Shake Shack Inc. Q1 FY2023 Earnings Call

Greetings and welcome to the Shake Shack First Quarter 2023 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. It is now my pleasure to introduce your host Annalee Leggett, Director of Investor Relations and FP&A. Thank you. You may begin.

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 23, 2023. 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 first-quarter 2023 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. 2023 is off to a strong start with first-quarter results ahead of our expectations as we grew sales, expanded margins, and remained disciplined on expenses across the company, including G&A and CapEx investments. As we execute against our strategic priorities, we generated total revenue of $253 million, up 25%. Average weekly sales of $73,000 were up by more than 7% year-over-year. System-wide sales grew 28% year-over-year to nearly $395 million, as our licensed business globally posted our strongest quarter ever. Same-Shack sales were up 10.3% with positive traffic of 4.8%. And as we've shared, the team has maintained an intense focus on growing profitability, and we executed on that goal to bring restaurant margins up to 18.3%, a 310 basis point improvement over last year. We opened six company-operated and seven licensed Shacks in the quarter, and we have 25 Shacks currently under construction, on our way to opening about 40 new company-operated Shacks this year. Based on our increased pipeline and strong execution in our domestic and international license business already this year, we're raising guidance today to 30 to 35 Shacks expected to open throughout 2023. Quarter-to-date solid momentum has continued with average weekly sales rising to $77,000. Same-Shack sales are about 4%, and we are tracking well towards increasing our Shack-level margins back above 20%, which Katie will talk more about in a bit. Now I want to provide an update on how we're executing our strategic plan. We're really proud of the team's progress in each of our priority areas. First, we're focused on recruiting, rewarding, and retaining a winning team. It's been a challenging few years for staffing in our industry, and this quarter, our team showed solid progress. We believe the macro hiring environment, while still demanding, has begun to improve. With that backdrop and the new tactics of our people team, we've improved application flow, turnover, and retention since last year. Our increased pay, benefits, and opportunities for leadership development at all levels are resonating with our teams. There's no question this will translate to better performance overall. Each of these metrics contributes to better throughput, optimizing sales, and increasing our operating profit while building a bench of talented leaders to achieve our growth goals and provide real advancement for the lives of our team members. Our work here is never done, and we plan to double down on these efforts to expand on this improvement. Our second priority is our relentless focus on the guest experience, aligned with the people improvements I just mentioned. With a strong foundation, we can better execute our core operations focus, menu strategy, and digital tools. This quarter, we captured strong performance and guest satisfaction with our premium white truffle menu at our innovation kitchen, and throughout our supply chain, we are constantly testing new and exciting menu items for our guests that highlight our commitment to premium ingredients and the kind of menu items that only happen at Shake Shack. We have a strong lineup. Through the remainder of the year, we’re continuing on a path of leading with innovative culinary offerings that use premium ingredients to drive frequency and new guests. This week we launched our new Veggie Shack nationwide. It's a delicious, only-at-Shake Shack Burger Patty, packed with real food, full of mushrooms, sweet potatoes, carrots, farro, quinoa, topped with American cheese, crispy onions, pickles, and Shack sauce. We also launched our non-dairy frozen custard shake nationally. In addition to our longtime guest favorite Truffle Burger, we believe these options can target current guest frequency and capture new guests over the long term. This summer, on top of the success of our premium lemonade category, we'll be launching Caffeinated Shack Lemonades for those guests looking for our classic lemonades with an extra zip. Stay tuned for more to come this year. And just one more fun brand note, our team continues to execute dynamic chef collaborations, regional marketing programs in our local communities, and attract valuable national media attention. Last month we teamed up with Universal Studios as they took over our Brooklyn Shack for the launch of the Super Mario Brothers movie. The event was hosted by Chance The Rapper and helped kick-off the extraordinary success of the movie. The team continues to target national media partnerships as we look to grow our brand and footprint. Third, we're executing on a targeted development strategy for growth. As we've discussed and you're seeing around the industry, persistent inflation and construction