Shake Shack Inc

NYSE:SHAK

Earnings Call Transcript 2017-Q4

[Operator]

Good day, ladies and gentlemen, and thank you for standing by. Welcome to the Shake Shack Fourth Quarter 2017 Earnings Call. At this time, all participants have been placed in a listen-only mode. And the lines will be open for your questions following the presentation. Please note that this conference is being recorded today, February 15, 2018.

On the call today from Shake Shack, we have Randy Garutti, Chief Executive Officer; Tara Comonte, Chief Financial Officer; and Josh Omin, Vice President of Finance and Investor Relations.

And now, I would like to turn the conference over to Mr. Josh Omin.

[Josh Omin, Vice President of Finance and Investor Relations]

Thank you, operator, and good evening to everyone. By now, you should all have access to our fourth quarter 2017 earnings release, which can be found at investor.shakeshack.com in the financial info section. Additionally, we have posted supplemental fourth quarter and fiscal year 2017 earnings materials, which can be found in the Events & Presentation section on our site or has an exhibit to our 8-K for the quarter.

Before we begin our formal remarks, I need to remind everyone that our discussions today will include forward-looking statements, which are not guarantees of future performance and therefore you should not place undue reliance on them.

Actual results may differ materially from those indicated by these forward-looking statements due to a number of risks and uncertainties, including those discussed in the Risk Factors section of our Annual Report on Form 10-K, filed on March 13, 2017. Additionally, 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.

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 in our earnings release and the appendix of the aforementioned supplemental materials.

Now I would like to turn the call over to our CEO, Randy Garutti.

[Randall Garutti, President and Chief Executive Officer]

Thanks, Josh, and good evening to everyone on the call today. I am pleased to report that we ended the year with robust fourth quarter momentum, opening 16 new Shacks and returning to positive comp, delivering stronger than expected sales and profit, capping off another year of exceptional results. We delivered full-year revenue growth of 34% beyond our initial and updated guidance, and adjusted EBITDA growth of 29% driven by the execution of our digital, menu innovation, and development strategies. I am incredibly proud of our teams across the world, who made that happen.

As of today, there are 162 Shake Shack's worldwide across 12 countries and 20 U.S. states, plus Washington DC. During our call today, we will give you an update on our fourth quarter 2017, including some of our key strategic growth initiatives. We’ll lay out, how we intend to continue to invest in and grow our business through 2018. Additionally, today we will share some specifics around our targets for the Company longer-term through 2020. Shake Shack is a growing, loyal, and connected community. We are relentlessly focused on excellence, experience, and hospitality. And we are excited to share our strategic growth plans with you today.

Let me update you on how we wrapped up 2017. On the domestic development front, we opened our 100 Shack in the United States, with 90 company-owned Shacks and 10 domestic licensed by the end of the year. Our opening and training teams worked really hard in the fourth quarter executing a record number of openings, with a 11 new company-operated Shacks, five of which opened in the month of December, resulting in 26 new Shacks for fiscal 2017 and over 41% unit growth over the prior year.

During the year, we expanded our footprint both in key existing region such as New York City, the Mid-Atlantic, Midwest, and Texas among others. As well, we entered a number of key new markets including Michigan, San Diego, St. Louis and more. 2017 was our biggest year yet for our licensing business with 19 net new Shacks, including 16 internationally across Japan, Korea, the Middle East, and the UK as well as three domestic at the LAX Airport, Minute Maid Park in Houston, the M&T Bank Stadium in Baltimore.

We also entered in a new licensing agreement to Shake to Shake Shack into Hong Kong, Macau, and Shanghai with nearly 40 Shacks planned over the next decade for this combined region. We are extremely pleased with our performance in Asia so far, and we believe there are many significant growths ahead in this region.

None of this would be possible without the strength and hard work of our leaders, and our teams across the world underpinned by the foundation of our culture and enlightened hospitality. I’ll talk more about this later on the call. You can count on us to continue to make significant investments in our people going forward.

With that, I’m going to turn it over to Tara, who will take you through the details of our 2017 results, our 2018 guidance. And then I’ll come back to give you context around those 2018 numbers and our longer-term targets.

[Tara Comonte]

Thanks, Randy. As you just heard we’re extremely pleased with our strong finish to 2017. Total revenues for the fourth quarter 2017, which includes sales from both company-operated Shacks as well as licensing revenue, increased 31% to $96.1 million. Sales from our company-operated Shacks also increased 31% to $93.1 million, largely due to the addition of 26 new domestic company-operated Shacks since the fourth quarter of 2016.

