Earnings Call Transcript - PERF Q3 2023

Rick Lee, Vice President of IR

Thank you, Andy. Hello, everyone, and welcome to Perfect Corp.'s Q3 Earnings Call. With us today are Ms. Alice Chang, Founder, Chairwoman and Chief Executive Officer; Mr. Louis Chen, our Executive Vice President and Chief Strategy Officer; and Mrs. Iris Chen, VP of Finance and Accounting. You can refer to our third quarter 2023 financial results on our IR website or in the Form of 6-K we filed with the SEC earlier. You can later access a replay of this call on our website after the conclusion of this call. For today's call, management will provide their prepared remarks first. Then we will host a Q&A session. Before we continue, I would like to refer you to our safe harbor statement in our earnings press release, which is prior to this call, but this call may contain forward-looking statements regarding Perfect Corporation's performance, anticipated plans, operational results and objectives. Forward-looking statements are based on management's expectations and are subject to a number of risks and uncertainties that could cause actual results to differ materially from those expressed or implied on our call today. Perfect Corp. undertakes no obligation to update any forward-looking statements, except as required by law after the date of this call. Please note that all numbers stated in the following management's prepared remarks are in U.S. dollar terms, and we will discuss non-IFRS measures today. Without further ado, I will now turn the call to our first speaker today, our CEO, Ms. Alice Chang.

Alice H. Chang, CEO

Hi, everyone. Thank you, Rick. Welcome to Perfect Corp.'s 2023 Third Quarter Earnings Call. We have some exciting news to share today. So let’s get started. In the third quarter of 2023, our growth momentum from Q2 persisted, resulting in a total revenue of $14.5 million. This marked a 13.2% increase in revenue compared to the same period of last year, and a 14.7% increase when compared to the previous quarter. The primary drivers of this quarter were made from our AR/AI cloud solutions for enterprise brands and the subscription services for our mobile beauty app business. We have seen very promising new developments in our AI skincare solutions and the AI hairstyle features, along with other innovative app features powered by Generative AI, which I will elaborate on shortly. For the bottom line, our net income for the third quarter of 2023 was positive, standing at $3.5 million on an adjusted basis. This underscores our commitment to effective cost management while growing top-line revenue. Overall, we are very encouraged by our continued top-line growth and improvement in profitability as a result of our continuous effort to optimize our business in both B2B and B2C. Our strategic development focused on Generative AI has already shown strong demand from both brand customers and consumers. Generative AI unlocks many new possibilities in individual imaging, video, beauty tech, skin tech, and fashion tech. These new use cases will extend our reach into an even bigger total addressable market in a rapidly evolving digital landscape where brands are investing more and more into digital transformation. Perfect is well positioned to help our brand partners with the latest generative AI models in addition to a complete line of beauty tech, skin tech, and fashion tech offerings. Finally, our consistent rollout of a wide range of innovative features driven by AI technology has maintained strong growth of our mobile app subscription business. These new AI features have not only drawn new mobile app installations, but also effectively converted users into premium subscribers. Perfect is ready to capitalize on this new opportunity, and we are positioning ourselves as a leader in AI for both B2B and B2C. Now let’s shift our focus to the operational outcomes of the third quarter and discuss our most recent advancements. In the third quarter, on the B2B side, we secured several sizable renewals and new contracts with beauty brands, some of which included upsell opportunities such as expanding their SKU offerings and extending into additional countries. This renewal not only underscores the growing reliance of these brands on our solutions to meet their evolving needs, but also reaffirms our leadership in the field of color cosmetics, which continues to be a key differentiator and core competence for our company. To that front, we have continued to reinforce our omnichannel strategy through the expansion of strategic alliances with various distribution channels of beauty, skincare, and fashion products to ensure comprehensive coverage of all customer touchpoints. For example, we teamed up with Dufry, a key player in global travel retail, to provide both in-store and web-based virtual trial experiences for 15 Dufry brands in airports across 27 countries worldwide. Additionally, we are very excited to announce our partnership with Walmart, the world’s largest retailer, to initially offer makeup virtual trial experiences for more than 1,400 beauty products in our mobile app. This level of integration is made possible thanks to