Perfect - Q2 2024

Transcript

Operator (participant)

Good morning and good evening, ladies and gentlemen. Thank you for standing by, and welcome to Perfect Corp's second quarter 2024 earnings conference call. All lines have been placed on mute to prevent any background noise. We will be hosting a question-and-answer session after management's prepared remarks. Please note that today's event is being recorded. I will now turn the conference over to the first speaker today, Mr. Jimmy Shu, IR Director of the company. Please go ahead.

Jimmy Shu (IR Director)

Thank you. Hello, everyone. Welcome to Perfect Corp's second quarter 2024 earnings call. With us today are Ms. Alice Chang, our Founder, Chairwoman, and Chief Executive Officer, Mr. Louis Chen, our Executive Vice President and Chief Strategy Officer, and Ms. Iris Chen, Vice President of Finance and Accounting. You can refer to our second quarter 2024 financial results on our IR website or in the Form 6-K we filed with SEC earlier. A replay of this call will also be available on our website shortly after its conclusion. For today's call, management will provide our prepared remarks, followed by a Q&A session. Before we continue, I would like to refer you to our Safe Harbor statement in our earnings press release. This call may contain forward-looking statements regarding performance, anticipated plans, our original results, and our objectives.

Forward-looking statements are based on management's expectations and are subject to numerous risks and uncertainties that could cause actual results to differ materially from those expressed or implied in 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 management's prepared remarks are in U.S. dollars, and we will discuss non-IFRS measures today. I will now turn the call over to our CEO, Ms. Alice Chang.

Alice Chang (Founder, Chairwoman, and CEO)

Thank you, Jimmy, and welcome to Perfect Corp's 2024 second quarter earnings call. We have some exciting news to share today. Let's get started. Leveraging our advanced AI capabilities, we started the first half of 2024 with a strong growth, way within our previously provided guidance. Our first half revenue grew by 13.5% year-over-year to $28.2 million. Our net income grew 185% year-over-year to a positive $1.4 million, and the adjusted net income increased 26.2% to $2.8 million compared to the first half of last year. The double-digit increase in revenue and the positive net income were driven by the strong growth in our AI/AR cloud solutions and the subscription services for mobile beauty apps and enterprise business both. Both businesses benefited from our superior AI/AR technologies and contributed to the increase in the pipeline and also to the profitability.

The first half of 2024 saw our operating cash flow generate a net inflow of $5.5 million. In the second quarter, our continuous improvement in the company bottom line showed a net income of $0.8 million compared to net loss of $0.2 million during the same period in 2023. Our operational strength lies in efficient cost management initiatives, improvements in operational efficiency while sustaining our competitive edge, investments in AI/AR services, and the continuous development in our market footprint.

Furthermore, we delivered $1.3 million in adjusted net income for the second quarter of 2024 versus $0.9 million in the same period of 2023, an increase of 43.8%. An essential advantage we possess is leveraging our unified AI engine for both consumer mobile apps and enterprise SaaS solutions, allowing us to maximize innovation across various sectors. Our B2C business, particularly our mobile beauty apps, has continued to grow very strong.

We witnessed an 18.3% year-over-year increase in our mobile beauty app active subscribers, reaching a historical high of over 919,000. This substantial growth in active subscribers is a testament to the increasing demand for mobile apps that empower users to edit, enhance, and beautify their photos and videos. It also indicates a more promising future for our growth in our user base. Our suite of YouCam apps continues to lead to innovative digital solutions, harnessing cutting-edge technologies like GenAI for photos and videos. Users can now explore and express their unique styles in photos, videos, and artworks, unlocking their creativity through the latest AI capabilities. As mentioned earlier, we have introduced quite a few enhancements driven by GenAI, including AI Avatar, AI Fashion, AI Hairstyle, AI Headshot, AI Studio, AI Color, and AI-enhanced Photo/Video Editing Tool.

These tools offer users sophisticated options for beautification and enhancement, setting new standards in digital creativity, and showing a case of our commitment to continuous innovation. Turn to our B2B operations. This quarter, we focused on the B2B sector, centered on enhancing market penetration across various verticals. We made additional inroads in AI-powered skin diagnostics products and jewelry, fashion, versatile solutions. Simultaneously, we expanded the adoption of our Makeup VTO across all brands in the region. We secured multiple new contracts for our beauty, skincare, and jewelry solutions within B2B sectors, highlighting strong demand for our comprehensive offers and advanced technology across diverse industries. Additionally, we successfully renewed major licenses with key beauty groups and retailers. This renewal underscores the growing trust in our solution to meet evolving demands and affirm our leadership in VTO versatile services.

Furthermore, we leveraged this opportunity to cross-sell to affiliated brands and offer expanded services, including broader skill selections and market expansion. The strong revenue growth this quarter reflects the continuous recovery in sales cycles and the expansion of our enterprise business pipeline. Another exciting event took place during the second quarter. We formally announced our generative AI framework for beauty, PerfectGPT, at our 6th annual Global Beauty and Fashion AI Forum in New York City this June.

