Shake Shack Inc. Q4 FY2022 Earnings Call

Good day, and welcome to the Shake Shack Fourth Quarter 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded. At this time, I'd like to turn the call over to Annalee Leggett, Senior Manager of Investor Relations and FP&A.

Thank you, and good morning, everyone. Joining me for Shake Shack's conference call is our CEO, Randy Garutti; and CFO, Katie Fogertey. During today's call, we will discuss non-GAAP financial measures, which we believe can be useful in evaluating our performance. The presentation of this additional information should not be considered in isolation or as a substitute for results prepared in accordance with GAAP. Reconciliations to comparable GAAP measures are available on our earnings release and financial details section of our shareholder letter. Some of today's statements may be forward-looking, and actual results may differ materially due to a number of risks and uncertainties, including those discussed in our annual report on Form 10-K filed on February 18, 2022. Any forward-looking statements represent our views only as of today, and we assume no obligation to update any forward-looking statements if our views change. By now, you should have access to our fourth quarter 2022 Shareholder Letter, which can be found at invest.shakeshack.com in the Quarterly Results section or as an exhibit to our 8-K for the quarter. I will now turn the call over to Randy.

Thanks, Annalee. Good morning, everyone. 2022 was a year of continuous improvement in Shack formats, culinary innovation, and focused strategic planning for the exciting road we have ahead. We ended the year opening 69 Shacks globally, growing our unit count by more than 18%, with system-wide sales expanding more than 22% year-over-year to a record $1.4 billion. Our total revenue grew over 21% to approximately $900 million, led by new openings and 7.8% same-Shack sales. We continue to build back our Shack-level operating profit margins to 17.4% for the year, exiting the year at 18.8% in the fourth quarter, all the while continuing to demonstrate the global appeal of our brand as we stand for something good in all that we do, elevating our teams and communities along the way. We ended the year with solid momentum in the fourth quarter, raising average weekly sales, expanding our margins, and investing with discipline on G&A and CapEx. Our performance was led by price and strong in-Shack traffic growth, reaching $76,000 in average weekly sales and 5.1% in same-Shack sales. This momentum has carried into January with total revenue up nearly 35%, including a 17% comp and double-digit traffic growth, as we lapped last year's heavy impact from Omicron. Our licensed business performed well in the fourth quarter despite pressures from COVID-related disruptions in China and other regions, and some of that volatility in our China Shacks has subsided in January and we're cautiously optimistic that things can begin to level out towards a more normalized sales environment internationally this year. Our 18.8% Shack-level operating profit margin in the fourth quarter was supported by our October menu price increase, efficiencies in labor, and positive channel mix as more guests return in-Shack. Rest assured though that our work to build our profitability is far from done. We have a plan in place to continue this improvement in 2023. And given the uncertain economic backdrop, we expect conditions to remain challenging for some time. However, we are confident that we have the right strategic priorities and team in place across the company to navigate these pressures and set us up for solid long-term growth. We've shared a lot of detail around our '23 strategic plan at the ICR Conference in January, a presentation and replay of which is available on our IR website. Today I want to recap where we're focused this year. Our number one focus is on recruiting, rewarding, and retaining a winning team. Fielding an exceptional team is the key ingredient to operating efficient and successful Shacks. We have not been immune to the staffing challenges the industry has faced and we've doubled down on recruitment, retention, and training efforts. We've raised pay, expanded benefits, added tips, and enhanced access to the opportunities our team members have to advance in making Shake Shack a real career choice. Last year, we filled nearly 60% of operations leadership positions with internal candidates, a critical pipeline to meet our growth goals. Seventy-seven percent of our promotions were awarded to people of color and over 50% to women. While many Shacks remain below their optimal staffing levels, we've seen marked improvement in hiring over the last few months. And let's remember that we opened 22 domestic company-operated Shacks in the fourth quarter, so we're still in the midst of a lot of training and moving team members around to support new openings. We're expecting to have some additional costs running into the first quarter as we get to more optimal operations. We still have a lot of work to do, but we're incredibly proud of how the team is developing. Our second priority is keeping our relentless focus on the guest experience. Shake Shack has always been differentiated from traditional fast-food, and we win by doing what most QSR and other restaurants are either unwilling or unable to do. Between collaborating with celebrity chefs for marquee events and LTOs to partnering with media companies like Hot Ones as well as brands like Maker's Mark for our bourbon bacon jam. We are continually learning how to better drive engagement with new and existing guests. This past week, we launched our White Truffle LTO, which includes the White Truffle Burger, a vegetarian option, with the White Truffle 'Shroom and Parmesan White Truffle Fries. This is a great example of something only Shake Shack can do, creating an elevated affordable culinary experience. It'll also be a big year for plant-based innovation. We plan to launch our Non-dairy Chocolate Shake as well as our new Veggie Shack Burger developed right here in our Innovation Kitchen in the West Village. It's an elevated and delicious alternative to the highly processed meatless offerings in the market today. It's packed with mushrooms, farro, quinoa, sweet potatoes, carrots, and more, topped with American cheese, crispy onions, pickles, and Shack Sauce. I think we've landed on a vegetarian option that's craveable, and we look forward to introducing it to a wider audience to get feedback this year. We also plan to keep a rotating