our existing relationships with over 600 global brands, enabling the effortless distribution of these brands' virtual product offerings across diverse retail platforms. As we look to the future, it is clear that virtual trial technology is becoming essential for all beauty and fashion brands and retailers in engaging with customers and delivering personalized shopping experiences. In the third quarter, a significant highlight was the accelerated penetration of skincare markets. This was marked by a notable increase in new deal flow from the skincare sector. We believe the skincare industry is experiencing a transformational change as it adopts more digital technology to offer consumers user-friendly and results-driven styles. Our AI skincare technology distinguishes itself by delivering unparalleled AI-powered skin analysis that encompasses 14 different skin concerns in real time, providing users with comprehensive and instant feedback on their skin progress. Secondly, we have introduced a new range of subscription plans tailored specifically for small and mid-sized skincare brands. This expanded strategy on skincare enables us to engage with a larger potential customer base. By providing tiered subscription plans, we not only make our skincare technology more accessible but also streamline the sales process, leading to a larger installed base for our AI skincare services. Another new use case we launched in the market is our Generative AI hairstyle solution. We upgraded our AI hairstyle solution by replacing the previous generation AI model with the latest generative AI model, and the results are exceptionally good. The realism of the hairstyle images is now hyper-realistic, and the generative style variations unlock more choices for consumers to visualize hairstyles. We announced our partnership with TRESemmé, a Unilever brand of hair products, to offer AI hairstyle generation for their consumers to try on. The possibilities are ever-expanding. We are also targeting broader hair brand markets. This is a testament to the versatility and broad applicability of our generative AI-powered virtual trial technology, demonstrating its potential to cater to diverse market needs. Another cutting-edge AI innovation we launched in the third quarter is high-quality automated 2D to 3D SKU conversion technology for jewelry and large virtual try-on experiences. This technology can significantly enlarge the number of SKUs our jewelry brand customers can offer on their websites in a cost-effective and 3D way. Now, let’s shift our focus to our B2C mobile beauty app business. We had another strong quarter for our app business, evidenced by a 62.5% year-over-year increase in our mobile app active subscribers to 835,000. This sustained growth shows a testament to the increasing demand and market expansion in the realm of photo, video, and camera applications. With our YouCam app, we are diversifying our product offering and expanding our revenues for monetization to capitalize on the app market expansion trend. We have implemented the following strategies: First, our team created a regional map of premium features for subscribers. We introduced multiple AI-driven premium features through Generative AI, such as AI Avatar, AI Fashion, AI Hairstyle, AI Selfie, and more to come, offering our mobile users a wide range of photo and video beautification and enhancement solutions. We have an active roadmap to include AI in all of our products and services, which will transform the entire industry with the power of beautiful AI. Again, we have strengthened our cross-promotion initiatives across our fleet of mobile apps and actively executed marketing programs to increase app discoverability among new users. This consumer market is very large and growing. More and more global consumers are opting to pay for premium features, and Perfect is focused on gaining more market share in the B2B mobile app business. Third, we have expanded our B2C monetization opportunities by introducing new apps like YouCam AI Pro. This app is a Generative AI tool for image curation and more features from our Gen AI collections. This new app has a robust roadmap to include many of our future Generative AI innovations from Perfect Labs. We have also optimized our mobile app pricing, maintaining our competitiveness while increasing our revenue in several markets. Collectively, these efforts have been instrumental in driving the impressive expansion of our mobile app business. We are committed to sustaining this effort to enhance the visibility and reputation of our YouCam app in the mobile app sector while positioning ourselves favorably for future expansion. In summary, our third quarter was robust, featuring double-digit revenue growth and positive net earnings. Our observations suggest that we are well positioned to meet the revenue growth target we shared in Q2. Consequently, we reaffirm our projected revenue growth for 2023, which is expected to range from 11.5% to 14.5% year-over-year in comparison to 2022. With that, I have now concluded my remarks, and I will be handing the call over to Louis, who will discuss our financial details with you.