PerfectGPT is a framework that connects all other perfect beauty services, aiming at solving customer beauty and fashion pain points through natural language conversation, LLM, large language models, and generative AI visual content. Any brand can use this framework to develop its own personalized AI assistant for beauty, skincare, and fashion, and deploy it in conjunction with other digital services for a unified consumer experience.

Together with the PerfectGPT framework, we also announced a range of new beauty AI solutions, including the brand new services of BeautyGPT, with specialized AI Makeup Transfer, step-by-step tutorials, and product recommendations. Also, SkincareGPT with AI Skin Analysis and product recommendations. Down the road, we will develop more generative beauty fashion solutions using GPT technology, such as HairGPT, JewelryGPT, FashionGPT, and more, to enrich consumers' journey. All these services can be integrated into a single touchpoint experience for consumers, all via a simple, intuitive conversational way of an AI assistant on a brand website or in our app. Besides GPT, in Q2, we launched the world's first HD Skin Analysis solution, capable of detecting two times higher precision when doing AI Skin Analysis on users' face.

The improved AI model can now handle more input data from the high-definition smartphone camera, and the upgrade enables brands and clinics to perform an even more accurate diagnosis for users' skin concerns. Plus, the AI skin solution is upgraded with a batch capability to handle a large amount of data images with a new AI Skin Score Validator. Right now, in brands' labs, brands can use this new model to efficiently process large amounts of clinical test data and get results faster. The innovation continues also in the AI makeup domain. We pioneered the launch of the world's first AI Makeup Transfer with virtual creation. This leading technology uses AI to detect and create exact replicas of any trending makeup looks from social media or from any photo out of a beauty magazine.

Our GenAI model can detect the color, texture, and patterns of a look and transport it seamlessly to the user's personal selfie photo. Consumers can try all kinds of trending looks with just one single photo image. The AI model can further compare look shades and textures with our database of makeup product SKUs and offer users a recommendation of specific brand products. On the jewelry side, we also launched the world's first real-time multi-category stacking capability, virtual try-on. Consumers can now try pairing several items together, such as wearing multiple rings on different fingers or combining them with bracelets and watches at the same time. The enhanced capability is thanks to our improved tracking and rendering performance architecture to process multiple 3D objects all together directly from smartphone, CPU, GPU.

Our company is fully committed to creating new AI innovations to help solve both consumers' and the brands' pain points with our full line of AI services, including we achieved robust business performance in the second quarter and the first half of 2024, marked by strong revenue growth, enhanced operational efficiency, and a positive financial outcome. Our B2C segment continues to experience rapid organic growth with the launch of PerfectGPT and all other industry-leading AI technologies. We are confident that Perfect Corp. is strategically poised to seize expansion market opportunities for consumers and brands and sustain our business goals both in the near term and the longer term.

Driven by the good demand for both our app subscription and the enterprise SaaS renewal solution, we iterate our outlook for the full year 2024, projecting total revenue growth recognized under IFRS to range from 12%-16% compared to the full year 2023 results. With that, I have concluded my remarks and will now pass the call to Louis, who will discuss our financial details with you. Thank you.

Louis Chen (EVP and Chief Strategy Officer)

Thank you, Alice. Please note that all financial comparisons are on a year-over-year basis, and the reporting period is the second quarter of 2024 versus the comparable period in 2023. That, on top of the International Financial Reporting Standards measures, we will also discuss non-IFRS measures to provide greater clarity on the trends in our operations.

In the second quarter of 2024, our total revenue increased to $13.9 million from $12.7 million for the same period in 2023, representing year-over-year growth rates of 9.6%. The robust performance was mainly due to the consistent growth momentum of our AI and AR cloud solutions and mobile app subscription business, which is also the main focus of our business model transformation carried out in the past few years to convert legacy contracts from licensing revenue into recurring subscription revenue. Our AI and AR cloud solution and subscription revenue saw a much stronger increase versus the total revenue increase rate, reaching $12.9 million in the second quarter of 2024, a 17.4% rise compared to the same period in 2023. The subscription revenue contribution was at 92.8% of the total revenue in the second quarter.

This growth can be attributed to the robust expansion of our mobile beauty app subscription and the rising demand of our online skincare diagnosis solutions and online virtual product solutions among brands and retailers. Furthermore, this growth was also contributed by the addition of new categories and the increased popularity of our GenAI technologies for AI creation and editing features for photos and video. Notably, our mobile app active subscribers have surged by 18.3% year-over-year, reaching an all-time high of over 919,000 by the end of the second quarter this year. The strong momentum underscored the continued growth interest in our suite of mobile beauty apps and our capability to retain and convert those app users into paying subscribers.

The licensing revenue, which is mostly generated from our traditional offline services, decreased by 49.8% in the second quarter of 2024 to $0.7 million compared to $1.4 million during the same period of 2023. This result was well expected as the company is on a mission to convert this type of legacy non-recurring revenue into AI/AR subscription revenue from brands and consumers instead. The licensing revenue will gradually become immaterial as it continues to be phased out in place of a new subscription revenue model. Gross profit for the second quarter of 2024 grew by 7.8% to $11 million, with a gross margin of 79.3% compared to $10.2 million and a gross margin of 80.6% for the same period in 2023.

