Playboy, Inc. Q3 FY2022 Earnings Call

Good day and thank you for standing by. Welcome to PLBY Group’s Third quarter 2022 Earnings Conference Call. At this time, all participants are in listen-only mode. After the speakers' presentation, there will be a question-and-answer session. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your host today Ashley DeSimone at ICR. Please go ahead.

Good afternoon everyone and welcome to PLBY Group’s third quarter 2022 earnings conference call. I’m Ashley DeSimone from ICR. Hosting today’s call are Ben Kohn, Chief Executive Officer; and Lance Barton, Chief Financial Officer. After our prepared remarks we will open up the call for questions when we'll be joined by Ashley Kechter, President of Global Consumer Business. The information discussed today is qualified in its entirety by the Form 8-K that has been filed today by PLBY Group Inc, which may be accessed on the SEC’s website and PLBY Group’s website. Today’s call is also being webcast and a replay will be posted to PLBY Group’s Investor Relations website. Please note that statements made during this call, including financial projections or other statements that are not historical in nature, may constitute Forward-Looking Statements. Such statements are made on the basis of PLBY Group’s views and assumptions regarding future events and business performance at the time they are made and we do not undertake any obligation to update these statements. Forward-Looking Statements are subject to risks which could cause PLBY’s actual results to differ from its historical results and forecast, including those risks set forth in PLBY Group’s filings with the SEC and you should refer to and carefully consider those for more information. These cautionary statements apply to all Forward-Looking Statements made during this call. Do not place undue reliance on any Forward-Looking Statements. During this call PLBY will be referring to non-GAAP financial measures. These non-GAAP measures are not prepared in accordance with generally accepted accounting principles. A reconciliation of the non-GAAP financial measures to the most directly comparable GAAP measures is available in the earnings release PLBY filed with its Form 8-K today. And now, I will now open the call to Ben Kohn. Ben, please go ahead.

