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

So welcome, everyone, today to our fireside chat with Shack today. We're very excited to have the new CEO, Rob Lynch; as well as CFO, Katie Fogertey with us today. My name is Christine. I'm the restaurant analyst here at Goldman Sachs. So really a lot of things to be excited about Shack right now. So you have been delivering 14 consecutive quarters of positive Same-Shack growth. You've been delivering on margin expansion. Also, with the 550 stores across the globe, you're still growing units at mid-teens. So great, a lot of things going on. Very excited about this conversation. I think I just want to -- first off congratulate you on your very successful earnings call last month. And I now you shared some early learnings as well as some of the priorities that you'd be focused on. How about we grow through some of those components, starting with driving healthy Same-Shack sales growth as well as building the brand. And obviously, there are leading challenges in the macroeconomic environment. We do see price mix being less of a tailwind with all the normalized cost environment. And also, you're seeing stepped-up competition in the industry, right. So what are the levers that you're looking to pull to drive a sustainable Same-Shack growth?

Yes. So the first thing to say is that with 14 straight quarters of Same-Shack sales, I think it's a strong testament to the ability of this company and this business model to continue to grow regardless of what the macroeconomic environment looks like over the last 3.5 years. So obviously, being in the industry, seeing kind of what the macroeconomic environment has been and then coming to Shake Shack. But when I got here, there's a lot of concern around the premium nature of our menu and our business and our price points that go with that. And I think that we actually look at that as a positive. And I think our results that we've disclosed so far this year would indicate that, that's the case. Shake Shack footprint is actually company-owned 330-unit system, we have the opportunity to go into market and really pick the best real estate in every market. We don't have franchisees out looking for units in their neighborhood, like we go into markets like, obviously, growing up here, the business growing up in New York, we have highest penetration here, lots of Shacks in California. But as you go into markets like Dallas and Houston and Atlanta, when you go in and you look at our real estate, we don't have the same exposure to the hyper value-conscious consumer, which is probably the biggest challenge and biggest drag on from a spending standpoint right now. So we have a little bit of a buffer from that guest. And so we are going to continue to focus on delivering both premium products and premium experience during these times. And so far, it's worked out really well. Looking forward in the future and how we're going to drive comps, we are building a strategic product innovation calendar. We're going to -- culinary innovation has been a part of Shake Shack's DNA for a long time, but it hasn't necessarily been built as a strategic calendar. My background, coming from Taco Bell and Arby's and Papa John's has really been -- I've been taught how to build a portfolio of new product innovation that complement each other and drives comp sales growth. That hasn't necessarily been the model at Shake Shack. So we're building that muscle right now. We don't have a loyalty platform. We're working on building out a loyalty platform to deliver our enlightened hospitality in a world where hospitality, it needs to deliver more across the digital footprint than necessarily in the dining room. So we're working hard on that, and that's going to be a comp driver for us for a long time. And then lastly, just operational efficiency, throughput, as I talked a lot on the earnings call, we don't have a demand problem. We have lines at most of our Shacks pretty much every day. We can improve both our short-term sales by increasing our throughput, but also by decreasing the time to serve and increasing -- it will improve the guest experience. That's going to be a longtime builder of repeat. So we're focused on driving frequency through improved guest experience through our digital channels, and through throughput, decreasing the amount of time it takes to serve. So those are kind of the 3 areas from a top line standpoint. But we're also super focused right now on improving our productivity in our -- inside our 4 walls. We just hired a new COO, Stephanie, who has come in and is -- in just 60 days, is bringing in a lot of new thinking to our operating model. And we believe that there is some short-term benefit to improving productivity. But over the long term, we're also challenging our restaurant footprint and how we can streamline our operations. Historically, we've been grounded in kind of a fine dining operating model with multiple stations all coming to an expo line and coordinating it all together. QSR is about streamlined process. It's about starting here, finishing here and handing it to the guest. And so we're looking at ways that we can execute our model more efficiently in a more streamlined way. That will be a long-term impact to our operating productivity. And then lastly, from a growth standpoint, you mentioned we've got 330 Shacks today. We feel like there's a lot of room for us to do that better. But we can only do that if we continue to deliver the kind of cash-on-cash returns that we hold ourselves to right now. So we're going to continue to look at ways that we can decrease our cost to build as we enter into markets that have different levels of population density and make sure that we can make the economic model just as lucrative as it is today. So that's kind of the top line.

