OneConnect Financial Technology Co Ltd (OCFT) 2020 Q3 法說會逐字稿

Ladies and gentlemen, welcome to OneConnect's Third Quarter 2020 Earnings Conference Call. At this point, I'd like to turn the call to Ms. Patricia Cheng, OneConnect's Head of Investor Relations. Please proceed.

Hello, everyone. Thank you for joining OneConnect's third quarter presentation. Let me start with some housekeeping notes.

First of all, you can download the earnings press release and presentation from the IR website. Second, our remarks today will include forward-looking statements, which involve a number of risks and uncertainties that could cause actual results to differ materially. Any forward-looking statements that we make on this call are based on assumptions as of today, and we undertake no obligation to update these statements except as required under applicable law.

During this call, we may present both IFRS and non-IFRS financial measures. A discussion of the limitations of non-IFRS measures and a reconciliation to IFRS measures is included in the earnings press release.

I'm joined on the call today by our Chairman and CEO, Mr. Ye Wangchun; CFO, Jacky Lo; CEO of SME Banking, Michael Fei; and CEO of Gamma, Ricky Ou. Chairman Ye will make his prepared remarks in Chinese. Translation in English will follow. Chairman Ye, please.

[Interpreted] Hello, everyone. It's great to speak with you again. I am pleased to see the continued progress made in our business in terms of growth, efficiency and profitability. We have achieved over 50% revenue growth alongside margin expansion of over 4 percentage points. Our ability to combine technology with business insights rides at the core of our success. To further sharpen our competitive edge as a test company, we have been introducing more end-to-end solutions. Our suite of products has expanded from front, middle to back office, covering sales, risk as well as operational need of financial institutions.

The latest launch, the cloud services platform allows us to penetrate the infrastructure level, offering all-round support to financial institutions. In short, OneConnect is in a position of strength to guide financial institutions in the journey of digital transformation.

Finally, I would like to share with you 2 milestones we made in the third quarter. Ping An OneConnect Bank officially opened for business on September 29. We are excited about the opportunities of using cutting-edge technology to facilitate the everyday needs of SMEs and individuals. The second was further breakthrough in overseas markets. We have broadened our cooperation with leading banks in Southeast Asia and signed an agreement with Swiss Re in Europe. Our partnership with global leaders is further testament to OneConnect's technological capabilities and unique business model.

We have a clear goal to be a leading TaaS company globally. The potential of the TaaS market is immense. There is a lot more we can do. It's our honor to have you with us on the journey. Thank you for your trust and support.

Thank you, Chairman Ye. Next, our CFO, Jacky Lo, will go through the financial results in more detail. Please go ahead, Jacky.

Thank you, Patricia. Good day, everyone. As Chairman Ye said, the demand for digitalization has been a major driver for the TaaS market, and it's encouraging to see the success of OneConnect reflected in the numbers.

In the third quarter, total revenue grew by 50.7% to CNY 881 million. By customer group, revenue of Ping An Group increased by 105.3% to CNY 491 million or 55.7% of the total revenue.

Operations have performed strongly in the quarter. The newly launched cloud services platform also gave an additional push and temporarily skew the mix. At Lufax, revenue went up by 61.2% to CNY 88 million or 10% of total revenue, largely due to the base effect.

For third-party customers, revenue grew 3.9% in the quarter, and revenue contribution fell to 34.3% from 49.8%, following changes undertaken in the business origination segment. I'll go into a bit more detail on this.

By segment, revenue from business origination fell 38.2% to CNY 130 million. As a percentage of revenue, it dropped to 14.8% from 36%. While there was some temporary slowdown, I can assure you that this is proof of our healthy development. OneConnect has been prioritizing product optimization since our IPO. We have taken the strategic decision to shift away from legacy solutions that do not fit the TaaS focus.

Business origination has been the focal point of our attention. We started a firm-wide review of our entire suite of offerings last year. Those that did not fit our strategy -- strategic goals or meet return requirements have come under review. Our product development team and our sales team work closely together to identify the problems and find the solutions. In some cases, the best solution is to stop offering some products, which is never an easy decision. To execute on change is an even more daunting task. But as a listed company, we need to look at the long term and think heavily about how to establish and run a sustainable and profitable business.

Volatility during any reshuffle is unavoidable. This year also saw the spread of COVID-19. It makes everyone rethink their IT strategy and has been driving long-term demand for cloud-based solutions. We are excited about the opportunities from the digitalization trend. Nonetheless, near-term macro conditions have come under pressure, and the operating environment has become more challenging for financial institutions. Some of the transaction activities suffered as a result.