The decrease in gross margins was primarily due to the increase in third-party payment processing fees paid to digital distribution partners such as Google and Apple due to the increase in our mobile app subscription revenue. The total operating expenses for the second quarter of 2024 increased by 0.7% to $12.4 million compared to $12.3 million for the same period last year.

The increase was primarily due to the higher sales and marketing expenses, research development expenses, offset by a decline in general and administrative expenses in the second quarter of 2024. To break down operating expenses, sales and marketing expenses for the second quarter of 2024 were $7 million compared to $6.6 million during the same period of last year, an increase of 7%. This was due to an increase in marketing events, advertising costs for our mobile apps, and cloud computing costs.

Research and development expenses were $3 million for the second quarter of 2024 compared to $2.8 million during the same period of 2023, an increase of 7.5%. The increases were from additional R&D headcounts and related personnel costs. General and administrative expenses were $2.4 million for the second quarter of 2024 compared to $3 million during the same period of 2023, a decrease of 19.1%. The decrease was mainly due to lower corporate insurance expenses and increased operational efficiency. Net income was $0.8 million for the second quarter of 2024 compared to a net loss of $0.2 million during the same period of last year. The positive net income in the second quarter of 2024 was supported by continuous revenue growth and effective cost control.

Excluding non-cash share-based compensations, non-cash valuation gains and losses of financial liabilities, adjusted net income was $1.3 million for the second quarter of 2024 compared to adjusted net income of $0.9 million in the same period of 2023, an increase of 43.8%. This represents an adjusted net margin of 9.1% in the second quarter of 2024. Looking at our balance sheet, as of June 30, 2024, the company held $158.8 million in cash, cash equivalent, and six-month time deposits compared to $157.3 million as of March 31, 2024. This increase was a result of the positive operating cash flow and the interest income received from the company's bank deposits. We had a positive operating cash flow of $2 million in the second quarter of 2024 compared to $2.6 million during the same period in 2023.

The positive cash flow demonstrated the company's continued ability to generate cash flow to support its business operations and growth strategy. In total, our customer base had a net increase of 20 brand clients since the end of last quarter, achieving a total of 686 brand clients with over 774,000 SKUs for makeup, skincare, eyewear, and jewelry products as of the end of June.

This is yet another record quarter for these metrics, showing the continuous increase in customer penetration and SKUs expansion. More brands and products are leveraging on Perfect Console platforms to manage its services subscribed from Perfect. In the second quarter, Perfect had 151 key customers compared to 152 in Q1 2024, a net decrease of one, a result of normal fluctuation in the B2B business. Renewal continued to be strong, while upward sales were weaker in this quarter.

In the second quarter of 2024, our total revenue has consistently exhibited expected growth, primarily driven by the continuous momentum in our AI/AR cloud solution and mobile app subscription of our YouCam family of AI-powered apps. Our operational efficiencies and financial prudence show continued profitability in creating value for investors. Given our robust SaaS business model, we are confident in the growth of our business as we move into the second half of 2024. We are also committed to investing in professional development and talent acquisitions, especially in the field of GenAI technology innovation, to strengthen our core capabilities. This investment aims to further enhance our role as a transformative force reshaping how consumers interact with digital experiences both in brand offerings and in mobile app utilization.

We are confident that our strategic position through our proprietary technology will keep us at the forefront of this revolutionizing how beauty and fashion brands interact with their audience. Finally, we reiterate the 2024 guidance that the total revenue year-over-year growth will range from 12%-16%. This forecast is based on the company's current assessment of the market and operational conditions, and management will closely monitor business progress and provide updates in order to offer better transparency to the market. That concludes my prepared remarks. Operator, please open up the call for questions.

Operator (participant)

Thank you. We will now begin the question-and-answer session. If you would like to ask a question, please press star 1 on your telephone keypad to raise your hand and join the queue. If you would like to withdraw that question, again, press star 1. Your first question comes from Brian Schwartz with Oppenheimer. Please go ahead.

Brian Schwartz (Managing Director and Senior Analyst)

Yeah. Hi, Alice and Louis. Congratulations on the subscription revenue growth, all the technology innovation in the quarter. A couple of questions I wanted to ask you was maybe about the outlook and thinking about the second half. I know there's a lot of concern out here about the macro and the election impact to demand in this half. Maybe from a high level, I don't know if it's for Louis or can you talk about kind of the shape of the pipeline seeing exiting Q2 compared to maybe where it started in the first quarter, how your coverage ratios and just the shape of the pipeline is as we enter the second half of the year? And then I have

Louis Chen (EVP and Chief Strategy Officer)

Hi, Brian. Good to talk to you again.

