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

Good afternoon, everyone. Hope you're good. I'm Simeon Gutman, Morgan Stanley's hardline and broadline and food retail analyst. It is my pleasure to welcome European Wax Center, represented by David Berg, welcome back, CEO and Executive Chairman; and Stacie Shirley, CFO. I'm going to read some disclosures, and we'll ask the first question from here, and then we'll come and take a seat. And at the end, we will have time for Q&A. 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. Just as a quick intro for those that don't know the story, European Wax is the largest operator of waxing centers and style studios in the United States. We've always said and we continue to say they run the best mousetrap from a chain waxing perspective across the U.S. It's a franchise business 99% and generates a lot of free cash flow. And welcome Dave back to running the company to talk about how the business is being repositioned for the next few years.

So, the first question, Dave, what's changed under your leadership since returning to CEO? And presumably, you worked with your predecessor when you were Executive Chairman. What are you doing differently than previous leadership?

Simeon, thanks. And just for the record, waxing, we're not a candle company. We're wax on your body and take care of. We actually got asked that question during IPO a few years ago. We've come a long way since then, Simeon. Thank you. Great to be here. Maybe I'll try to answer that, Simeon, and for the audience, I was the CEO for 5 years, went to Executive Chairman for a year and then came back about four months ago now in the day-to-day CEO role. I might address it by sort of kind of what am I hearing? What have we done about that? And then why are we optimistic about the future? So, what are we hearing? Obviously, we had our Q3 announcement here a couple of weeks ago. I think number one is that, everybody recognizes that it's a tough macroeconomic situation for consumers these days. That there's a recognition of that, and we haven't been immune to that. Second, I think the deliberate pause that we took as difficult as it was to sort of say, hey, we're going to take a pause in terms of our unit growth to focus on the business. And we've got three core focus areas. One is how do we drive new guests into the system; second, how do we drive tickets or transactions, and we do those two ways, by retaining guests and reactivating guests; and then third, how do we help underperforming centers. So that's really what our focus has been. And we've gotten some credit to say, hey, that's great that you're really hyper focused on that core aspect of the business. We made a decision we have a pilot running now in 22 of our stores, we call our store centers here in New York on laser. That's a modality that we think our guests and our brand gives us permission to play. We plan to roll that out more broadly, but we decided to pause that to take some of those resources and put them back focusing on the core business, which is 99.9% of what our business is about. So, I guess I was segueing into what have we done. First and foremost, we got focused on those three areas that I mentioned. Second, I've been spending a significant amount of time with our franchisee leadership. I think we lost our way a little bit in terms of really making sure that we understood actions that we took, what impact they had on the 4-wall profitability of our franchisee, and that's obviously an incredibly important piece of the business and mindset that we have to have. We consider ourselves at corporate as the customer service department for our franchisees, and I think that's our job. We announced a fairly significant restructure in terms of our field organization so that we could, again, have more focus on helping our franchisees enhance their profitability. And then the other thing that we've done is we engaged a group called Dolabra, which is a marketing and technology group that's going to help us accelerate in those three focus areas, help us in terms of attraction of new guests, real deep knowledge in technology and creative and media buying that will help us build that top of the funnel. And our job is to bring those new guests in and get them to articulate through on to what is our Wax Pass, which is like our membership model so that they can continue to come to us on a regular basis. Dolabra is also focused on CRM and data analytics and metrics where we can reactivate those guests that have lapsed a bit. So, I feel good that those actions that we've taken are starting to take root, and we're excited in March to kind of talk about the progress that we've made. Why do we still feel incredibly confident about this business? It's about an $18 billion -- the hair removal business in the U.S. is about an $18 billion TAM. Out-of-home waxing about $6 billion of that. We're far and away, as Simeon said at the outset, the leader in that space, 11x bigger in terms of revenue and 6x bigger in terms of unit count. We have 1,060 centers that are open today. Our core guest makes up 75% of our revenue. She comes on, I say she because 95% of our guests are female, comes in on a regular basis. We have incredible free cash flow, as you alluded to, Simeon. And we continue to feel great about the position that we're in, in the white space that we've got to go grow.

