Earnings Call Transcript - PERF Q2 2023

Rick Lee, VP of IR

Good morning and good evening, ladies and gentlemen. Thank you for standing by and welcome to Perfect Corp.'s earnings conference call. Please note that today's event is being recorded. I will now turn the conference over to the first speaker for today, Mr. Rick Lee, VP of IR of the company. Please go ahead, sir. Hello, everyone, and welcome to Perfect Corp.'s earnings call. With us today are Ms. Alice Chang, our Founder, Chairwoman, and CEO; Mr. Louis Chen, our EVP and CSO; and Ms. Iris Chen, VP of Finance and Accounting. You can refer to our second quarter 2023 financial results on our IR website or in the Form 6-K we filed with the SEC earlier. You can later access a replay of this call on our IR website shortly after the conclusion of this call. For today's call, management will provide their prepared remarks first, and 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 also applies to this call, as this call may contain forward-looking statements regarding Perfect Corp.'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 statement, except as required by law, after the date of this call. Please note that all numbers stated in the following management prepared remarks are in U.S. dollar terms. And we will discuss non-IFRS measures today.

Alice H. Chang, CEO

Thank you, Rick. Hi, everyone. Welcome to Perfect Corp.'s 2023 Second Quarter Earnings Conference Call. Today, I'm happy to share with you how Perfect Corp., a pioneer in AI and AR solutions for beauty and fashion, is driving innovation and shaping the future for beauty tech, skin tech, and fashion tech. For the second quarter of 2023, we generated $12.7 million in total revenue, representing year-over-year growth of 11.9%. The double-digit growth mainly comes from our AR/AI cloud solutions and mobile beauty app subscription services. In addition, we managed to improve our net income on an adjusted basis to $1.1 million in the second quarter of 2023 from $0.6 million in the same period of 2022, reflecting a margin of improvement of 2.7%. Perfect Corp. has been an AI pioneer since its inception, utilizing AI and machine learning in 2015 for real-time makeup virtual try-ons. With over 50% of our R&D developers specializing in AI, we continuously harness the latest AI advancements to push the boundaries of beauty and fashion. Over the years, we have expanded our AI applications, including face shape detection for foundation matching, real-time live hair color virtual try-ons, advanced selfie skincare diagnosis using AI deep learning models, and the incorporation of AI GAN technology for various video effects. In the second half of 2022, we introduced generative AI to beauty tech, such as AI avatars, which allow each user to create his or her own digital twin. Now in 2023, we proudly unveil our range of innovative generative AI products, including AI fashion, AI hairstyles, and more to come. At Perfect, we are committed to utilizing the most advanced AI and AR technologies and providing continuous support to our three key growth pillars: beauty tech, skin tech, and fashion tech. By harnessing this cutting-edge technology, we aim to enhance and further develop our capabilities in these domains. Our AI advances are not only leading to more collaborations with brands and enthusiasts in beauty and fashion but are also positioning us for future success and revenue growth. This is especially true with generative AI, where the combination of human creativity and AI allows us to develop products and experiences that captivate our customers. It sets us apart from competitors and serves as the driving force for sustained financial growth in the long run. Now let me turn to our operational results for the second quarter and explain how our focus on AI has contributed to our growth. On the brand side, we have observed encouraging signs of improvements in product demand. It is evident through stable renewals, growth in key customers, and increases in our innovative projects, particularly those involving generative AI. Recently, we participated in the VivaTech conference in Paris and hosted our fifth annual global beauty and fashion tech forum in New York. These events serve as platforms for us to unveil and showcase our latest advances in beauty tech, skin tech, and fashion tech, as well as the creative usage model of generative AI across the board. Several brand groups have shown high interest in our pilot programs using generative AI for new collaborations. On the other hand, our mobile beauty apps have sustained their impressive growth momentum since the first quarter. This is due to the introduction of various premium add-on features powered by generative AI, such as AI avatars and AI fashion. AI fashion is our latest innovation, which enables users to explore different fashion styles, outfits, and hairstyles through AI-generated images, which we just introduced in our mobile beauty apps, with a very high engagement rate. On the technological development front, in addition to the new features powered by generative AI, Perfect has also been working on enhancing our virtual try-ons for jewelry and watches, especially with multiple-product acting capability. Now we can combine rings, bracelets, and watches