group of LTOs to drive frequency and you'll see various tests on a number of new items through the year, including new packaging, caffeinated lemonades, mini shakes, and more. We're offering a better overall experience, committed to premium ingredients, and greeting our guests with genuine hospitality. This is our competitive advantage and our focus. If we do this well, we believe more people than ever will come. Our third priority is focused on development and how we grow from here. We believe our total addressable market globally continues to expand. We opened 36 domestic company-operated Shacks in 2022. In the fourth quarter alone, we opened 22 restaurants in a balance of formats, including core Shacks, small formats, and five new drive-thrus. While many of these Shacks opened just weeks and, in some cases, just days before the quarter ended, we're encouraged with the early results as they settle into 2023. This coming year, we expect to open about 40 Shacks, with roughly six of them in this first quarter, having just opened a new drive-thru in Dublin, Ohio and a core Shack right here in New York City in Brooklyn's Bed-Stuy neighborhood. Currently, we have 24 Shacks under construction. On drive-thru specifically, with 12 opened today, we're encouraged by the initial reads and are targeting to nearly double that with our plans to open 10 to 15 more drive-thrus this year. We know there's still much we have to learn and much to prove out as we've been rolling out a few different designs as well as kitchen flows so that we can optimize this investment for learning quickly and evolving the model for the long run. Our licensed Shack business is the other key part of our development strategy. In 2022, our partners opened 33 licensed Shacks, 20 of those in Asia, three in the Middle East region, two in Mexico, and eight in the United States in our airports, travel plazas, and event venues. This is an asset-light way to grow our profitability over the long term, speaks to the strength of our brand which resonates globally across geographies and cultures. Very few, if any, restaurant companies at our scale have successfully grown with this level of excitement and brand acceptance around the globe, and you'll see us continue to build in existing markets while adding new markets in the future. This year, we expect our partners to open between 25 to 30 more licensed locations across formats and regions, with six to seven more in the first quarter. Nearly half of our openings we expect to be in Asia, including a launch in Thailand later this spring. We'll also unlock another format type as we partner with the Atlantis in the Bahamas to open our first-ever resort hotel Shack. We will also test our first drive-thru in our licensed business with our partners Alshaya in Dubai. And lastly, we're spending a lot of time considering new countries, territories, and formats where we can grow this critical part of the Shack opportunity for the long term. Our licensed business and partners remain an incredibly dynamic, profitable, and powerful way to keep expanding our presence in brands across the globe. Our fourth priority is improving our overall company profitability with particular focus on our domestic company-operated Shacks. We know the dynamics over the last few years have impacted our historical margin profile; we're focusing our work to rebuild over the long term. We're committed to improving profitability by driving sales, emphasizing our own higher-margin channels, finding COGS, labor, and OpEx efficiencies, improving off-premise profitability, and utilizing strategic menu pricing. We showed margin progression in the fourth quarter and we have the right plan in place. Leading with sales, our priority has to be to retain our winning team. We have to keep improving staffing levels so that we can optimize total hours and sales potential. Our big opportunity, especially in newer markets, is around building our brand strength. We've been testing various brand campaigns across media channels, investing in targeted performance marketing, and more than ever, building community marketing with our regional leaders participating in and supporting more local events than ever. On the expense side, we've got an intense focus on every line of the P&L in our Shacks. We're building teams to collaborate with our operators, designers, and suppliers to go after the profitability measures we can tackle this year, and Katie will talk more about these efforts in a bit. Finally, as we build an enduring company, we are committed to investing with discipline. We see growth opportunities with a strong return potential across development, digital, and our business overall. In the last few years, we made the critical decision to fortress our balance sheet with a historically low cost of capital. That's provided us with the dry powder to grow in this current environment, and we're committed to doing it with discipline while remaining aggressive. You'll see us continue to deploy capital towards strong returns in four main areas: building Shacks; updating our current Shacks; investing in our digital infrastructure; and structuring our home office capabilities to support our restaurants. We have historically outperformed our long-term AUV targets while delivering strong cash-on-cash returns. Over the last few years with profitability under pressure and net build costs elevated on average, our new Shacks generated returns just below long-term targets. Building back our Shack-level op profit margin as well as addressing higher build costs is the work to be done to bring us back to our longer-term return targets. The Shack class of '22 average net build cost is tracking around $2.4 million. Inflationary pressures in the building and construction market worked against us last year, but we're also investing in a more expensive mix of Shacks with drive-thrus included. In 2023, we expect a similar build and cost mix as we target 10 to 15 drive-thru Shacks. We're addressing cost-savings where we can for the class of '23 and beyond. We've cast our operational and construction design teams to work towards bringing down long-term average costs to build for all formats. We're going to keep building Shacks to win with focused and scalable designs and formats where we know we can drive strong returns over the long term. We've got the right plan and team in place for '23 and we'll keep you posted on progress as we go. With that, I'll hand it off to Katie to share more about the details of the quarter and expectations looking forward.

