Perfect Corp

NYSE:PERF

Earnings Call Transcript 2023-Q1

[Operator]

Good morning and good evening, ladies and gentlemen. Thank you for standing by, and welcome to Perfect Corp.'s earnings conference call. [Operator Instructions] Please note that today's event is being recorded.

I will now turn the conference over to the first speaker today, Mr. Rick Lee, VP of IR of the company. Please go ahead, sir.

[Rick Lee, executive]

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 are 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, executive]

Thank you, Rick. Welcome everyone to Perfect Corp.'s first quarter 2023 earnings conference call. We takeoff 2023 with USD 12.1 million in total revenue for the first quarter, representing quarter-over-over gross 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 the subscription revenue, which historically accounted for 2/3 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 logos from 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 meaningful impact to 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 continue making strategic adjustments like those we disclosed in last earning calls as we navigated a challenging business environment. We would like to take the opportunity here to provide some business update and share with you our latest industry observation. Along with insights on how our technology and partnership with brands have helped shape the industry.

First, color cosmetics remain a very resilient and attractive category. We saw more luxury fashion brands offer color cosmetic products to consumer in an account to attract younger shoppers as well as to diversify their revenue mix. Perfect is the leader in the color cosmetics beauty tech yield, 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 virtual try-on feature will drive an 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 skin care routines since the face mask mandates was lifted. We have seen good recovery momentum for both our WeChat and Taobao solution in China.

Third, in the first quarter, we secured several skin care deals, including one of prestigious of latest skin care group in Japan and another with a U.S. based health care conglomerate to newly launched 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 the skin concerns.

As we continue to innovate, we are excited to bring some more AI skin share diagnosis and recommendation services to brands and retailers around the world.

Fourth, we saw digitalization has arrived in the jewelry and watch industry. Watches and jewelry brands are finally caught on with virtual try-on technology. 2 more notable new wins in this quarter were from Europe based luxury fashion groups, which officially rolled off our watch and the jewelry VTOs on their website 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 attractive in a very new way for brands to target more consumers. In a new partnership, Perfect and [indiscernible] have joined forces to deliver the first native virtual try-on AR app format on to [indiscernible] apps platform.

This joint solutions enable 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 2 global luxury fashion brands featured their watches in AR media campaign using our AR ads.

And also, we offer AR ads to several other cosmetic companies through this type of collaboration, jewelries and the beauty brands can reach out to 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 search 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, developing and monetizing more attractive AI features. One of the demo to share, we recently introduced a new product feature called Magic Avatar by AI, to enhance our U.K. mobile beauty app. This powerful AI tool, driven upon advanced AI-generated content AIGC technology and the custom, stable diffusion models can produce from an realistic digital avatars , which app users can use to express themselves in their online social community.

This 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 and leverage the latest AI technologies for product innovation.

We will keep on investing in AI developments for both beauty brands and the beauty consumers. And this unique synergy of business model where our core technology is developed once and it can monetize in both brand business and also consumer beauty apps. It offers perfect a very valuable insight and a very unique cost advantage.

The search in digital commerce pushed the transaction far beyond the traditional offline stores. Those are increasingly happening online in apps, in social platform via content services and even in 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, we believe that our value proposition, the beauty brands and beauty consumers remain intact. Our dedicated AI/AR innovation and continued investment in the latest AIGC technologies and AI talent and AI skin care 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 experience across omnichannel, which provides very good business opportunity for us.

In addition, because of our renewed focus on online services, our AI/AR cloud solutions and the mobile app subscription business will grow more rapidly versus the previous year, and their revenue contribution will be more prominent.

As more and more brands look to improve sales efficiency, operate more sustainably reduce product waste, we remain committed to driving top line growth, while focusing on profitability. Benefited from the strong signs of growth in each respective area, as I mentioned, and a very healthy market demand, we are very confident to deliver strong growth in 2023.

