European Wax Center, Inc. (EWCZ) Earnings Call Transcript & Summary

Hi, everyone. Good afternoon. I'm Simeon Gutman, Morgan Stanley's Hardline, Broadline and Food Retail Analyst. My pleasure to welcome European Wax Center, represented by David Willis, CEO and Director; Stacie Shirley, CFO; and Andrea Wasserman, Chief Commercial Officer. I'm going to read a quick disclosure, make an even quicker intro, and then we'll get right at the questions. For important disclosures, please see the Morgan Stanley research disclosure website at www.morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales representative. And for those not familiar, this is the largest out-of-home waxing franchise chain in the entire United States. I always like to describe it as, this is the business that has the best mousetrap in their space. The story is, doing quite well, it's evolving. We're talking about lasering to some degree and continuing franchise growth. One of the best margin profiles actually across our coverage universe, and a pretty decent growth profile. So I will sit down, and we'll get right at it. Thanks for being here.

Thanks for hosting, Simeon.

So you were here last year. So thanks for being a regular. If we look at '23 and the way in which you thought it would play out, what surprised you to the good, what surprised you to the less than good?

I guess I'll first start with our guests. As you had referenced, our Wax Pass and our routine guests are continuing to spend with the same frequency, spend just as much money. So that's largely played out as we had expected. For those that are newer to the story, Wax Pass is a loyalty vehicle, where guests prepurchase a certain amount of services, they pay for 9 services, they get 11 services or 2 free in a non-promotional period. And during our customary promotional periods they buy 9, get 3. We found that these guests really visit with the same frequency they'd be waxing as a nondiscretionary service. So they present a very predictable and recurring revenue stream from the brand, which is good. Another thing that's really played out as expected is the strength of our new center opening pipeline. Our franchisees have continued to generate strong returns that justify reinvesting into the brand to expand their footprint. So we've been really, really pleased that, that demand for new licenses and new center openings has remained robust even in this environment. We can't get away from the fact that the challenging macro has had an impact on at least part of our guest file. And our less frequent guests, who have not made the commitment to a Wax Pass or to a regular monthly routine visit, they've been a little bit less predictable in this environment. So what are we doing about it? Well, Andrea here, in a minute, can talk about some of the CRM initiatives, leveraging the power of our data warehouse, so we can try to reengage with some part of this guest. We reached that to them in the second quarter with different initiatives, and we saw that they were responsive to that. What else we can do about it outside the macro, which is not directly within our control, obviously, is I think lean in and help our franchisees better drive results within their centers. The teams have been working on a number of initiatives, a bit more discipline in our new center opening playbook, to ensure that each center that opens, the franchisees have done all those things they can do to ensure that they open with the right number of new guests, they're staffed with properly trained aestheticians when they opened, so they can really launch with that very predictable AUV ramp that we've seen over the history of the brand. Andrea, maybe you want to double click on some of the things we're doing with respect to media and our new agency.

Yes, sure. So I think it's -- there are a couple of pieces to it. There is the guest acquisition piece, where we're going out and we're looking for new guests and getting any guests, even existing guest, who is anywhere online, to book a reservation with us. So we have, like David said, brought on a new media agency, just onboarded them last month. And so seeing that ramp really in effect now. And part of that is approaching things with a much more of an analytical rigor. We're using mixed media modeling on a regular basis to make sure that we understand where reservations are coming from, where incremental reservations are coming from and being able to go out and get more reservations like that. We're also using that to help drive a creative targeting strategy, to make sure that the right guest is seeing the right type of ad, or the right prospect is seeing the right type of ad, in the right places with enough frequency that they really, really resonate. And then we're using our vast data warehouse to build new audience segments so that we're able to go out and be very targeted to make sure that we're reaching guests who are most likely to be of the greatest value to us as a brand. And then -- so that's the acquisition piece of it. On the retention piece of it, we're using that same data warehouse that we built within the past couple of years to make sure that we're reaching guests in the most relevant and timely ways. So that, for example, if we want to run a promotion, we don't need to do it to every guest on file. We're able to target guests who have lapsed or who, based on our predictive churn modeling, we think might lapse, and target them with specific communications, using e-mail, using SMS and more recently using both app push notifications as well as a direct mail push.

We talk about -- I want to get to a lot of that stuff and talk about the episodic customer. Let's maybe set up the macro and think about, I guess, the competitive landscape, first. Is it changing? Can that describe some of the episodic customers, no pun intended? Or is it competition entering the market? How do you think about that?