for virtual try-on at the same time, along with the makeup virtual try-on to create a complete virtual look in real-time. This would allow consumers to try on different makeup products and accessories together to see how they complement each other, helping them visualize a complete look. This is unique in the market. For brands, this powerful tool will allow cross-sell and build customer loyalty. Furthermore, to accelerate the adoption of virtual try-on technology for fashion and jewelry, Perfect announced in June the world’s first 3D VTO open format with the release of a comprehensive white paper on a new open-standard .vto file format. The new format is designed to establish a standardized and simplified process for integrating third-party 3D objects into our virtual try-on platform. In addition, we also launched a 2D-to-3D SKU creation tool for jewelry. This tool can convert a 2D product image into a simplified 3D asset for virtual try-on. Both initiatives aim to expedite market adoption for jewelry virtual try-on. We will significantly reduce the time and costs required for brands to integrate their products into our platform. This breakthrough has the potential to revolutionize the fashion industry by enabling ready integration of virtual try-on experiences benefiting both brands and consumers. On the business development front, we have made significant progress in expanding our presence in the skincare market. Our diligent business development efforts have resulted in notable progress. Specifically, during the second quarter, we acquired over 10 new skincare clients across various business segments, including pharma brands and beauty clinics, in different regions, including the United States, Pan-Asia, and the Middle East. This demonstrates our strategy in penetrating key growth markets and establishing partnerships with skincare verticals. At the same pace, we have successfully introduced additional premium add-on features in our mobile beauty apps by incorporating advanced generative AI technology into our offerings. This initiative has allowed us to attract a great number of engaged mobile app users, resulting in incremental subscription revenue. On the client success front in the second quarter, we have worked with several prestige brands to expand their existing VTO offerings in new cases. For example, Dior recently launched its new online and remote one-to-one consultation service to complement its existing digital beauty footprint. This showcased that virtual try-on experience is multichannel, and we expect that newer use cases will start adopting virtual try-on as a key experience in digital beauty. Another good example is TRESemmé, which is a prominent Unilever hair care brand. It recently introduced an exciting feature on its U.S. website: an AI hairstyle virtual try-on. This innovative tool empowers consumers to explore and visualize different hairstyles before making a commitment to a hair makeover. By leveraging our AI technology, TRESemmé aims to provide a more engaging and personalized experience for its customers. This interactive and user-friendly AI tool enables individuals to make more informed decisions about their desired hair transformations, eliminating any uncertainty that may arise when considering a new hairstyle. In addition, we also helped a well-known European luxury fashion brand launch its first-ever comprehensive virtual try-on services for makeup, nail polish, nail stickers, bracelets, and watches. At the same time, the largest luxury group in Europe also rolled out its jewelry VTO on its website in the second quarter. Lastly, the world's largest e-commerce company has chosen Perfect to launch its VTO features for its nail brands on its shopping app. This innovative collaboration aims to revolutionize the way consumers shop for nail and jewelry products. The introduction of virtual try-on services for beauty and fashion jewelry highlights a significant shift in the industry. It indicates that virtual try-on has now become an essential requirement for brands to stay relevant in consumers' digital journey over time. Consumers increasingly expect the ability to visualize how makeup and accessories will look before making any purchase, and virtual try-ons fulfill that demand. Perfect Corp, as a pioneering force, is leading the market to provide AI-driven virtual try-on solutions across all categories. With a steadfast commitment to innovations and cutting-edge technology, Perfect has been instrumental in revolutionizing the beauty and fashion industry to enhance consumer engagement and the consumer purchasing journey. In summary, we had a good second quarter with double-digit revenue growth. As we look forward to the full year 2023, we estimate a year-over-year total revenue growth ranging from 11.5% to 14.5% compared to 2022. Throughout this journey, our teams will diligently monitor and assess key performance indicators to ensure we stay on track with our objectives. Perfect is well positioned to benefit from the megatrend of digital transformation in beauty and fashion. Together with the new wave of innovation created by generative AI technology, we will continue to propel the growth of both our brand SaaS business as well as our mobile app consumer subscription business.

