Earnings Call Transcript - PERF Q1 2023

Rick Lee, VP of IR

Thank you, Polly. 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 Chief Strategy Officer; and Ms. Iris Chen, VP of Finance and Accounting. You can refer to our first quarter 2023 financial results on our IR website at ir.perfectcorp.com or in the Form 6-K we furnished to the SEC yesterday afternoon. You can also access a replay of this call on our IR website when it becomes available a few hours after its conclusion. For today's call, management will provide their prepared remarks first and we will be hosting a question-and-answer 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, and 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 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. We will discuss non-IFRS measures today, which are more thoroughly compared and reconciled to the most comparable measures reported in our earnings release and Form 6-K furnished to the SEC. I will now turn the call to our first speaker today, Founder, Chairwoman and CEO of Perfect, Ms. Chang.

Alice H. Chang, CEO

Thank you, Rick. Welcome everyone to Perfect Corp.'s first quarter 2023 earnings conference call. We kick off 2023 with $12.1 million in total revenue for the first quarter, representing quarter-over-quarter growth of 9.7% and a year-over-year growth of 0.9%. The nominal growth reflects the strategic shifts in prioritizing our new subscription-based cloud business driven by much stronger market demand. Specifically, our AI/AR cloud solutions and subscription revenue, which historically accounted for two-thirds of total revenue, grew by 18.7% year-over-year in the first quarter. This is a key area of future growth for Perfect. Although we are still impacted by a longer sales cycle, our value proposition to our clients and our market leadership in AI/AR solutions continue to be strong. We saw very stable renewals with existing brand customers in the first quarter. We also managed to acquire more new clients from an extended pipeline as we fine-tune our strategy to counter the impact of the prolonged sales cycle. These new clients will need time to grow and make a meaningful impact on our top-line revenue. Meanwhile, we continue to invest in AI skincare technology as it is an untapped market with great growth potential. Lastly, our mobile beauty app subscription business powered by AI capabilities such as AIGC continues to experience strong growth momentum, helping to stabilize and balance our revenue streams. During the first quarter of 2023, we continued making strategic adjustments like those we disclosed in last earnings call as we navigated a challenging business environment. We would like to take the opportunity here to provide some business updates and share with you our latest industry observations. Along with insights on how our technology and partnerships with brands have helped shape the industry. First, color cosmetics remain a very resilient and attractive category. We saw more luxury fashion brands offering color cosmetic products to consumers in an attempt to attract younger shoppers as well as to diversify their revenue mix. Perfect is the leader in the color cosmetics beauty tech field, and we are well positioned to support this new group of brands. One of the most exciting developments for this quarter is our new partnership with a global top luxury fashion brand from Europe. We will be launching their first-ever makeup virtual try-on on its dotcom website across multiple countries and also on Taobao, which is China's biggest online shopping platform. This is a very significant milestone for this client as they are relatively new to the makeup category. We expect that the virtual try-on feature will drive enhanced customer engagement and increased sales conversions for the brand. Second, as China reopens its border, brands are coming back and investing in digital solutions to target shoppers in China. In addition, consumers have resumed their color cosmetics applications and skincare routines since the face mask mandates were lifted. We have seen good recovery momentum for both our WeChat and Taobao solutions in China. Third, in the first quarter, we secured several skincare deals, including one of the prestigious skincare groups in Japan and another with a U.S. based healthcare conglomerate to newly launch Perfect AI skin analysis. This partnership enabled us to deliver our cutting-edge skin technology of skin diagnosis to a wider range of users, providing personalized recommendations for a diverse range of skin types and concerns. As we continue to innovate, we are excited to bring more AI skin diagnosis and recommendation services to brands and retailers around the world. Fourth, digitalization has arrived in the jewelry and watch industry. Watches and jewelry brands are finally catching on with virtual try-on technology. Two more notable new wins in this quarter were from Europe-based luxury fashion groups, which officially rolled out our watch and jewelry VTOs on their websites across multiple countries using our Perfect jewelry VTO technology. As more brands create 3D digital assets, we expect to see wider VTO deployments across all channels, including websites, apps, and WeChat. Fifth, interactive AR advertisements started to become an attractive new way for brands to target more consumers. In a new partnership, Perfect and Teads have joined forces to deliver the first native virtual try-on AR app format on Teads’ ad platform. This joint solution enables brands to offer a state-of-the-art VTO experience across makeup, watches, and all other AR VTO categories in popular media around the globe. We have had two global luxury fashion brands feature their watches in an AR media campaign using our AR ads. We also offer AR ads to several other cosmetic companies through this type of collaboration; jewelers and beauty brands can reach millions of potential end consumers through AR ads, which is a brand-new form. Another good news to share here: our mobile beauty app business has been growing quite strongly. With the injection of more AI features, we have recently seen a robust surge in growth. Our mobile beauty app active subscribers increased by 15% from the previous quarter and increased 50% from the same period last year. This strong growth can be attributed to our efforts in improving digital marketing and developing and monetizing more attractive AI features. One of the examples to share is we recently introduced a new product feature called Magic Avatar by AI to enhance our YouCam mobile beauty app. This powerful AI tool, driven by advanced AI-generated content AIGC technology and stable diffusion models, can produce realistic digital avatars, which app users can use to express themselves in their online social community. The positive user feedback we have received towards this feature has helped drive conversions to our mobile app subscriptions. This is just one of our main R&D initiatives leveraging the latest AI technologies for product innovation. We will keep on investing in AI developments for both beauty brands and beauty consumers. This unique synergy of business model where our core technology is developed once and can monetize in both brand business and consumer beauty apps offers Perfect valuable insights and a unique cost advantage. The surge in digital commerce pushed transactions far beyond traditional offline stores; those are increasingly happening online in apps, social platforms, content services, and even search. Brands are rolling out their strategy in omnichannel more than ever. This larger mix of channels is what makes Perfect so valuable in any environment and across every sales channel. Our strength is our ability to build all the right tools for commerce to happen in every place. This is why brand customers are building their future digital strategies with Perfect. To sum up, despite uncertainty in the macro environment, we believe that our value proposition to beauty brands and beauty consumers remains intact. Our dedicated AI/AR innovation and continued investment in the latest AIGC technologies, AI talent, and AI skincare technology will better position Perfect in the competitive landscape. Looking to the rest of 2023, as brands continue to undergo digital transformation, AI and AR technology is a crucial component of creating immersive personalized omnichannel shopping experiences, which provides a good business opportunity for us. In addition, due to our renewed focus on online services, our AI/AR cloud solutions and mobile app subscription business will grow more rapidly compared to the previous year, and their revenue contribution will be more prominent. As more brands look to improve sales efficiency and operate more sustainably to reduce product waste, we remain committed to driving top-line growth while focusing on profitability. Benefitted from the strong signs of growth in each respective area and a healthy market demand, we are very confident in delivering strong growth in 2023.