costs, permit delays, and equipment availability continue to impact our openings and our near-term returns. But the team is making significant progress on accelerating pipeline prototype design and new Shack openings. Year-to-date, we’ve opened nine Shacks with strong sites in Walnut Creek, Portland, Oregon, Jersey City, and more. I want to take some time today to share some of the work the team is doing to improve our returns on Shack builds over the long-term. This year, we expect to open up 15 drive-throughs, and now with this higher mix of drive-throughs and ongoing inflation pressures, we do expect our build costs for the class of '23 to be somewhat above last year's average. While our core Shacks are impacted by inflation, most of that system average cost increase is due to our commitment to drive-throughs that cost more to build than our traditional core Shacks. So what are we doing about it? Well, since the drive-through project has begun, we've learned a lot and we are honing-in on cost reduction elements of the design. We're refining templates for efficient and more standardized operations. This year we expect to reduce drive-through costs by about 10% versus 2022. And in future years, we'll be rolling out new and tighter prototypes for drive-through and core Shacks, focused on combining the great Shack experience we're known for at a reduced cost and ability to scale. Long-term costs will vary depending on sites and geographies that we target; as an example, next year we may spend more on certain drive-throughs in the New York Metro and California markets, but we correspondingly expect a strong return on higher sales there as well. We're working on our next generation of designs with an aim to execute on additional cost-saving measures. We’re going to optimize the size of the Shack box, how many seats we need, standardized kitchen designs, and building materials that can reduce the total cost of future Shack classes. But this work takes time to roll through the system, and while you won't see an immediate impact this year, this intense focus on balanced portfolios, Shack types, and new next-generation prototypical designs will add up to more savings over time on our cost to build and overall returns. We're committed to further improving this part of our economic model, and we're really excited about what's ahead. Regarding the license business, we saw extraordinary growth and execution in the first quarter, and we expect that trend to continue. Our team has performed exceptionally well in China, and our domestic business continues to grow. We continue to expand our global footprint as only the Shack brand can do. We're unlocking new regions and formats with the introduction of development agreements in Israel and Canada, as well as new Shacks opening in roadside travel plazas throughout the U.S. I was fortunate to join our teams on a multi-country Asia trip this spring, and I had the privilege of welcoming our first Shack in Bangkok to an incredible crowd with strong sales. Since opening, I had the chance to connect with our teams in mature markets such as Singapore and Japan, where our growth continues, and to plan ahead for our upcoming opening in Malaysia and potential other markets in Southeast Asia. There’s a lot that's probably underappreciated and undervalued about this part of the Shack’s story and our strategy. My hope is that our shareholders take the opportunity to visit some of our international sites. We take great pride in the amazing brand we share globally, and I'm really thankful for our team members around the world continuing to execute and standing for something good. Wherever Shack Burgers are found, our fourth priority is being even more profitable in our Shacks ahead of our own expectations. We delivered 18.3% Shack-level operating profit this quarter. We showed strong progress in our key initiatives, including driving sales, especially in our own channels, labor efficiencies, off-premise profitability, and managing controllable supply chain and other operating expenses. There's still much work to do, and there is risk around the macro environment and continued cost inflation this year, but with the plan the team has put in place, we're guiding Shack-level operating profit of 19% to 20% for the full year, and we see the opportunity to return over 20%. Katie will share more details on the work here in a bit. Finally, the fifth pillar of our plan is we build an enduring business. We are committed to investing with discipline. We're deploying capital towards strong returns in four main areas: we're going to build Shacks, update our current Shacks, invest in our digital infrastructure, and structure our home office capabilities to further support our restaurants. We remain confident that we can meet or exceed our long-term unit cash-on-cash return targets over time by growing sales and profitability and lowering development costs, all of which we emphasize in our strategic plan. We've got the right plan in place. We're pleased to see progress taking root. I'm now handing off to Katie to share more about the details of the quarter and expectations for the rest of the year.

