Shake Shack Inc. (SHAK) Earnings Call Transcript & Summary

Thank you for joining us. My name is Jeff Bernstein, and I'm the restaurant and foodservice distribution analyst at Barclays. I'm thrilled to introduce our next presenting company, Shake Shack. With us this morning from their New York City headquarters, we have Randy Garutti, CEO; and Katie Fogertey, CFO. By way of background, for those not familiar, Shake Shack is a fast casual chain with roughly 200 company-operated units in the U.S., while licensing an additional 20-plus inside and another 120-plus outside the U.S. Shake Shack is impressively on track to deliver 20% unit growth in 2021 and looking like another 20%-plus growth in 2022 on the path to 450 U.S. company-operated units long term. So, just more than double where they are today. So thank you, Randy and Katie for joining us this morning. I figured I would kick it off with some bigger picture questions and then drill down more specifically to the Shake Shack brand.

But I will start just as we look back, we were involved in your IPO. That seems like a long, long time ago. Just over the past 20 months, it has been an adventure that I don't think anybody anticipated. So I'm just wondering if you can maybe share what you think COVID accelerated. I mean there were structural changes. I know you guys were embracing pre-COVID but I have to imagine there's a lot of things that have really changed transformative wise in your business. I'm just wondering if you can maybe talk about what you accelerated or what you learned, both positive and negative that maybe you would not have been doing 20 months ago?

Yes. Sure. Look, thanks, Jeff. Always good to be with you, and thanks, everybody, for being here with us. We could take the whole time on just that question, and someday we'll write a book on it. I simply would say it as it accelerated and amplified the things we were already doing and has helped us really crystallize where we want to head in the future. And in a crazy way as hard as this couple of years has been and remains hard. It's certainly been a catalyst for what we believe will create a bigger total opportunity for Shake Shack, than we probably might have imagined even before. And that's exciting. And it's hard. So a couple of things. I think our focus -- our strategic plan right now is focused on 4 things. It's elevating our people. We can talk all day about how challenging it is at this moment. The restaurant has always been hard work. It's exceptionally hard today with everything happening. We've got to focus on that, number one. Number two, the digital transformation. Thank goodness, we had made the investments we made before COVID that allowed us to accelerate all of that and really survive during COVID if you really think about. And now to harness that power and to deeply go further. And you'll see us making incredible investments in the digital transformation of this company, getting to know our guests better, allowing them to order however, whenever, wherever they want. And I think our team has done an incredible job with the toolbox of things that we use. Third is formats in how we think about it. Next week, I'll be in Minnesota near Maple Grove, where we expect, if all goes right this week to open our first ever drive-thru. That's just one part, but an important part of how we see the future opening up the total addressable market for Shake Shack. Finding ways to keep -- actually double down on the Shake Shack experience that has always set us apart from traditional fast food. But now to add convenient ways to do it more than ever in new places that we might not have gone to before. Super excited about that. Shack Track and all the digital infrastructure that has led to the evolving physical formats that we now see for our largest class ever next year up to 50 Shacks. And last, the guest experience. We were -- I was talking with a team member this morning about little things in our guest experience, and we have to constantly make that better. The tools I just name will help, but it's also nuts and bolts, day-to-day, one burger at a time work. That's the stuff. On the -- what you might call negative, I would say, on the challenges. We have, obviously, the inflationary pressures that we're all learning about living with as recently as yesterday, grappling with what it will mean in the next phase here. We have those pressures on our business, like everyone does through supply chain, through cost of goods and everything. And that weighs on our profitability at some near-term level. None of us will sit here today and give you a guess on when that ends. But it's tough. And that trickles down through the cost of goods, labor and our operating expenses. There's very few things that have gone down in cost over this last year, and we're grappling with that. But we're also incredibly proud that the team has basically rebuilt about 3/4 of our profitability through this time, even as many of our restaurants remain down. So I would say that's the biggest challenge. The cost structure, the staffing challenges that we have, but these things have seasons. As we look ahead, like nothing -- no challenge lasts forever, it will evolve. We'll pay people what we need to pay people to have great people, and we'll charge prices that we need to charge to have a great product and regain our profitability over time. But we're patient, we're diligent, and we're super excited about what everything I just said goes into the soup of this opportunity of Shake Shack for the future.

