European Wax Center, Inc. (NASDAQ:EWCZ) Q3 2023 Earnings Call Transcript
European Wax Center, Inc. (NASDAQ:EWCZ) Q3 2023 Earnings Call Transcript November 11, 2023
Operator: Good morning, ladies and gentlemen, and thank you for standing by. Welcome to European Wax Center's Third Quarter Fiscal 2023 Earnings Call. At this time, all participants are in listen-only mode. After the speakers' presentation, there will be a Q&A session. [Operator Instructions]. At this time, I would like to turn the conference over to Bethany Johns, Director of Investor Relations. Ma'am, you may begin.
Bethany Johns: Thank you, and welcome to European Wax Center's third quarter fiscal 2023 earnings call. With me today are David Willis, Chief Executive Officer; and Stacie Shirley, Chief Financial Officer. For today's call, David Willis will provide a brief review of our third quarter performance and discuss our priorities for fiscal 2023. Then Stacie will provide additional details regarding our third quarter financial performance and our fiscal 2023 outlook. Following the prepared remarks, David and Stacie will be available to take questions. Before we start, I would like to remind you of our legal disclaimer. We will make certain statements today, which are forward-looking within the meaning of the federal securities laws, including statements about the outlook of our business and other matters referenced in our earnings release issued today.
These forward-looking statements involve a number of risks and uncertainties that could cause actual results to differ materially. Please refer to our SEC filings as well as our earnings release issued today for a more detailed description of the risk factors that may affect our results. Please also note that these forward-looking statements reflect our opinion only as of the date of this call, and we take no obligation to revise or publicly release the results of any revision to our forward-looking statements in light of new information or future events. Also during this call, we will discuss non-GAAP financial measures, which adjust our GAAP results to eliminate the impact of certain items. You will find additional information regarding these non-GAAP financial measures and a reconciliation of these non-GAAP to GAAP measures in our earnings release.
A live broadcast of this call is also available on the Investor Relations section of our website at investors.waxcenter.com. I will now turn the call over to David Willis.
David Willis: Thank you, Bethany, and good morning, everyone. It's a pleasure to be speaking to you all for the first time in my new role as European Wax Center's Chief Executive Officer. And I want to thank you for joining us today. As we shared in our press release this morning, we delivered another quarter of new unit, top-line and bottom line growth in Q3. Our strong and committed franchisees drove more than 12% unit growth through '23 net new center openings and continue to add to our pipeline of future new units. We generated $241 million in system-wide sales, $56 million in total revenue and $19 million in adjusted EBITDA, each representing growth over the third quarter of fiscal 2022 despite a challenging macro environment.
Furthermore, we delivered a 3.4% same-store sales increase driven by positive comps in both ramping and mature centers. We're grateful to our associates, franchisees and in-center partners for their relentless commitment to excellence. While we delivered organic growth in each of these metrics, our third quarter did not materialize as we expected. I'll take a minute to talk about how business trends evolved as the quarter progressed. I'm pleased to say that throughout Q3, our Wax Pass holders and routine guests remain committed to their waxing routines, driving consistent visit frequency and spend, just as they have in previous quarters. Both of these groups demonstrate strong brand loyalty and represent predictable recurring revenue. We remain focused on continuing to grow these loyal guest cohorts who together comprise about 75% of network sales and increased share of wallet from them.
We also remain focused on engaging our episodic guests who contribute a smaller portion of network sales, but whose behavior has been less predictable amid a difficult macro environment. During the second quarter, we deployed several initiatives through our CRM and data warehouse tools to reengage episodic guests, which were effective. As we noted in our earnings call in August, we were pleased with their performance as we exited Q2. Additionally, solid sales trends entering Q3 gave us confidence in reiterating our fiscal year outlook, which assumed continued momentum. However, third quarter survey work confirmed that while substantially all guests continue to be pleased with their experience at European Wax Center and plan to return a portion of them report that economic concerns are impacting their waxing frequency and spend.