In addition, the signing of some contracts got held up, but we are gradually getting there. It's fair to say that a combination of internal and external factors has meant that performance of business origination has slowed to a level below our expectations. And during this process, third-party customers have been undoubtedly the most affected. By the way, adjusting for the impact of product optimization, third-party customer revenue growth will be higher than total revenue growth in the first 9 months.

Moving on to segmental breakdown. Operation support was a major driving force in the third quarter. Revenue jumped 126.1% year-over-year to CNY 314 million. It now accounts to 35.7% of revenue, up over 11.9 percentage points. Within the segment, AI customer service is the biggest in terms of both growth rate and size.

Risk management posted a rebound this quarter with revenue up by 3.8% year-over-year. It was a modest increase because of the drop in retail loan volume processed by our solutions, which was about 40% drop. And as you know, also keep the business origination segment. But the softness in retail lending has been offset by SME, and the number of fast claims also continue to improve.

Implementation also did well. Revenue there increased by 87.5%, led by an uptick in core systems. In short, we have successfully built a diversified revenue base that ensures resilience of revenue performance while going through a product review and uncertainty in the macro environment.

We are confident in reiterating our second half guidance. That is we expect our overall revenue growth in the second half of 2020 to be higher than the first half.

Going below the revenue line is where the success of our optimization process becomes more evident. Gross margins increased by 4.1 percentage points to 42.7% year-over-year, benefiting from the change in product mix. Less business origination revenues means less related fees.

Continuous strengthening of existing solutions also allows us to be more efficient in labor costs. Gross profit went up by 66.6% as a result. Gross margins are also better on a quarter-on-quarter basis, up by 4.3 percentage points. At the non-IFRS level, the gain was similar.

Next, I would like to talk about operating expenses. Alongside the review of our products, we have also been reviewing our spending. R&D expenses are still the biggest ticket item. This is core for a technology company. It goes hand in hand with our product upgrade, and it's not something that we will be frugal about. The absolute amount was higher year-over-year, increasing to CNY 296 million from CNY 199 million. As a percentage of revenue, the ratio was 33.5%.

The benefit from operating leverage is even more noticeable in other operating lines. Sales and marketing expenses dropped 20% to CNY 154 million. As a percentage of revenue, it fell to 17.5% from 32.9%.

General and administrative expenses rose 36.2% to CNY 201 million, reflecting the increase in staff costs related to our expansions overseas. I'll return to overseas in a minute. As a percentage of revenue, G&A has improved to 22.7% from 25.2%.

The growth of our business, coupled with cost discipline meant that OneConnect saw a drop in operating loss to CNY 250 million from CNY 305 million. Net loss also narrowed to CNY 243 million from CNY 286 million a year ago. As a percentage of revenue, net loss ratio improved by 21.4 percentage points to 27.6%. Both the net loss amount and net loss ratio went down for all 3 quarters this year.

Needless to say, we also significantly reduced our cash burn. In fact, the drop in net loss will have been even greater if we strip out the impact of Ping An OneConnect Bank, our 100% consolidated virtual bank in Hong Kong. As the bank was in preparation most of the year and only opened officially on September 29, the losses were not meaningful. For both the third quarter and the first 9 months, its losses account for over 10% of our total net loss.

On overseas, we are seeing encouraging signs for new pipeline. As Chairman Ye said earlier, we signed up 2 agreements in the quarter, exporting our solutions in digital financing, digital trade, eKYC and fast claims to regional as well as global financial institutions. We are excited about the opportunities in front of us, not just China. We have firmly made our entry into global TaaS market. This is also why we have been driving hard with business optimization. Nobody has infinite resources. We need to make sure that our resource allocations aligns with our strategic focus. That is to support financial institutions in the journey of digitalization and to strengthen our position as a leading TaaS company. And of course, to continue to deliver on growth and profitability to our shareholders. We are proud of our achievements, and we are confident about keeping all the mid-term targets unchanged.

Thank you for your attention. I'll turn it back over to Patricia.

Thank you, Jacky. We'll now open up for your questions. Our management team are calling in from 2 different locations. So after you ask a question, I'm going to direct it to the relevant member to respond. Operator, please open the line.

(Operator Instructions) Your first question comes from the line of Hans Chung from KeyBanc Capital Markets.

So first question, can you give us more color about the performance in business origination segment, how much impact from low-value product is out versus the caution in lending activities due to the weak macro? And then -- and how should we think about this business line, I mean, in fourth quarter and next year?