You mentioned seasons, Randy. I hope that you're prepared next week in Minnesota, you get yourself a warm jacket for that drive-thru [indiscernible].

Right here I've got our -- we teamed up with our friends at Carhartt. And this is the drive-thru jacket. I keep it in my office now. So if you're working outside of the drive-thru, you'll see me there taking orders wearing that jacket. We're ready. We're excited.

How did I know? I don't know.

We really tried. We really tried to have Florida and Orlando to be our drive-thru. But the stuff in the world right now, we couldn't quite time that just yet.

Yes. And obviously, I'd be remiss and hopefully, it doesn't take more than 30 seconds, but there's a new variant upon us, which I get the impression that with each passing variant while the severity should not be minimized that the consumer seems to take it more in stride, needless to say. So is there anything you now say, we better revert back to step 1 or anything like that? Or is your system totally operating on a protocol that you're ready for anything like this?

Well, I think we're ready. Yes, we're ready. No question. I think we got to be patient in our reaction. We'll see quickly if there -- this is an overreaction or not by world governments worldwide. I think that the thing that gives us pause would be travel, and whether people change their thing. As we said in our October numbers, we're seeing that recovery. We're seeing it in urban. I got off the subway this morning in New York City, and it was packed. It was packed. I was in Rockefeller Center a couple of weeks ago with my kids, it's packed. New York is fun. And I use New York as a metaphor for our other urban relationships around the world, not just the country. We have teams in the U.K. today, and they're grappling with what this new requirement will mean for them, right? So I think the pause is what happens with global and then domestic travel. Our hope is that people continue to keep moving forward, and this isn't as bad as it could seem. But it's yet another thing that pushes back the offices from coming back, and events and other things that you see. I went to a Broadway show the other night, and it was packed and fun and felt like New York again.

I mean we're looking at our business, we've been able to retain 80% -- roughly 80% of the digital business that we got during the surge last year. So we're really grateful for the digital investments that we've made before. But obviously, an uptick in cases would likely be a negative impact for our business.

And the fact that you mentioned a surge -- I'm sorry, the digital mix. I mean does that fade as people feel more comfortable and they want to come back to the restaurants, and then it spikes up when there's a virus like this? Or is it really that that's a customer that is now forever a digital customer?

We don't know if they're going to be forever digital customers. Our hope is that these investments that we've been making, and not just touching -- not just in the digital space, but also touching our restaurants to make that digital experience much better for the guest. We'll make that their channel of choice. We want our digital channels to be the priority channel that our guests say, I have the best experience when I order ahead on the app and go pick up there, and we're able to convene and be together as a group in the Shack when we want to be. But if I need that to grab and go, I also have that option. So we hope that, that will persist, and we're encouraged by the fact that we've been able to retain such a big part of the digital business even as our In-Shack business doubled last quarter. But we'll have to see.

And Jeff, I think -- I don't think you go back on it, right? You may see retreats or people turn more to delivery in moments like this. But like I haven't viewed -- I haven't ordered with a human being at Shake Shack in two years, right, myself, and I eat Shake Shack all the time. I always hope my mom is not listening to these conferences because I always use her as like the great example. My mom, like is not tech savvy, and she only orders with the Shack app. Like -- and I think she's not going back from that, right? And I think that's the exciting way we can connect. What we do know as we're learning and adding to this is that when we get you in our omnichannel experience, and you're using multiple versions of our tools, you're incredibly valuable guest over time. And we need to -- that's why we're investing here, and you'll see us keep doing more in all those channels to get that out there.

We were observing when our guests use our digital channels, whether it's the app, the website and even kiosks, that they just understand the menu a lot more. They see the visuals, it's compelling. They add more items and so great opportunity over time.

Right. It seems like yourself and your peers are talking about doing more with less during this time, whether it's from an efficiency standpoint or technology. If we can get sales back to full strength, obviously, your urban stores are a different discussion. But if you just look at maybe your suburban stores if their sales are back to full strength. Is there a vision that there could be upside to margin over time in a more normalized environment because of these different initiatives and technology or whatnot? Or are you -- do you not think of these things as something that could enhance the margin?