So I think if we look at our first half of the year, top line, we reached 13.5% growth. That's well within the range of the annual guidance that we have given, between 12%-16%. Certainly, the Q2 was slightly slower compared to Q1, but I think that's also part of the seasonality effect. As we see the pipeline, the renewal from the brand customers are performing quite robust. So we are able to renew all the major contracts in this first half of the year. That gives us confidence of moving into the second half to keep up this performance. So with that said, I think looking at the second half of the year with the pipeline that we have been developing and the visibility that we see, we reiterate the annual guidance.

So I think we will still perform within the range that we have given to the market. If second half, the macro improves, say, the interest rates come down, the cost of capital is cheaper, enterprises are willing to spend more, we certainly can hit a higher range of our guidance. If not, I think we'll be in that range.

Alice Chang (Founder, Chairwoman, and CEO)

Hi, Brian. This is Alice. Nice to talk to you. So Brian, Q2 is normally, as we expected, not a high-growth season. B2C, in this case, consumers think are not affected by all the conditions, and this is quite global. So we're expanding to a lot of new regions in Q2. For B2B, just like Louis said, renewal is still strong, and the new upsales are not as strong as we expected.

However, all the new AI we announced in June in New York and Paris, the PerfectGPT part, all the AI transfer part, got all the brand groups' high interest. I think all of them are considering how GenAI, AI, GPT can have an impact on their internal operation efficiency, but externally, how to face the consumer using GenAI, GPT. And we are currently the only solution in the market. Innovation for those brand groups already form a very high AI committee to engage, evaluate it. It takes time, but my assumption, my vision for every beauty group, they need to have an AI assistant using GPT and our AI services together as an external consumer engaging way, brand new way. It may take time, but we see the end of this year will be some of POC to come.

Brian Schwartz (Managing Director and Senior Analyst)

That's real helpful.

And then, Alice, that's a good lead-in to my second question. I just wanted to ask about AI and spending trends. Is there a possibility, as we think about budget at these brands, is there a possibility that the business will allocate more funds specifically to AI initiatives as the technology and you're introducing new products here in the second half of the year? What are you hearing from kind of the brands in the market?

Louis Chen (EVP and Chief Strategy Officer)

Hi, Brian. From the beauty enterprise, as we have been introducing this AI, all of them are very interested, and the majority of them have actually set up AI committees or even a special AI budget to explore new possibilities, how AI can help on beauty and fashion. I think the enterprises are certainly cautious about how to do the AI. So these budgets are initially for proof of concepts or pilot projects.

So this is one of the main tasks for the second half of the year to develop these tailor-made solutions, how to use generative AI, GPT, LLM solutions to help the beauty consumer with the discovering product and finding a new look, trying on and learning tutorials and more. So certainly, I think it's a promising area for years to come, and especially this year, it's a phase of initial exploratory and using these AI budgets to build some pilot projects. I believe that is going to be the initial trend.

Brian Schwartz (Managing Director and Senior Analyst)

Thank you, Louis. And then with Q2 specifically, with the key customer account, because there's been a little bit of churn there, I think it mentioned that there's some financial distress among those customers churning. Is it fair to assume that those customers that are churning are more smaller brand partners of the business than larger ones? Or maybe the question is, what's the typical average size of these key customers that are churning? Thanks.

Louis Chen (EVP and Chief Strategy Officer)

Right. So some of these are not necessarily churning. Sometimes it can be just a downgrade as we define key customers as a threshold of $50,000. So typically, we do see exactly as you said, the larger enterprises are very stable. So they are using multiple services in multiple regions and for many, many years already. There's not much impact in there. However, some of the customers who are just starting or we hope to upgrade in, or they are just marginally over the threshold, that is what we see as a normal fluctuation. Typically, we try to upscale newer modules to them to make sure that they become a larger client so we can increase the number of KC.

In this quarter too, we see that upgrade sales have been a bit smaller. Smaller brands and across beauty industry, I think certainly the growth has been a little bit more modest across the industry, affected whether it's China or in other regions as well. So we don't see that as too much of an alert at the moment. Of course, the growing momentum, hopefully to come back as enterprise spending reopens and they are willing to commit to a larger amount of contract or spending services to more geographies or injecting more SKUs.

Well, that's good. So they haven't fully gone away. Last question for me. You have a global business. Shed a little light in terms of what you're seeing in terms of trends and momentum in the different geographies, what you're seeing in Asia-Pac versus what you're seeing in the Americas versus EMEA Thank you again for taking my questions.

You're welcome, Brian. We do see a few from a global perspective. Quarter two, Japanese yen has been demonstrating much weaker in quarter two. Certainly, the currency seems to be recovering in these past few days. But as far as quarter two, that affected somewhere between 0.3%-0.4% of our top line of the currency against U.S. dollar. I think we see a good momentum in Latin America and in Brazil, especially for our B2C mobile app business. Really, really grow a good momentum going there for mobile consumers willing to pay for annual subscription for beauty apps. So that contribution in Latin, especially in Brazil, is increasing. Certainly, the challenges, the lowlights continue to be China, per se. I think that condition is fierce competition in pricing in China. So that momentum seems to be slow.