If the backdrop were stronger, do you think we'd have that kind of conversation, meaning the business could still be growing, may not have looked so deeply at the footprint. And you're looking at a lot of things from top to bottom. But if the backdrop was giving, you're doing a full, not a reset, but you're really looking at all the key drivers of the business?

Yes. We're getting back to the fundamentals of the business. Yes, I think the backdrop, I mean if the economic situation is better, I think these are still the key focus areas. We are a rate and frequency business. How often do you come in and how much money do you spend? So we think about attract more, buy more, visit more, that's kind of our goals as we think about guest acquisition.

And then working with some other companies on technology, and I also think it's customer acquisition. Is there a model that was working that just stopped working? And why did that stop working?

I think it's been more difficult, Simeon, with the macroeconomic backdrop to get new guests in and typically, our new guest is somebody who is not familiar to waxing. It's not that we're taking somebody from threading or sugaring and converting them into a waxer. It's somebody that's probably just new to that modality, probably with shaving at home was most likely. That's our most likely new guest. As things got tougher economically, it was harder to get them off the sofa. Our average ticket is $60. You throw a tip in there, and so you're at $70 per visit. And we knew from our guest survey work that those new guests that, that was somewhat of an impediment to them. Bringing in Dolabra, where we've now gone back and to your question about what was working, our creative probably lost its way a bit. Over the course of the past two months ago, we started a test with four different imagery comparisons, one, everything from quite aggressive and racy to conservative, ran those against each other across a uniform meta channel and found that one prevailed. So, that helps inform not just our prospective 2025 advertising campaign, but also our holiday campaign. So, you'll see probably a little bit more skin and a little bit more revealing beautiful skin messaging in our creative here in the coming weeks.

Nice. Talk about the health of the consumer. Has it evolved or it's been tough for a couple of years? Then, where else are they going or where are they doing this? You mentioned it.

I don't know if it's evolved. I think it's been tough over the last couple of years. And we don't think they're going anywhere. We don't think that they're going to sugar or thread. We think they're probably just -- mostly our data would say they're just staying home and shaving. They're just opting for the cheapest way of hair removal, and that's what they're doing.

So, we could just be overreacting?

I think you are totally overreacted, but the record to be crystal clear on that one.

Just the health of the customer engaging in this category.

Yes, we think so.

That 75% that David mentioned, that guest, is very, very stable and very, very consistent. We haven't seen that change over the course of where there's been some more macro kind of challenges. That gives us a lot of confidence in the fundamentals of the model are still there.

And the way you're planning for the consumer for '25 is tentative? Not about guidance, but how you take what you're seeing, do you play offense or defense as you move into next year?

I think we've sort of said, great, that's not a bush we're going to hide behind. It is what it is. It's a tough consumer environment. That's the environment we're in. And we're not going to say, if we get the serendipitous consumer all of a sudden is flushed with cash and is spending drunk in disorderly fashion, great. That's not how we're playing it, Simeon. We're going to say, okay, it's a tough environment. How do we go out, play offense and get that guest to come into our system.

So, the market is fragmented. You mentioned that?

Yes.

And the customer is constrained. So, the higher-priced options probably don't make sense for them. What is the core value proposition? What is it can you describe it again? I think you did. And then is it -- did it degrade at all? Are there opportunities to make it better?

If you go back to our founders, they saw the opportunity 20 years ago, we're on -- 2024 was our 20th anniversary. They saw an opportunity to professionalize out-of-home waxing. So historically, this was really relegated to the back room, quite schlocky, not very hygienic and the two brothers who founded the business saw an opportunity to professionalize that. They did that through a very hygienic environment. We still have that today, a ton of training. So all of our aestheticians are licensed in the states in which they operate, and they have to go through our rigorous EWC proprietary training before they ever see a guest. We have something that's called Comfort Wax, which is proprietary to us. It's a wax that goes on at 138 degrees, adhesives to your hair and not to your skin. So when it's removed, it's as comfortable as it possibly can be. The mom-and-pops, the fragmented market you alluded to, Simeon, doesn't have any of that. We get a marketing fund from our franchisees that allows us to go spend money in terms of acquisition and talking about the brand that others can't do. And it also allows us to make technology investments to enhance the guest experience. The guest experience, your question about, has that degraded? I think that there is an opportunity for us. The model here is you drive a guest into the system, you wow her with that service and then she matriculates into a Wax Pass to become that core guest that Stacie talked about that makes up that recurring revenue model, whose behavior spending -- spend and frequency haven't changed pre-COVID, post-COVID or in a difficult macro situation.

