also earn more money because of their trading pattern is based on the cost per episode. The more episode they produce, the more they earn.

That is quite different for the Internet platforms like us. So we are keen on the subscription business. That's our main driver, and more attractive to our users is our content and we derive our subscription mantle from the user attraction and the stickiness. Also considering the tight schedule of the modern people, they have less time on entertainment and they may much more favor on the short drama. It's maybe only 12 episodes for this month, they verify and attracted by the one title and the next month, they will find a new drama title that they are - that is quite interesting to them. They will also keep the subscription, their subscription service on. So that is the main driver for us. And so if we will develop more short dramas, then - with the total cost is quite low, but with quite - much better ROI that is very wise strategy for us. So we definitely will produce more short dramas.

Alex Xie - Credit Suisse - Analyst

Got it. Thank you.

Lei Zhang - Investor Relations Director

Next question, please.

Operator

Your next question comes from Zhijing Liu from UBS. Please ask your question.

Zhijing Liu - UBS - Analyst

[Foreign Speech] My question is as we see that the Focus Media has seen some very good recovery in the past two quarters, so can we see that advertising - applying the advertising is still very attractive for many other titles? Thank you.

Yu Gong - Founder, Chief Executive Officer and Director

[Foreign Speech] As for the brand advertising method for the domestic Internet platform, the first one is content target, that the advertising is targeted to the one single-specific content. Because of the pandemic, the content released - some of the content release were delayed and definitely that influenced our - the brand advertising. And also another one is auto-distributed, but considering that the content delay is quite recovering after the pandemic is controlled and also that our advertising supply is quite advertent, so it's that we keep very positive on the chance and outlook for our brand advertising. Thank you.

Zhijing Liu - UBS - Analyst

Thank you.

Lei Zhang - Investor Relations Director

Next question please.

Operator

Your next question comes from Bo Pei from Oppenheimer. Please ask your question.

Bo Pei - Oppenheimer & Co. Inc. - Analyst

[Foreign Speech] I will translate for myself. So first question on the short video platform. We noticed there are many people watching dramas and movies on short video platforms now. And I was just wondering what is the net impact on us, because on one side they serve as a promotional channel, but on the other side, they actually attract some potential paying users for us. And then so on a net basis, is this impact good or bad for us? And is there any licensing views or how do we handle the copyright on short video platforms?

And then the second question is about our theater model. So in the long-term, what percentage of dramas can come from this theater models? And then does that mean, if we achieve this percentage does mean we can further lower our content cost given the total number of episodes will decrease? Thank you very much.

Yu Gong - Founder, Chief Executive Officer and Director

[Foreign Speech] There is a lot of clicks of the long form videos on the short video platform. It has a huge negative impact on the long form video platform. We are imposing that legal actions and negotiations with short form videos. And also there is - yes, there are some positive impact on the - such after attracting new users that - like you said, but overall we think that the negative impacts definitely surpass the positive ones. Thank you.

[Foreign Speech] After saying about very good things about the short episode dramas, I want to talk about advantages of the theaters. Normally after a title is fully released, the audience passion will also go away with that. But with the theater, as to our paying users, our audience will keep more on the theater and the users accumulated and was to attracted and stick to the theater, but not to just a single title. In another word, they will stick to our platform instead. So that we will see that the theater definitely is a very good way for us to maintain our paying users. In the future, I think that roughly speaking, we may have half and half between the short episode dramas to long dramas. And of course, the viewing time of the long dramas will be longer. So we are seeing that right now that the average viewing times per title is dropping down on our platform recently because of the short dramas, but definitely that the short drama is the right way approach to improve both the monetization and user stickiness to our platform. Thank you.

Bo Pei - Oppenheimer & Co. Inc. - Analyst

[Foreign Speech] Thank you.

Lei Zhang - Investor Relations Director

Operator, I think - thank you very much. Operator, I think that's enough for today. No? Okay. It's okay that we don't have another question. That's the last one.

Operator

Thank you. Our final question comes from Binnie Wong from HSBC. Please ask the question.

Binnie Wong - HSBC - Analyst

[Foreign Speech] So I will just quickly translate. So I guess the first question here is that if you look at the content spend, right, Tencent has announced that in the next few years, they are going to step up to RMB100 billion in the next three years versus RMB50 billion in the last few years in terms of content spend. So how does this affect iQIYI's content strategy?

And then in terms of the mix versus like in the split in terms of self-production licensing, how do we see the split now and then what is our optimal structure? Can you remind us that?

And then very lastly is just on the advertising growth. It's still on a double-digit decline, but then if we look at, say, Tencent, right, the media advertising in terms of the magnitude of the decline has nailed down from a double digit in the last several quarters down to only - almost like a flattish type of growth rate, only down like 1%. So I just want to understand, is it just a matter of timing for iQIYI? And then down the road, we should probably able to see a better advertising growth or there is something structural in our advertising business that we should be reminded of? Thank you management.

Yu Gong - Founder, Chief Executive Officer and Director

[Foreign Speech] Talking about the total content spending, it definitely will be our main and the biggest investment in the coming years. If you look at it in the coming three years, you can easily calculate it based on the spending for the our past experiences. So this - today's earnings call is not a new precedent or that we can tell the stories like millions or the billions of the spending. This is not a new story. So I think if you want really a number, please look at the spending for the past few years and it will not much of a big change.

And we will take about the ratio between our original content versus the license content - in the general speaking, we definitely see the trend only increasing our original content. If you take it into - if you talk about the detailed ratios, that is quite different based on the content categories. You look at the variety shows that almost most of content cost goes to the original variety shows on our self-produced ones. And if you look at the drama, if you look at the contract - at the future titles we are about to produce or are producing, that over a half are original content, but if you look at the release time of this year, the licensed content costs are maybe higher. And if you talk about the movies, definitely that - almost all the movies - the theatrical movies or the licensed movies are still take the lead. And for this year, we only launched one self-produced movie and also the quality and investment scale still have differences to the mainstream movies. Thank you.

[Foreign Speech] So we did some internal analysis to that - analysis or research about our advertisers and - versus our peers' advertisers we think is comparable to our business and we see a bit higher or better recovering of our advertiser business. And for the overall industry, we think that the worst time has already passed and definitely this year is quite tough and we think that it will get better. Thank you.

Binnie Wong - HSBC - Analyst

Thank you.

Lei Zhang - Investor Relations Director

Thank you. Operator, I think that is all for us today.

Operator

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Q3 2020

Earnings Transcript

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