Thank you, Ashley, and good afternoon everyone. As we have stated throughout 2022, we had two goals this year, the consolidation of our DTC businesses and the continued build-out of a creator-led digital platform. I am pleased with the progress we have made against both goals in the past quarter. While our short-term results continue to be impacted by global macro and foreign exchange headwinds, the quarter was defined by a number of positive results executing against our plan. This inflationary period continues to impact consumer retail businesses with higher costs, rising interest rates, oversupply, and declines in discretionary consumer spending. As a result, our revenue continues to come under pressure, and consumers are projected to pull back on holiday spending. Inventory is reaching peak levels while consumer demand slows, and customer acquisition costs are increasing. Despite this, we have remained hyper-focused on our goals and have taken a number of steps to navigate the challenging macro environment. We have removed nearly $18 million of annualized operating expenses from the Company. Part of this reduction includes the sale of the Big Bunny aircraft, which we sold for $17.5 million, generating more than 2x return on our initial cash investment, and more than $10 billion pressing questions in under two years of ownership. We believe there are further cost reductions to be realized and we are working towards simplifying our business and reducing operational complexity to achieve those savings. As a result, our business will align around Honey Birdette and our hero brand Playboy. It's one of the reasons we believe that continued investment in our greater platform is so crucial. Demand for these luxury and iconic brands remains strong. Honey Birdette continues to perform well, especially given the macroeconomic environment and the strong U.S. dollar that continues to impact results. We opened a new store in Short Hills, New Jersey, and plan to open our Tampa, Florida, and Paramus, New Jersey stores before the end of the year. We also began to expand Honey Birdette into new categories and launched the essentials collection in October. The essentials collection was the best release in the year for the brand, but more importantly, it attracted a new audience. It's noteworthy that 22% of the essential sales were to customers who are new to the brand. We will continue to invest in diversifying the product to expand our addressable market. We also launched Honey Birdette sexual wellness products at Lovers stores to great success, and we'll continue to replace third-party products with higher margin owned and operated inventory. Following on the success of our Honey Birdette store in the luxury high traffic Westfield Century City Mall in Los Angeles, we opened our first owned Playboy pop-up store in mid-October. We are excited to test this elevated mall-based pop-up as a prototype for permanent brick and mortar locations targeting the Playboy consumer. The space features rotating iconic Playboy favorites, brand collaborations, and seasonal lines, and we are encouraged by its early success. The store is off to a great start, generating revenue comparable to the average Honey Birdette store in the U.S. The current margin for Playboy's pop-up location is also 7 percentage points higher than Playboy's e-commerce margin, and we expect that to increase as we incorporate more of our owned and operated merchandise into the store. We also continue to make great progress developing those higher margin owned and operated products. Last week, our first true private label consumer product for Playboy launched was Playboy lingerie, which has seen great early success. This is the beginning of a larger Playboy lingerie and intimate collection as well as a full line of new private label products you will see over the next year. Playboy.com continues to perform well with revenue growth of over 100% through the first three quarters of this year. Within our licensing business, we're excited about recently launched brand partnerships in Asia, including My Sugar Babe in trendy Japanese streetwear brands and an experiential lounge collaboration with a retail pop-up and world-renowned nightclub 1OAK in Tokyo. In the U.S., we set the tone for the ear stacking trends with Playboy and Studs Y2K collection for those who love bold self-expression. We have also launched new collaborations with Oceana Swimwear and global sports giant Leeds, which officially dropped in mid-October. Lovers remain down year-over-year. Long-term, we believe Playboy needs to be integrated into or replace Lovers as the brand. We are currently working on our brand new strategy and have launched Playboy pleasure products in Lovers stores. Based on performance, we will begin to solidify our plans to integrate Lovers into Playboy. Yandy continues to struggle for a number of reasons as we have previously discussed. The traditional Yandy customer has been massively impacted by inflation and the brand itself is not clearly differentiated within the market. Its trendy products sell at a low margin and have historically relied almost 100% on performance marketing. With the iOS changes last year, the Yandy business has become even more challenging to operate efficiently. We are currently reviewing strategic alternatives for the long-term set of Yandy within our company. That brings me to the Playboy creator platform. Our Playboy creator platform is the most strategic opportunity we can continue to invest in. First and foremost, it represents an enormous revenue opportunity as a product unto itself. Second, we believe it can be a highly effective top of the funnel customer acquisition engine that we expect will lower our customer acquisition costs across all of our PLBY business lines over time. And third, we believe it can become the Playboy magazine of the 21st century and its ability to drive enormous cultural relevance and priceless emotional connection with a massive consumer base around the world. On the first point, we strongly believe that the Playboy creator space is right for a brand that is aspirational, one that creators are proud to show off their affiliation with and one that is deemed safe by creators and consumers alike. For nearly 70 years, the pages of Playboy were the place for creators of their time to freely express themselves and monetize their sex appeal in a sophisticated and aspirational way. This brand authenticity makes Playboy today enormously appealing as a high-end space for creators and talent to launch their careers and make money from those fans who are eager to connect with them. We are confident that there is enormous market share to be taken, given the power of our brands. And the trust we have with the creator community makes us uniquely positioned to win. But of course, prayer is not all it will take. We also need to have a product that's variance in value proposition for creators and users superior to our competition. I'm excited to report today on the immense progress our team has made on all of these fronts. In September, our new product and technology team migrated our creator product to a newly built platform. The goal of our re-platform was twofold: to enable rapid product development to deliver a product to creators and their fans that is as good if not better than the competition and to ensure a sustainable cost base with infrastructure that will scale with the business. Since we platformed, we have reduced our ongoing tech infrastructure costs by roughly 90%. We've vastly improved key functionality for creators focusing first and foremost on optimizing their ability to monetize their engagement with their fans. For example, we now offer superior messaging capabilities, custom personalized data analytics, and advanced content organizational tools for creators to most effectively engage with and monetize their fan relationships. We are now continuously rolling out data-informed product enhancements and have received tremendously positive feedback from the creator community. Since the new platform has gone live, the number of creators who are making money in any given week has doubled. The number of actively paying users has doubled and continues to grow week over week. And most importantly, on average each week, 70% of our creators are making more money than they made the previous week. We're very encouraged by the strong desire we see from top and emerging creators who want to be part of Playboy, and we're confident that we can provide them with a superior product experience to the competition. We're also thrilled to start integrating our creators more deeply into the Playboy ecosystem in mutually beneficial ways and furthermore to integrate the creator platform as a massive customer acquisition engine across our business lines. Every creator we speak with wants to become a Playboy fashion ambassador; they want to model in the Playboy fashion campaign. And most of all, they aspire to join the ranks of the celebrities and influencers who showed up in the pages of Playboy before them as stars of Playboy covers, editorial features, and pictorials. The fact that our Playboy lingerie model search has already generated more than 10,000 applicants less than halfway through the open submission proves that the potential to be on the face of Playboy is an enormously effective creator recruitment tool. These are the creator opportunities that only Playboy can offer. This is our unmatched value proposition. We have started testing our way into building more integrated relationships with creators to expand the benefits we can derive across our business lines. You've likely noticed more of our social posts now feature Playboy creators showing off their favorite Playboy merchandise and our fashion campaigns featuring Playboy creators. As paid digital marketing continues to become less effective and efficient, with privacy changes and other industry challenges, expanding our owned network of fashion influencers and affiliates has enormous strategic advantage. Of course, as we scale our actively engaged creators, we believe this should exponentially scale the traffic we're generating, thus growing our customer database and helping us drive reduced customer acquisition costs across the organization. The most coveted creator experiences like editorial collaboration, fashion campaign shoots, and creative director partnerships will be reserved for the highest performing and most influential creators. Our Yandy, Lana Rhoades collection released in Q3 was a great early test of how we can execute these special opportunities for creators in a way that drives accelerated growth across our business lines. This past summer, we gave Lana the opportunity to serve as a creative director on her own Yandy lingerie line. She partnered hand-in-hand with our in-house design team to develop her branded Yandy collection, which was released on her birthday in September. The built-in promotional momentum she created drove an 84% uptick in traffic to yandy.com, and a 37% increase in daily revenue at a margin 10% higher than similar lingerie. We also saw Playboy creators like Amanda Cerny organically support Lana, pointing to the value of nurturing a Playboy community of creators. We strongly believe that by putting creators at the center of everything we do, we will activate a flywheel of growth across the organization. I'm very encouraged by the accelerated progress our team has accomplished across product, technology, and our creator value proposition. We are well poised to enter this great brand's 70th year, which just so happens to be the year of the rabbit, with great brand and business momentum driven by our creators. With this team in place, we look forward to what we will continue to accomplish together. As I said in our last call, the path forward will not always be a straight line. But our long-term plan is intact and I am proud of how this team is executing, especially in the past few months as the new members are beginning to hit their stride. We have one of the biggest brands in the world, and I'm confident the business plan we have is unique, differentiated, and will deliver. I'll now turn the call over to Lance.