And then second question is about just recently, there have been some changes involving in regulation environment. So just -- if possible, can you share with your view about any potential implications to the changing environment to our business or to our customer, particularly on the new regulation on the interest cap or the reason one about the micro loan business?

And last one is about the cost basis. Just want to know what kind of gross margin profile of the business and compared to the corporate average? And how big it could be in terms of the percentage of revenue, let's say, in the next 1 to 2 years?

Yes. Thank you, Hans. Jacky is going to take your first question about business origination, about the impact, and then he can also talk about the margin profile of the cloud business. And then actually, we have our cloud guru, Ricky, on the call as well. And he can give you a bit more color on the business itself. And then finally, Michael will take your question about the regulatory environment. So Jacky first.

Okay. Yes. Hans, thank you for your questions on our business origination. Maybe I'll answer that together with the third parties as well because they go hand in hand basically in this quarter, as I explained during my prepared remarks.

So for the business origination, if you look at the quarter, it went down by about 38% year-over-year. And also for third-party customers, the drop is actually more -- is much higher than that. So -- but for third-party customer, it was offset by the strong double-digit growth in risk management and also the triple-digit growth in our operation support. So overall, we still see revenue growth for our third-party customers, but mainly the drop came from business origination. And there are actually 2 reasons behind the drop.

So first of all, if you look at the external, so we still see the impact from COVID-19. And also if you consider the macro environment together with the regulatory change, so all these transaction activities, actually, they have been affected. So specifically on retail loan volume, our process on our platform, it went down by about 40% year-over-year. So that's the external factor that impact business origination.

And internally, we talk about this extensively on the previous earnings call as well. So started about a year ago, we have been optimizing our product mix, our product offering. So this is a strategic shift away from those low-margin or low-value products or like products that don't really fit into our long-term strategies as a TaaS company. So that came mainly in the business origination business or the customer acquisition. So this is an ongoing exercise.

So -- and also for the last few quarters, we have also put in place margin requirements for products and customers. So for those that do not meet the requirements, we'll direct the resources to other areas. So if you adjust the impact from the product optimization -- so if you look at the first 9 months, overall third party customers' growth was like 24%. But if we adjust the impact from these business origination, the products that we phase out, the growth rate would be actually more than double the debt rate. And also, it will be higher than the total revenue growth rate of 44% in the first 9 months.

And so the impact from this product optimization, particularly on business origination, it has a temporary impact, but it's a necessary change. We feel that it's a more efficient way to allocate our resources to create or achieve a more sustainable, profitable long-term business.

But I encourage you to look at the overall picture. So there's some impact on our business origination revenue growth and also on our third-party revenue growth. But overall, the profitability has improved significantly. So first of all, if you look at gross margin, if you recall, the first quarter, it was about 35%, and into the third quarter, improved to 43%. So it's over an 8 percentage point improvement just from this product optimization.

And in terms of net loss, our first quarter operating margin was negative 71%, and it's actually improved to a negative 28% in the third quarter. So we are just doing this like for the long-term health of the business.

Do you want to talk about the cloud business margin as well?

Okay, yes. Sure. So if you look at the cloud business, in the third quarter, it represented about 15% of our total revenue. For the first 9 months, it was about 7% because the cloud services platform business were only launched in the later part of the second quarter. And so the third quarter was only the full quarter with this -- with revenue from this product line.

And as you know, whenever we have new products, we will provide to the Ping An Group first to address their needs before we export to external customers. And considering the -- or usually, typically for a new product, in the initial years, the gross margin will be lower compared to the overall level. So for cloud solutions platform, since this is relatively new, only in the later second part of the second quarter. So we expect the revenue mix will remain roughly about the same as you see in this quarter next year or in the fourth quarter, it will be roughly about 15% or so. Yes. But gradually, as we -- as the products become more mature, we will export to external parties, external customers. That's the strategy we have been undertaking over the years.

Now over to you, Ricky, about the cloud business itself.

Thank you. This is Ricky. I think for those that kind of read my kind of experience then, I was the leader for the Ping An cloud business at Ping An Tech. So as Jacky mentioned, since 2013, we actually have been developing cloud extensively within the group. And at this point, up to 85% of the core system has been on Ping An cloud. So this product platform has been well tested within the group.

Now as Jacky mentioned, we are moving that part of the capability as part of our overall task. As Chairman Ye mentioned, we aspire to be the leading TaaS provider. And then the inclusion of the cloud platform, then it will -- we will be able to provide a much more end-to-end and full stack solution to our customer. Thank you.