Thank you. Good morning. We ended the year positively with growing momentum and clear indications that our strategic priorities are effective in rebuilding our profitability and expanding long-term opportunities. During the quarter, we achieved strong year-over-year progress, including high-teens revenue growth, an increase of 240 basis points in restaurant margins, and over 55% growth in adjusted EBITDA. We accomplished these results despite challenges such as labor shortages, supply chain issues, and food and paper inflation, among others. Our total revenue for the fourth quarter reached $238.5 million, representing a year-over-year increase of 17.4%. Shack sales matched this growth, hitting $229.9 million, while licensing revenue grew 16.6% to $8.6 million. We reported a Shack-level operating profit margin of 18.8% and increased adjusted EBITDA to $19.3 million. For the full year 2022, despite the significant impact of Omicron on our early sales and profitability, we grew adjusted EBITDA by 25.8% to $70.5 million. In the fourth quarter, system-wide sales were $364.1 million, pushing total annual sales above $1.4 billion, with 436 total Shacks, including 69 new openings in both the U.S. and international markets. In October, we implemented a mid to high single-digit menu price increase across various strategies ranging from 2% to 10%. This adjustment was necessary to address food and paper inflation and to continue investing in our team members. We anticipate maintaining a blended high single-digit price across channels in the first half of 2023, rolling off the 3.5% menu price increase from March 2022 and an additional 5% in third-party delivery premiums. In the fourth quarter, our average weekly sales increased to $76,000, up from $73,000 in the previous quarter, bolstered by price increases and in-Shack traffic. Same-Shack sales rose by 5.1% compared to 2021, although in-Shack traffic dipped slightly as we compared against a particularly strong fourth quarter in 2021. Our digital engagement continues to be promising, with 36% of Shack sales originating from digital channels such as our app, website, and third-party delivery in the fourth quarter. Since March 2020, we've encountered 4.8 million new digital purchasers through our app and website. This reinforces our commitment to optimizing all channels and leveraging existing investments in our app, website, and kiosks for better acquisition and conversion rates. Our digital initiatives in the Shacks will see kiosks rolled out to nearly all domestic locations by the year's end, as they represent our highest-margin channel. In the fourth quarter, urban same-Shack sales grew by 8%, driven by positive price/mix and traffic growth. Suburban Shack sales rose by 3% due to positive pricing and slight traffic declines year-over-year. As we move into January, trends for return to work and overall mobility appear strong. Our fourth quarter openings performed well, generating $72,000 in average weekly sales and 17% same-Shack sales growth, with increases attributed to traffic and pricing. While Omicron had the most significant impact on our January sales last year, we have seen a sales recovery throughout the first quarter. Licensing sales rose to $134.1 million, a 13% year-over-year increase, with $8.6 million in licensing revenue. The success of our licensed Shacks has been bolstered by strong holiday demand, but licensing sales faced setbacks due to COVID impacts in China and the stronger U.S. dollar. Our licensed partners opened 33 new Shacks in 2022, with six openings already in 2023, targeting a total of 25 to 30 licensed Shack openings this year. In the fourth quarter, Shack-level operating profit was $43.2 million, or 18.8% of Shack sales, which marked a 240 basis point increase from last year despite inflationary pressures. We achieved this through menu price increases, solid sales performance, labor efficiencies, and favorable channel mix. Our profitability strategy involves several key actions: prioritizing sales in our core channels, improving labor efficiency through our kiosk rollout, enhancing off-premise profitability by adjusting packaging costs and delivery pricing, and taking a calculated approach to menu pricing. Food and paper costs in the fourth quarter totaled $67.9 million, which constituted 29.5% of Shack sales, a decline from previous quarters due to price increases, although high single-digit inflation persisted. Labor costs were $66.4 million, or 28.9% of Shack sales, a decrease compared to last year. Other operating expenses accounted for $34.1 million or 14.8% of Shack sales, aided by a lower delivery sales mix. We remain vigilant about inflationary pressures affecting in-Shack operations, although we are striving to manage these costs effectively. Occupancy expenses were $18.2 million or 7.9% of Shack sales, a slight reduction driven by sales leverage. General and administrative expenses were $31.8 million, representing 13.3% of total revenue, an increase attributed to investments in marketing, operations, and technology. We finished 2022 with $112 million in G&A, adjusted for legal settlements, marking over 30% growth from the previous year. In the fourth quarter, we reported a pre-tax loss of $4.3 million and a tax expense of $6.8 million. Our net loss attributable to Shake Shack Inc. stood at $10.7 million, amounting to negative $0.27 per share. On an adjusted pro forma basis, our net loss was $2.6 million, or negative $0.06 per diluted share. Despite these challenges, our balance sheet remains robust, with cash and cash equivalents totaling $311.2 million. Looking to the first quarter and full year of 2023, we do not anticipate significant changes in macroeconomic conditions or further COVID disruptions. Given strong performances seen in January and early February, we are confident in raising our Shack sales guidance to a range of $232 million to $237 million, with same-Shack sales projected to increase by high single-digit percentages year-over-year. We are aware that our comparisons will become more challenging as we move into mid-February. Our licensed revenue guidance for the first quarter has also been raised to $8.25 million to $8.75 million, reflecting improved conditions in our domestic and international markets. Overall, we expect total revenue between $240.25 million and $245.75 million, indicating an 18% to 21% year-over-year growth. For the first quarter, Shack-level operating profit margin is estimated to be between 16% and 18%. We anticipate facing inflation in food and paper costs at high single-digit rates, particularly concerning items like fries, dairy, and packaging. Although beef costs are likely to see a decline, they will still rise slightly quarter-over-quarter. The inflation outlook remains unpredictable, and we do not have contracts in place for many of our essential inputs. Our 2023 G&A guidance is set at $125 million to $130 million, reflecting a 12% to 16% increase year-over-year, aimed at maintaining a disciplined spending strategy while allowing for continued investment in growth. While certain uncertainties could influence our total revenue for the year, we believe our guidance is practical and aligns with our business expansion plan. We're targeting approximately 16% growth in our company-operated units and 14% to 16% growth in our licensed operations. We expect equity-based compensation expenses to be around $17 million, with full-year depreciation estimated at $86 million to $91 million and pre-opening expenses from $17 million to $19 million. We are not providing guidance on an adjusted pro forma tax rate at this time but expect to see a minimal tax benefit this year influenced by various factors. Thank you for your attention. I will now hand it back to Randy.