Wow, great overview. You covered a lot of my questions already. But just going back to raising brand awareness, I know you have big plans to increase advertising this year. How do you -- what are the key messages that you're trying to get out there? And how do you see this evolving over time as you grow? And also, it would be great if you can you walk us through your pipeline to optimize those marketing dollars to reach the right core customers as well as kind of generating the right return.

Yes, for sure. I mean I think something I get tagged with the moniker of being a marketing guy because I started at P&G and brand management. But for me, marketing is a lot more than just advertising. Like marketing is truly understanding the wants and needs of your target customer base, understanding what you need to say or do to either increase or change your customers' behavior, right. And it all comes down to 3 questions, who's your target audience? What do you need to tell them to change or increase their behavior? And then how do you reach them most efficiently, right? If you can answer those 3 questions, you can drive top line sales. And so we're starting with who is our target audience. And as I mentioned, we've had a guest over the history of the brand that is willing to spend -- to pay a bit higher prices for a lot better quality. And whether that's in New York with one level of household income or in Oklahoma City with another level of average household income, still need that math to work, right. Because we're not going to go in and decrease the quality of our products or sell our stuff for less than its worth. So we're really trying to make sure as we increase our market penetration as we look to these other markets, do we really understand what that target guest needs to hear from us, needs us to do for them to make sure that they come to us and try our products and then come back with a high level of frequency. So that's the first step. And then the second step is like what are we going to communicate to them? And that's where we have a great story. And that story is around the quality of our product, what goes into our product, the way we take care of the people that -- our suppliers, our guests, our team members, our communities. So that message has resonated kind of a word of mouth away throughout the markets that we currently compete in. We need to be able to preach that from the mountain in all the new markets that we're going into, and that's where the spend comes in and that's the media dollars. And we have increased our investment behind media, primarily digital media and primarily in a much more surgical, localized way. Wouldn't make sense for us to go out and run national advertising when we're only in probably 50% off the DMAs today, we'd be throwing some money out of the window on a national level. So we have built a very structured surgical marketing model that is helping to drive the comp growth and mitigate some of these industry traffic malaise that we've seen across the board. So all of those things are really critical, and we're going to continue to invest in marketing as long as we get the returns on that investment that we expect. I'm not here to spend marketing dollars or advertising dollars just for the sake of doing it because I'm the marketing guy. Like it's got to generate a return. And so far, we're seeing great returns on that investment.

Great. I think you mentioned that loyalty program might be within your near-term plan. Can we just talk about how do you ensure that it just doesn't become a discounting mechanism for your top line customers?

Yes, it all goes into how you structure that, right. If it is just pure pay-to-play points base, then it does just become a discounting mechanism. But I've challenged our team, our brand was founded by Danny Meyer, it was a whole core around Union Square Hospitality Group and Shake Shack is enlightened hospitality, right? It's in the name of Danny company. So you have to find a way to leverage our loyalty platform, not just to give discounts, but to create that type of one-to-one connectivity with our customers. It's been a part of our DNA since the founding in Madison Square Park. And once again, as our industry moves more towards a digital delivery channel, both through our organic channels, our web and app and also the third-party delivery providers, like we need to find ways and challenge ourselves to bring enlightened hospitality life. And so I think the team has been able to do that through the way we -- the seamless nature of ordering through our app, the way we partner with our delivery providers, our loyalty platform also needs to deliver on that.