Pin-Jen Chen, CFO

Thank you, Alice. Before I go into the detail of our financial results, please note that all comparisons are on a year-over-year basis; and that the reporting period is the second quarter of 2023 versus the comparable period of 2022; and that, on top of the IFRS measures, we will also discuss non-IFRS measures to provide greater clarity on the trends in our actual operations. For the second quarter of 2023, our total revenue increased from USD 11.3 million in the same period last year to USD 12.7 million, representing a year-over-year growth of 11.9%. Our AR and AI cloud solution and subscription revenue, which now contributes 86.7% of our total revenue, grew by 16.3% year-over-year, showing strong growth momentum in our core business. Meanwhile, licensing revenue for physical stores, which now accounted for 10.9% of our total revenue, increased by 6.2%. This trend aligns with our continuous focus on prioritizing online services and underscores customer inclinations to directly source into our AR cloud solutions and subscriptions. Regarding customer order extension and acquisition trends during the second quarter, the renewal rate for existing subscriptions has remained strong and healthy, demonstrating continued customer engagement with our platforms. Additionally, as the macro economy showed signs of recovery, our effort in acquiring new customers has shown improvements. We remain cautiously optimistic about the long-term growth potential that they bring to our business. Among our revenue sources, AR/AI cloud solution and subscription revenue grew by 16.3% to USD 11 million, representing 86.7% of our total revenue in the second quarter of 2023, mainly due to solid demand for our online virtual try-on solutions for brand customers and robust growth in our mobile beauty app subscriptions. Our mobile beauty app active subscribers have surged by 63.3% year-over-year, reaching a historical high of over 777,000 by the end of the second quarter of 2023. This remarkable growth shows the strong demand for innovative features powered by generative AI in our suite of mobile beauty apps and highlights the strong momentum we have generated in the market. Licensing revenue, which is mostly generated from our traditional offline services, increased by 6.2% to USD 1.4 million, representing 10.9% of our total revenue compared to 11.5% of total revenue in the second quarter of 2022. This reflects brand customers' continuous elevated interest in online services other than traditional physical store deployments. Our licensing revenue seems to stabilize at the current level. AR/AI cloud solution and subscription revenue showed strong growth momentum in this quarter. This trend aligns with management's continuous strategy to prioritize new cloud-based subscription services and demonstrates the significant role that generative AI plays in driving business growth. As generative AI technology regularly evolves, we expect to see even more creative and advanced applications to further drive our revenue growth. Gross profit was USD 10.2 million, while gross margin was 80.6% compared to 85.8% for the same period last year. The change in gross margin was due to an increase in the cost of goods sold, which was driven by the growth in the company's mobile beauty app subscription. This surge in subscription led to higher platform fees paid to third-party digital distribution platforms, namely Apple and Google. Compared with a 78.8% gross margin for the first quarter of 2023, the second quarter was 80.6%, demonstrating a quarter-over-quarter improvement. Total operating expenses increased 12.5% to USD 12.3 million from USD 11 million for the same period last year. To break down operating expenses, sales and marketing expenses were USD 6.6 million, representing 51.7% of our total revenue, compared to $6.1 million and 53.6% of total revenue during the same period last year. The 7.9% year-over-year changes were primarily due to an increase in promotion and user acquisition expenses. Research and development expenses were USD 2.8 million, representing 21.8% of total revenue, compared to USD 2.6 million and 23.3% of total revenue during the same period last year. General and administrative expenses were USD 3 million, representing 23.8% of total revenue, compared to $2.2 million and 19.8% of total revenue during the same period last year. The 34.3% year-over-year changes were primarily due to an increase in public company-related costs. The change in expense category reflects a moderate increase in spending while our core business is growing. Moving forward, we will carefully monitor and control our expenses to ensure responsible spending practices. Net loss was USD 0.2 million for the second quarter of 2023 compared to a net income of USD 27.4 million during the same period of 2022, mainly due to the $28.4 million adjustment in non-cash valuation gain on financial liabilities at fair value through profit or loss in the second quarter of 2022. Excluding non-cash share-based compensation, foreign exchange impacts, and one-time nonrecurring costs associated with our de-SPAC deal, adjusted net income was USD 1.1 million for the second quarter of 2023 compared to adjusted net income of USD 0.6 million in the same period of 2022. Turning to our balance sheet. As of June 30, 2023, our company held USD 198 million in cash and cash equivalents and time deposits of six months or longer, compared to USD 196.1 million as of March 31, 2023, reflecting a USD 1.9 million or 0.9% quarter-over-quarter increase. The company's cash position remains healthy. In total, our customer base had a net increase of 76 new brand clients since the end of the last quarter, achieving a total of 601 brand customers with over 655,000 SKUs for makeup, skincare, eyewear, and jewelry products as of June 30, 2023. In this quarter, we grew our key customers to 163 from 158 at the end of the last quarter. The new acquisition came from the improvement in our sales cycles, with larger funnels and increased inbound leads brought by the recovery in market conditions. In the second quarter, our revenue saw strong momentum due to the continued demand for our online AI cloud solutions and subscriptions, as well as the rapid increase in our mobile app subscribers. Concurrently, we effectively managed our expenditures to ensure profitability while achieving revenue growth. A stable renewal rate of existing subscriptions, diligent cost control measures, and a healthy cash position further reinforce our unwavering confidence in growing our revenue in the long term. That concludes my prepared remarks. Operator, let's open up for calls for questions.