Thanks, Katie. Just want to wrap things up, and thank all of our teams for executing through 2022 and evolving for the work ahead in 2023. We're all squarely focused on our strategic plan, which begins with taking care of our team. That's what fuels our great culture. We believe our results from the fourth quarter are showing what our focus and dedication can do to help drive continued improvement in our business and longer-term returns. As we all seek out what the new normal looks like in a post-pandemic 2023, we believe more than ever that people need places to gather, great food at the right price served by warm and hospitable people, and we'll look forward to sharing a White Truffle Burger with you soon at the Shack. As always, we hope you and your family stay safe and healthy. With that, operator, please go ahead and open the call for questions.

Thank you. We will now be conducting a question-and-answer session. We'll take our first question from the line of Lauren Silberman with Credit Suisse. Please go ahead.

Thank you very much. Just my first one, on new classes of Shacks, historically, Shacks have opened at high volumes at the honeymoon period and then settle. Have you been seeing the same trend with your newer classes of Shacks, recognizing there's a lot of noise in there? Just trying to understand if you're getting to a stage where there's less of a honeymoon period?

Thank you, Lauren. That's a great question because it relates to a significant trend in our performance. The answer varies by location. In well-established markets like New York City or Los Angeles where we have many Shacks, we tend to see more stable performance without the initial surge followed by a decline. Instead, we observe a steady improvement right from the start, and this has been consistent. However, there are still many areas we have yet to enter, even in neighborhoods close to existing Shacks. For instance, we recently opened in Dublin, Ohio. Although we already have several Shacks in Ohio, Dublin is distant enough that it attracted many new visitors in its opening week, which we expect to normalize over time. In general, for our approximately 40 new Shacks this year, if they are in newer or expanding neighborhoods, we typically experience the initial surge followed by a stabilization, and then an increase over time. In mature markets, we are less likely to see that same pattern.

Very helpful. And then, just a follow-up on your commentary around opportunities with build costs. Can you expand on where you might see potential costs out? Just given the uniqueness of your sites, are there opportunities for more standardized images? Or how are you thinking about that? Thank you.

Certainly. Thank you. There are many ways to approach this. First, we'll need to monitor how the inflation situation develops. The construction environment remains significantly elevated across the country, which everyone is facing. This will influence our strategies moving forward, and we hope to see some positive changes. Proactively, we are working to standardize our various formats, creating better templates and prototypes, and reducing sizes where feasible. The drive-thru model serves as a prime example; our initial investment in over 20 drive-thrus allowed us to experiment and learn what works best. As we gather insights, we anticipate designing our drive-thrus for 2024 and 2025 in a way that allows for better templates and lower costs. This strategy applies similarly to our smaller formats and core locations. We are also exploring different deal structures, such as build-to-suit agreements to minimize construction costs. Our focus is on increasing small formats to lower overall expenses. This is a top priority for the company at present. While we do not expect to see immediate benefits this year, we are optimistic about long-term opportunities to improve how we build and design our restaurants, making our operations more efficient over time.

Thank you very much.

Thank you. We'll take the next question from the line of Mike Tamas with Oppenheimer & Co. Please go ahead.

Hi, good morning. Thank you. I know you're not giving exact margin guidance for the full year in '23, but there's a group of analysts' consensus has you guys expanding margins quite a bit versus 2022, which would be pretty unique in the space. So, I know you gave guidance from mid- to high-single-digit COGS inflation, mid-single digit labor inflation. But if you think about how you guys are modeling your business internally for sales and costs, you just sort of qualitatively think that you can expand margins in 2023 versus 2022?