Thanks Ben. Third quarter revenue grew 9% year-over-year to $63.6 million. Our top-line results were impacted by $1.2 million of foreign exchange headwinds and a 27% reduction in marketing spend versus the prior year quarter as we prioritize higher margin spend over revenue growth. On a constant currency basis, revenue growth was up 11%. Revenue in our direct to consumer segment was up 22% year-over-year to $44 million, and on a constant currency basis was up 25%. Similar to the trends we saw in the first half of this year, we continued to see strong revenue growth at both Honey Birdette and Playboy, offset by significant declines at Yandy and, to a much lesser extent, Lovers. Honey Birdette posted solid growth, with revenue up 34% year-over-year to just over $21 million in the third quarter, and on a constant currency basis revenue grew 41%. As Ben mentioned, we expect to open three new stores in the fourth quarter which will bring our U.S. store footprint to 11 by the end of the year. We've also signed a lease in Boca Raton, Florida with plans to open next summer and are working to land additional suitable locations in the U.S. and Europe, planning to open in the back half of next year. Playboy e-commerce revenue was up 58% year-over-year in the third quarter driven by a 338% increase in email and SMS. We also saw strong results over key holiday weekend sale periods such as July 4th and Labor Day due to a significant improvement in stock levels across our best sellers and a strong finish to the quarter from intentionally stocking our Halloween costumes early. The success we saw on email and SMS is a direct result of building out a CRM team and program to focus on customer segmentation, new SMS capabilities, and a digital marketing strategy to reward our loyal customers through early access events and new product launches. It's also particularly interesting given we've not yet started to tap into the email database that the Playboy creator platform forms brings, which we believe will be a powerful unlock to drive growth and reduce customer acquisition costs for our direct-to-consumer business over the long run. Yandy revenue declined 50% year-over-year in Q3 while Lovers revenue declined 10%. While the current macro environment continues to negatively impact discretionary spending habits of the target Yandy and Lovers consumer, we're focusing on the levers within our control. This has meant spending less on digital marketing in light of the reduced efficiency we've seen in those channels, ultimately leading to lower revenue but increased profitability. Third quarter revenue in the licensing segment declined 13% year-over-year to $14.9 million. The decline was mostly driven by a $1.7 million reduction in overages that we received compared to last year, as our retail partners are facing similar challenges in the current macroeconomic environment. From a GAAP earnings perspective, we had a number of extraordinary non-cash charges in Q3 that drove our net loss, such as the impairment of intangible assets and inventory reserves. In the third quarter, we recognized around $306 million of impairment charges related to the write down of goodwill, trademarks, and other intangible assets. The need for impairment was due to the reduction of our financial outlook associated with ongoing macroeconomic uncertainty, along with a higher discount rate being applied to our forecasts. In the third quarter, we also recognized $5.9 million of inventory reserves. This non-cash provision was driven by a number of historical factors along with our strategic plan to further consolidate our businesses and improve margins. One major factor is the supply chain challenges that we've encountered over the last two years, leading to late arriving seasonal inventory that has not turned as quickly as the inventory that arrived on time. Additionally, the significant decline in Yandy revenue has left us with low quality and low margin wholesale inventory that we need to liquidate as we realign our business around higher quality and higher margin owned and operated Playboy products. As I mentioned on the last earnings call, revenue is incredibly difficult to forecast in the current environment. And as such, we remain very focused on the cost levers that we control. We have made significant progress on our expense reduction initiatives, taking roughly $18 million of annualized operating expenses out of the business. This puts our baseline level of operating expenses excluding stock-based costs and other non-cash charges at roughly $165 million annually. And we will continue to control costs tightly so that we can manage through the current economic environment. These cost reduction initiatives have led to improvements in both EBITDA profitability and cash flow. Adjusted EBITDA for the third quarter was over $700,000, a sequential improvement of $3.3 million, despite $1.8 million less revenue compared to the second quarter. Our total cash position has been stable since the end of September, and we currently have over $65 million in cash equivalents, including crypto and restricted cash. Even with continued investment into our growth initiatives, we expect cash flow from operations to remain roughly neutral to the end of this year. We have multiple levers to further reduce costs if circumstances dictate, giving us the financial flexibility to manage within the covenants of our amended credit agreement as we head into 2023. With that, I'll ask the operator to please open the line for questions.