We don't know yet when that will be recovering. Other good growth area will be Middle East and Southeast Asia. Although its revenue contribution relatively to developed countries, it's still slightly lower. But the momentum, I do see promising new brands, new retailers, a lot of them travel retailers is coming back as well in various regions. So these were the highlights and the lowlights.

Brian Schwartz (Managing Director and Senior Analyst)

Thanks.

Operator (participant)

Your next question comes from the line of Lisa Thompson with Zacks. Please go ahead.

Lisa Thompson (Senior Technology Analyst)

Hi, guys. I have lots of questions, but I'll just ask a few of them. Just to go back to the AI assistant, you said by year-end, you might see some pilots or something. What kind of company do you think is the first to start rolling this out? Is it going to be retailers or brands?

What might they be using them for, like the first ones we're going to see?

Alice Chang (Founder, Chairwoman, and CEO)

Hi, Lisa. Glad to talk to you. So in our forum, we announced PerfectGPT. It's natural dialogue to the end user, plus all the AI services we have. My view, just like all the new innovations, will start from a prestige beauty group. And then once it's matured, then it'll go to the mass market. So by saying that, we are talking to those potential beauty groups, fashion groups, very on top of the prestige part. Most of them are groups. And just like Louis said, because they are forming AI committees to see how using GenAI, GPT for their internal and external services.

Answering your question, we see this is more from, will be earlier from a top beauty group, fashion group, and for the end of this year, and then expanded to more mass and the retailer.

Lisa Thompson (Senior Technology Analyst)

All right. Great. I'm excited to see this. There's so much potential. Let me ask a question just about revenues. The licensing revenues are a mystery to me. Are they going to be going up and down quarterly, or are they just starting to wane to zero from here? Going forward, is it ever going to be higher than the second quarter number?

Louis Chen (EVP and Chief Strategy Officer)

Hi, Lisa. I think the licensing revenue is going to be expected to be more flat compared to what we see in the trend. But years ago, it used to be a much higher rate, especially pre-COVID.

After that, I think the business and technology have moved much more online and also revenue subscription-based, recurring basis. So it's really for those more legacy products like in-store versus trial products, these types of demand. I think it's not going to be zero. It's always going to be there because in some markets, there might be a need for still deploying these products along the side of doing that online. But I think we don't expect that to be another significant, as I said in my remarks, it will gradually become more immaterial, somewhere, let's say, between 5%, no more than 10% of the revenue. That seems to be the expected results.

Alice Chang (Founder, Chairwoman, and CEO)

Yeah, Lisa. The in-store now, we start from in-store after COVID, every brand and the retailers trying to engage on the website. And it's more renewal, sustainable for our business model.

So internally, we also encourage them to transform to the renewal base, especially online. So in-store still has its demand for some of the events or in specific stores. But we did not expect it will grow, and we will also encourage them to move the model to our subscription and the renewal base.

Lisa Thompson (Senior Technology Analyst)

Okay. So do you think it would be logical to keep revenues under $1 million a quarter going forward?

Louis Chen (EVP and Chief Strategy Officer)

I think that is fair to say.

Lisa Thompson (Senior Technology Analyst)

Okay. Good. That's helpful. Let me go back to my questions. And so another mystery I have is when I look at the Q2 gross margin versus the Q1, it's up, but licensing was down a lot, and I would assume that's like 100% gross margin. And I thought that mobile was the apps were going faster than B2B, so that should also take margins down. What am I not understanding about how this works?

Louis Chen (EVP and Chief Strategy Officer)

I think it's a normal fluctuation. The Q1, Q2, isn't really too much different internal margin profile. You are right in this quarter two, the B2C app is growing faster than the B2B. Therefore, the margin, we see year-over-year basis decline of around 1%. So I don't think there's anything wrong in your estimate. The B2B has a slight higher margins, but depending on the type of product, right? So some are 90%, some are 92%, some are even higher. So I don't think it's a fair comparison quarter to quarter because the different mix and the renewal period of each may be different. But again, if we look at the summary and the overall average, I think it's quite in line quarter one and quarter two.

Lisa Thompson (Senior Technology Analyst)

Okay. All right.

Another question I have, have you given any thought to doing advertising for the mobile apps? I shockingly saw a couple of Facetune ads a few weeks ago, which surprised me. Are you looking at doing any other different marketing than what you've been doing?

Louis Chen (EVP and Chief Strategy Officer)

We certainly spend some of the market sales marketing expenses and effort in user acquisition. So we do advertise in select countries and select channels. It's really based on the analytics of how much of those advertisements can bring real ROI to bring real user conversion and become paying active subscribers. So there's always new channels and new platforms for doing ads, and we continue to pilot test. But again, this is not a very big part of it. I think organic growth, digital SEO, that is where our big investment comes. But additionally, some users are very hard to be targeted, and advertising comes as additional help.