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, as the reporting period is the first quarter of 2023 versus the comparable period in 2022. On top of the IFRS measures, we will also be discussing non-IFRS measures to provide greater clarity on the trends in our actual operations. During the first quarter of 2023, our total revenue increased from $12 million in the same period of last year to $12.1 million, representing quarter-over-quarter growth of 9.7% and year-over-year growth of 0.9%. Our AI and AR cloud solutions and subscription revenue, which now contribute 85.4% of our total revenue in quarter one, grew by 18.7% year-over-year, showing strong growth momentum in our core business. Meanwhile, legacy licensing revenue for physical stores, which accounted for 12.3% of our total revenue, declined by 47.1%. This trend not only shows our new prioritization in investing in online services, but also reflects customer preferences for investing more in our AI/AR cloud solutions and subscriptions instead of legacy offline SDK services, which are the main components of the licensing revenue. Turning to our customer order expansion and acquisition, during the first quarter, the renewal rate for existing subscriptions remained as strong and healthy as in the previous cycle. Customers continue to be active on our platform. Furthermore, our ability to acquire new customers is improving via a larger funnel and inbound leads for prospects. However, it will take some time for these new customers to grow sizable revenues through us. Among our revenue sources, AR/AI cloud solutions and subscription revenue, which grew by 18.7% to $10.4 million, mainly due to the strong and stable demand for our online virtual try-on solutions for brand customers as well as strong growth in our mobile beauty app subscriptions. Our mobile beauty app active subscribers grew by 53.3% year-over-year, reaching a historical high of 694,000 active subscribers at the end of the first quarter of 2023. This increase demonstrates robust growth momentum for our suite of mobile apps. Licensing revenue, which is mostly generated from our more traditional offline services, was $1.5 million, representing 12.3% of our total revenue, primarily driven by brand customer demand and more interest in e-commerce rather than traditional physical store deployment. The strong growth momentum in AI/AR solutions and subscription revenue and the decrease in license revenue aligns with management's expectations and is a result of a strategy to prioritize AI innovation and invest in new cloud-based subscription services. The strategic shift in revenue mix showed that the AI/AR cloud solutions and subscription business will continue to drive revenue growth and become our primary growth engine in the future. As we direct our resources in online business going forward, we encourage investors to closely observe the future growth trajectory of our AR/AI cloud solutions and subscription services. Gross profit was $9.6 million, while gross margin was 78.8% compared to 86.2% for the same period of last year. This was due to a change in our cost of goods sold, which was driven by the growth in mobile beauty app subscriptions generating higher platform fees based on third-party digital distribution platforms such as Apple and Google. Total operating expenses decreased by 0.9% to $11.1 million from $11.2 million for the same period of last year, demonstrating management's successful effort to control costs and enhance our productivity. To break down operating expenses, marketing expenses remained flat at $6 million, representing 49.6% of our total revenue compared with the same ratio during the same period of last year. This again shows the effective cost control measures put in place by the management. Research and development expenses decreased by 3.1% from $2.7 million to $2.6 million, representing 21.6% of our total revenue compared to 22.5% in the same period of last year. The decrease was mainly due to the foreign exchange gain from the strong U.S. dollar versus NT dollars as the majority of our R&D expenses are incurred in Taiwan. General and administrative expenses decreased by 1.8% or $2.5 million to $2.4 million or 19.9% of total revenue compared to 20.4% in the same period of last year, during which there were significant changes. All expense categories reflected effective cost control measures carried out by the management team to increase our team's productivity under such a challenging macroeconomic and inflationary environment. Net income turned positive to $0.7 million from a net loss of $0.5 million in the same period of last year, mainly due to $2.2 million interest income during the quarter. Excluding noncash share-based compensation, foreign exchange impact, and one-time nonrecurring costs associated with our de-SPAC, adjusted net income was $1.4 million compared to an adjusted net income of $1.2 million during the same period of last year. Turning to our balance sheet, as of March 31, 2023, our company held $196.1 million in cash equivalents and time deposits for six months and longer compared to $192.6 million as of December 31, 2022, a $3.5 million or 1.8% quarter-over-quarter increase. The company's cash position remains healthy, and we do not have any exposure to Silicon Valley Bank or any other U.S. regional banks or Credit Suisse. In total, our customer base had a net increase of 16 brand clients since the end of 2022, achieving a total of 525 brand clients with over 590,000 SKUs for makeup, skincare, eyewear, and jewelry products as of March 31, 2023. In this quarter, we grew our key customers to 158 from 152 at the end of 2022. The new acquisition came from the expanded pipeline as we fine-tuned our strategy to counter the impact of a prolonged sales cycle. While the present business environment is full of uncertainties, we believe the macro situation may improve in the quarters to come. Despite these difficulties, our solid customer base, effective cost management, and expansion into new categories and geographies leave us well positioned to see future growth opportunities. That concludes my prepared remarks. Operator, let's open up our call for questions.