Great. Good morning, everyone. We are proud of our strong results this quarter that are a direct outcome of our team's solid progress on our 2023 strategic plan. We grew revenue by 25% year-over-year as our teams executed well on recent openings and drove higher sales in our existing company-operated and licensed Shacks. We also showed strong improvement in our restaurant margin this quarter, expanding it by 310 basis points year-over-year to 18.3%. This is the highest first-quarter restaurant profitability margin we have posted since COVID, and we generated record-high quarterly restaurant profit dollars and adjusted EBITDA in what is typically the softest sales quarter of the year. We accomplished this despite the many profitability headwinds we face, including the large number of Q4 and Q1 new Shack openings, ongoing inflationary pressures, and mobility measures in key markets, like New York City, still deeply impacted by COVID. We did this by executing on our plan with some important highlights and actions, including tactically increasing menu prices to protect margins against broad-based and persistent inflationary pressures, driving sales into our more profitable channels, demonstrating better cost controls over our other operating expenses, and bringing more kiosks into our Shacks, driving efficiencies and other benefits. We are reassured by these results and look forward to showing continued progress through the rest of the year. We understand the many macroeconomic risks that may further impact the restaurant sector and our results. However, our business has demonstrated a level of stability that now allows us to go back to our pre-COVID guidance practices and reintroduce full-year guidance for total revenue, same-Shack sales, our licensed business, and Shack-level operating profit. We are also providing a new guidance metric with full-year adjusted EBITDA. As we continue to observe a normalization of our trends, we are reducing our urban-suburban disclosures, as regions are now a stronger driver of our performance compared to just the level of urbanity. So now on to first-quarter results. Total revenue was $253.3 million, up 24.5% year-over-year. Shack sales grew 24.1% to $244.3 million. Licensing revenue grew 36.7% to $9 million. System-wide sales reached a record high at $394.7 million, up 27.5% year-over-year with stronger sales and flow-through as well as expense discipline. All points of our 2023 strategic plan. We grew adjusted EBITDA by 163.9% to $27.6 million. This quarter we generated $73,000 in average weekly sales and grew same-Shack sales by 10.3% versus 2022, with 4.8% higher traffic. Year-over-year price was up high single digits, and our mix was driven by more guests returning to pre-COVID behaviors, including channels shifting into in-Shack and smaller group sizes. We have discussed that a key strategy for us to improve our restaurant profitability is to drive sales into our own channels, where we are most profitable. We showed strong progress against that goal in the first quarter as we grew in-Shack same-store sales by more than 20% year-over-year and more than doubled our total kiosk sales versus last year. Putting kiosks into our Shacks is another key way we have identified to improve our sales and profitability, and we shared a goal last year to roll out kiosks into nearly all Shacks by the end of 2023. We are proud to report that we are executing ahead of this timeline. Kiosk order values are higher than traditional cashier transactions. Kiosks represent our highest margin channel, and we are pleased with our return on investment here. We are also pleased with April same-Shack sales of about 4% versus last year; an average weekly sales of $77,000, up versus the $76,000 in March, despite shifts in the spring break calendar. In April, we benefited from driving a strong mix of sales into our own channels and had less benefit from menu price compared to the first quarter. Our licensed Shacks also performed well this quarter as we grew sales 33.4% year-over-year to $150.5 million. We had successful recent openings across the world, and our partners have performed exceptionally well serving the strong guest demand, particularly in the U.S. with airports and our new roadside Shacks, as well as in China and Mexico. First-quarter Shack-level operating profit was $44.7 million, or 18.3% of Shack sales, 310 basis points higher versus last year. Despite margin pressure from a large number of recent Shack openings and persistent inflation, our strong performance this quarter was a direct outcome of progress on our four key priorities to improve our restaurant profitability. First, driving sales and prioritizing our channels where we are most profitable; we are leveraging targeted marketing strategies to drive awareness and visits. In addition, we are directing more business into our own channels by offering the lowest menu prices there, early access to exciting limited-time offers, as well as value-added day-part promotions. Second, targeting labor efficiencies and growing throughput. We're seeing great benefits here from recruiting and retention tactics and better staffing is helping us to extend our operating hours and be more efficient. Kiosks are another important tool to help drive efficiencies in our Shacks. Third, improving off-premise profitability and other strategies to lower our controllable expenses, from standards for condiments and lessening packaging on to-go orders to premium prices on third-party delivery; we continue to push forward opportunities to be more profitable off-premise. We also showed strong progress here in the quarter with controlling additional elements of other operating expenses. As just an example, we were able to lower our repair and maintenance expenses that have been a meaningful headwind in prior quarters as we were able to secure additional needed supply for critical restaurant equipment. Lastly, we will continue to take a strategic approach to menu pricing and supply chain opportunities. On this point, we are pleased with the guest reception to the price we've taken thus far, and we'll take approximately a 2% price increase towards the end of the second quarter. This level is more in line with our historical annual price increases and is needed to help protect our profitability against persistent food and paper inflationary pressures. But, bottom line, we are encouraged by the margin expansion we delivered in the first quarter, and despite the pressures we face, we have line of sight into further improvements throughout the year. Now, into the components of restaurant profitability. Food and paper costs were $71.8 million, or 29.4% of Shack sales, 100 basis points below last year. Our blended food and paper inflation increased by high single digits year-over-year, which was offset by the benefit from a higher menu price. Additionally, with our focus on operations and investing in our people with training and retention