I think we got to get through this moment of margin pressure in every single input before we can answer that. We're always going to lean into sales. That's who we've been from day 1. It's why we have high AUVs. It's why Shake Shack does things that other restaurants in our category don't generally tend to do in terms of total sales. We'd much rather go with that than start thinking about efficiency. It's not a word we talk about a lot. We don't -- I don't love the word efficiency. I want to be effective and I want to grow sales. So people have a great experience. So decades from now, they keep coming back. We're, of course, laser-focused on that, Jeff, especially now with our -- with the challenges of our costs, but we're really focused on staffing up to optimize sales.

Right. Needless to say, commodity and labor inflation like you mentioned. It seems like it's more permanent than transitory. It seems like people have kind of come to that realization. But I was wondering in what ways does that impact your business? I mean, obviously, from a financial perspective, but do you do anything differently? I mean you talked about contemplating pricing, like how do you with leadership figure out or how important or how permanent is this? Is it worthwhile taking a price increase that you're never going to take back? So how do you think about that sensitivity from a consumer standpoint?

Well, I'll take a couple and Katie can jump in. I think the -- What's not transitory very clearly is labor and the investments you're going to need to make in paying people stronger wages over time today and moving forward. That is the right thing to do, and it's going to need to keep happening. What will be in and out as it has been in the history of the world, will be cost of goods. I think we're living an elevated time of everything, right? Everything is higher. That will moderate. I can't tell you when. I don't know if it will be next year or '23 or '24 or which product it will be. That's unclear. And today, we're living high, everything. Those things will moderate. Those things will come down. They'll be balanced. So that's why we don't overreact with price too quickly. Other cost of the digital business with a delivery otherwise that are up right now, those things will moderate over time. So I think that's leading us to the balance that we're living right now.

Yes. And when we look across all the potential opportunities that we see and really can flex the model. Price is one thing that you can take to help offset this, but there's a lot of other things. We've been more strategic about our price through delivery, third-party delivery channels to help differentiate and account for the greater cost of doing delivery business through third party versus having somebody come pick it up in our stores. But then also, you've seen, and you'll continue to see -- we've had kind of this ability for the guest to [ premiumitize ] their items. So they can add -- right now, they're able to add fried shallots, but also it's avocado, it's cherry peppers. It's all of these different up-sell items, which the guest walks away, hopefully, with feeling like they had a great experience. They got exactly what they wanted. It's just a little bit of a premium touch for us to help offset some of the higher cost pressures here, but it's not just a blood force price across the entire system. When you look at a brand like ours, we're very early in our growth stage. I'm very optimistic about all the Shacks that we have yet to open. And so we want to be more mindful about price and not just roll out a very aggressive price across all markets, especially ones where we're still looking to establish and grow, our brand awareness of who we are. We just want to be thoughtful about that. That's not to say that we won't take more price. Certainly, we've talked about the potential to take more price earlier next year. But we're -- it's a balance. There's other strategies at play to help in this currently very inflationary environment.

That's interesting because it seems like a company like yours would want to have a mainstay basic set of products that are at a certain price point for somebody who's more value conscious. But if you have that ability to kind of flex the premiumization, if that's a word, and upsell certain things...

It's now a word. I've made it a word.

That's exactly right. [ That's a good ] opportunity. That's an important way to Capture some upside for the people who want to spend that way. And it also gives the value perception and reality for core products that don't have to move up as much. And we feel good about capturing a little bit there. And we're not -- just a little bit. It's a new strategy, but we find generally -- it's actually this moment is a really good one because we've got our Black Truffle products going right now. That's a premium item. $8.99 roughly, depending on the price here, for a Black Truffle burger. That's a high-priced burger for us. And people really love it, and they're paying that and happy to do so. We've also got our Parmesan Black Truffle Fries. That's a premium add-on to a core product, and people are ordering it, right? So those things are, I think, really healthy signals for who our guest is, what they're willing to pay on the upside, while it allows us to protect as much as possible on the core products without moving them up more than we want to at this stage in our growth.

And then just one last kind of point on this whole side. There are especially in our digital channels, we just see a much higher tax rate for our higher-margin items. So as we continue to lean into digital, we'll have to see how the guest uses drive-thru with the digital menu boards as well. These are all margin accretive add-ons that we have. So cold beverage being one opportunity, but just even driving higher price, higher Shake attached, it's all part of the focus.