Operator, Operator

And your first question comes from the line of Timothy Zhao from Goldman Sachs.

Timothy Zhao, Analyst

Yes. Two questions from my side. First, I noticed that on your balance sheet, there's over 30% quarter-on-quarter growth of contract liabilities, which is actually quite strong relative to the revenue growth either on a quarter-on-quarter or year-on-year growth basis. Just wondering if management could share more detailed color behind this very strong increase in the contract liabilities. Shall we interpret that going forward, we should be able to see accelerating quarterly revenue growth for the rest of this year? And that would be my first question. And secondly, I think in your prepared remarks as well as in the press release, I think you mentioned that company is fine-tuning the sales and marketing strategy in the context of a prolonged sales cycle and also macro uncertainties. But I saw I think in the first quarter, the sales and marketing expenses were quite flat, stable year-on-year. Just wondering if management has any guidance for sales and marketing expenses for the rest of this year?

Pin-Jen Chen, CFO

This is Louis. Great to talk to you again. Yes, so the contract liabilities certainly are an advanced indicator that the company is gaining more contracts with the customers. As we said, we are prioritizing our subscription business model, and as part of the accounting for subscription contracts, it will take time to be fully recognized. So yes, you see significant growth in contract liabilities. It certainly reflects the nature of the business. On your second question, again, we are always running a very efficient team, whether it's in sales, marketing, or R&D. So even reaching out to new geographies, participating in many more trade shows, and also spending on digital marketing, we managed to get our costs well under control, allowing us to enlarge our funnel. I think these are early results we see as one of the measures that the management has put in place in the last six months, and it seems to be starting to yield results.

Operator, Operator

And your next question comes from Clarke Jeffries from Piper Sandler.

Clarke Jeffries, Analyst

I wanted to dig into the brief mention of generative AI. Just more broadly, how do you expect some of the recent innovations that have been made available to be applied to the platform? Certainly, encouraging to hear about the Magic Avatar functionality. Does that offer new revenue opportunities in sort of charging for consumption for some of those creations by users? Or do you see it as a user acquisition or retention tool within the mobile app product? And then I have one follow-up.