Operator, Operator

We have a question from Timothy Zhao from Goldman.

Timothy Zhao, Analyst

I think I have a question about your full-year revenue guidance. I think the guidance is quite helpful, which implies the revenue growth in the second half to be close to 20% year-on-year compared to single-digit growth in the first half. I was wondering if management could further elaborate on the drivers behind the revenue acceleration into the second half. And then also, a related question is that I noticed the brand customers actually increased quite a lot in the second quarter to over 600 in June, but it seems that revenue growth and contract liability growth lagged behind a little bit. Wondering if you could help us understand what is the customer paying behavior of those newly acquired customers and when we can see more revenue contribution from these new customers.

Pin-Jen Chen, CFO

Thank you, Timothy. Yes, we have seen certainly more demand for the brand customers. As we have seen, typically when the customer starts to join our platforms, initially they will start with more reasonable orders. Over time, we grow with more upsell and cross-sells, so we do see some healthy signs that more clients are coming to our solution for digital beauty solutions. That is how you saw the increase of total brand customers to over 600 now for the first time. Certainly, that will be encouraging signs for us to continue to work with those customers so they understand our solution and grow to be a bigger spender over time. In terms of the business outlook guidance, certainly, the company, as we grow, and again, with more maturity in our business and a more robust business model, also feels it's important to share visibility and transparency with the market. We certainly have seen indicators from both the online solutions, as I said, playing but also the mobile app subscription that is growing very fast, showing strong confidence to the company that the second half of the year will be performing much better than the first half of the year, therefore generating the guidance that we are putting forward at this time.

Operator, Operator

We have our second question from Clarke Jeffries from Piper Sandler.

Clarke Jeffries, Analyst

I just wanted to dig into the subcomponent of AR and AI cloud solutions. Louis, could I confirm with you what AR and AI cloud solutions are growing at right now? Maybe as a follow-up to the prior question: It seems like the subscription business is growing quite well, with active users increasing in excess of 30%. Could you just remind us what dynamics of AR and AI cloud solutions seem to be accelerating in the second part of the year based on that guidance?

Pin-Jen Chen, CFO

Yes, Clarke. The AR/AI cloud solutions include all our beauty tech and skin tech solutions that are online, mostly helping brands in their e-commerce journey, virtual try-on, skin diagnoses, and other related solutions. This also includes mobile app subscriptions for the premium subscriptions where consumers are downloading our family of beauty apps and opting to unlock premium features, including some of these new generative AI features. Both certainly continue to grow as we see these patterns. In this last quarter, the mobile app subscriptions were coming from a lower base, but are growing rapidly. We have seen quarter after quarter hitting record-high numbers of active subscribers, this time with over 60% active subscriber increase. This is certainly giving management confidence that the trends seem to be strong for the remaining year because of these two primary drivers that are driving our model for the year’s revenue projection.

Clarke Jeffries, Analyst

Certainly. Maybe a follow-up is the SKU count and the brand count are both growing quite well. Do you anticipate some of those SKUs and brand counts to see an inflection in monetization that you would expect the AR and AI cloud solutions to accelerate off of business you've already won and will start to build in terms of revenue contribution over the coming year? Does that make sense?

Pin-Jen Chen, CFO

Right. As I explained earlier, brand customer business typically takes a few years to grow into scale and maturity. I think we have seen from the end of last year and early this year that the leads and the funnel that we are developing is actually much larger and wider, although it was a very prolonged sales cycle. I think we are certainly passing through this process, and after 6 to 9 months of working on these deals, we are starting to see more capitalizing on these results. Certainly, these are the baseline where we want to grow our future business with. Once customers are with us and they have their initial SKUs on the platforms, then we open up opportunities to do more omnichannel cross-sells to them. Once they have the SKU digitized on our systems, they can take that into different e-commerce and e-tailers or their own websites. Each of these represents an opportunity to monetize with increased subscription revenue towards the brands. So, yes, you are right. I think we see good recovery from the number of new brands and the number of SKUs that keep joining these platforms. Additionally, we are also seeing more categories being added here. We have been working on the beyond beauty category for about 12 to 18 months now and are starting to see, as I reported in our last quarter, that we now have over a dozen jewelry or watch brands already on the systems. Each quarter, as they pass, more SKUs are also being injected through these new partnerships and new client categories.

Operator, Operator

As there are no further questions at this time, I would like to hand the conference back to management for the closing remarks. Thank you.

Rick Lee, VP of IR

Thank you, Ellie. Thank you, everyone, again for joining our call today. Have a good one. Thank you.