Yes. I think of your brand, obviously, in a Times Square or theater district type location, the customer is going to come. They're looking for that fun experience, and it's probably a different customer every day, but you're going to some of your suburban markets. Randy, like you said, people are seeing inflation on every item of their life. At some point, they have to reconcile and say, well, my pay only went up by x, but my cost of living went up by y. It would seem like you're at a major risk that you'd want to be a lagger to let the margin kind of settle in wherever it might for the near term, just to maintain your value.

I think that's right. And I would add, look, we don't want to try to ever to compete with fast food or that type of pricing. It's -- we're never going to win on that, that's not who we are. We've shown over the years, not just COVID and now. But I think the idea continues that our guest generally is willing to pay more for a better experience and willing to pay more for the things in their life that give them value that is knowing what kind of food I'm putting in my body. That is the experience of places where it's not just feeding myself with calories in a burger. It's saying, when I want to eat a burger, I want it to be a good one. It's going to be Shake Shack. I'm going to take the kids, I'm going to take my friends. I'm going to take a date. It's going to be cool. That will -- I think you'd see the consumer trend would continue to say people are willing and able to spend money there, even in this crazy up and down economy.

And then if you tie in our focus on added convenience across all of our channels, I think it does actually echo that point quite well.

Needless to say, everyone likes to talk about the comp side of things and the pricing component within. But you guys are a unit growth story, and I don't think that's lost on investors. So the fact that you're talking about 20%-plus unit growth in '21 could be north of 20% in '22. I mean how do you -- I mean when you sit back and try and arrive at the unit openings for 2022, for example, like how do you know that's the right number? I would think that accelerate too fast, and you run the risk of a labor shortage or a product shortage or a low-quality opening. Like how do you decide what the right number even is going forward?

Yes. Jeff, it's been a learning experience every year. And if you really look back outside of the one blip we've ever had, which was 2020, in COVID, we have generally taken our time and accelerated development every year of our history. When we look at that, what we don't like to do is say, hey, we're going to open 100 Shacks next year. Could we? Sure. Should we? No. We do a little bit more year after year, and we prove to ourselves that that's a good number. We execute. We scale our systems in order to do that, both base infrastructure and most importantly, training, operating and opening, and we've done that yet again. If you look at what investments have we made this year so that we can do 45, 50 company-operated Shacks in a year, double the size of our recruiting team, doubling the size of our training team, creating a special ops team that can execute new things like drive-thru. Our special ops team is on the ground right now in Minnesota. That team has never existed before last year, right? So we are investing a lot in those things that will allow us to scale that. But again, we'll get that 35-ish Shacks this year, as we've talked about getting that up to 45 cities. That's a big leap. As a percentage, it's a big leap. We believe it's doable. There's obviously challenges in supply chain people and all the otherwise, but we believe we can do it. And the other thing that is pushing in all this is the opportunity of the kind of real estate now with these new formats. We can really look out a few years and say, okay, we think we can do x amount of drive-thrus. It's not going to be the whole class, but let's do them and learn. As you know, we're going to do up to 10 in the next year. We can do some of the Shack Track drive-ups. We can do core Shacks, we can do some food courts, some outlet malls, a little bit of everything. We can talk separately. But don't forget, we also have a dynamic international license business that is 20 to 25 Shacks next year. So in total, you're looking at 65, 75 Shacks. In total, that's a big commitment. And with every step, this is why we're going to spend money on G&A. Expect us to have a big leap in G&A next year again. We need to support the question you just asked. We need to develop even more in our digital CapEx and OpEx investments so that our digital infrastructure is there. And we sum all that up. This is how I'm really trying to share it these days. We are optimizing for learning right now. We're not optimizing for leverage. We're not optimizing for cost reduction. We have only 200 restaurants. We're probably the smallest company that you follow when it comes to units. And we have a huge opportunity. So what we're trying to optimize for is to learn, figure these things out, tweak, admit our mistakes and go forward to a brighter and bigger future than we've imagined.

And a small part that it's not making it easy what we plan here, but it's healthy, it's a large part of our restaurants next year that are company operated will be open to the existing market. So not that it makes it easy, but it does make it easier.