Pin-Jen Chen, CFO

Clarke, this is Louis. The way that we introduced the Magic Avatar feature in our YouCam Perfect app is as an add-on service on top of the subscription. Consumers can decide to opt in for these features. We charge them $2.99 for 50 avatars or $3.99 for 100 avatars. Current active subscribers can also opt-in for these services at a discounted rate. Essentially, I think the first benefit of that is we see an increase in ARPU, allowing us to increase the average order value of the customer or lifetime value of the customers. We are also seeing this feature attract new types of customers who are not traditionally part of our app. So we certainly have just launched this in early March. Our early results show prominent potential to increase the value of existing subscribers while also attracting new subscribers.

Alice H. Chang, CEO

I'd like to add something about AIGC that we have developed. The first feature is AI art in the YouCam app, specifically the mobile app called Magic Avatar. This is just one of the AIGC applications we are developing. We are also considering many more AIGC applications that could be used not only in the app but also for brands with different fashion styles and hairstyles. Personally, I’m excited to see the progress of AIGC and how new AI technology can create new ways to connect with consumers while enabling brands to do the same. We have new technology integrated into our apps, allowing us to test the market directly with users. If the feedback is very positive, we present it to our brands so they can rethink how they engage with their customers. So yes, we are investing in and developing new applications for the next quarter, and I believe we can share more about our AIGC features and solutions with you.

Clarke Jeffries, Analyst

Perfect. Certainly, the harder question is how do the B2B products change with generative AI? Just my follow-up in terms of the current operating environment, I was curious where you see the most attractive return on your investments right now? Is that pursuing opportunities for expansion within the top 20? Is that growing outside of the top 20 beauty brands? Or is it maybe investing in the sort of digital marketing advertising accelerators for the B2C business?

Pin-Jen Chen, CFO

I think we are starting to diversify our business a lot more, as you have noted in our release. B2B remains a very strong core of our business with all our partners, and we continue to help them expand omnichannel, which means going to different e-tailers or retail partners to distribute their SKUs and AR experiences in more geographies and on more platforms. That continues to be strong. Of course, we see the long tail part of the beauty business starting to take off at a much faster pace. Virtual try-on is becoming a fundamental requirement for all e-commerce solutions, and that segment continues to grow well for online services. The mobile app subscription, as mentioned, has reached another record high quarter for active subscribers, which is another positive trend solidifying our business on that front. The advertising business with our newly announced partnership with Teads is very new, but we also want to go beyond traditional e-commerce and branding. Virtual experiences and engaging experiences are important to be seen by more consumers, not just those visiting the shopping cart. This offers a new way to provide engaging interactive advertising experiences. Consumers are not only satisfied with traditional banners or video ads; they want to be part of the experience, and VTO—for watches or makeup—makes sense. Fundamentally, one noteworthy point is that our core technologies remain the same. We develop the engine, whether it's AR or AIGC, and we find different use cases to apply for consumer business and brand business. This presents a very significant saving on development costs. We manage our engineering team, which only accounts for about 20% of our revenue, efficiently. Importantly, once this technology is piloted and tested on the consumer side, gaining feedback helps us understand how consumers react to it, which allows us to repackage the technology in different formats and use cases for beauty brands.

Operator, Operator

And your next question comes from the line of Chris Chia from Kendall Court.

Woon Liat Chia, Analyst

Louis, Alice, good to hear you on the call. I had a question on the competitive environment. Given what you've observed in the last 6 months, considering the longer sales cycle and the challenging market conditions, can you discuss a little bit about what you observe from a pricing and product differentiation strategy and how you think that could evolve in the coming months?

Alice H. Chang, CEO

Yes, Chris, this is Alice. From the competitive point of view, we do not see any competitors that are even stronger or far behind us right now. So there is no competition risk so far. What we have been doing, as we said, is increasing our pipeline, and it will take time to convert those brands in our pipeline to grow revenue. As for mobile apps, there are indeed many competitors in the beauty app space. However, we have leveraged AI significantly over the past year, adding more AI features, which have proven to be very attractive to users. This unique AI-driven feature attracts new users and encourages retention. We have increased our renewal rates as well. Just like Louis said, we apply the core technology to the end-user apps first and collect feedback. If the responses are positive, we can also introduce these technologies to brands so they can attract their own users. Do you have anything to add, Louis?

Pin-Jen Chen, CFO

Essentially, I think the competitive landscape remains pretty much the same. Our position and value proposition to brands remains intact. As I mentioned, the renewal rates are consistent with previous cycles, but we haven't seen any significant changes in that landscape.

Rick Lee, VP of IR

Thank you again for joining our call today. If you have any further questions, please feel free to contact us or request through our IR website. We look forward to speaking with everyone in our next call. Have a good day.

Alice H. Chang, CEO

Thank you.

Operator, Operator

This concludes today's conference call. You may now disconnect.