Great. Just moving on to the second area of focus, which is opening more stores, with a good cash-on-cash return, right. And it's very impressive to see your new stores performing very well while you're actually lowering your newbuild costs. So you talk about the strategies that's been driving the success? And how do you plan to keep this momentum going as you expand further?

Yes. I think it's about development comes down to real estate, construction costs and operating efficiency, like making sure you can operate efficiently, right? And the brand has been really good in the past at building big Shacks with really nice dining rooms and high-traffic areas that do really high AUVs. That's great, we want to continue to do that in a lot of places. We make a lot of margin and a lot of money in that model. But those -- that footprint is limited. And our aspirations are to have a much bigger footprint. So we need to make sure that we can go into markets that don't have that same dynamic and be able to succeed financially. So in order to do that, we have to have restaurant designs that are lower cost to build, still able to support the amount of demand that generates the AUVs that we have in an efficient way so that our margins can sustain, the expectations that we have in place today. So it really comes down to making decisions on the size, whether it's going to have a drive-thru. I mean, drive-thru should add capacity, right? And so we're looking at all of those things as we go into markets that where we're transitioning from a Manhattan model that is foot traffic to a Columbus Ohio model that is car traffic. And we just need to make sure that our Shacks and our operating models are built to support that different channel.

I think that's a great takeaway to the next question, which is drive-thrus, right? It's less than 10% of your store base right now. But how important is the success of drive-thrus going forward for the growth of the U.S. in the long run?

Yes. I think it's critically important. I think once again, if we're going to realize our full potential, we have to be able to successfully operate and execute a model that has, the customers, the guests in these different geographies have grown accustomed to. And full disclosure today, we don't do it as what we need to. And so I give a lot of credit to the Shake Shack organization during the pandemic when every unit was a dine-in unit, that business model was a bit challenged during the pandemic. They pivoted quickly to be able to execute a different model. And essentially, they punched a hole in the wall and try to execute their dining room model through a hole in the wall, that's not how you do drive-thru. Drive-thru, the priority of benefits that our guest demand changes in the drive-thru, speed and accuracy become a lot more important. And so how you design your menu board, where you -- what you promote drives how fast you can take orders, drives what level of customization you have, which leads to speed of service improvement and accuracy improvement. So we are right now challenging the model that we've launched drive-through with. We've hired Stephanie Sentell who spent 12 years operating in large company-owned QSR environment, who is rethinking and rebuilding that model. And the good news is it's not going to take a lot of capital to change it. It really is about changing some of the processes changing some of the ways we do things. So we have a lot of confidence in our ability to significantly improve the speed of service through the drive-thrus and that's going to unlock real estate and markets that we wouldn't be able to really deliver the cash on cash returns if we just go in and build a big dining room.

I'm sure Stephanie is very busy working with on the ground with the development teams. But any early thoughts on sprinkling the Shack magic on the drive-thru experience versus a traditional drive-thru experience?

Yes. I mean it needs to be -- like, I mean, right now, we don't offer combos, right? I mean, things like that. And then as people come through the drive-thru, making sure that we are delivering the same level of hospitality and service when they show up. But the best way to deliver hospitality is to improve their experience through speed and efficiency. I mean that is the #1 thing that people want and a drive-thru. So it will be Shack magic, this might show up a little differently than it does in the dining room.

Great. Any room for accelerating your unit growth? Or are you happy with that low to mid-teens cadence?

Yes, I'm never happy. So always challenging ourselves to get better, move faster, do more. As long as we can execute with excellence, you don't want to rush forward and then have to come back and fix a lot of stuff. So going to be strategic about it. We're going to be thoughtful about it. We're going to be planful about it. But yes, it absolutely challenging our organization on how we can move faster.