And is that loyalty beholden to the aesthetician who's doing the waxing?

It's a really good question. So one of the things back to the founders, having training and consistency. We now have 1,064 centers across 46 states that you can get a service here in Manhattan and it better be identical when you go out to La Jolla and get the same service or into Topeka for that matter. So, we think the loyalty is to the brand. Certainly, I get very comfortable with my aesthetician as you might with your hair stylist or your massage therapist, but there is -- you can get a service, and we have different levels of efficiency of our waxers that you should get the same exact experience regardless of which of those 1,064 centers you go into.

And I'll phrase this in when you talk to your franchisees because they're on the market. Are there more additions or subtractions of competitors coming into their domains?

Well, from a pure waxing standpoint, we don't see more competitors. It continues to be highly fragmented. There's one fairly significant regional player. A lot of discussion around laser. As I mentioned briefly that, we've launched a laser pilot here in New York because we think both the brand and the guest gives us permission to be not just the hair removal expert via wax, but the hair removal expert full stop. We're going to get that right. We're going to learn carefully and thoughtfully. We're the only place that you can go in and get one body part lasered, another body part waxed. So we haven't seen a competitive set that's come in, as I said earlier, Simeon, I think that economically pinch guest is just opting to do hair removal at home.

So, the first strategy you mentioned is attract new guests. I think some technology, Dolabra seems like they can help play a role. Is there any thought to -- something on execution that needs to fall into place before you go full steam? And then what is that path for attracting new guests look like?

I think attracting new guests has a couple of elements. One is this creative play. We're getting back to sort of that messaging that it works for both our core guests and new guests. So that's something, again, that we'll be launching here in the holiday. I think programs like affiliate programs, programs with influencers, program with partnerships. One of our biggest drivers of new guests is referrals. So how do we incent guests to have you come in as a referral? Similarly, how do we refer -- how do we incent our wax specialists to get their network of friends? It's a very intimate service, as you can imagine, and that trusted relationship with that aesthetician is really well regarded by our guests. Once we get you into the system, then that experience piece, we've got our trainer team that goes out and works with our franchisees to ensure that you got -- we talk about one of our values is delighting our guests. Any time you come into the center, you're going to be wowed. We've journey mapped from literally when you hear about us to come to the front door, walk through the front door, come to the front desk, get into the wax suite, have your service and leave. We've journey mapped each of those steps in the journey and where you can make money, where you follow the process or if you don't and are reinstituting and retraining that to our franchisees so that when we've done our job in driving that guest into the center that she gets delighted and then convert her into that Wax Pass and loyal guest.

Is it a couple of quarters? I know now we are getting little -- but like what is your expectation of when you see an inflection from this?

I think we feel really good about the actions or the seeds that we planted and that we'll announce in early March kind of on year-end in Q4. We certainly hope by then, we'll be able to talk about some of the green shoots that we're seeing on the actions that we're taking.

Laser, I thought we only talked about it maybe a year ago in August, and it was described well as, hey, we're going to try this out. It could be supplemental. And the market was questioning of it. Now you've paused it if something went wrong or it got too distracting. So, what is the story?