Our first question comes from a line of Alex Fuhrman with Craig-Hallum. Your line is now open.

I wanted to ask about the potential integration of the Playboy and Lovers brands or using the Playboy brand more to reinvent the Lovers stores. Can you talk a little bit about the timing of when we might start to see this? Are you envisioning Playboy branded storefronts in the former Lovers locations or the current Lovers locations? Would love to just hear more about this strategy and what we could expect to see next year?

Thanks Alex. And actually before Ashley and Ben get into that I misspoke I wanted to make sure I updated the impairment charges were actually $301.9 million of impairment charges, but I'll let Ashley and Ben answer your question.

Yes, Alex. I'll just start with a high level and turn it over to Ashley to get into more of the specifics. As we look to simplify and streamline our business, we have a brand that is probably one of the most recognized brands in the world and December will be in its 78th year. The organic awareness and traffic that it drives leads us to believe that long-term continuing to transition and rebrand other businesses that don't fall within either Playboy or Honey Birdette makes the most sense to really drive a cohesive ecosystem. With that, I'll let Ashley get into a few more of the specifics on Lovers.

So jumping in there on Lovers. Our first introduction into this is to launch Playboy pleasure; so we started receiving the inventory on this and will be live in our Lovers stores in time for our peak selling for Valentine's Day. We're also evaluating some new store opportunities we have within the Lovers business where we're going to brand those as Playboy pleasure stores. This will enable us to continue to sell the strong merchandise we have through the Lovers brand, but to exponentially add the Honey Birdette product that we're seeing success in as well as rolling out a much bigger expression of our Playboy pleasure product. So, we're going to start with the Playboy pleasure line and then lead into additional store opportunities that we will either rebrand or integrate into the Lovers business that exists today.