Thanks for the question. We haven't provided specific guidance for the full year. Our main focus is to improve our margins, building on the progress we made in the fourth quarter. We're concentrating on four key areas. First, we're working on increasing our sales, particularly through our most profitable channels. Kiosk sales are our most profitable, but we also value in-Shack sales. One significant pressure on our margins during the pandemic was the shift to digital sales, and as those return to in-Shack, it should positively impact our margins. We're also investing in marketing and other strategies to enhance brand awareness and overall sales. Secondly, our strategic approach to menu pricing remains important; we expect to implement high-single-digit price increases in the first part of this year. We haven’t discussed additional price increases yet to address inflation but are monitoring the situation, especially with beef prices. If they rise, a small price increase may be necessary. We're also focused on improving labor efficiency by fostering better performance among our current team members. We have recently hired many new employees, invested in training, and are ensuring that our locations are fully staffed to maximize sales. Additionally, we want to equip our operators with the necessary tools to enhance efficiency in the Shacks. Finally, we aim to improve our off-premise profitability. While we charge a premium for third-party delivery, we've worked on refining our packaging standards for off-premise orders. We're trying out packaging tests this year, which present another potential opportunity.

Okay. Thank you. And then, just want to follow-up on the commentary about some of the new store design and being more efficient with drive-thrus, I think, Randy just mentioned in '24 and '25 relative to the ones that are already in the ground. So, when you think about like what are some of those big changes that we can expect to see? And are they more like guest facing? Or are they more sort of like back-of-house in operations? Thanks.

It's a combination of factors. It's really about how we construct everything from the base up. This includes choices like using steel or wood for construction, and how our windows function. Guests will notice these details, and we believe they'll appreciate them. We're looking at how we built this initial group of 20 locations with varying kitchen designs and layouts, figuring out the necessary lanes and technology, all to optimize our learning process. As we begin construction, we’re gaining insights on what works, and we need to standardize more elements while maintaining the unique qualities that define Shake Shack. We’re confident that customers will find our drive-thrus to be an enjoyable and distinctive experience, recognizing the elevated design that Shake Shack offers. We're also learning about optimal sizing; we've observed that about half of our drive-thru sales come from the Shack, which we find encouraging. So we need to determine the number of seats required inside and outside, as well as the overall atmosphere we're creating. We're focused on making our drive-thrus community gathering spots rather than just places to quickly grab food. Today, we want to give our guests the freedom to choose their preferred service method, and we see that as an important aspect of our approach. There's still a lot of work to be done, and we plan to test various designs while aiming for greater efficiency in our future projects.

Awesome. Thank you.

Thank you. We'll take the next question from the line of Sharon Zackfia with William Blair. Please go ahead.

Hi, good morning. I apologize if you talked about this. My cellphone dropped in the middle of your comments. But I think I heard you say, Katie, that your staffing is getting better, but still isn't fully optimal. Can you give any kind of framework around where you are relative to ideal staffing? Maybe currently versus the fourth quarter, where you are on hours of operation across all channels? And then, on the drive-thru, I'm just curious whether you're seeing that bring in new customers, or if it's really more a function of increasing the accessibility and the frequency of your existing guests? Thank you.

Thanks, Sharon. We've seen improvement in our staffing over the last few months, but challenges remain. We would prefer to be fully staffed everywhere, but some locations are performing well while others still struggle to optimize team sizes. Compared to a year ago, when we faced significant challenges, we are feeling more optimistic. We have made progress since three months ago, but we recognize there's more to be done. Our initiatives for our employees, such as raising wages, now including tips, providing added benefits, and offering development opportunities, are making a positive impact despite the ongoing difficulties. Regarding hours, we've expanded operations in the fourth quarter, although there are still areas in certain locations where we can do more. We need to assess how to optimize hours for each Shack based on ongoing changes in the environment. There are still opportunities for improvement. As for drive-thru guests, we are gaining insights. We value guests who engage with us through multiple channels, including drive-thru. Our goal is to encourage more frequent visits by providing convenience. Feedback from drive-thru customers has been very positive, and while it's early to draw definitive conclusions, we believe this initiative could broaden our market reach and create new opportunities to connect with guests effectively.

Thank you. Sharon, do you have any further questions? You have a follow-up?

No, thank you.

Thank you. We'll take the next question from the line of Jake Bartlett with Truist Securities. Please go ahead.

Thank you for the question. My first follow-up is regarding margins. There were some unusual or higher costs in 2022, such as for repairs and maintenance and travel expenses as your existing staff assisted with opening new stores. How much of that in 2022 was typical and might disappear, providing a boost in 2023? Additionally, on the margin side, it seems you are very focused on improving margins. Are there any significant new initiatives underway? Some companies that have been around for decades continue to find small savings, while others are conducting time-motion studies to enhance operations substantially. Is that something you are considering as you work on increasing margins?