Yes. I don't know that we've seen, Simeon, a dramatic shift in our direct competitors in the waxing space. We're the largest scale player in a highly fragmented category. So we compete -- for those not as familiar with the model, we compete with literally thousands of mom-and-pop, kind of single shingle folks that offer waxing as a service. There's a handful of branded wax competitors that -- they're all growing. I don't necessarily know at the same rate and pace that we are. But I mean that, to me, shows that there is demand in this overall market. We've seen some institutional money enter the waxing market. Our largest regional competitor is backed by institutional capital, and we've seen another player enter the market in terms of a smaller regional player. So candidly, I think that bodes well for all of us. I think we get our outsized benefit as the leader in this space. Where I think we've seen other forms of hair removal, which we think is accelerating the overall TAM, is laser. There's been a lot of money invested in laser. There's been a lot of new laser clinics going up around the country. I know we'll talk about that here in a little bit, but we're dabbling in that as well to see if that might be incremental -- drive incremental revenue and EBITDA for our franchise system. So all in, haven't seen -- we've seen the competitive set largely stable. In terms of our position relative to everyone else, we remain the largest in terms of our scale and size.

We can go to laser and it connects to some of the targeting efforts. This business has grown steadily over its timeframe, and it should continue to grow steadily. But you're pivoting, right? Laser, we're doing different things with media. What's causing that? The consumer -- they're healthy. They're spending very choosingly in different places. But is it -- the consumer is doing something else, it could be lasering, or in theory, I talk about the competition in the space being invisible, because they're hard to track, especially from our side. So where is that customer going? And why the pivot to accelerate these efforts to get that customer back in the door?

Maybe touch on -- I'll start on laser and if you want to expand on kind of how we're thinking about media. So for us, I mean, laser is a bit going on offense. We've said since the day we've gone -- since the day we went public, we think it's a different guest. Candidly, using that theory, we think we can attract -- use laser to attract a different demographic to our brand. One of our other hypotheses is, we believe based on guest surveys, some of our guests that are very loyal to the brand that are waxing one body part, we think, are walking down the street and lasering a different body part at one of the competitive sets. So for us, we view this as an opportunity to go on offense. The litmus test for us -- and we're piloting, for those that aren't familiar, literally 6 centers here in New York. So it's a fairly small pilot. We're about 8 weeks into it, and we're encouraged by the preliminary results. But for us to determine whether this laser truly has a life within European Wax Center beyond these 6 centers, the litmus test is it's got to be accretive on both the top line and the bottom line for our franchisees. It's an incremental capital investment that we would be asking our franchisees to make. So we want to make sure we've seen enough data to say, hey, can they get an efficient return on that capital investment? One of the things that we're doing in laser is a little bit different approach on pricing. We're very transparent about what the cost of our laser services are within European Wax Center. We candidly, should be agnostic if that guest wants to wax a certain laser -- wants to wax a certain body part or laser a certain body part. So we've tried to take a little bit different approach, and we're learning as we go. And I think as we get more data, that will inform kind of whether laser has a home in an extended number of centers. Andrea, I don't know if you want to touch on how we're thinking about maturing our media.

Yes. I think that it's -- for me, it's less of a pivot and more of a natural, yet very exciting evolution for the business. David has talked in other forums about the creation of my role, which is this Chief Commercial Officer scope. The point -- which we have not had before as a brand. The point really being to start with data insights and to use that to inform all things media and marketing. And so a little bit of what you're seeing now is really that philosophy, that approach. One of the reasons that we did make a recent shift [as ] you alluded to with the media agency is because there was a certain amount of analytical rigor that I mentioned before that we really wanted. And so it's bringing that in, and using that to be this powerhouse engine that's fueling what we're doing across our marketing efforts. Likewise, with CRM, it's a fairly recent development that we have this data warehouse that we're able to use. And likewise, the CRM team is now more robust, more capable than it was before. So I don't think it's that anything specific happened that said, we need to make a pivot or these are brand-new things that we need to be doing. But it was more about the building blocks continuing to grow, for everything that ideally we always would have wanted to do, but we've been on this growth trajectory.

Can you talk about lasering and the industry work you've done, are there different degrees of success or outcomes with the different businesses who do lasering? There's a couple of chains. Is the technology uniform? Is the customer pleased with the service?