I think, long-term, as we stated, our essentially city stores are off to a great start. As a hero, Playboy store, I think that you can imagine that Lovers will be branded something with the Playboy name in it, but might be Playboy pleasure or something else as we work through that branding as we enter 2023.

Okay, that's really helpful. Thank you. And then if I could ask also about the licensing business. Can we get an update on how the licensing business in China is going? There's been a lot of headlines in the news about continued lockdowns and things like that, and just curious how that impacts your business and what the outlook is next year for that business?

Sure, so we haven't had any revenue impact because as we mentioned before, our partners pay us in advance. So, we receive more payments than the revenue that we've recognized. We did talk about last quarter how we've worked out some payment plans with our partners, because they have been impacted by the COVID lockdowns. Their business has been impacted. It's important for everyone to just be aware that they continue to pay us; some of those payments do get delayed because a lot of people don't know this, but the payments that they make us are subject to withholding tax at the time that they send out the wire. So, current China banking regulations require our partners to pay those payments in person. When a section of China goes into lockdown, they end up closing banks, and our partners actually can't go in person to make that payment, so that's led to some delays. But what we've seen is as soon as those banks reopen, our partners come out and pay us. So, we're going to continue working with them and pleased with where they are.

Alex, let me just also add long-term as we sort of think about 2023 and beyond, I think I stated this historically, but for the past couple of years, we believe transitioning our China business into a joint venture would be the most beneficial to provide long-term stability and growth in the market. Over the past few months, we've made substantial progress towards a potential joint venture with a sophisticated operator. So, as we move forward, I think that is the best structure for our business and also provides the most stability and long-term growth and that's what we're focused on.

Our next question comes from a line of Jason Tilchen with Canaccord Genuity. Your line is now open.

Yes, thanks for taking the question. In the prepared remarks, you mentioned that the inventory in stock was much better over the summer as you sort of tried to get stuff in stock ahead of the Halloween season. So I'm curious. Can you talk about how demand has trended going into October, leading up to Halloween relative to both your expectations over recent months and relative to last year where you saw strong demand, but couldn't be as a business out of stock?

How do you see this? This is Ashley, and I will address the Halloween situation. There are two aspects to our Halloween business this season. We experienced strong demand and ongoing enthusiasm for our Playboy brand, which contributed to a successful Halloween season with sustained interest in the bunny suit. We also integrated some additional Yandy Halloween costumes into the Playboy collection, and this trend continued through much of Q3 and into October. Regarding Yandy, as Lance mentioned earlier, we have significantly cut back on our paid media spending. Last year, we approached Yandy differently, prioritizing revenue over profitability by aggressively pursuing top-line growth. However, in light of ineffective marketing results and the impact of iOS privacy changes, we made substantial reductions in paid media expenditures. Consequently, this made revenue growth more challenging for Yandy. Despite seeing negative comparisons, we improved our earnings compared to last year. Notably, we reduced our paid media spending by 2.5 times more than the revenue decline, indicating that our revenue dip was much smaller in comparison to the reduction in our paid media costs. This again highlights the positive shift in our earnings.

Just one follow-up on Centerfold, it was really great detail you shared about the progress being made there on the tech side. I'm just wondering, how do you view the go-to-market strategy there? Do you feel like the product is at the point where you're going to start expanding the outreach to consumers? And also, how do you view the competitive landscape obviously, listing existing players there? Twitter over recent weeks has mentioned the possibility of launching sort of similar tools and services to their users. But just curious how you view the competitive landscape going forward there?

Sure. So look, I am pleased with where the product is today and the improvements we've made. We've reduced our tech infrastructure costs by over 90%. But more importantly, we are able to roll out changes very quickly, in a matter of hours or days versus where we were before on the old platform in a matter of weeks or months. There is still room to improve the product. The way we're thinking about the Centerfold product, which is really now Playboy as we integrate everything together, that is really our magazine moving forward into the 21st Century. And so, you'll continue to see improvements to the home screen, search functionality, and we know what the consumer is wanting; it comes down to messaging. We have started to onboard creators at a faster pace over the past few weeks now that we feel very comfortable with the product. And when we think about the top of the funnel and the integration that it provides for the rest of the ecosystem, you're seeing it through our social media posts. Instead of just posting a t-shirt and then a creator, we're now posting that creator in a t-shirt. We've had engagements on our social media that have topped 1.3 million views doing that. I remain bullish that this is the best investment we can continue to make long-term. As Lance said, we saw a massive increase in our email and SMS at playboy.com and that's without tapping into the tens of thousands plus of customers that we have, we see their email on at Centerfold. So as we move forward, this is a brand that has worked with creators for the past 70 years. That's really what drove this brand at the end of the day, and that's what we're returning to. I believe that if we are successful and continue to be successful with the creators that we bring onto the platform, it will not only lead to a very profitable business in Centerfold by itself, but it will drive the rest of the business as well.