Certainly. Last quarter, we highlighted some pressures affecting us. Firstly, we faced higher repair and maintenance costs. Equipment availability has hindered our ability to open new restaurants and also affects how quickly we can replace equipment inside the existing ones, forcing us to service it instead of replacing it. Additionally, we encountered increased travel and entertainment expenses to support our team members, along with higher utility costs. The positive news is that our teams managed these challenges effectively in the fourth quarter, although costs remained above average levels. We are actively looking for ways to reduce these expenses overall. Travel and entertainment expenses for Shack openings will depend on the number of locations we open in a given quarter, particularly in overlapping markets. Our aim is to have a more consistent development year, which would help in this area. Regarding utility costs, the broader commodity landscape is a significant factor. In response to whether we have specific plans in place, I can confirm that we do. We’ve outlined these in our Shareholder Letter and on the call. Our focus is on driving sales, enhancing labor efficiencies, and training our team members.

I’m curious about the efficiencies you’re implementing. Are you taking a significant approach to do things differently, especially since you've been outpacing younger concepts? I believe there’s a chance to improve kitchen efficiency, but is that a deliberate effort? Additionally, I’d like to understand the outlook on food costs. Many investors, including myself, are mainly concerned about beef as a potential risk. However, your outlook on beef seems stable, with expectations of flat to mid-single-digit changes, while other factors appear to be causing inflation. What visibility do you have on those other items? I’m trying to identify the major factors we should monitor to determine if you're on track to meet your guidance, such as dairy, poultry, or any other significant items we should be following closely.

Yes. So, we had a pretty inflationary year for beef in general. It's been kind of a pressure for us for a while. So, calling for a flat to up mid-single-digit inflation on that side, that does reflect a pickup in beef prices overall for the year. Certainly, we'll have to see how the year plays out and if it ends up being more extreme or less extreme than that. But we are factoring in a degree of beef inflation in our outlook. Then, the other thing to keep an eye on is chicken; it is dairy; it is fries; fryer oil, like we've called out a lot of these big drivers here of our COGS that are seeing pretty material pickups here. We don't contract on a lot of it. That would be how we think about the inflationary cadence for the year.

Thank you very much.

Thank you. We'll take the next question from the line of Peter Saleh with BTIG. Please go ahead.

Great. Thanks for taking the question. Randy, I think you mentioned this a couple of times on the tipping that's been implemented. Can you talk about the consumer response to the tipping, maybe parsing out urban versus suburban or just how often you're seeing consumers actually tip the employees?

Thanks, Peter. Yes. We're not going to break out any of that urban, suburban, or data on that other than to say, since the beginning of Shake Shack 20 years ago, people have asked us if they could add a little extra something for our team, and we always said no. This year, we've said yes. The beauty of the way we've done it is it's not in your face. We don't start with this 20%, 25% expectation like many restaurants do, and you have this kind of moment as a consumer where you are like, 'Wow, 20%, 25%, that's a lot.' We make it very on your side, and if you would like to do that, great. We're happy to see how many people are doing it; and there are a lot of people who don't; and that's cool too. This is really an optionality feature that if you really want to take care of our team and feel like it, you want to give a little something, $1 or $2, or 10% or whatever, that can work. It's making a material impact for our team. In some cases, it's $2 to $3 more per hour that our teams can make, thanks to a percentage of people who are tipping. We're hopeful that that's a continued strategy that will help us find the right overall wages for our team to take care of them and hopefully have people be retained, and allow our guests to feel good about it. It's like we always said, we all experienced this when you go to a coffee shop or anything else; if you don't want to tip, that's totally cool, and we appreciate that, and we're never going to have a pressure-filled environment trying to make that work. It should feel great to both sides of the equation.

Thank you. That was very helpful. Just on kind of staying on labor for a second. Katie, I think the last time we spoke, you had mentioned that it was maybe a little bit more challenging to staff some of the suburban versus the urban lately. Have you guys seen any improvement on that front just the staffing between those two, suburban and urban?

Yes, we are still seeing an opportunity to regain our sales by focusing on staffing. We had some success in certain suburban locations during the quarter, and towards the end of the quarter, we began to establish a stronger position in some areas, but there are still opportunities in others. Many of the trends we discussed continue to be relevant.

Thank you. We'll take the next question from the line of Andrew Charles with Cowen & Company. Please go ahead.

Great. Thank you. Randy, you guys seem open-minded about taking more price in 2023, as you mentioned with the beef prices that potentially could revert higher later this year. Can you talk about what gives you confidence that you guys have further pricing power, just given well-documented trade-down across the fast-casual industry and the quick service?