Finally, Michael, can you take a question on regulatory environment?

Sure. Happy to do that. On the regulatory environment, actually, we don't think this is a surprise to -- at least to us, okay? We have seen this kind of trend for the past 12 months or even longer. It has been anticipated. And we have been proactively optimize our business, optimize our product in response to these trends. Again, I think we remain very positive in the mid- to long term. We will see more demand from licensed financial institutions. We will see more demand on digitalization.

OneConnect, again, is very uniquely positioned in the market to provide end-to-end solution to banks to license the financial institutions. So we think, actually, this is a very positive sign for us in the medium to long term. Of course, in the short term, there will be certain impact because, as you know, our fee mechanism is based on transaction, yes? There will be some hit on the transaction volume, so there will be some impact on us. But I think Jacky Lo has already explained that in previous questions. So yes, I don't want to go too much time on -- to repeat that again.

Our next question comes from the line of Carson Lo from HSBC.

So I have 2 questions. So the first one is on -- is about the cloud business. So it seems like our product offering is kind of the infrastructure-related products? Then how about -- what do management saying is our key advantages versus other infrastructure player in the market like the Ali Cloud and Tencent Cloud. So I think -- I think there are more -- so I would like to understand more about the key differentiator or the key advantages in the view of management on this front.

And then the second is about the -- I just want to follow up about the regulatory. So we see that there's an impact on the transaction volume in Q3, right, so around 40% decline in the retail loan volume we processed. So what is the management estimation now that such temporary impact will be normalizing in phase outs? So when we will be the inflection point that we see the OEM is going to pick back up from licensed financial institutions?

Thank you, Carson. Ricky will take your first question, and then Michael will take the second one.

Yes. As related to the cloud, I think, as you mentioned, the other cloud player, I think they're focused on providing a low-cost and large-scale cloud service that are suited for everyone's need. However, for Ping An Cloud, we only focused on the financial sector, as in the financial sector, the requirement will be focused on security, stability and also the know-how in the industry. So as I mentioned earlier, we have been using Ping An Cloud within the group since 2013, as such that we know the regulator's requirement deeply. As such, we could help the other financial institute embarking their digital transformation under the full compliance of the regulator.

Yes. On the second question about the transaction volume, we actually don't disclose the exact transaction volume due to business optimization. But I can share with you that if we've taken out the impact of our product optimization, our third-party revenues actually increased more than double compared with our last year. Our increase of third-party revenue is actually faster than the company's average. I think that gives an indication of the impact from the transaction volume and will remain positive on the fourth quarter. We believe our overall revenue growth and third-party revenue growth will remain positive in the fourth quarter.

Yes, Carson, I'll just add 1 point to what Michael said. So in terms of the retail loan volume, the drop was due to the reasons I explained earlier. So part of it is because we phase out certain products and business origination, but also it's because of the macro environment. And so as the macro environment improves, we believe this will recover. But how that's going to turn out, it remains to be seen. But in terms of like business, the product optimization is an ongoing process as well. So there will be like some fluctuation going forward.

Your next question comes from the line of Alex Yao from JPMorgan.

My first question is regarding the latest regulatory introduction on the micro lenders. Is it fair to say the business model for the micro lenders with the co-lending business model needs to be significantly restructured while the business model for loan facilitator or loan referral will be hardly affected? And can you -- can you guys perhaps talk about your revenue exposure to these 2 business models? And also, given the change in the regulatory environment, what do you expect the change in the general online lending market?

The second question is on the cloud services. Given that you guys are actually building up a cloud service on the Ping An Cloud. Is it fair to say Ping An Cloud is more of IaaS infrastructure cloud while you guys are building up the SaaS services and perhaps other PaaS services on top of the Ping An Cloud? And can you give us like a few example of the key revenue generative cloud service product?

Thank you, Alex. Michael will take the first question, and then Ricky will do the second one.

Yes. I would like Ricky talk first. I need to think about the first question. Ricky will talk about the cloud question first.

Sure. Yes. So as related to the cloud platform services, we will actually increase it for both underlying IaaS service. But however, our focus would be on the PaaS layer. In particular for the PaaS layer, we will be focused on the data platform, the AI platform and the cloud management platform.

Okay. On the first question, the short answer is, yes, we believe there will be change in the business cooperation model between financial institutions and those Internet platform. But as I said earlier, this change, we had been anticipated for actually much longer time. Starting from last year or even earlier, there have been a very clear side that the regulator is pushing forward to reform the current model we have seen in the market. And there's no surprise. And this asset actually also corresponds to the change of the business model or the product optimization of our strategy, of our business. Yes.