Great. I think just moving on to driving profitability, Katie. I want to be -- the first half restaurant level margins were close to almost 21%. You've revised up your lower end of the guidance, but kept the 21% on the high end. So can you actually walk us through some of the key drivers and assumptions there. And just at a high level, how should we think about the long-term margin potential if we assume that all of this operating leverage and cost efficiency continues to improve.

Yes. I mean the margin expansion story -- can you hear me? Here at Shake Shack has been absolutely tremendous. We did 100 basis points of expansion last quarter. And really, if you think about where we were relative to the past 3 years, our teams have just done so much to drive increased sales make, material improvements in our supply chain. On labor and staffing, we've already just moved the needle so much and really throughout most areas within other OpEx as well, just getting better and smarter. And at the same time, there's still so much to go. And that's what's really exciting. So whether it's the work that Stephanie has been doing within our restaurants, it's the work that our marketing team has been doing and we're thinking about digital profitability. It's all taking hold and it's a really exciting time here at Shake Shack. So I'd say, we're really proud of where we've come. A lot of that has been kind of through a mix of variety of strategies within supply chain, really just utilizing our scale and doing the things that one would do at the stage of growth at our company. So it's diversifying suppliers. It's thinking more holistically about freight. On the labor side, we've made tremendous improvements in how we're staffing our restaurants to plan and to guide. And there's been a lot of coordination between finance and operations to help get our operators there. And still, we have more to go with the new labor model that's going in later this year, and then Stephanie has a ton of thoughts on that side on managers and all other parts of the P&L. So yes, really, really excited about what we've accomplished and still a lot to go.

Great. So any metrics you can share on the new labor deployment model and whether that would impact, whether it will be a swing factor to the overall full year guidance or the implied second half guidance?

Sure. So for everybody's benefit, this new labor deployment model. So historically, at Shake Shack, labor was deployed just based on your sales level. And what we've done is we've developed a model that's really unique to us and looking at the major drivers that determine how many hours are needed per shift. And so basically, at the high level, it is channel mix. So are you heavy delivery? Do you have drive-thru? Are you heavy dine-in? It's menu mix. So there are certain items that we produce that just require more labor than others, so incorporating that into the mix. And then also looking at the peaks of the day. So some of our restaurants operate pretty even throughout the day. And then we also have other restaurants that had 2 very heavy lunch, very heavy dinner. And those just have different staffing requirements. And so with time and motion study, we've put up basically a bespoke labor model for each of our shacks working with the operator. Stephanie has been such an amazing enabler to help us deploy that throughout the system, and we are very pleased by what we're seeing.

Great. Kiosk has been a very big win for you in the last 18 months. And I want to -- if you can talk about where we are in terms of that kiosk journey and how that kiosk experience would evolve over time.

So yes, a couple of years ago, we made this decision that looking at where all of our margin profile was and what the opportunities were that kiosk was actually really, really powerful tool for us, and we wanted to just retrofit all of our Shacks with kiosks. And so last year, that was a big focus of the year. And we've talked about just recently, we're still seeing a mid-teens check lift, high-teens check lift relative to traditional check. It's been such a powerful enabler for us to really get our guests to understand the menu. So how our kiosk work, if you haven't seen them yet. It really takes you through the entire trade building process, where you have an opportunity to add sandwich, drink, fries. We heavily feature LTO through really a very compelling digital marketing and it's a very successful tool. The new labor model helps us also to optimize labor for that tool. So we have them largely deployed throughout our system. And now the work that the team is doing is really on optimizing and enhancing what those features are. We're on this continuous evolution of getting smarter about how we are offering our digital merchandising experience with our guests.

Great. Could you also talk about additional tech unlock opportunities beyond the kiosk for example, is there any opportunities to automate some of the process or a digital kitchen opportunity, any of that in the midterm that we can look forward to? And how do we ensure that we have the right investments in place to ensure technology adoption in the right places.