With that, I will now turn the call over to Louis to go over the financial details with you. Louis?

[Pin-Jen Chen, executive]

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. And on top of the IFRS measures, we will be also 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 1 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 show our new prioritization in investing online services, but also reflect customer preference in investing more in our AI/AR cloud solutions and subscription instead of the legacy offline SDK services, which are the main component of the licensing revenue.

Turning to our customer order expansion and acquisition. During the first quarter, renewal rate for existing subscription remained as strong as healthy as in the previous cycle. The customer continues to be active on our platform. Furthermore, our ability to acquire new customers is improving via larger funnel and [indiscernible] 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 subscription.

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 demonstrated growth of robust growth momentum of 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 interest more interest in e-commerce rather than traditional physical store deployment.

The strong growth momentum in AI/AR cloud solutions and subscription revenue and the decrease in license revenue aligned with management expectation and is a result of a strategy to prioritize AI innovation and to 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 solution 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 subscription generated higher platform fee 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, further marketing expense 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 post control measures put 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 that there were significant changes during the quarter.

Our expense category reflected effective cost control area out by the management team to increase our team productivity under such a challenging macroeconomic in 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 onetime nonrecurring costs associated to our de-SPAC, adjusted net income was $1.4 million compared to 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 kind deposits 6 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 brands clients since the end of 2022, achieving a total of 525 brand clients with over 590,000 SKUs for makeup, skincare, eyewear, 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-tune strategy to counter the impact of a prolonged 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 of solid customer base, effective cost management, expansion into new categories and geographies and leave us very well positioned to see the future growth opportunities.

That concludes my prepared remarks. Operator, let's open up for questions.

[Operator]

[Operator Instructions] And your first question comes from the line of Timothy Zhao from Goldman Sachs.

[Timothy Zhao, analyst]

Yes. 2 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 Q-on-Q 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 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 marketing expenses was quite flattish, stable year-on-year. Just wondering if management have any guidance with sales market expenses for the rest of this year?

[Pin-Jen Chen, executive]

This is Louis. Great to talk to you again. Yes, so the contract liabilities certainly is an advanced indicator that the company is gaining more contract with the customers. As we said, we are prioritizing our subscription business model and as part of the accounting and the subscription contracts, it will take time to be fully recognized. So yes, so you see a significant sizable growth in contract liabilities. It certainly reflect 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 to new geography, participating in a lot more trade share and also spending in the digital marketing, we managed to get our costs very well under control, are able to enlarge our funnel. I think this is early results we see one of the measures that the management has put together in the last 6 months already, and it seems to be started to work out the results.

[Operator]

Your next question comes from the line of Clarke Jeffries from Piper Sandler.

[Clarke Jeffries, analyst]

I wanted to dig into the brief mention of generative II. And 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 sort of 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, executive]

Clarke, this is Louis. So the way that we introduced the Magic Avatar feature in our YouCam Perfect app, it is an add-on service on top of the subscription. Consumers can decide to just-opt in for these features. So I think we charged them $2.99 or 50 avatar or $3.99 for 100 avatar. The current active subscriber, they can also opt-in to do that at a discounting rate.

So basically, I think the first benefit of that is we see an increase in the ARPU to allow us to increase the average order value of the customer or lifetime value of the customers. After where are we seeing these to attract new type of customers who are not traditionally part of our app.

So we certainly -- it's still early. We launched this in early March. So it just made for the first month. Our early results shows a prominent potential to both increase the value of existing subscribers but also to attract new subscribers.

[Alice H. Chang, executive]

I'd like to add something about AIGC that we have developed. The first feature is what you said AI art is YouCam app -- mobile app that's Magic Avatar. This is only one of the AIGC applications we are developing. We already developed and the released.