Pin-Jen Chen, CFO

Thank you, Alice. Before I go into the details of our financial results, please note that all comparisons are on a year-over-year basis, and that the reporting period is the third quarter of 2023 versus the comparable period in 2022. Now, on top of the IFRS measures, we will also discuss non-IFRS measures to provide greater clarity on the trend in our actual operations. For the third quarter of 2023, the total revenue increased to USD 14.5 million from USD 12.9 million in the same period of last year, representing a year-over-year double-digit growth of 13.2%. Among our revenue sources, AI cloud solution and subscription revenue, which constitute 78.3% of our total revenue, grew by 24.8% to $11.4 million in the third quarter of 2023. This intensive expansion can be attributed to the strong demand for our online virtual trial solutions among brand customers and robust growth in our mobile beauty app subscriptions. In the current quarter, we have successfully renewed contracts with prominent beauty brands, with some renewals offering opportunities to expand SKU offerings and extend deployment to cover more regions. We also acquired several new customers in this quarter, including Walmart. Notably, our mobile beauty app active subscribers surged by 62.5% year-over-year, reaching an all-time high of over 835,000 at the end of the third quarter of 2023. This significant expansion in this quarter reflects the increasing demand for photo and video editing applications and the widespread acclaim of our innovative generative AI features within our fleet of mobile beauty apps. These premium AI features not only span our mobile beauty app user base, but also capture the attention of enterprise users, resulting in a growth synergy between our mobile app and enterprise operations that may bring more revenue streams into our business. Licensing revenue, which is now mostly from traditional offline services, decreased by 13.6% from $3.3 million to $2.8 million, representing 19.5% of our total revenue compared to 25.5% of total revenue in the third quarter of 2022. The lower revenue contribution from licensing aligns with management's expectations and underscores customers' continued elevated interest in online services rather than legacy offline offerings. Our gross profit was USD 11.8 million, while gross margin was 81.2% compared to 85.3% for the same period of last year. This change in gross margin stems from the higher platform fees paid to third-party distribution platforms, Apple and Google, which can be attributed to the company’s expansion of subscriptions for its mobile app business. Compared to the 80.6% gross operating margin for the second quarter of 2023, the third quarter showed a quarter-over-quarter improvement at 81.2%. Total operating expenses increased by 13.3% to $12.7 million from $11.2 million for the same period of last year. To break down operating expenses, total marketing expenses were $6.4 million, representing 44.3% of our total revenue compared to $6.1 million and 47.8% of total revenue during the same period last year. This year-over-year change was primarily due to the increase in marketing and user acquisition costs. Research and development expenses were $3 million, representing 20.9% of total revenue compared to $2.6 million and 19.9% of total revenue during the same period last year. This change resulted from an increase in R&D headcount expenses. General and administrative expenses were $3.2 million, representing 21.8% of total revenue compared to $2.5 million and 19.3% of total revenue during the same period last year. This year-over-year change was primarily due to an increase in public company-related costs. The change in expense categories signifies a major increase in spending, a necessary step for our business team to seek to grow revenue. Looking ahead, we will maintain cautious oversight and implement effective expense control measures to ensure that our spending remains responsible and aligned with our growth objectives. Net income was $3.5 million for the third quarter of 2023 compared to the net income of $1.6 million during the same period of 2022, showing a 126.7% year-over-year increase in our bottom line. Excluding noncash share-based compensation and onetime non-recurring costs associated with our leaseback deal, adjusted net income was $2.7 million for the third quarter of 2023 compared to adjusted net income of $2.3 million in the same period of 2022. Turning to our balance sheet, as of September 30, 2023, our company held $201.3 million in cash and cash equivalents and 6 months time deposits, compared to $198 million as of June 30, 2023, reflecting a $3.3 million or 1.7% quarter-over-quarter increase. The company’s cash position remains sound and healthy. In total, our customer base saw a net increase of 26 new brand clients at the end of last quarter, achieving a total of 627 brand clients with over 678,000 SKUs for makeup, skincare, eyewear, and jewelry products as of September 30, 2023. This quarter, we grew our key customers from 163 at the end of the last quarter to 159. The addition came from our new wins for more beauty and fashion brands, benefiting from our successful penetration into skincare, jewelry, and hair markets in the last quarter. In the third quarter of 2023, our total revenue exhibited strong growth, primarily driven by impressive momentum in our AI, AR cloud solution, and mobile app subscriptions for premium features and AI-powered app, including the newly launched YouCam AI Pro. Furthermore, our unwavering commitment to operational efficiency has led to a noteworthy uptick in our gross profit, showcasing our dedication to maintaining a balance between revenue expansion and profitability. Concurrently, we have continued our investment in talent acquisition and technology innovation. Despite rising operating expenses, our net income remains robust. We firmly believe that our position within the thriving AI industry equips us to seize the opportunities ahead and deliver sustainable value to our shareholders. That concludes my prepared remarks. Operator, please open the call for questions.

Operator, Operator

I will now open or we will now begin the question-and-answer session. Our first question comes from Clarke Jeffries from Piper Sandler.

Clarke Jeffries, Analyst

Louis, you mentioned some renewals with some large customers. I wonder if you could speak to the spending trends in the top 5 customer cohort? I know that was nearly 1/3 of the business last year. Just wanted to get an update on how your spend with the largest customers has changed year-over-year? And then maybe a follow-up is, we've seen pretty promising brand and SKU growth at nearly 30% year-over-year. But brand revenues seem a little bit disconnected from that. Any expectation on whether we could see brand revenue accelerate here over the coming quarters? I know that licensing versus cloud revenue is a dynamic here, but hoping you could comment on any other factors that might play out such that brand and SKU growth would match revenue growth going forward.

Pin-Jen Chen, CFO

Clarke, we have seen the renewals for large customers have been very healthy this year. The majority of large customers have renewed their licenses with us on time. This is a strong testament that they find the functionality and licenses essential to their business. From that perspective, we remain confident about the results for this year and next year as the renewals are mostly for 2023 and 2024. In terms of larger acceleration in the brand business, we think it may come from the potential adoption of new AI innovations such as Generative AI and other beauty tech solutions that we bring to the market. The first half of this year has been particularly challenging for brands looking into additional spending. The good news is they are utilizing their current existing license assets. Their renewal rates and churn rates have been positive. We will remain cautiously optimistic. We have introduced many new solutions, especially in the Generative AI space to the brands, and we look forward to materializing that into better and larger deals for next year. We will encourage brands to onboard more SKUs in additional territories. We believe that in the long term, this investment is going to pay off and accelerate our revenue once there’s a massive scale of use across all touchpoints, transforming the way users shop online forever.