That's a very complicated question. And something we focus a lot of our time on. If you really look at kiosk, that was a way of us automating the order process, automating the front of house, but still doing it in a way that we believe provides a actually superior guest experience. So I really did that with the guest in mind. And the work that Rob and Stephanie have been doing on kitchen flow, all ties into this as well.

Yes. I mean a lot of it is the analytics, right? It's what you're measuring and what your KPIs are. And so when we think about technology and you talk about automation, people envision robots back. I don't think we're moving a robots anytime soon, although we did have a robot delivery in Los Angeles a couple of weeks ago. Where technology is really impacting us is leveraging AI to really look at all of our processes and just think about how we can do things in a smarter way. And so it's really more analytics than it is necessarily like engineering, if you will. And those analytics are going to inform like, I mean Katie just walked you through, I mean, our whole labor model is way more sophisticated than it used to be. It used to have million of sales equal to this amount of labor and the GMs were deploying it, however they saw fit. Now we are giving them guidance on, based on your business, here's what you should be scheduling by hour. I mean that there may be a lot larger companies that are already doing that, but that's a game danger for us. So everything we do is grounded in analytics and technology at this point. And so yes, our biggest G&A and our biggest capital investments outside of building new Shacks is in tech.

Okay. Great. Just a few long-term questions. So I know there's a lot of things that changed after the IPO when you were looking at a 450 plus a long-term opportunity for stores [indiscernible] you're already at 311 in the last quarter. So and still growing mid-teens year-over-year. So that being said, could you help us to frame we should think of what are the key considerations in thinking about the TAM at the long-term.

When I was making the decision on whether I came to Shack, I got really excited knowing that we are going to be at like 330 units this year, and we could build 450 forever. No, that wasn't the case. So obviously, with our growth rate, and how we're looking at things, we're really excited about the potential of this brand. And our business has changed dramatically since the IPO. I think the IPO there is 15 units. So 450 seemed like a really, really big number.

Big, big numbers. Yes. I mean what I would say is that all of the things -- well, first of all, as a former restaurant analyst, and you look at this all the time. But all of these things that we're working on today and improvements that we've made just make the opportunity bigger and bigger. And so we've talked about all the opportunities that we see, ripe opportunity for continued margin improvement and sales growth. But then we've talked about it a little bit, but we haven't focused that much on that. I mean the real estate team is doing a tremendous job in lowering the build cost. So I mean we've also talked about having a line of sight to future reductions next year and a bigger amount of unit growth next year than we're opening up this year. So all of these things kind of feed on themselves. And the total addressable market, we're really, really, it is a tremendous opportunity as we continue to execute on plans.

You recently announced the closure of 9 stores, your plans to do so. Does that impact your TAM? What was the thinking behind that?

That will have no impact on anything. I mean that was really us -- it was really me coming in and saying, okay, so you've never closed a restaurant before. Does that mean that every single restaurant we have is awesome? And it came down to, of the 330, 321 were. So pretty exciting. So there's 9 Shacks that frankly, weren't delivering on the financial performance that we need them to, and we didn't see a path to get them there. So not a material change in really any of our KPIs. And frankly, no impact on our development plans moving forward. I think the media really picked that story up and used it for their own purposes. But we still have 40 Shacks in California, and we're still building more this year and next year. And we didn't just close Shacks, California. We closed them in Texas and Ohio, which look a lot different than California. So this is really just, I think, portfolio management, and it's never an easy decision for anybody to close down a business. It has impacts on team members that has impacts on communities. And so I didn't make that decision lightly. But it was the right thing to shift resources from Shacks that were unproductive to productive Shacks. And we were able to move every single manager that worked in those Shacks to other Shacks and help fill our pipeline as we continue to grow and build in those communities. So, yes. I know it's been a weigh on the stock for the last couple of weeks. It's frankly, surprising to me. But yes, there's only positive benefit from what we've decided to do.