This is Ashley. I'll just jump in quickly on that. One of the other things that we've done to integrate across both our Centerfold business and our consumer products business, we currently have a model search going on through this partner orbit. We have a goal of acquiring 20,000 additional customers into our file. What we're seeing is as we have applicants into this program, we are able to shift them into the creator program and have a significant amount of interest from those same applicants to join Centerfold. For us, this is a big win where there's a significant amount of synergy between creators that want to be part of Playboy. That includes participating in whether it's a campaign for lingerie or signing up to become a creator for Centerfold.

Yes, I think everything we do is going to be centered on one ecosystem moving forward. The nice thing about the platform as well as we now have a technology stack that is very flexible, current, and modern. As we look to further consolidate the business and integrate products, such as our legacy products, we now have a platform that we can do that on, which allows us to have better operating efficiency moving forward.

Our next question comes from the line of Jim Duffy with Stifel. Your line is now open.

Hey, I'm traveling. I joined the call late so forgive me if I'm retreading content covered earlier in the prepared remarks. But Lance, could you give us a rundown on cash balances, liquidity, cash flow projections, and interest expense projections, please?

Yes, sure. From a cash perspective, as I mentioned, we're pretty much flat today, to where we ended the quarter, right around $65 million of cash equivalents and restricted cash. In terms of where we see things moving forward, our business is creating cash flow, but we are reinvesting that cash flow back into these growth initiatives around building out that creator-led platform, building out our owned and operated business on the direct-to-consumer side, because we see the long-term potential for margin uplift there. So, we can make a choice that we could not be investing back into those businesses and produce more cash flow, where we're trying to strike a fine balance between reinvesting that cash flow into the business but not investing too much in the current environment. So that's really how we're thinking about it right now. I also said on the call that we've got a lot of levers within our control in terms of managing our costs and managing investment back into the business. Ben also talked about the replatforming we did on the creator-led platform and some of the efficiencies that we were able to wring out of that. On an annualized basis, you can save around $1 million just on the infrastructure costs alone based on the work that we've done there. We're going to continue again to make those near-term investments and kind of balance everything in terms of our liquidity needs and make sure that we're living within the covenants of our credit agreement. We have a lot of different levers that we can pull if need be, but I think right now we're managing as best as we can in the current environment and we feel good about the flexibility that we maintain.

Understood. Through the lens of the leverage profile, do you see opportunities to improve the EBITDA focus?

Yes, I think look over the long term, we really are just starting to put out our private label products, and we're seeing it right now with the initial launch of Playboy lingerie. We'll see it with the upcoming launch of Playboy products in Lovers stores. We see a real ability to drive increased improved product margins there. Yes, I think these investments that we're making, we've talked about this kind of time and again, we're making near-term investments that we expect to pay off over the long term in terms of margin pickup. I think you'd also asked about the interest expense; it's hard to know exactly where rates are going to end up continuing to increase. Our interest payment this year is still at the LIBOR plus 625 and LIBOR being 55 basis points for that we're still locked into through this next payment period. Next year, I anticipate the debt service costs to go up by at least $10 million or more, so we're factoring that into our investment plans for next year to make sure that we're, like I said, cash flow breakeven for the year. That's really what we're targeting is to reinvest back into the business in a thoughtful way and preserve cash to weather the current environment.

And let's say here, you say the expense rate is $165 million annually, did I hear that correct?

Yes.

And then Ben, one coming your way, I'm very interested in your comments on the potential conversion to a JV structure in China. Is there a contractual window in the current license agreement that allows you to do that without compensating the licensing partner? I'm curious what you'd see as the realized margin opportunity versus the license royalty rate that you think gives that strategic justification?