programs, we were able to improve our waste impact versus last year. Our beef costs rose slightly versus last quarter levels and were down high single digits versus last year. Importantly, nearly every other item in our food basket showed accelerating cost pressures versus last year, including fry costs rising by more than 20% and dairy and other costs increasing by double-digit percentages. Labor and related expenses were $74.3 million, or 30.4% of Shack sales, down from 30.7% in the first quarter of 2022 and up 150 basis points quarter over quarter as we continue to make investments in our valued teams needed to staff and operate our Shacks. As expected, we face profitability pressures from the 28 new Shack openings over the past six months, still working their way up to optimized staffing levels. However, in our more mature Shacks, our teams capitalized on strong sales and produced solid flow-through as we execute our plan to improve restaurant profitability. Other operating expenses were $34.9 million, or 14.3% of Shack sales, down 100 basis points from the first quarter of 2022. Our improvement came from our menu price, driving sales in our channels, lower marketing expenses, and better management of expenses like repairs and maintenance. Occupancy and related expenses were $18.6 million, or 7.6% of Shack sales, down 70 basis points from the first quarter of 2022, with the benefit really coming from higher sales performance. G&A was $31.3 million, or 12.4% of total revenue, excluding $1.6 million in legal settlements and professional fees. Adjusted G&A was $29.7 million, or 11.7% of total revenue, showing 90 basis points of leverage versus last year, as we invest with discipline. Pre-opening costs were $3.6 million in the quarter, and depreciation was $21.3 million. We realized a net loss attributable to Shake Shack Inc. of $1.5 million, or $0.04 per share. We reported an adjusted pro forma net loss of $290,000 or one cent per fully exchanged and diluted share. Our adjusted pro forma tax rate, excluding the tax impact of equity-based compensation was 17.2%. Finally, our balance sheet remains solid with $293.4 million in cash and cash equivalents at the end of the quarter. Now on guidance, which balances the strong underlying business factors we’ve seen so far in the first quarter with the degree of uncertainty around the consumer spending landscape and our current expectations for ongoing inflationary pressures; this range does not reflect any additional unknown delays to our development schedule. For the second quarter, we guide total revenue of $269.5 million to $274.8 million with $9.5 million to $9.8 million in licensed revenue. We guide for both our company-operated and our licensed partners to each open approximately 10 new Shacks, and for same-Shack sales to grow by low to mid single digits year-over-year with high single-digit pricing, inclusive of the 2% price increase we plan to take at the end of the second quarter. COVID has had a larger impact on our business than many of our competitors, and its lingering impacts on consumer mobility patterns, including work-from-home trends, have been a challenge for us. However, even with the pressures we face and persistent inflation, we guide for second-quarter Shack-level operating profit margins to reach approximately 20%, marking the highest level of quarterly profitability that we have delivered since the onset of COVID. With more consistent trends we’re seeing in our business, we’re able to finally reintroduce full-year guidance for many metrics. For the full year 2023, we guide total revenue of $1.06 billion to $1.11 billion, representing 18% to 23% year-over-year growth, with licensing revenue of $39 million to $41 million. We expect to grow our system-wide Shack count by approximately 70 to 75 units this year, about 40 of which will be domestic company-operated, and 30 to 35 operated by our licensed partners. Our guide is for same-Shack sales to grow by low to mid single digits with mid-to-high single-digit pricing and consistent trends in our mix. Despite ongoing inflationary headwinds, we expect to deliver at least 150 to 250 basis points of restaurant margin expansion in 2023 and guide for a full-year Shack-level operating profit margins to reach 19% to 20%. As we continue to execute on our strategic priorities, while we are focused on exceeding the bar, inflationary pressures are not abating in this guidance. We're reflecting a degree of impact from potential consumer softness as well as beef inflationary pressures above and beyond what we're experiencing today. But all else equal, if both of these risks did not materialize, we see a path for our restaurant margin to surpass 20% this year. We are planning for food and paper costs to rise by mid to high single digits year-over-year, led by beef costs rising by a similar degree. We do not hedge on many components of our basket, including beef, which is the largest single part of our basket, and an area where we see a significant degree of uncertainty around the cost this year. In the first quarter, our beef costs were up just modestly versus the fourth quarter and down year-over-year. However, we have recently started to see our beef costs increase with broad-based challenges across the supply chain, and we anticipate this to be a material pressure throughout the year. We are also seeing signs of even further inflationary pressures from many other items in our basket, including fries that are likely to cost us approximately 20% more this year than last. Above all, we are also making continued investments in our people as we focus on building up and supporting our winning teams. This is resulting in mid-single-digit year-over-year wage pressures. Taken together, our operating backdrop is not easy. Inflationary pressures remain, and we believe we have the right plan in place to navigate and continue to show higher operating profitability despite these continued challenges. In fact, even with the inflationary and potential macroeconomic pressures, we are planning to grow fiscal 2023 adjusted EBITDA by at least 50% to 70% this year to $110 to $125 million, as we target achieving record profits this year. We have line of sight to exceeding this range; however, this will be dependent on the degree of pressures we face throughout the year. We reiterate our 2023 G&A guidance of $125 million to $130 million absent the $1.6 million in legal and professional fees that are excluded from adjusted EBITDA this quarter. At the midpoint, G&A would be 11.8% of total revenue, more than 80 basis points of leverage versus 2022 levels. Other guidance points include equity-based compensation expense of approximately $17 million, pre-opening costs of $17 million to $19 million, depreciation of $88 million to $93 million, and an adjusted pro forma tax rate, excluding the impact of stock-based compensation, to be 16% to 18%. Thank you for your time, and with that, I can turn it back to Randy.