So if you look at our business, in particular, and as you know very well that we are a technology service provider, we provide the financial institutions, especially banks with systems, infrastructure as well as tools for them to better assess the risk, for them to better manage their customers, et cetera. So this will actually be a boost to our business model.

Now in the medium to long term, as I said, I think the demand is still there. The economy of China is still growing, and we will still see the online kind of digitalize the business model is a trend. The banks themselves are even actually following this type of model. The banks are also investing heavily to build the platforms themselves or to build online-to-offline business models to develop the business. So again, I think this will change the cooperation between banks and the other Internet platforms, but it will not change the fundamental trend of people going digital.

Your next question comes from the line of Yang Liu from Morgan Stanley.

The first question from my side is also on the cloud service platform. Could you please elaborate more of the business model here? Is it a volume-based or usage-based? Or is this still a transaction-based business model or pricing scheme?

The second question is related with the implementation business. If I remember correctly, implementation, you really generated relatively low gross margin, but we saw a pretty fast increase of the implementation revenue contribution, but also a pretty fast increase of gross margin. Could management elaborate more about the margin profile for implementation in the third quarter or generally in 2020 on the margin profile of this business?

The third question is we saw a pretty big negative impact from the foreign currency translation. So I would like to update in terms of company's strategy on the FX risk going forward. That's pretty much my questions.

Thank you, Yang. The first question goes to Ricky, and then Jacky will take your second and third question.

So as related to the cloud service, I think there's 2 approach. One approach is to augment our existing SaaS capability so that we can provide a full step end-to-end solution to our customer. So that's kind of a sell with the other SaaS capability. The other approach where we're finding is there are major cooperation that's embarked in the journey of digitization, and Ping An has been the early leader for the digitalization and have been well-regarded within the industry for their experience and our leadership. So as such, there are financial institute now looking to us to help them for the full digital transformation. And therefore, we will also provide a full solution around that and cloud would be very much a big part of the basic infrastructure for help them to set up.

Now as related to the fee model, this will be a little bit different from the public cloud as those will be based on usage primarily. But our business model would be primarily based on the value-driven so we will be -- use that as part of the solution to increase the efficiency for the corporation and also lower the cost. So as such that we will extract our fee based on the value generated on that.

On your second question related to gross margin, let me just tell you the overall improvement in gross margin first, like the reasons behind that. So year-over-year, it was improved by 4.1 percentage points. So part of that is actually because the business -- origination business that we have been gradually phased out. So because as I explained in the prepared remarks, less business origination revenue means actually less business origination-related costs. So -- and I think we talked about this before. For business origination, usually, the margin is actually lower than the overall company level as well. So by phasing that out and optimizing our product mix, that helps to improve the overall margin.

And the second is, as you know, implementation is our first level of engagement with our customers. And over the last couple of years, we have launched a lot of new products. But as the products become more standardized and more mature, we are able to shorten the implementation time and therefore lower the labor cost.

So -- and for implementation specifically, I think ever since 2018, quarter-after-quarter, we have seen improvement in the margin. And so implementation right now, it has actually approached the overall company's level just because from standardization and also from a maturity of the products.

But as we launch new products, for example, like this year, the AI consumer service and also the cloud services platform. So that will partially offset the overall margin. But for implementation, I guess, whenever we have new products, that will have some offsetting effect. But overall, because of the full suite of products we launched in prior years, so we have seen the margin for implementation going up quarter after quarter.

And on your questions on foreign currency strategy. So if you look at our perspective, you can see our annual report. Yes, you can see we have entered into actually a currency swap. But on top of that, we actually -- we have -- foresee like the currency, the renminbi will appreciate. So we have actually moved some of our cash offshore back to onshore in the first quarter this year. So -- and you can see, we have actually lowered the amount of cash, like just from the offshore patch onshore loan. That's because we -- that's part of another strategy to actually mitigate the impact from foreign currency fluctuation.

Sure. A quick follow-up on cloud platform business. Origination pricing scheme is based on value generation. Should I assume that the value to the customer is recurring rather than just compare their hardware cost, et cetera, which is still one-off better creation, which is the mainstream of the pricing scheme if we think about the value generation for customers?

Ricky?

Well, I think the case is -- would be different from each customer. Now in general, I think I'll give an example. For example, the data platform that we're offering as part of our platform services. So many companies today have a legacy system. So their data are not sure. The data center are not consistent. And therefore, it will be very difficult for them to form a company-wide kind of data profile and database. And as such that our data platform will be able to grab the necessary data from all the various different systems, consolidate it and be able to cleanse and provide a standard across the different system. And as such that once the data profile is created, then we will be able to develop more value-added capability on top of those data platform. So those would be the value that would be extracted from the system transformation as part.