In particular, episodic guest behavior has been more impacted. As planned in the third quarter, we increased our digital ad spend focused on driving reservations across all guest cohorts in lieu of broad or unnatural promotional activity that could impact four-wall margins. However, these media efforts proved less effective than planned, leading to top line trends below our expectations. As a result, we are updating our guidance for the remainder of the year to reflect current transactional run rates. We have also retained a new media agency that is implementing new strategies, which we believe have the potential to favorably impact reservation trends over time. However, our revised guidance for fiscal 2023 has prudently not assumed a near-term change in trend from Q3 and Q4 to date.
Stacie will provide more color on our outlook momentarily. We are very encouraged that our Wax Pass and routine guests remain committed to our brand and underscore the strength and consistency of the European Wax Center model. We recognize that we have an opportunity to not only better engage existing episodic guests but also drive new customers to our brand, which I'll dive into shortly. To that end, we are more focused than ever on our two growth vectors, expanding our footprint through new center growth and driving in-center sales to benefit both system-wide and same-store sales growth. Turning first to unit growth. Our consistent execution of new center openings remains unchanged. We believe that both our pipeline of new locations and the health of our franchisees remain strong, and demand from franchisees of all sizes remains robust.
In the third quarter, we opened 23 net new centers across 12 different states, all of which were in existing markets. Through Q3, we have already opened more than 80% of our expected fiscal '23 new centers. We are not seeing our franchisees slow their interest or new unit development. As a result, we continue to feel confident in our outlook of more than 10% unit growth this year, our multiyear pipeline and our long-term unit growth algorithm. Given the relatively modest initial investment for our centers, our franchisees have sufficient access to capital to fund their growth even in an elevated interest rate environment. We believe our franchisee base is well capitalized with access to lenders who recognize our model's strong cash-on-cash returns and are committed to supporting network expansion.
Additionally, our development team has worked tirelessly to offset industry-wide inflation in the construction process, both through value engineering and by leveraging our scale to drive savings with vendors. We are incredibly focused on managing franchisee upfront costs and ultimately, return on capital, which has encouraged continued reinvestment from our existing franchisees who are driving nearly all of our new center openings this year and comprise more than 90% of our forward-looking pipeline. With these franchisees in mind, our teams are hyper focused on driving top-line and four-wall performance through various initiatives, including staffing pipeline efforts, facilitating network best practices, advising franchisees on how to address controllable costs, implementing grassroots marketing efforts in identifying center-specific sales benchmarks to drive incremental revenue opportunities.
And as always, the team continues to build our pipeline of wax specialists to support near-term and long-term growth. During Q3, we hosted a gathering of more than 100 franchisees, which featured several helpful sessions on associate recruitment and retention. Wax specialist utilization in centers has improved year-over-year and third quarter staffing levels were in line with targets. We are also making progress towards the brand's optimal mix of more experienced wax specialists. We remain confident in our ability to support both the existing centers and new center growth through our wax specialist initiatives for years to come. Turning to our second growth vector, increasing both system-wide and same-store sales by driving in-center sales.
As I mentioned last quarter, we were pleased to welcome Andrea Wasserman to our executive team earlier this summer as our first ever Chief Commercial Officer. While our marketing pillars remain attract more, buy more and visit more, under Andrea's leadership, we are evolving our approach to marketing and media with an even greater discipline around driving visits from both new and existing guests as well as attracting more guests to the brand. We recently engaged a new media agency focused on implementing a streamlined media strategy across all our paid digital channels and search efforts. Our revised approach launched this month with a singular focus, driving more guest reservations in centers. We continue to leverage enhanced guest insights to better refine the audiences we target, deliver the right creative at the right frequency and drive high conversion rates.
To drive more visits from existing guests, we have already implemented additional action messaging to target guests that are at risk of lapsing. We are also testing additional channels in Q4 to learn even more about the most effective method of driving reservations among both new and existing guests regardless of cohort. As I've shared before, Wax Pass holders visit more than twice as often as episodic guests, making the Wax Pass our most powerful frequency driver. With that in mind, we have recently developed key communication flows to encourage Wax Pass consideration and purchase through our marketing channels, not just in sensors. In fact, Wax Passes and gift cards are now available online for the first time in our brand's history, just in time for the holidays in our semiannual wax pass promotional period.