It's a huge point. It's like when you can borrow a couple of sugar from your Shack friends next door, like it really matters. And when you think about the long-term leverage we will have in this company, we have not even begun to establish economies of scale for our supply chain, for our distribution, for our people, and for all the things that will come when we actually have five restaurants in a city instead of one or two, right? And these things are hard. When we open a Shack and we kind of orphan it out there by itself. It's hard. It's hard for the team, it's hard for the supply chain. And then as we add and we get -- we were just in North Carolina with the exec team a few weeks ago. And we're starting to see -- we now have six restaurants in North Carolina. We have more coming in the coming years. And you can already feel how that changes the brand, people get who we are over time in a new place. And it just helps operate so much better when you have some scale.

Yes. I mean one of the things that was really very true is when you kind of have one Shack as an island, it's actually just harder from a hiring perspective because the employees don't know who the brand is either. So again, to Randy's point, when we're able to cluster and get more of a network of Shacks in a particular location, it's not that it's easy to own restaurants right now, but it does make it easier.

I was going to say investors should be reminded of that idea that maybe a bell goes off when you hit a certain number of units to say, all right, maybe we'll be leverage on our Shake Shack P&L. But in that market, we've now turned the switch, and we are now executing on that efficiency. And Randy, to your point earlier, the fact that most people haven't had a look under the hood in five or six years. Like I often forget, and I think, oh, the Shake Shack I knew in 2015, how are they doing 50 units? I mean they were operating out of Randy's apartment. I mean you should have a...

I think we still do from time-to-time. But...

But some sort of event where you showcased our -- the number of people we have in these departments versus what we had six years ago, like people would be blown away.

Well, I can show you. We've got this little home office here. And we've got a lot of people here humming away. We're actually expanding our home office right now in New York City. That's not something you're hearing a lot, we need to. We are hiring. We're hiring in tech in marketing, in operations and people. And it's a really important point. And I do encourage investors to go check out some of the new stuff we're doing, right? When you see that -- those first few drive-thrus -- by the way, I'm sure we're going to get a lot wrong. So give us some time and patience. But when you feel drive up, we opened a restaurant two days ago outside of Columbus, Ohio, in the Polaris area. This is a drive up right? There's only about five or six of those that exist. We're learning about that. That's a good way to think about the future of the digital experience. And oh, by the way, we just signed a lease near in the meat packing district of Manhattan at the foot of The High Line. So like the things that Shake Shack is: parks, community gathering, visitors from all over the world, like we're doubling down on that too, right? So it's important. People know -- yes, most of our growth will be "suburban" as we go. That's just what's in the world, right? But we're going to keep being an urban brand as well. We've captured some locations in urban centers during COVID that would not have been available, and others were running from. And we're not going to run from it. We're going to go deeper because we believe in urban centers. We believe in that offices will have a life and Manhattan will continue to thrive, and we're going to do a lot there. So yes, it's a lot of work. We've got a big, incredible and growing team. And again, count on us to invest in those long-term goals.

Right. 2022 seems like a breakout year from the variety of formats that you're testing and learning with. Just talk maybe about those openings. I mean do you say the drive-thru, we'd expect at the end of year one or two should generate this sales margins, returns? Or how do you go into that when you have so many formats ramping?

Yes. Well, look, at this stage, we don't have one, right? So we're not going to guide towards what we are going to guess that to be. Obviously, we are doing drive-thru and some of the other formats because we believe that they can all over time contribute a higher AUV and/or Shack-level op profit and ultimately strong returns. But again, I'll say this again because we are optimized for learning, and we're going to spend a lot of money to build these things. We're going to then spend a lot of money to fix them because we will mess something up, I guarantee, right? And we'll learn, oh, the menu board should have been over here, not over here. We should do it this way or we should cook this way, but that is where the -- this is why, Jeff, we went and got all the money that we did. It's why we now have -- we will use the fortress balance sheet that we built up over the last 1.5 years through COVID to exit this thing stronger and to go get that learning going. So yes, we are going to be doing a lot of different formats so that we quickly learn and can say, okay, '23, '24, let's start planning this type of mix, all with the -- again, I still think we're so early that we've got to balance that portfolio of risk and reward, and we will do that in these kind of classes.