Best diligence that we've done to date, Simeon, would say the quality of the laser machine makes a difference. It seems the guest seems to truly value the quality of the service. And the technology makes a difference. I think the professionalism with the laser tech makes a difference. So what we're trying to do with this pilot is to see, can we leverage -- we started in New York. So regulations, I should step back, very state by state. The 6 centers that we're piloting in our corporate-owned center in Merrick, Long Island, we hired 3 experienced laser techs for the pilot. Our franchise partner who is piloting in 5 of their centers actually cross-trained a number of their wax specialists, to be certified to use the machine. We're learning a lot. We're learning what does it look like to acquire that guest. It does require consultation. That's a bit different than our core wax service where we can go out and spend some money in different channels and recruit that guest. Boom, they make a reservation. We know we can service that guest when they show up. Not every hair type or skin type necessarily is applicable for laser. So it's a little bit different sales process. It's a consultative approach, and then we're also measuring, of those consultations, which percentage of those guests are willing to sign up for a laser package. We've found certain examples, as you might not be surprised, that folks came in and their hair types were not really -- lend themselves to laser, and we were able to convert some of them into purchasing Wax Passes. So we'll continue to learn a lot. We're encouraged about the potential impact on 4-wall, but a lot more to measure before I think we're prepared to say, here's what we think laser looks like in EWC.

One more go at laser. With the traditional waxing, you hear some of the more experienced aestheticians, the speed at which they do it, the angle, the degrees, the outcome is better. Is there a technique and a skill in lasering, or if the technology works and it's not about retraining as much as it is the sales process?

I'm not an expert. Actually, I was at our Merrick location yesterday and had a sample of the laser. I think it's a combination of the -- best as I can tell, a combination of the laser machine and the training of the laser tech itself. What we are finding is, it's quite efficient in terms of the time of delivery. When you think about our core service offering, we've always said, we can really only experiment in incremental services, where the brand gives us permission to go and where our guests give us permission. The guest survey suggested they would give us permission with this laser hair removal treatment. But if you think about it through the lens of a franchisee, our core service offering is quite profitable in 15-minute increments. So the way that most of our core services work is we want to be able to service our guests, 1 or 2 services in the same 15-minute window. So the gross margin profile that our franchisees can generate in 15 minutes, that matters. So really to get franchisees excited about this, it's got to economically prove that it can be probably even more accretive in that same 15-minute window. Early learnings, but we're seeing a number of these services can be formed in -- can be provided in a handful of minutes, not even the full 15-minute window.

Okay. back to the core, thinking about industry growth, I want to say 2024, but not about guidance, but there isn't a lot of data on this industry. Is it a discretionary service, nondiscretionary? How do you think about, I guess, the industry's growth potential as you look forward, and given the consumer backdrop?

Well, I think if we look at our guest file, we can certainly look at the majority of our revenues and say that's coming from a guest that views this service to be nondiscretionary. I think our biggest opportunity, in terms of continuing to grow our market share, is to attract more guests to the brand and get them through that guest journey funnel, where we can convert them onto a Wax Pass or at least a routine guest opportunity. We spend a fair amount of time talking about our less frequent guests or this episodic guest. But I think our biggest bang for the buck is continuing to focus our energies on driving more guests to the brand, increasing the conversion of first-to-brand ultimately into that Wax Pass bucket. As demonstrated over the last several quarters, once we can get them into that bucket, they seem to be -- I don't want to say on autopilot, but their visit frequency and their spend are very, very predictable and recurring.

Unit growth potential, where is the limit? And if you take your best performing markets versus the spread with your least performing markets, how wide is that and where does that best performing market stand?

So every year, we'll open a center. For those less familiar with our model, we're a relatively modest upfront capital investment and at maturity -- takes 4, 5 years to get to maturity. And our mature centers are averaging just under $1.1 million and historically throwing off 20% to 22% cash flows. We see centers every year, Simeon, get to $1 million in year 1. That's not typical. I would say the historical average is kind of $450,000 to $500,000 in AUVs in year 1. EBITDA breakeven generally in month 14 and then they get to the very attractive cash-on-cash returns at maturity. What we're doing now is studying how did those guys get to $1 million. So not just -- what we have found, Simeon, it's not by geographic market, it's not by lucky location. It's informed with data, meaning for those franchise owners that spent the right amount of money on the right things to open with an active guest file of several hundred guests, perhaps no surprise they ramp a little bit more predictably and a little bit more aggressively. For those franchise owners that staff with the right level of experienced waxers in month 1, in month 3 and month 6, no surprise those tend to ramp with a little bit more predictable rate and pace. So we're putting a bit more discipline around our preopening playbooks and a bit more discipline, candidly, around our post-opening continued marketing spend, so that we can best support our franchisees in building more new guests into that file as they mature.

Right. And is there some degree to which the franchisee is spending money? It's not on your P&L -- that they're spending, investing in themselves and is that part of the secret sauce?