Lastly, as we mentioned last quarter, we believe that offering additional hair removal modalities could be an effective method of attracting more guests to the brand, encouraging more visits and getting guests to buy more products and services over the long-term. Our belief is that laser hair removal has the potential to both capture an incremental customer demographic and increased share of wallet from existing wax guests in turn, enhancing already robust four-wall economics over time. We are in the very early stages of this effort and officially launched our laser test in six New York area centers about a month ago. While we plan to share initial test results further in 2024, we're pleased with the enthusiasm from both franchisees and guests during these early days.
As we think about our longer-term opportunities and corporate responsibilities, I also want to highlight the third quarter release of our inaugural ESG report, detailing our efforts to build a more confident, inclusive and sustainable community as well as our first brand-wide fundraising campaign supporting the national domestic top line. Both of these efforts underscore our commitment to sustainability and living our values as a company every day. With that, I'd like to hand the call over to Stacie Shirley to review our financial performance and updated guidance for the balance of fiscal 2023. Stacie?
Stacie Shirley: Thanks, David, and good morning. Before I begin my remarks, I'd like to remind everyone that in some instances, I will speak to adjusted metrics on this call. You can find reconciliation tables to the most comparable GAAP figures in our press release and 8-K filed with the SEC today. Let's begin with our third quarter financial results. We were pleased with how we exited Q2 and entered Q3, which began largely as we expected. However, as David described, a challenged macro environment impacted transactions and our media efforts were less effective than planned, causing top-line trends to trail our expectations as we move through the quarter. Nonetheless, we still delivered continued growth over the prior year period.
Q3 system-wide sales increased 2.4% to $240.7 million, and total revenue increased 1.2% to $55.7 million. Year-over-year growth rates reflect the impact of a reporting calendar that shifted some of our largest Wax Pass promotional days into Q2 this year instead of Q3. And as a reminder, payments for Wax Passes are a component of system-wide sales and trigger royalty revenue for us as a franchisor. Overall, top-line growth was driven by our two growth vectors, including 12.6% unit growth over the third quarter of last year. Same-store sales also increased 3.4%, driven by both our ramping and mature centers. Consistent with the first half of this year, higher average tickets were the primary comp driver. From a profit standpoint, third quarter gross margin of 71.8% was largely in line with our expectations.
Third quarter SG&A was $14.4 million and as a percent of revenue, was 25.8%, 100 basis points higher than Q3 last year, driven by an increase in corporate funded marketing. Q3 adjusted EBITDA increased 3.4% to $19.3 million. Adjusted EBITDA margin was 34.6%, representing an 80 basis point improvement year-over-year and exceeding our low 30s expectations, primarily due to the timing of advertising and professional fees that shifted into the fourth quarter. Below the line, adjusted net income was $6.1 million. This differs from $19.3 million in adjusted EBITDA due to three primary factors. First, interest expense was $6.5 million, a slight decrease from $6.8 million in Q3 2022 due to additional short-term interest income this year. Second, Q3 depreciation and amortization expenses were $5 million.
Consistent with prior quarters, the vast majority of this line item relates to the noncash amortization of intangible assets, such as franchisee relationships and area representative rights that were established prior to our IPO. And third, income taxes. We released our valuation allowance on deferred tax assets at the end of 2022. As a result, we expect to recognize annual income tax expense compared to negligible expense incurred during the period covered by the valuation allowance. For Q3, GAAP net income reflects $1.8 million of tax expense and adjusted net income reflects $1.7 million of adjusted tax expense. And now to our cash flows and liquidity, which reflect the significant strength of our asset-light model. Even in a tough environment, we continue to generate strong free cash flows for the benefit of both our network and our shareholders.
From Q2 to Q3, our cash position increased by roughly $10 million to $64 million. We had $395 million outstanding under our senior secured notes and nothing drawn on our $40 million revolver. Net leverage continued to decrease sequentially, ending Q3 at 4.4x adjusted EBITDA compared to 5.3x in Q3 last year. Based on our outlook, we expect to further delever in the fourth quarter. Operating activities generated $17.6 million in cash during the third quarter compared to investing outflows of approximately $150,000. We purchased approximately $5.5 million of stock during the quarter and still have approximately $23.5 million remaining under our current buyback authorization. Ultimately, our asset-light, capital-light business model enables us to determine the best way to deliver long-term shareholder value as we continue to monitor our environment.