Alice Chang (Founder, Chairwoman, and CEO)

So besides those, in our operation, organic growth is the key. And of course, CPI advertising is part of them, but organic growth is always the key focus of our business app business growth. So you can see our advertisements out of our total paid subscriber percentage is pretty low, but we're still trying all different kinds of advertisements, all channels to try and get good ROI for all the investment of the advertisement.

Lisa Thompson (Senior Technology Analyst)

Okay. All right. And I guess one last question is kind of a big picture question. I've started to see companies that are talking about AI for e-commerce, where they seem like they're putting together platforms for selling and retailing. How big of an impact was that going to have on you, or are they just going about it the wrong way?

Louis Chen (EVP and Chief Strategy Officer)

I don't think it's a direct impact. I think the different AI technology we developed works in conjunction to different commerce platforms and different types of targeting. What we have tried to build as our unique solution is more for personalized recommendations, right? So as part of the AI, try to find what you need, and it's important for beauty categories specifically to know the user's style, the state of their shape, the color of their eyes, the color of their hair. So this is where we come very strong with our AI services, be able to understand and analyze and pair that with the right looks.

I think that technology, again, it is a supplemental technology to the overall e-commerce platform, where the brand now not only sending them email marketing or having an AI chatbot, be able to actually analyze and give users a very, very personalized recommendation, which we believe is going to increase the conversion rate and the basket size.

Alice Chang (Founder, Chairwoman, and CEO)

Lisa, my view for all the AI conversational AI assistants will be on every vertical website for retailers, no matter what kind of vertical. That's the future. You don't need to search and browse. You just go online. You don't need to go to the store to ask BA. Now you just go online. Every vertical website will have an AI assistant to talk to you. You can ask any question, reply, and recommend. So I think that's the future for every website.

Perfect, we are focusing on beauty, skincare, fashion. That's our vertical because not only ChatGPT conversation, message text conversation. Besides the in the dialogue, we can also add the value add of all our AI services that are already developed for beauty, skincare, fashion. So provide a real recommendation digitally to the users. So Perfect Corp right now is the only solution for AI assistant, conversational assistant with all the virtual trial, recommendation, analysis together as a one point of user point, single point of view for all the AI assistants on any of the brand side. However, I think this new brand new experience, I believe, will come from top brand groups and then turning to all mass markets one by one in the next 3-5 years.

Lisa Thompson (Senior Technology Analyst)

Right.

I just can't imagine that those companies that are just getting involved in this would even have the information required to make recommendations other than find me a red lipstick, something very simple, whereas you have years of experience that have to be somewhat of a moat to keep them away. Okay. Sounds good. I'm looking forward to seeing that out in the wild. I really am because it's going to be great to just be able to ask some questions and find a product. So much need for it.

Alice Chang (Founder, Chairwoman, and CEO)

Yes. Thank you for that. And because of just like you said, because of all of the knowledge about beauty, skincare. So in the Perfect GPT, not only it's a GPT platform, but we use RAG. We use our own know-how database to integrate it and specifically for each brand recommendation.

I think that's also one of the uniqueness based on our over 600, almost 700 brand experience, and we know exactly what the user likes and do the recommendations through the conversational dialogue with AI assistant.

Operator (participant)

Your next question comes from the line of Christopher Recouso with Partners Corp. Please go ahead.

Christopher Recouso (Managing Director)

Good morning, Alice and Louis. Can you hear me?

Alice Chang (Founder, Chairwoman, and CEO)

Yes. Very clear, Christopher.

Christopher Recouso (Managing Director)

Good. Good. Good morning to you both. Just a few questions. I wonder if you could walk me through the process of converting your brand clients into a key customer. Is there a specific methodology that you guys try to use? Is there a marketing approach? Is there a top salespeople that you assign to certain brands to try to convert them into a "key customer"?

Is there an overarching methodology, so to speak, to make them this upper-tier customer within your brand client pool? That's my first question. I guess the second question related would be, and forgive me if it's somewhat of a naïve or even question, but is there an overarching profile to your key customers? Are they all retailers? If you could possibly generalize as to what your key customers, other than the obvious revenue profile, what do the key customers typically look like, if at all, or do they range throughout the span of your brand clients?

Louis Chen (EVP and Chief Strategy Officer)

Hi, Chris. This is Louis. Let me answer the second question first. So typically, a typical profile of a key customer, they are typically multinationals, so they're operating in more than one country.

These are typically beauty brands that are there for a few years already, so extended their business across the continent. And that is where once they start using the service, they typically have a unified global strategy to align their offering in different countries. Therefore, their consumption of our services is in greater territories, right? So that will generate more revenue. Now, the other thing that we have seen as part of that profile of the key customers is the brand or brand groups, meaning that they are not only operating one brand. They probably have a sister brand or a number of group brands, so either they acquired over the years or they have grown organically into some adjacent brands. So that's kind of a typical profile. Retailer is the same thing, right?

So retailers like Sephora, for example, they are operating in many other countries, so they are certainly part of the key customer list. Your first question for the process of converting brand client to key client, mostly it starts we always want to make the entry to start working with the brand very easy, right? So this is new technology to them.