It is, It is. And we've seen -- and we're willing to support them. Andrea's team is doling out kind of local match programs. So if they want to spend a bit extra on driving incremental local marketing efforts, we've come up with a match program that they can take advantage of. So we found over time that, obviously, they're giving us 3% in this marketing fund. But a number of folks will continue to invest another 1.5%, 2% in local marketing efforts on top of that 3% money they give us.

Right. And as you think about future growth penetrating markets, the total store number, do you have the markets mapped out, certain number -- opportunity set, number of locations and even some franchisees earmarked for that growth?

We really do. We get asked quite a bit, Simeon, about this 3,000 target. So as we're finished the third quarter, we're over 1,000 centers now, less than -- directionally 1/3 of the way to our end target. Why do we feel good about that? Well, we've got data that came up with that number pre-IPO, and it was a credible data set. But as a management team, we've got to deliver on that. And so when our development teams can go rebuild to that number on a market-by-market DMA-by-DMA basis. That gives me much greater confidence that over the long term, we can deliver that. We've seen an evolution in our -- a bit of an evolution in our franchisee base. So the day we went public, a little over 2 years ago, we had 275 different ownership groups in our system. Fast forward to today, we're a little over 200. We've seen a bit of consolidation within our network, and we've seen the entrance of private equity and institutional capital money into the franchisee side of our portfolio. Today, we have a little over a dozen, what we refer to as growth partners, Simeon. These could be private equity-backed operators or multiunit developers. Little over a dozen of these folks, today, that group represents about 50% of our open centers in the system, but about 70% of licenses yet to be developed. What I'm probably most excited about is we continue to see investment from our smaller operators, who are wanting to add 1 and 2 more. So the -- while over 90% of our growth is coming from our own franchise system, I'm really pleased it's coming from franchisees of all sizes. It's not just the big guys, it's not just the little guys. But up to this point, we've continued to see demand from folks of all sizes because I think the 4-wall economics are so compelling.

And growth of this business will be exclusively through franchising, as opposed to you wanting to own more corporate stores?

By and large, I think that's right. I mean we get asked from a capital allocation, we throw off a lot of cash flow, would we ever see opportunistically the opportunity to buy franchise locations? And I would say you never say never. If a portfolio came available on the market, and it's something we wanted to look at. But by and large, we like our asset-light, capital-light profile. Really strong preference to 0.1 of our growth partners to those opportunities, instead of us leveraging our balance sheet in the same regard.

And if a portfolio came available, you'd step into shepherd it along, or actually run it because it can generate good profits for the business?

It's great profits. I think we would be more of a babysitter. I think we would be more of a shepherd.

Right. Okay. Can we talk about pricing? And then it may be related to margin, but thinking about pricing, pricing power, consumer willingness. And then things you've done to prevent taking price up and how the margins could benefit from actually taking pricing in '24?

So pricing has definitely been a tailwind for us. We took price -- and we say we took price. We as EWC recommended a price increase in Q1 of '21 and Q1 of '22. We, of course, cannot dictate pricing to our franchisees, but they generally will do -- take those recommendations. Now in addition to that, our franchisees take price whenever they feel it's appropriate. Whenever we're looking at it, when they're looking at it, there's a number of factors that we take into consideration, including what's going on from a competitive landscape. Is our guest, are they kind of giving us permission to do so. And of course, looking at our costs. So one of the big drivers for our franchisees is as labor costs are increasing. For this year, it's also been a tailwind, just as this is kind of annualized. At this point, we haven't made any announcements for '24, as to whether or not we will take price, but we'll continue to evaluate that on a SKU by SKU and kind of service-by-service basis. The one thing that we have done that we've talked about for a few months is bundling, where we're taking -- giving an opportunity to a guest to bundle two services at the same time when they're booking, and then they might get a slight -- they do get a slight discount on that second service. And so with that, it's very accretive to the franchisee. Because for the most part, that wax specialist is we're talking about being so efficient, they're able to do a second service within that same time of that 15 minutes booking. And then, of course, the guest gets a little bit of that discount as well. So we'll continue to play that out. We're at about 230 centers today and see what the opportunity is to roll that out, making sure that we're not just trading -- that customer is not just trading down. So that's an opportunity there as well.

The inputs to cost inflation in the P&L, your P&L -- franchise P&L: labor, input cost, product cost, I'm not sure if rents are resetting. But where do we stand on that continuum? It's been very inflationary for every retailer for the last couple of years. Is it cresting? Trying to gauge the need to push further price in '24.