Is it safe to assume like if you open up a drive-thru unit, this unit is a great location for a sit-down experience. So you're picking a unit that it would generate the sales of a sit down. And then by the way, behind the back bush over here, we have a drive-thru. So you would think it has the opportunity to generate meaningful incremental sales over time.

That's our hope, right? And again, not guiding to that, but that is our goal. And you're right, at this stage in the drive-thru that we're building, they're not generally kind of pull off the highway in the middle of nowhere drive-thru. They are places that we expect and hope that people will also want to gather. And they are the full experience of that. Now we may learn that there are places where, hey, people really just want the experience, maybe we don't need a drive-thru. And I'm sure we'll learn their places where people just want to drive-thru, and they don't really need the whole experience. And maybe we'll have a model over time that looks at that type of convenience factor and it's smaller right now. And look, we didn't invent the drive-thru. Other companies have taken 70, 80 years to master it. We're certainly going to take some time. And my belief, and the way I want everybody to leave this, is building optionality so that we have a few different versions of this that we can employ, depending on the location, depending on the learning that happens.

Yes. I know it's funny to listen. Some people say, well, why do you open so many. But like you said, you're not the pioneer. You could have examined 50 years' worth of drive-thrus, and you have a much better competitive advantage than opening up your first one.

Yes. And on that point, we've guided to 45 to 50 new opens for next year and also by the end of next year, only 10 or so, we expect to be drive-thru. So we're opening, we're learning, we're planning on opening up some more and evolving from there.

And Jeff, you're right, we've heard that question before. Why don't you just do one, why don't you just do a couple. Well, we don't think that's going to give us the best amount of learning. And like you said, the great news is, let's take a scenario that I don't believe will happen. But in the worst, worst case scenario, nobody ever wants Shake Shack as a drive-thru. Okay. Well, then we got these great restaurants that are Shake Shack, as you know it, plus-plus. So I don't see a downside other than investing some capital in that learning. And we believe there's going to be a lot of upside because now when we're looking at any city, we can say, all right, we used to say, let's go urban first, let's go premier shopping center second or first, and then we'll kind of fill in. Well, now we can say maybe, but maybe the first should be the really, really busy street where we can employ a drive-thru where there's just a lot of human beings who want to gather and move around, and we'll do the urban and we'll do the shopping center. And that's a really fun new addition when we sit with our real estate committee to map out cities and think about how we want to grow. It gives you a lot of optionality.

I think people think of the drive-thru as waiting in line for a few minutes. This is really like you're going to be ordering at the drive-thru than waiting for that food to be prepared. Is that -- it's not to say Shack lane where you're picking up what you previously ordered. You order it right then and there.

Yes. And we said we will certainly not win the award of fastest drive-thru. Our goal is great experience drive-thru. That may take time, maybe longer than you're used to in a traditional fast food drive-thru. But we'll be working on that. We'll be working on how we move food through the kitchen quickly while still adhering to the way we have cooked our great ingredients over time.

I've got 30 seconds, which doesn't justify it. But Katie, the last time I hosted a fireside chat was Shake Shack. I was looking at Randy, but then I was looking at somebody else in the CFO role. So now that you are the CFO, and I have been on our side, I've been on your side. Where do you think you can have the greatest positive impact? And is that something that's going to be noticeable across the system? Or is that really more behind the scenes?

Yes. Well, what I'm really excited about is I spent almost 17 years working with company management teams, investors and just kind of on my own intellectual curiosity, just looking at ways for companies to really look into how they are going to deliver shareholder value. So I think bringing that skill set over to this side that is laser focused is helpful. But I'm also learning a lot from the teams here. And I couldn't have really thought of a better team to join than the Shake Shack team. Everybody here has been really great. It's been super collaborative. So I'm very excited for what's to come.

Well, congratulations on the role. It's fun to see somebody who I know did my job in an Excel spreadsheet now doing it in the kitchen. So congratulations. And we want to thank Shake Shack for joining us this morning. Randy and Katie, really appreciate your time. Hope you have a great day and a happy and healthy holiday season. We look forward to talking to you soon.

Thank you. You too. Bye-bye.

Thank you.

Thank you, guys. Have A good day.