We are not asking them to commit upfront multi-million dollar agreement, which might be very high commitment. So I think we'll typically start they can do a pilot. They can do in one country only for selected products, right? So something easy under $50,000 to start with. And the process there is let them see the result. Let them see the analytics is showing a better conversion, lower return rates, bigger basket size, and then encourage them to deploy these services to more countries.

Therefore, they will have these recurring compounding effects on the revenue to increase and hopefully become bigger than $50,000 a year, much more than that, and then become key customers. So the strategy there has been always to upsell, right? So to start using something to get familiar with the platforms and then upsell them more services, either to more categories or beauty products or more geographies, or even if they are a brand group, start using them in their sister brands.

Christopher Recouso (Managing Director)

I see. Thank you. Two quick follow-up questions. One actually related to a previous question. Very briefly, I see that your R&D has traditionally seems to amount to around a 21% cost margin. Is that something that is going to be is that very stable? In other words, there's not a lot of operating leverage there as you continue to scale up.

We should continue to see you committing around 21% of your top line to R&D, or does that begin as your revenue line continues to grow? Does that flatten out and we begin to see more and more of your operating leverage being squeezed, so to speak, from that cost line?

Louis Chen (EVP and Chief Strategy Officer)

I think we are pretty pleased with the R&D cost structure, especially out of here in Taiwan. Very efficient team, very good cost structure. I think traditionally has ranged in between 20%-25% of the revenue. As the revenue size is increasing, certainly we're still investing in R&D talents. As I mentioned in the remarks, I think it's an area of generative AI that needs a lot more talent to develop a lot of new use cases.

So I think generally we are happy to see or are able to run this team around 21%, as you mentioned. If we were to run these in different countries or different development cities, Silicon Valley or other places, it will be a lot higher cost. So I think it is fine to run around these. Of course, as we grow the category bigger, that ratio may go down a little bit, as you said, the leverage. But at the same point, we are also increasing our independent internal hiring or headcount. So net to net, I think we remain about the same ratio of the revenue, at least for the near or midterm.

Operator (participant)

Your next question. Please limit yourself to one question and one follow-up. Comes from Aashi Shah with Sidoti. Please go ahead.

Speaker 8

Hi, Alice. I'm Louis. Thank you for taking my question, and congratulations on a very solid second quarter results. I have one question about the monthly active subscribers. This quarter, we saw an up 18% year-over-year. Can you give us some color on the subscribers' nature? What percentage is new to the applications, and what does the churn rate look like? Thank you for taking my question.

Louis Chen (EVP and Chief Strategy Officer)

Hi, Aashi. I think the subscriber would be quarter-over-quarter increase. Typically, those increases are on an annual subscription basis.

So I think that's good, meaning those customers, they are really high-frequency use. They are committed to use these apps throughout the entire year rather than just taking a short-term, one-month subscription. So I think that means that they are also more likely to renew year after year after year. We haven't announced publicly yet our renewal rate or churn rate in specific terms.

So I will be thankful for answering that. But I think we're sure we see the momentum be good. It's not just coming from one particular country or one particular product. I see what we have seen is more than 10 countries, probably 15-20 countries now, that the consumer, the mobile app consumer, are really much more open to paying a subscription for digital apps, even for tool-like apps, which is traditionally what's very, very difficult.

But I think now the mindset probably has changed. There are so many other apps that all are requesting some sort of subscription base and to unlock the premium features. So our strategy has been, as long as we keep innovating on these innovations and premium features, we're able to retain those active subscribers and then continue to convert more of the free trial users into our paying subscribers. Thank you.

Speaker 8

I have a follow-up question. If you can rank maybe three or five new categories in terms of growth, what would those categories be, and which ones would you think would most likely contribute to revenue growth in the second half of 2024? What are the catalysts that you're looking at right now in terms of categories or the new categories that you just started working with? Thank you.

Louis Chen (EVP and Chief Strategy Officer)

You're welcome. I think it doesn't matter which category. Typically, it takes time, right? Enterprise customers, they are really cautious on deploying services. So services that we have deployed and already passed the pilot tests, things like, for example, the pilot last year, we started to see more scale this year and even more the following year. From our historical experience, typically, a client will take about two years until they become a more mature consumption of these services.

So with that said, I think the growth momentum on the skincare is very strong because it's an area that we invested heavily in the past three years and started to see to capitalize on that result. Of course, makeup is very mature and robust, so we see probably a slower growth rate from that perspective, but the size of it is bigger, right? So because we've been doing makeup for eight, nine years now. Jewelry and jewelry watches, we see very, very good momentum going on because we were able to launch about 10-12 pilots end of last year. Many of these pilots have been concluded, and they are converting into full deployment and then also expanding to more countries.

So internal contribution, I feel that skincare, because of the strategy of going to the med spa, the clinics, even addressing the long-tail clients, will show more results financially. The B2C consumer app continues to be very strong, so we're spending in more locales. We are getting more digital marketing efforts around different languages to expand the market there. And then jewelry and watches, I think it's very promising. Our quality is really, really superior to any competitor, so we're winning virtually every deal that is open in the market.