So Jim, not to answer your question. But unfortunately, at this time, I can't answer that, as you can imagine, for legal reasons and for business reasons. I'll just sort of reiterate, we're enough for like, just to follow-up on what you asked Lance to focus on, we're continuing to streamline the business. I believe that we now have the team and the pieces in place. So you look at what Ashley's team has done, which really didn't get into place until July time frame, with what they've developed in a short period of time with lingerie what they have coming over the next year with private-label products, all of these things allow us to enhance our margins. Then you start to think about the consolidation of our, what I would say is these very small legacy businesses into what I would say are hero products moving forward. That gives us a lot of flexibility moving forward from a cost perspective, and that's what we're focused on as we approach 2023. We need to continue to invest in the things that are strategically important. We've seen great growth on Centerfold in other areas and Playboy lingerie after a great start, coupled with making sure that we've maintained plenty of headroom with our covenants and our cash balances, given no one knows how long the economy will be where it is, and if it will get worse or not. But we're planning for the worst and making sure that we maintain maximum flexibility as a company.

Our next question comes from the line of George Kelly with ROTH. Your line is now open.

So first for Lance. Regarding your, the kind of formula, the guidance you provided about this, I think last quarter, you called them the annualized non-product costs. Isn't there a second part of the formula, which is what the product costs are on top of that? I think it was 25%. So just curious, if any of that has changed?

Yes, no real change on the product side. I mean, the one thing that we are seeing, you're obviously seeing this across the board, and you'll see it in the third quarter, you're going to see it in the fourth quarter, stepped-up promotional activity. There's a lot of inventory that we've got to move that other competitors in the retail space have to move. So that will have an impact on near-term product margins. But in terms of input costs, they're not really changing in terms of how we're thinking about it over the long term.

Yes, and I'll just jump in on that. So, we know there's significant improvement with the owned and operated coming. We are also evaluating other costs related to our fulfillment model. That’s an area where, just from my past, we have an opportunity to reduce spend and costs. So we're looking pretty heavily into how we can go after savings there across our brands, and then identify, obviously, the improved product margin and tighten buys on inventory in the current quarter all the way through the front half of next year. Tightening those buys does enable us to really reduce the amount of promotion we have to do heading into Q1. We will be up against aggressive promotions next year, just because we've been promoting through Q3. But we’re feeling good about how we've tightened buys, knowing that the economy is slowing.

And that 25% number has been consistent over the last two quarters. So, it's not moving a ton.

And then, next question. You talked a lot about consolidating and really investing in the core power brands. Curious if that could involve any outright asset sales? Or could there be other potential asset sales that you're considering?

So without talking about where we're moving from a strategic perspective, at this point, I would say that our goal is to have as many arrows in our quiver as possible. We will always look at things opportunistically as fiduciaries. But right now, what we're focused on is consolidating the businesses we have around the brands that we know that work, which are Honey Birdette and Playboy. One of the challenges with a 70-year-old company is you have a lot of small business lines that take back office infrastructure, finance, accounting, legal, HR, etc., to maintain. Now that we've seen the traction that we started to see on Centerfold, it allows us moving forward to be strategic in how we consolidate business lines with a goal of improving our efficiency. Right now, as we said, we're looking through everything from a strategic standpoint; we think there's a real opportunity to lower our fulfillment costs, and we'll have to think through Yandy long-term and how that fits into the Playboy ecosystem.

Yes, I mean consolidation can take many different forms. We've talked about the consolidation really on the brand side, and how do we leverage the Playboy brand within Lovers and within Yandy because those aren't really brands standalone. We also never really talked about it on this call, but historically, we've talked about the product breadth at Yandy, which was kind of historically how they operated with well over 10,000 or 15,000 SKUs. That creates real fulfillment headaches and challenges when you're a small-ish company like Yandy. Part of that consolidation is how do we move through kind of that wholesale third-party, low-margin, low-quality inventory? How do we reduce the number of SKUs and drive more higher margin SKUs through that business? That's another way that we think about consolidation, as Ben mentioned, if we're able to consolidate warehouses to consolidate operations on that side of the house. When we look at standard fulfillment costs as a percentage of revenue, we run incredibly high relative to where we think we should be over the long-term. So we think there's real room to drive efficiency through that.

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