Thanks a lot, Katie. We're really proud of the team and the way they continue to execute our strategic plan, driving sales and better profitability across our restaurants. We're going to keep our focus on recruiting, rewarding, and retaining this team, relentlessly focusing on the guest experience, opening great Shacks through a targeted development strategy, improving our margins, and investing with discipline for strong returns. I spent a lot of my time recently in our Shacks with our teams and visiting our partners around the country and around the world. We've been listening, learning, and working collaboratively across our teams to run better Shacks that are great investments and stand the test of time. I can tell you confidently that our brand carries a weight well beyond our scale today, and we continue to execute a plan to scale our business for tomorrow. Hope we see you all soon for a Shack burger. And with that, operator, go ahead and open up the call for questions.

Our first question comes from Jeffrey Bernstein with Barclays. Please proceed with your question.

Great, thank you very much. One question, one follow-up; the question just on the near-term concerns. And Katie, you mentioned, the uncertain macro and the short term. I think investors are concerned about slowing same-store sales of late. First-quarter results beat expectations. I'm wondering if you can maybe share your thoughts on the trend through the quarter. There's obviously been a lot of noise, but how do you read those first-quarter results and more importantly, in April with a 4% comp? It looks like it would be a deceleration from the first quarter, but hard to tell when pricing's being lapped and different shifts and whatnot. So I'm just trying to get your sense for how you think the consumer's behaving through the first quarter and through April as that impacts your second-quarter outlook? And then I had one follow-up.