Yes, we need to be cautious and are monitoring the situation closely like every other company. We've probably increased our prices less than many others, particularly among our competitors in fast-casual and fast-food, over the last few years. I believe we have been more careful, and we intend to remain that way. This approach has been integral to Shake Shack since our inception. However, we must ensure that we protect our margins. As of today, in February, we have no plans for new price increases. We'll evaluate this as we observe how inflationary pressures fluctuate. We expect these pressures to persist at some level this year, but it's uncertain. We have to ensure we continue providing the great value we always have. We will also focus on our strategic planning, ensuring we execute our operations, hospitality, and the premium nature of Shake Shack that delivers good value. We will keep an eye on this. Looking at the current evidence, we are encouraged by the trends in our average order values and the number of items per check, along with our overall value scores which have been consistent. However, everyone is dealing with a challenging inflationary environment, and we must adapt. We will not become a major discounting fast-food entity. Instead, we will emphasize our ingredients. Currently, we are promoting a premium offering of White Truffle. This aligns with our strategy; we aim to attract customers who appreciate that for $9.99 or less, they can enjoy a White Truffle Burger that is not available in typical fast-food eateries. While this is a refined experience, it still represents great value and helps establish us as a leader in providing affordable, high-quality options. This is our intention moving forward, and we will inform you if our stance on pricing changes soon.

Just also a reminder, we over-indexed to higher-income consumers and we're generally seeing pretty good trends from that group as well, so it's just also something to keep in mind.

That's helpful. And then, Katie, beef guidance for the year flat- to mid-single digit guidance. So, obviously, a very wide range, just anticipating on certain backdrop. Curious though, you mentioned that you guys aren't seeing any inflation yet or any inflation on the comp, but can you just help us with the guidance? Is it fair to say that conversations with vendors suggested that you guys would be closer to flat and that mid-single-digit will perhaps be just conservatively baked in? Just, I guess, to understand the big guidance a bit more for the year.

Yes. When comparing the first quarter to the full year, we're projecting a mid-single digit decline for the first quarter. This suggests that we have taken into account an increase in beef prices for the latter half of the year. We don't make contracts on beef, and we are engaging with our vendors to understand their perspectives while also aligning this information with broader industry and analyst forecasts. Thus, there remains a significant level of uncertainty around this as we have clearly communicated.

Thank you very much.

Thank you. We'll take the next question from the line of David Tarantino with Baird. Please go ahead.

Hi. Good morning. Katie, I have a question about CapEx. I think the final number for 2022 came in quite above what we would have been anticipating at the beginning of the year. So, I was wondering if you could maybe break down where some of the increases came from? And then, I have a follow-up.

Sure. When we simplify it, we are developing much more actively than we did last year. Currently, we have 24 Shacks under construction, and we had several more at the end of last year, with many openings occurring in this quarter. What you're noticing is significantly greater investment in our pipeline compared to this time last year. We've also increased our investments in IT and digital, but the main focus is on that area. Additionally, we've made extra investments as we expand the rollout of kiosks to a larger number of our Shacks.

Great. And then, I guess the follow-up is, if you're willing, is that a good number to maybe think about going forward? Or will it come down given that some of that investment might have been temporary? And then, I guess, bigger picture, as you think about how the business scales over the next several years, do you have a year in mind where you might get kind of breakeven on free cash flow or positive on free cash flow?

Yes. We're not going to be talking about any guidance on that point because we haven't given anything. But what we are focused on is bringing down our build costs overall for our Shacks and really having a disciplined approach to capital investments and to G&A. And that, inclusive of also building back our profitability, we feel like we're on a really good path here.

Thank you. We'll take the next question from the line of Jim Sanderson with Northcoast Research. Please go ahead.

Hey. Thanks for the question. I wanted to talk a little bit more about store profit margin longer-term. If you can maybe give us your thoughts on how you look at flow-through profit margin as you make these improvements, especially in labor adding some technology into the store with the kiosks, so maybe there is an opportunity to see basis point improvement in store margin going forward as you drive stronger AURs, let's say over the next year or two. Just how we should look at that as far as flow-through profit margin?

I think that's definitely a very good way to approach it. When we are working on our initiatives to enhance profitability, we begin with sales. We focus on sales within our own channel, but are also committed to overall sales growth at this time. There are several factors that will influence this, including our overall channel mix. While we don't have specific details to share right now, we believe that sales will significantly contribute to improving our profitability.

Okay. Just a quick follow-up. Any thoughts on how you're budgeting labor hours for comparable stores and how that's changing? Is it starting to lag behind sales growth or anything like that?

Well, I think it's really just budget to meet demand and how busy we think we can be. I think we're getting better than ever at the technology we use, and the way that we both take care of our team and budget for trying to meet peak demand and try not to be overstaffed during the lighter times of the day. So, that's an ongoing journey, Jim, that always will be. But I don't think there's any real new data to say other than, I think the team did a really nice job in the fourth quarter. We'll be pressured a little bit in the first quarter as we name with 22 new Shacks that really just opened heading into that. So they will probably be tighter as we talked about in the first quarter, and we've got to do the work to level all that out as we go through 2023.

All right. Thank you very much.

Thank you. We'll take the next question from the line of Rahul Krotthapalli with J.P. Morgan. Please go ahead.

Thank you for taking my question. I would like to focus on the margin aspect. Is there a notable difference between the highest and lowest margin stores? Besides sales, what practices are the higher margin stores implementing that could be easily adopted by the lower-margin stores? Also, could changes in manager compensation be more focused on addressing the margin opportunities between these two types of stores?