Your next question comes from Mike Kupinski with Noble. Please go ahead. Yeah. First, let me offer my congratulations on a solid quarter as well. Just a couple of questions related around the margins.

Mike Kupinski (Director of Research, Managing Director Media and Entertainment)

You mentioned cost efficiency initiatives, and I was wondering if you can just give me the impact that those cost initiatives had in the quarter, in this latest quarter? And then I was just wondering if you can maybe give me a little regarding your verticals? You're expanding beyond skincare into fashion, apparel, and jewelry. I was just wondering if that is going to more so affect B2B, or do you think that those expansions in verticals are going to affect more B2C? And then based on that answer, if you can just kind of give me your thoughts on sustainable margins as you kind of look forward over the course of the next couple of years, given how you see the two different businesses growing, given that there is a different margin profile between B2B and B2C?

Louis Chen (EVP and Chief Strategy Officer)

Hi, Mike.

Let me start with the first and I'll get to the others too. So in terms of the margin, if we look at the B2B, one of the fortes and the advantages we have is these clients that we serve, many of them have multi-category, right? So a beauty brand, they have makeup products, color cosmetics, they have skincare, they have hair products, and more. Even some of the groups, they also do jewelry and fashions and eyewear, which means our customer acquisition cost for our new category is the efficiency there because it's the same sales team, it's the same customer service team, customer support, so that's the team. But we're able to expand our offering and serve more products and services to the same client or the client groups.

So I feel that is a very unique part of our business, how we are able to move from a single category to a multi-category in these past few years. And that may continue to execute on that strategy as there's certainly more consolidation in the industry. So these beauty groups, they're also expanding, they're acquiring new brands, they are getting into newer categories, and then we are able to serve them as the current service providers. On the sustainable margin, if we look at the B2B business, the margin is typically much higher, over 90%. We develop technology in-house. We don't pay somebody royalties to anybody. So this is really a pure margin business. The B2C part, we pay Apple and Google for their distribution. We know Apple charges 30% and Google 15%.

So in that perspective, the Apple consumer margin will be at 70% for us, and then the Google will be at 85%. So the overall sustainable margin is really dependent mix ratio between the Apple users, the Google users, and our B2B customers. So I think what we see here on that 79% may go down a little bit depending on if the B2C continues to grow stronger in the next few quarters, but I don't think it's going to be much lower than what we see now. Maybe 1% or 2% more dip, but that should be it. I think for new vertical, and maybe I'll let Alice comment on the potential for new verticals.

Alice Chang (Founder, Chairwoman, and CEO)

For new verticals, it is that for B2B, it's very vertical because a makeup brand, they may not need jewelry.

So we talk to makeup brands, skincare brands, jewelry brands, hair brands by its own demand. So this is like Louis said, some of the brand groups, they have all the different divisions. So once we know one of the divisions, it's easier for us to talk to the others. And for purely new brand groups with very specific vertical demands like hair or even like med spa clinic, that we need to review, build from, not review, build from digital marketing and then talk to them.

So for med spa, I would say it is a new market with very, very high demand for our skin analysis and aesthetic simulation. And this is not in the brand group. But within brand groups, they have multiple demands that for us, we don't need to do too much front-ground marketing efforts. Then we can expand easily to different verticals.

But we do see a very, very strong demand from med spa clinics for the skin analysis and aesthetic simulation, micro-plastic surgery requests. And for the B2C, all these are for B2B, very vertical. But for B2C, glad that we can leverage all the technology we work with vertical, and we integrate them into our beauty apps. For the app user, the end user, they pay $35-$40 per year. They can enjoy everything. So that is also one of the keys that although the whole economy has some challenge, but the B2C beauty app market still keeps on growing very strong.

Mike Kupinski (Director of Research, Managing Director Media and Entertainment)

Thank you for the color. Just one quick question, if I may. Can you just talk a little bit?

You touched on the prospect of M&A, I think, and wondering if you can just talk a little bit about the M&A environment and whether or not you would look for some compelling acquisition opportunities here?

Louis Chen (EVP and Chief Strategy Officer)

Hi, Mike. Certainly, M&A is part of the growth strategy besides organic growth. We've certainly been paying attention and looking at opportunities. Nothing material has been ready to be announced yet. I think the market, it is reopening. I think the valuation has come down to a much more reasonable rate level for a lot of these tech companies. So it's something that we're certainly actively looking at the synergy that we can be with our global distribution, with our global platform. So again, once we have any news, we'll be sharing that to the market.

Operator (participant)

And that concludes the question and answer session.

I will now turn the conference over to Jimmy Shu for closing remarks.

Jimmy Shu (IR Director)

Thank you once again for joining the call today. If you have any further questions, please feel free to contact us directly or through our IR website. We look forward to speaking with everyone in our next call. You may now disconnect.

Operator (participant)

This concludes the conference call. Thank you for your participation. You may now disconnect.