Now obviously, every company has a different profile, and therefore, the value extracted would be different. So this -- we'll be working on it on a case-by-case basis in terms of helping them on the digital transformation.

Yes. I think probably we may not directly answer your question. I would suggest we arrange a time after the call that we can give you probably more color on the fee mechanism we had on the cloud platform, on the cloud service.

Your next question comes from the line of Ethan Wang from CLSA.

Congratulations for another strong set of quarterly results. I have 3 questions. I know we keep coming back to this cloud service platform, but I just want to make things crystal clear. So are we now offering Ping An Cloud under OneConnect? So are we moving that business under that? Or OneConnect providing some sort of like more application level data management platform at this level of services? I just want to make it clear there.

And maybe Jacky and Ricky have mentioned that before and I missed it. Just wondering the gross margin for the cloud services when we compare that with other revenue. Is it high-margin service? Or is this in the middle? That's my first question.

And my second question is on business origination service. So for the lending-related business origination service, what's our strategy going forward? So are we -- I think -- do we plan to maybe abandon this service, lending-related service completely because it's low-margin as regulation risk and investors keep asking whether we are seeing [can lend] or not. So maybe from the long-term benefit for the company, is it a good idea to abandon that business? Just want to hear management's thoughts on this.

And my third question is on sales and marketing expense. It's a very impressive expense line in this quarter. So we understand there some operating leverage there, but the decrease -- the extent of decrease is still quite large. And so I just want to have some more color on that so we can get a better understanding of the trend going forward?

Thank you, Ethan. Ricky, you are very popular today. So please take the first question on cloud. And then the second one on business origination. Michael, I'm going to pass it to you. And then finally, Jacky is going to talk about sales and marketing expenses.

Yes. As related to our cloud business model, I think the fee structure, right now, we are focused on providing the private cloud installation. So initially, the fee will come in from the deployment of the public cloud. And obviously along with the infrastructure, there will be annual maintenance fee, obviously, associated with that. That's the basic model. However, we will be focusing on, like I said earlier, some of the value-generated capability. So once we will be -- once we are able to help the customer to set up the data platform and AI capability, we will then be able to tie some of their more revenue-generating business along with our capability -- along with our other SaaS capability such that we can drive a more continuous revenue stream out of the customers' business growth in there.

Yes. On the second question of business origination or lending-related business origination, I think the short answer is we will still have this service as a part of our overall solution provided to our customers. If you look at the optimization we have done, we actually have kept those business origination service as a part of the total solution. This is one of our -- actually, our overall strategy, as we explained earlier that we want to provide end-to-end total solution to our customers. And then as a part of the total end-to-end solution, business origination will be a part of the total solution. We will provide that as an additional service; to the systems, we will provide it; to the risk management services, we'll provide it.

What we have phased out -- optimized, are those actually the pure kind of channel business origination type of services, where we have a very, very low margin.

Ethan, on your questions on the cloud margin. So as I explained, this product, we only launched in the later part of the second quarter. So third quarter was the only full quarter we have this business. And so -- and similar to our other products that we launched in the past, the initial stage, usually, the margin will be lower. So right now, for cloud services platform margin is slightly lower than the overall margin level for the company. So -- but this is normal for any new products. And so as we -- as I said, the product becomes more mature then the revenue -- the margin will gradually improve.

Then on your questions on sales and marketing. Yes. So I mean if you look at the third quarter, the percentage of -- as a percentage of revenue, it actually went down quite significantly to 17.5%. And this is actually within our expectation. I mean while we always talk about for our mid-term target, we have a breakeven target. So -- and for all the operating expenses, as a percentage of revenue, they will gradually go down. So this trend is actually within our expectation. And as you point out, part of that actually came from economies of scale. And another reason is for the third quarter, we have -- we see some decline in, for example, marketing expenses. And also, we have been streamlining our operations. And also, we have some initiatives to actually tighter control in terms of cost.

But I think for the fourth quarter, we're going to increase our sales and marketing activities in the last quarter of the year just to solidify the pipeline going into 2021. So we expect there will be some fluctuations quarter-on-quarter for sales and marketing expense. But overall, the trend will continue to improve. As a percentage of revenue, it will go down. That's our mid-term target.

Your next question comes from the line of Elsie Cheng from Goldman Sachs.