That's a great question. We do have a range of margin performance within our base. If I was to kind of classify like where are our strongest Shacks, it's probably the ones that have the higher sales. We have a great group of Shacks that have very, very strong sales, and when you have great sales, you can leverage your rent; you can leverage your occupancy. So those tend to be the best performers. You can also really get great labor levels as well. Then you kind of leverage up a lot of the fixed costs. Where we have opportunity to improve and where we've been focused is in the Shacks that have a little bit of lower sales and how we can kind of bring those back up. That's a lot of the work that's been going on right now. Kiosk is one example though, broadly of a strategy that we're using to help improve labor throughput overall. Instead of having two to three, maybe four people taking orders depending on how busy the Shack is, we were able to then redeploy that labor and have people just go to the kiosk when they come in the Shacks. So that's how we would think about it. There's obviously areas where certain Shacks can improve and areas where other Shacks are doing exceptionally well, but if you're kind of looking at the biggest driver overall, it's likely sales.

Is there like anything on the manager comp side at this point that you can tweak or adjust to address the part of this?

On the manager compensation side, we prioritize competitive pay, which is crucial for solid retention at the manager and GM levels, and we are confident in our approach. It's important to note that managers are significantly incentivized by their bonuses on a monthly and quarterly basis to meet their targets, which differ depending on the type of Shack. We set and continually adjust aggressive targets, and we believe our team understands what they need to achieve in order to earn their bonuses. Additionally, our GMs are shareholders; each of them receives a $10,000 annual Shake Shack stock grant, which encourages them to operate like entrepreneurs focused on long-term success and the overall achievement of the company. Overall, we believe we have the right compensation strategy in place at the Shack level.

Thanks for the information on that, Randy. I would like to follow up on general and administrative spending, specifically marketing. What kind of spending are you planning for next year going forward, and how is that expected to change?

We don't break out the G&A, but when it comes to marketing, we are continuing to invest significantly in a few key areas. We focus on targeted performance marketing when it makes sense and where the cost to acquire guests is low; we are quite effective in that regard. We're increasing our expenditure and efforts as we grow, but we may not be large enough yet to justify a mass media campaign, although we will reach that point eventually. We are currently investing in trials of localized brand media campaigns across various media channels. Our community managers, regional marketing leaders, and operations leaders are engaged in various activities to support their local communities. These three areas will see the majority of our marketing budget this year. We are confident in our budget as it aligns with our scale. Our brand has always had the potential to lead, and we need to continue to increase that investment over the coming years to support our growth and eventually take advantage of those marketing efforts as we expand our number of locations.

Understood. Thanks for the color, guys. I appreciate it.

Thank you. We take the last question from the line of Brian Harbour with Morgan Stanley. Please go ahead.

Thank you. Good morning. I wanted to ask about the mobile app. Are you still seeing an increase in mobile ordering, and what percentage of sales does that represent today? I believe that's an appealing margin order and likely contributes to your throughput. How does focusing on the mobile app contribute to the margin improvement you are aiming for?

Yes. Definitely leaning into it, continue to have for the last few years quite a bit. We also feel like we've got a lot of that investment in there right now, and now it's about continuing to just improve pieces of the experience, so that it's consistent, reliable, and something we can rely on all day. We're not going to break out the numbers. We don't break out the difference between that and our third-party and all of the web channels, everything we do, but we are really proud of the overall digital business. We do things like drive engagement and downloads when we launched our White Truffle menu last week, we launched that in the app only. We also have done a little bit more campaign of delivery through our app. Margins on that are strong comparatively to straight third parties. So, there's a lot of ways that we'll continue to focus on the app; we love it, it's a significant part of our business, we see solid frequency usage there, and you'll see us continue to invest.

Okay. Great. Thanks. And just kind of the suburban stores, obviously, you've seen those moderate a little bit from a same-store sales perspective, but maybe talk about what's kind of key to continuing to drive those sales? Are those better staffed? Are they worse staffed? What else can kind of help drive some of the suburban stores?

Yes, Brian. I would say we are improving staffing in our urban markets compared to our suburban ones, and we believe there is an opportunity to regain some sales in suburban markets as our staffing levels improve. Additionally, some dynamics in suburban areas require consideration. For instance, several of our suburban locations are situated in or near malls and outlet centers, which influences consumer behavior and their shopping patterns. Moreover, our suburban locations had significantly better performance than our urban locations during COVID. As people gradually return to working in cities, we anticipate some shifts in sales between suburban and urban areas. Overall, we are very pleased with the performance of our restaurants, and they are maintaining strong same-store sales even as urban areas recover.

Thank you. Ladies and gentlemen, we have reached the end of the question-and-answer session. And I'd like to turn the floor back over to Randy Garutti, CEO, for closing remarks. Over to you, sir.

Thanks so much, everybody. Really appreciate your time this morning and look forward to seeing you soon at the Shack. Take care.

Ladies and gentlemen, this concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.