I don't think anything went wrong. There were really two reasons for the pause. One was to take some of those resources that we put on laser. I just felt it was more important to get them back on our core business is really what is the basis for our growth and our foundation. The second was, I wanted to make sure we get the offering right. Maybe surprisingly, in the state of New York, it has the lowest regulatory hurdle. So, we've got to get it right here. And by get it right, what do I mean? We had to make sure that we had sort of the new guest funnel perfected, how cost of acquisition got to a reasonable amount so that we could actually acquire guests in a way that our franchisees could make money. What was the right pricing? What was right bundling? We originally went out, for example, with single body part laser. That really doesn't make sense. You actually have to have bundles to get to a price point that makes sense. We do think, again, one of the only players that can be uniquely positioned to offer you different modalities. Certain hair types, certain body skin types aren't receptive to laser. So we still think there's a differentiator there. This is absolutely and to your question, Simeon, that we think this could be a real positive addition to the core business of waxing in our centers. Our centers are about 1,300 to 1,500 square feet, 6 wax suites in them, 70 or 80 square feet each. We're going to dedicate one wax suite for laser. So it's not a huge cost expense for our franchisees to add laser into them.

And maybe a hypothesis on laser being part of the market, but not replacing waxing, your hypothesis and your thesis hasn't changed.

No, it's a no. It's no.

Demographics, I want to talk about, I guess, not customer, geographic and then performance among regions and customer type. And I think you distilled it down to just average customer, just not spending. But do you see differences? And then what describes the differences among the chain?

Okay. So we've talked -- I think the main topic coming out of COVID was how do you get employees back, particularly in California? It feels like we're still talking about California, slightly different topic these days. We do see our centers in California that are facing higher cost pressures, particularly in rent, labor, some insurance, and that's had an impact on their overall profitability. So if you looked at the entire chain, and we've got roughly 15% of that 1,000-plus centers that are in California, they are not having the same financial returns as the rest of the network. The rest of the geography, there isn't really any specific instance to say this state is worse than another state. If you look at averages and averages are very, very difficult and sometimes misleading, but I think this is a fair representation of our network. We have franchisees that voluntarily input their financials, so about half of the system. If you take that and then take an average, the average unit volume is $1.1 million at maturity and EBITDA margins in mid-teens. So, that's kind of on average what the entire chain is doing.

What happens these franchises out on the West Coast maybe end up making less money? Is there a negative feedback loop that you have to come in and try to prevent less go out and targeting customers or these things and then they go down the slippery slope?

Yes, it could be. One of the things that we announced, obviously, was the 16 closures that we had that, again, on the scale of 1,000-plus is not that significant, but was higher than we've had historically. So we've put a lot more rigor around our sort of at-risk centers. And that's not to sort of say, okay, on such and such a date, they're going to close. It's actually so we can go out and work with that franchisee to say, hey, are you having rent problems? Can we help you renegotiate your lease with your landlord? Are you having labor problems? Let us help you with labor optimization. Is there some relief that you can get that you need just from a cash flow standpoint for a period of time? So we've really tried, Simeon, to get much more rigor around that so that we can help those franchisees be successful. Of the 16 centers that closed, as I mentioned, 6 of those closed in California. And those were largely driven because the ticket production had gone down and the cost structure had gone up and it just didn't become profitable for them to continue to be open.

And in any of those cases, was it the way the stores were laid out, maybe market density, proximity to competition?

Yes. I mean, we continually look at sort of our cannibalization rates to make sure that we're going to not cannibalize. We want to -- we talk about thoughtful growth. We want to make sure that it's done in a way that a franchisee opens a center and can be productive. So we have cannibalization assumptions in there when we approve new sites. One of the things that we did for our franchisees was that anybody that opened a cohort in 2022 or 2023, we've said to them that we will not open any other center or approve any other center for opening until 2026 within a 10-mile radius of those cohorts so that they can get up to speed and not face any sort of potential cannibalization impact.

When you look at the map of concentration, market concentration across the U.S., what are the big -- what are the white spaces?

Yes. Our 5 biggest -- I'll answer it in 2 ways. Our 5 biggest states are New Jersey, New York, Texas, California and Florida. We see white space there isn't a single market that we believe is over densified. There are certainly other -- there are places where there are less dots that we think that we can go to. So we're trying to take, again, Simeon, this holistic approach to say, if you want to sign up for what we call a MUD, which is a multiunit development agreement for a particular geography, so a part of a city or part of a metropolitan area, we're willing to do that. We kind of like having a single franchisee or a couple of franchisees where I'm much better off cannibalizing myself than if we had 14 franchisees in one city and bringing in another operator.

Is there a long-term plan, a footprint plan that can help you get to that point?