And when we look at these restaurants, a lot of these restaurants, we talked about the long lead time on development, could be 18 months, it can be much longer than that. And so a lot of these locations were things that were contemplated pre-COVID, during COVID. We also know that just the way that the people are moving around the way that the world has changed. Why is very stable performance of delivery as something that's here to stay. That all changed the face of the landscape for restaurants. So, to Rob's [indiscernible] coming in here and making this decision, it really will set us up very well to be able to scale and focus our efforts on our restaurants, which have the opportunity to really generate a lot more profitability.

Great. So the company has made hires including very high profile CEO, COO beginning the growing scale of the business, both domestically and internationally, do you feel like you have all the right people in place right now? And is there any obvious gaps that you're looking to fill. And more importantly, how do you, ensure that everybody from kind of them all the way to the managers to the store staff are aligned in terms of achieving towards the goals that you've set for the next few?

Yes. I mean, so you essentially just described what the CEO's job is, right. I would tell you my last full roles, President of Arby's, CEO of Papa John's. I've come in and everyone said, Rob, we need you to fix this. Like Shake Shack doesn't need fix. There is a huge amount of upside opportunity for us from an optimization standpoint. But it's not broken by any means as evidenced by the great results that I got to stand up last quarter and take credit for that I have nothing to do. So we have a great team in place, I have a ton of confidence in our management team. Yes, there's some optimizations, and there are some changes, but that's -- I mean that's not just going to happen today or tomorrow. I mean that's -- my job is to continue to make sure that for the changing needs of our business, we have the right people, the right resources, the right infrastructure in place. But once again, this is a situation where I have the luxury of coming into a business that has a ton of momentum that has a really strong team, and we just need to challenge ourselves to look at things differently. I'll use the store closures as an example, like that was off limits in the past. And I said, look, I mean, you wouldn't keep in your portfolio, your personal stock investment portfolio, you wouldn't keep investments that you didn't believe were going to improve or were going to be stable. And that shouldn't be how we run this business. I mean we're going to do everything we can. We looked operationally. We looked from a marketing standpoint or the things we haven't done. And when we vetted all that, these 9 said that we weren't going to move forward with them. And those are the tough a change in philosophy that I brought. And there's other changes in the way we manage our restaurants and the labor modeling and in the developed strategy, more penetration versus kind of scattering were. So there's definitely going to be a change, and there's a lot of room, low-hanging fruit for us to optimize the model. But right now, we've got a great team doing all the right things.

Excellent. I want to touch a little bit on the international business. I know you're seeing price sensitivity across the globe, not just in the U.S., I think especially places in China has been under a lot of pressure. So how are your international partners thinking about pricing and marketing in their own markets. And how do you ensure that those local strategies align with ours, right, especially in terms of the brand equity, making sure that a consistent across the globe.

Yes. I mean we have a great license business domestically and internationally. So our licensees in the U.S. are the folks that operate our airport units, which a lot of you have probably frequent did and the stadiums and other areas where we can't get into those pieces of real estate. And then we have our licensed partners that are essentially responsible for building out a country in the international markets. And yes, there's no question that China and the Middle East, 2 markets where we are heavily penetrated have been challenges over the last months but that's been built -- that's been offset by other markets that are performing really well. So our international business is actually doing really well relative to what the expectations were this year given the geopolitical macroeconomic environment. So that being said, we can absolutely get better. And we've got a great international team that is working with our international partners to do what exactly what you just said. And we have great properties. We have amazing Shacks across the globe with partners that have the resources and have the acumen to be able to operate very effectively. So have strategic discussions with them on their value proposition, making sure that they're not thinking about or trying to do things that would compromise our brand. We have very strong license agreements with them. And they're brought into the future. So it has even despite some of the business challenges, I think our partners are strong enough that they've been able to stay true to what has made them successful in the past ride out some of these waves.

Great. That's all the time we have. Unfortunately, thank you so much, Rob and Katie for joining us.

Thank you, Christine.

Thank you.