Great, thank you. So, overall, I would describe the cadence of the first quarter as we started strong. We had a lot of very good new Shack openings helping as a tailwind at our back. But then really kind of in February, with the launch of white truffle, we did see above-average sales performance in our more mature Shacks. We saw pretty healthy behavior from high-income consumers where we over-indexed. But throughout income cohorts, we were pretty pleased with what we saw. We are taking a mindful approach, though, as we're going throughout the year for all of the reasons that you just discussed and see, we're baking in some views about how the back half of this year could play out. But from what we're seeing right here, we are pleased with our performance. I will say, as it pertains to April, you're right, we rolled off about three and a half percent menu price and an additional 5% increase on DSP that we took to March, and so that is part of what you're seeing there. There were also some spring break shifts as well.

Understood. So it doesn't seem like you're seeing a material change in consumer behavior of late when you back out those unusuals, or would you say April is somewhat of a deceleration?

We're very pleased with the trends that we have seen in April consistent with what we saw exiting the first quarter. But that's just one month, so we'll have to see how the rest of the quarter plays out.

Understood. And then my follow-up was just the restaurant margin outlook. I mean, very impressed with the 19% to 20% guidance. I think you even mentioned this potential upside to that 20%. I'm just wondering if you can maybe prioritize what you think are the greatest drivers there, or maybe more importantly, what's the greatest risk to that? Because obviously, that's above expectations, and it just seems like the environment inflation's getting worse, pricing's easing, and the consumer is just so uncertain. It would seem like that's aggressive. So wondering where you think there's upside versus where there's the greatest risk to that margin outlook? Thank you.

Yep, thank you. So as we're thinking about the margin progression throughout this year and what really helped us in the first quarter achieve that 310, which actually is closer to 360 basis points of improvement versus last year when you adjust for the gift card benefit we had in the first quarter of 2022. Let's talk about what we did. We drove sales and we drove sales into our own channels. And we expect for that to continue to be a tailwind for us this year. We have key strategies in place to reward our guests to come into our restaurants to come in and use our app and to do delivery through us as well. So we want to see more of that throughout this year, and we think that's going to be a benefit. Additionally, we’re really encouraged by the work we’ve done around staffing and improving retention around our team members. I think we’re just in early days in seeing that benefit. Randy talked about the big increases we saw in retention in the first quarter. We’re seeing some lower waste here on the back of it, and we were able to be open longer hours. These are all things that you want to see to help us be more profitable. But conversely, we have some of this in our guidance; I would say one of the biggest risks to achieving that range is if we had macroeconomic uncertainty outside of what we're expecting today, or had a more significant fall-off in the consumer. And then beef; we've continued to say beef is the largest part of uncertainty in our basket this year. We're starting to see it pick up here. We've baked in our views right now as to what that is, but if you're asking me where the biggest part of uncertainty is on the cost side, to me it's beef.

Our next question comes from Michael Tamas with Oppenheimer and Company. Please proceed with your question.

Hi. Thank you. Good morning. I wanted to follow up on the consumer softness comment within your guidance. Can you talk about where you're assuming on the sales side of things? You mentioned margins could exceed 20% if there was no softness, but how much of a headwind to sales are you sort of thinking about right now? Thank you.

We have reflected a modest degree of slowing into our guidance at the midpoint. If the consumer remains healthy, there's a path to exceed that. However, if there is more material macroeconomic contraction than what we're pricing in our guidance, we may miss that. So that's kind of how I would think about the guide on that side. We over-indexed to higher-income consumers, and we were really encouraged by that 4.8% traffic we generated in the first quarter. We have to really kind of note that the white truffle was the most expensive limited-time offer that we've ever launched, and we've had very strong success with that. So what we're seeing today is that we're kind of that attainable luxury. We're definitely gaining share at the high end, and we hope that that continues, but for planning the business, we think it's prudent to take a balanced approach through the rest of the year.

We have reached the end of our question-and-answer session. I would now like to turn the floor back over to Mr. Garutti for closing comments.

Just want to thank you, everybody, for taking time with us this morning, and we look forward to seeing you soon at the Shack. Thanks, take care.