Operator, Operator

Our next question comes from Timothy Zhao from Goldman Sachs.

Timothy Zhao, Analyst

Great. Two questions here. One is on your revenue breakdown. I’m wondering if management can share the growth for each segment within the AI solutions, i.e., what the growth rate is like for revenue 2B versus 2C? I think that will be very helpful. Secondly, it seems you reiterated the full-year guidance that revenue will be growing at around 11.5% to 14.5% for this year. Do you have any thoughts on growth rates for next year? Should we expect a faster growth rate? I believe earlier this year, you mentioned there was a delayed sales cycle because of the macro environment. Just wondering how that has changed since then.

Pin-Jen Chen, CFO

We remain confident about our yearly guidance for this year, as we expressed. Everything seems to be moving according to our plan. The macro environment is still challenging to predict for the longer term. We are working internally to better understand each client funnel and how we look into next year. As soon as we have completed this analysis, we will share broader publicly about our view for 2024. If we look at the industry, it’s moving in a positive direction. The digital transformation across all sectors is a non-stop trend. Some categories are going faster than others, while some, such as creating 3D SKUs, take more time to enable more brands and SKUs in a short period. The 2D to 3D conversion is expected to help our industry typically operate. Our goal is to deliver perfection to clients and automatically create more SKUs, which will consequently generate more revenue for us. In terms of segments, we find that the skincare segment is growing across different geographies. Demand for skin tech is relatively stronger compared to others. Of course, Color Cosmetics remains our core competence, contributing a little over half of our revenue. Skincare, after investing in this area for the past few years, is finally showing good momentum for brands of all sizes. B2C, on the other hand, is growing much stronger. We’ve seen our number of active paying subscribers grow year-over-year by over 60%, which is very encouraging. The market has a lot of room for us to grow. We are gaining market share quarter after quarter from competitors. The AI segment is very promising, although it is still relatively small in revenue contribution this quarter. We are constantly looking for new innovations that will generate consumer interest. We are investing significantly in the development of Generative AI, with more than a dozen products launched or coming soon to market.

Operator, Operator

Our next question comes from Camden Levy from Oppenheimer.

Camden Levy, Analyst

Hi. Good morning. This is Camden Levy sitting in for Brian Schwartz. Thinking about 2024 and your go-to-market and sales organization, do you anticipate any adjustments in terms of investment cadence? How should we think about the sales and marketing line heading into next year on the back of the Walmart partnership and the brand opportunities?

Pin-Jen Chen, CFO

For our enterprise sales process, it’s the same Perfect formula we have been using for years. Certainly, the world is adapting, and as more brands start adopting, the sales cycle seems to be improving compared to early this year, which is good news. We are addressing a broader market to enter new verticals like watches and jewelry. Regarding investment, we certainly want to increase our R&D expenses, as that area is very worthy of investment. On the sales and marketing side, we remain cautious. Our global team is capable of delivering and expanding our business in these new categories. Therefore, we are not looking at a significant increase in internal sales and marketing headcount. However, engineering development remains a core competence we need to invest in to create a new roadmap for addressing a broader market in 2024. As mentioned in our remarks, we closely monitor our top-line trends and control our expenses to ensure we deliver positive profitability for our investors and shareholders.

Camden Levy, Analyst

If we consider the emerging industries and verticals that you’re targeting with VTO and beauty tech, if you were to rank your top 3 new categories in terms of growth catalysts, which ones do you think will contribute the most in 2024 and 2025?

Pin-Jen Chen, CFO

Our primary target customers are always the female shoppers. When considering our roadmap and business expansion, we think about the categories where shoppers, especially female, need to try before they buy. This will generate more value. That’s why we began with makeup, and we are now moving into jewelry and watches. In broad terms, I think accessories, apparel, and anything that can be worn will be on our radar. We are cautious not to rush into markets with unfinished products. Whenever we come to market, we want to impress consumers and brands with something they haven't seen before. This belief remains foundational to our approach. We strongly believe in AR commerce, and a significant new area is Generative AI, which offers considerable potential. For example, our hairstyle generation with TRESemmé showcases how we can create real use cases that deliver genuine business benefits to brands by harnessing the power of Generative AI.

Operator, Operator

As there are no further questions at this time, I would like to return the conference to the management for their closing remarks.

Rick Lee, Vice President of IR

Thank you, everyone, for joining our call today. We wish you a good day. Goodbye.

Alice H. Chang, CEO

Thank you.