And a lot more -- and this one is for B2C app first. A lot of more AIGC, we are thinking how we cannot apply that not only on app, but also to brands with a different fashion, style, hairstyle. So I -- personally I'm excited to see AIGC progress new AI technology developed to the market and open up a new ways to engage with consumers and also the brand can leverage to engage with their customers.

Always, we have new technology to embed on our apps -- users beauty apps to try the markets with the users directly if the feedback is very positive and always we would bring to our brands for them to imagine how they can leverage it and engage with their beauty consumers. So yes, we are people investing and developing our new application next quarter. I believe we can share more about more of our AIGC features and solutions with you.

[Clarke Jeffries, analyst]

Perfect. Certainly, the harder question is how does the B2B products change generative AI. Just my follow-up in terms of the current operating environment, I was curious, where do you see the most attractive return on your investment 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 may be investing in the sort of digital marketing advertising accelerators for the B2C business?

[Pin-Jen Chen, executive]

I think we are starting to diversify a lot more of business as you have noted in our release, right? So I think 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 retailers partner to distribute their SKUs, the AR experience in more geographies, in more platforms, but 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, right? So virtual try-on is becoming very much the table stake for all the e-commerce solutions. That segment is continued to grow well for online services.

The mobile app subscription seems to be as mentioned, we reached another record high quarter for active subscribers. I think there's another positive trend we are seeing the business also solidifying on that front.

The advertising business with our newly announced partnership with [indiscernible], but the other way that we want to go beyond is the traditional e-commerce and the brand as well, right? The virtual experience engaging experience that is worth to be seen for more consumers and not only those on visiting the e-commerce shopping cart, right?

So I think this will be a new way to offer engagement type of interactive advertising ads, right? So I think consumers are not only satisfied with the traditional banners or video ads, they will try to be part of that and I think VTO whether it's for watches or for makeup does make sense.

And fundamentally, I think one point worth noted here, the core technology are the same, right? We develop the engine, whether it's AR or AIGC, and we find different use cases to apply for consumer business but as well for brand business. So there is a very huge saving for us from a development cost perspective. We managed to run this engineering team, which only accounted about 20% of our revenue. I think that is a very efficient way to run that.

And at the same time, once this technology, we can pilot test that almost in a test that on the consumer side. And as we gain feedback and understand how consumers are reacting to that, repackaging this technology in the different form factors and different use cases and offered to the beauty brands.

[Operator]

[Operator Instructions] 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, given the longer sales cycle and the challenging market condition, can you discuss a little bit about what you observe from a pricing and product differentiation strategy and how you think that that's going to evolve in the coming months?

[Alice H. Chang, executive]

Yes. Chris, this is Alice. From the competitive point of view, actually, we do not see any competitors even stronger than us or far behind us right now. So it's not competition any risk so far. So just what we did -- as we said, increased the pipeline, and it will take some time to make the revenue, keep the revenue -- keep those brands in our pipeline to grow the revenue.

And for mobile apps, actually, there are a lot of competitors of beauty apps. There are quite several beauty apps in there. But we did see -- since we leverage AI more last year, add more AI features that turns out to be very attractive to the end user, very unique features by AI and the track and make those end users -- new users not only on our app, but also very sticky. We increased the renewal rate, everything. So -- and just like Louis said, the core technology we applied to end user efforts and collective feedback is good, and we approach and also introduced to the brand site.

So since these new features, AI features to the beauty upside is so attractive. Hopefully, that's our wish that we can leverage that and also give feedback to the brands, and they can also use our technologies to attract their own users. Do you want to add something Louis?

[Pin-Jen Chen, executive]

So essentially, I think the competitive landscape that we are remains pretty much the same. Our position -- our value proposition to the brand remain very intact. As I mentioned, the renewal rates are pretty much the same as in previous cycles, but we haven't seen really a significant change in that landscape.

[Operator]

Since there are no further questions at this time. I'd like to hand the conference back to management for closing remarks.

[Rick Lee, executive]

All right. 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, executive]

Thank you.

[Operator]

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