I have a few smaller follow-ups. The first question is about the retail lending, SME lending trend, especially on the retail side in terms of the loan volumes. When we think about 4Q, are we still seeing some of the conservativism in our banking partners to give up loans into 4Q on a sequential basis? And then a follow-up to that is now that the SME loan size is of similar size versus retail, what does it mean for our tax fees that's generated from these 2 segments of the business? That's one.

And second question is also about the loan side. The third-party revenue, I think, Jacky, you mentioned that you would have doubled this quarter if we take out this historical legacy products. So going into the 4Q, when we think about the legacy products revenue contribution in 4Q last year, how much roughly that could be and when can we see a wash out of these legacy products impact in overall OCFT's businesses?

And the last one, sorry, smaller ones. The cloud business, I know we talk about value-add and the business model in terms of the charging model. Right now it's categorized as transaction-based. Going forward, just wondering what's the time line to launch it to the third-party customers? And by then, can we expect a subscription model or because of the nature of its financial cloud product, we are still probably looking at the transaction-based monetization method when we launch it to the third-party customers.

Thank you, Elsie. Michael, please address the first one about the retail and SME transaction trend. And then Jacky will take the second one on third-party revenue. And finally, Ricky would elaborate a bit more on the cloud business.

Yes. On the transaction volume, if you look at the SME side, I think we -- I remain positive on the volume in the fourth quarter. You actually see a very good trend quarter-on-quarter, starting from the -- starting from this year. So I think this is also corresponded to the overall macro economy, where the government and the regulators are pushing forward to provide a better financing -- access to financial services for SME companies.

Now on the retail side, I agree with Jacky that there will be short-term fluctuations, especially all those questions you asked about the regulatory trend, especially those new regulations being issued earlier this week, although this has been anticipated. But there will be some banks, they will review their business model, their cooperation with the channels, with the third parties. So yes, in the fourth quarter, I think there's some uncertainties we're still anticipating in the retail volume.

Yes. Elsie, I'll answer your second questions on the third-party revenue trend. So let me just clarify 1 point first. So for the first 9 months of the year, our third-party revenue growth rate was 24%. And we were saying earlier, if we adjust for the impact from all these product optimization, the products that we phase out, the impact, the growth rate for our third-party customers will more than double this 24%. So not just this quarter, but for the first 9 months.

And then -- so -- but as I explained earlier, the product optimization, that's an ongoing exercise. So that will be ongoing impact into the fourth quarter. But right now, we do see some pickup in the pipeline and also sequential improvement in our third-party customers. So we fully expect the third-party growth rate for the fourth quarter versus the third quarter, it will be better.

Your next question comes from line of Daphne Poon from Citi.

I'm sorry Jason, can you please hold it? We still have one more question unanswered. So Ricky, can you talk about cloud?

Yes. Yes. Well, I think subscription model, obviously, would be the optimal model for the cloud services. However, in China, I think most of the financial institute, they remain rather conservative in terms of using cloud service using a subscription model. However, we have been -- had some good success in certain part of the cloud service such as our facial recognition. Majority of our facial recognition revenue is actually based on a subscription usage-based model.

However, for the other deeper infrastructure, like particularly the IaaS layer, I think our customer at the moment still prefer a private installation. So as such that this -- we will go with what the customer needs. And hopefully, we will be leading the market once they're changing their appetite for consuming the service, change to a subscription model, then we are ready to serve.

And now your next question comes...

(inaudible)

Certainly, your next question comes from the line of Daphne Poon from Citi.

So I think just first is the follow-up in terms of the margin outlook. So in this quarter, we do see very meaningful improvement in terms of, I think, both your gross margin and the operating margin. And as you mentioned, it's partially thanks to the product optimization. Just wondering, in terms of sustainability, do you expect like both the gross margin and operating margin continue to improve. And especially, I guess, that when thinking about when you expand your new solutions like to more third-party customers, will that be a jack maybe to your operating margins?

And then second is just a small question regarding the Ping An OneConnect Bank. So you mentioned that it is some meaningful net loss number here. So just wondering whether you have any, I guess, time line in terms of when it will hit breakeven like any internal target. I know it's still very early stage, but yes, anything you can share would be helpful.

Thank you, Daphne. Jacky will take both of the questions.

Daphne, thank you for your questions. First, let me answer the questions on margin, both the gross margin and operating margin trend. So I would like to reaffirm our mid-term guidance. So we talk about for midterm, we want to achieve a gross margin on a non-IFRS basis of 50% to 52%. So that target remains unchanged. And also, we have a mid-term target to breakeven. So also, that remains unchanged. And obviously, I think based on the numbers you have seen today, we are moving into that direction.