Turning now to our updated outlook for 2023. With strong franchisee confidence in demand, we remain confident in delivering more than 10% unit growth for fiscal 2023. We have clear visibility and now expect to open 98 to 100 net new centers this year, which is towards the high end of our previous outlook. In terms of the top-line, as David mentioned earlier, our previous guidance incorporated a solid start to the quarter and assumed that our strategic initiatives and media efforts would drive continued improvement through the back half of this year. While Wax Pass and routine guests continued to show resilience and consistency, trends among our less frequent guests did not sustain the momentum we expected. As a result, we are updating our financial outlook for the balance of the year to reflect the current trends we observed in Q3 and Q4 to date.
Our 2023 system-wide sales expectations are now between $945 million and $955 million, with total revenue expected between $217 million and $219 million. Our full-year same-store sales expectations moved to a range of 1.5% to 2.5%. Our adjusted EBITDA outlook is $74.5 million to $76 million, reflecting the impact of a lower top-line. As a reminder, and consistent with our remarks last quarter, this range includes up to $1 million of SG&A, primarily in the fourth quarter to support our laser hair removal test. Despite a challenged environment, we are committed to our promotional discipline in preserving four-wall economics. As a result, our full-year gross margin expectations remain approximately 71%, unchanged from our previous outlook. Our 2023 interest expense outlook remains approximately $28 million, slightly weighted to Q4, given a 53rd week in 2023.
As a reminder, both fiscal years 2022 and 2023 included a 53rd week, but we will return to a 52-week year in fiscal 2024. We continue to expect our 2023 blended statutory tax rate to approximate 20%, which is based on known year-to-date exchanges from Class B to Class A shares. All in, we expect adjusted net income between $20.5 million and $21.5 million. Transaction trends have been relatively stable exiting Q3 and into Q4 to date. Our revised guidance incorporates a range of outcomes for the balance of the year, including continued stability or moderate deceleration from the current run rate. At the midpoint, our updated full-year outlook translates to more than 10% unit growth alongside mid-single-digit system-wide sales, total revenue and adjusted EBITDA increases.
Even in an uncertain environment, we are proud to expect meaningful organic top-line growth and stable adjusted EBITDA margins year-over-year. Most importantly, our existing franchisee network continues to reinvest in the brand, and we feel confident in our long-term unit growth algorithm. In conclusion, we remain the undisputed leader in our category, delighting guests in more than 1,000 centers across 45 states. Frequency and spend among our core guests are solid and consistent. However, the macro environment has been a headwind this year among our less frequent guests. We believe our best-in-class business model remains lucrative for franchisees to enjoy robust cash-on-cash returns at maturity. Those compelling unit economics in turn drive sustained reinvestment from existing franchisees.
We expect our continued focus on unit growth and in-center sales growth will enable us over the long-term to grow both network and corporate revenue, leverage our fixed cost profile for EBITDA margin expansion and continue generating significant free cash flow, in turn creating further value for European Wax Center, our franchisees and our shareholders. With that, I'd like to turn the call back to David to wrap up our prepared remarks and open it up for Q&A. David?
David Willis: Thank you, Stacie. As I laid out at the top of the call, we're focused on driving reservations and top-line growth amid the near-term challenges presented by this macro environment, while also maintaining our promotional discipline and margin profile. Despite these challenges, we remain confident in our long-term growth potential. We believe we have a resilient service offering with loyal core guests and continued opportunities to expand our brand and the model. As the dominant player in a highly fragmented category, we are well positioned to leverage our scale and take market share in a period of disruption. At only one-third of our long-term unit target of 3,000 centers, our white space is significant, and we benefit from continued reinvestment from committed franchisees to support our growth trajectory.
With so much potential yet to be realized, we remain as excited as ever about our future and the growth opportunities ahead for all of our stakeholders. We'd now like to open up the call for questions. Operator?
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