And -- but I guess, over the quarter, there will be some quarterly fluctuation. So the overall -- the guidance for mid-term remains unchanged. So for example, gross margin, it will come from -- the expansion will come from continuous product optimization and also from standardization of our more mature products. But that will like -- but also at the same time, we are launching new products in the process, so there will be some offsetting effect, for example, the cloud services platform I talked about. So -- but we fully expect, like it will gradually improve, get to the mid-term target that we set.

And in terms of the operating margin, so we fully expect both -- all the R&D expenses, sales and marketing expenses and also G&A expenses, as a percentage of revenue, they will continue to go down. But obviously, there will be quarterly fluctuation as I explained earlier on the questions regarding sales and marketing. So especially in the fourth quarter, we will ramp up some activities to solidify the pipeline heading to next year.

But for R&D expenses, we expect the ratio will continue to decline. But in absolute dollar amount, it will go up because we are still a very young technology company. We will invest in research and development to actually continue to launch innovative products to ensure we are staying ahead, and we keep our leadership position in the TaaS market.

And for G&A expenses, yes, again, the ratio will go down because of economies of scale. And also, we have been looking at how to optimize our organization structure, improve our efficiency at the same time. So yes, just to wrap up, I mean, we fully expect we'll achieve the mid-term target that we set, that remains unchanged.

And in terms of PAOB, it is only launched pretty much on the last day of this quarter. So it's still a little bit early. But we talked about in terms of net loss impact for both the first 9 months as well as the third quarter, the loss actually make up more than 10% of our total loss. So we are still in an investment stage. But going back to the overall company target. So we have set this mid-term target to breakeven, and that's unchanged. And obviously, the Ping An OneConnect Bank will be part of it.

Yes. Your final question comes from the line of Emerson Chan from Bank of America.

Two questions. My first question is regarding the outlook for next year. How should we think about the trend of top line growth in next year? I wonder whether our growth will accelerate from this year's level, given there should be no profit impact to next year and less impact from the product optimization. And particularly, our implementation revenue was accelerating. So does this suggest a better growth on the recurring revenue going forward? Even normally, it takes some time for customers to ramp up their usage or [transaction]

And lastly, also on the cloud business. I wonder if both our infrastructure and the platform layer will be mainly deployed on private cloud or the public cloud. And how should we look at the long-term gross margin when it is getting more mature, will we also serve the nonfinancial company in the future?

Jacky will take your first question about what outlook and then Ricky will take the final one.

Yes, Emerson, on your question on outlook. So if you look at it, I mean, we talked about this a few times. Like the product optimization is an ongoing process, so it's an ongoing impact as well. We have already seen -- like heading into the fourth quarter, we see some pickup in the pipeline, we see sequential improvement. Yes, but nonetheless, it's an ongoing process. And so we will continue to optimize our product offerings, especially in business origination.

But I think another focus of us, just for this year and also next year, they will be on the premium customers. So we set the mid-term target to get to 1,000 premium customers. So that target also remain unchanged. So our focus for next year will be to improve -- or to continue to increase the number of premium customers and also improve the ARPU from these premium customers. So that remains unchanged.

But in terms of guidance, yes, I think we intend to follow other listed companies in providing guidance. But as you can appreciate, 2020 is an exceptional year. So -- and you see a lot of like listed companies, they have to end up withdrawing their guidance or they have to cut down on the guidance. So right now, we just -- it's a little bit early to talk about like whether we will provide guidance specifically for next year. So we'll just wait and see how the -- especially on the corporate front, how that's going to shape out. And so for the

(technical difficulty)

Ricky, over to you.

Yes. As I said earlier, right now, the financial customer, they will prefer a private installation of the cloud. So that would be much more a private cloud. Even for the private cloud, we will be focused on the more higher value capabilities, such as our cloud management platform, our container platform and our micro services platform.

However, going forward, we would very much like to work with the regulator to provide a dedicated cloud for the financial services so that the smaller banking and insurance institute, they can consume cloud services using a much more industry cloud model as such.

And with final...

Ricky?

My apologies for that, Ms. Cheng.

Yes. Sorry, David. I think this is all the time that we have for Q&A. I think we're going to wrap up here. Thank you, everyone, for joining us today. We look forward to speaking with you again.

That concludes today's conference call. Thank you, everyone, so much for joining. You may now disconnect.

[Portions of this transcript that are marked [Interpreted] were spoken by an interpreter present on the live call.]