Licensing revenue increased 28% to $3 million driven by a net increase of 19 Shacks since the same quarter last year and the strong performance of our nearest Shacks in South Korea. For the full-year 2017, total revenue increased 34% to $358.8 million. In November, we’ve raised our total revenue guidance for the year and we're pleased to have exceeded that primarily driven by the strength of our most recent opening.

We opened 11 Shacks in the fourth quarter and are encouraged by the early performance out of the gate. We also delivered returns positive, same Shacks sales, which increased 0.8% during the fourth quarter, consisting of a 2.3% increase in pricing mix, partially offset by 1.5% decrease in traffic. This lapped to $1.5 increase in the same quarter in the prior year.

Our comparable Shack base in the fourth quarter included only 43 or roughly half the total number of company-operated Shacks in the system, a majority of which are located in the Northeast region including New York City. As a result our same Shacks sales continue to be influenced by changes from a small number of Shacks. This will lessen over time as we increase both the number and location of Shacks in the base.

In the meantime however, this metric will continue to show degree of volatility. In this case the fourth quarter results benefited from warmer than usual weather in the Northeast in October and the strength of the delivery pilots in many of our Shacks. As we talk about delivery, you may remember we're taking a long-term perspective to this opportunity and being deliberate and patient about our market test. We were encouraged by the learning from each of the pilots and we do believe we saw some uplift in sales as a result.

Average weekly sales for domestic company-operated Shacks were $85,000 for the fourth quarter of 2017. And average unit volumes for all domestic company-operated Shacks was $4.6 million the full-year 2017. Shack level operating profit, a non-GAAP measure was 30% in the fourth quarter to $23.5 million and Shack level operating margins were 25.2%. The fiscal 2017 Shack level operating profit grew 26% to $92.3 million with Shack level operating margins of 26.6%.

Both the fourth quarter and the full-year, so operating profit in absolute terms delivered significant growth, while as expected margins as a percentage of sales decline. The primary reason for this percentage margin decline are labor, which remains a headwind of the result of minimum wage increases and other regulatory factors such as the Fair Workweek within New York. In addition, and as Randy noted, we plan to continue to invest in our teams of confidence as we view our team as the foundation of our success.

Other operating expenses to deleverage driven mainly by certain fixed expenses and increasing facility cost as our Shacks mature and most significantly the introduction of a broader range of unit volume Shanks into the system. This company started in New York City with industry leading average unit volumes and operating margins.

As we open more Shacks at lower AUV and generally lower operating margins across the country we will see these percentage based metrics continue to come down, at the same time delivering extremely healthy returns and significant absolute dollar growth on both the top and bottom line.

G&A increased during the fourth quarter, primarily due to increase headcount at the home office to support our ongoing growth, technology development costs related to our digital product. First, phase costs associated with our planned systems update, which we will talk about in a minute. Our non-cash deferred rents for our new home office.

Adjusted EBITDA in the fourth quarter grew 31%, from the same quarter in the prior year to $14.9 million, and adjusted EBITDA margin was 15.5%. For the full-year, adjusted EBITDA increased 29% to $64.7 million with an adjusted EBITDA margin of 18%. In the fourth quarter, on an adjusted pro forma basis, we earned $3.9 million or $0.10 to fully exchanged and diluted share, compared to $3.3 million or $0.09 from the same quarter last year.

On an adjusted pro forma basis for the full-year, our net income increased 25% to $21 million or $0.57 to fully exchanged and diluted share, compared to $16.8 million or $0.46 in the prior year.

Included within these full-year pro forma results is a $600,000 tax benefit or $0.02 for fully exchanged and diluted share due to the stock-based compensation accounting standard we adopted at the beginning of 2017. This changed the way we account for excess tax benefits associated with stock-based compensation and can results in volatility on the tax line.

Moving on to 2018, which represents another exciting year for Shake Shack and in many ways a pivotal one as we expanded to greater scale ever before and strengthen our foundation for many more years of growth ahead.

Our guidance for the fiscal 2018 is as follows. Total revenue of $444 million to $448 million, an increase of approximately 24% to 25% over 2017. Within this total revenue, we expect $12 million to $13 million of licensing revenue. It's important to note that compared to 2017, this particular revenue line is impacted by $500,000 of non-recurring revenue in 2017 related to launch of the Shake Shack cookbook.

Many of our Korean Shacks exiting the honeymoon periods during 2018 and the implementation of the new revenue recognition standards, specifically as it relates to the timing of recognizing upfront territory fees and Shack opening fees, which will now generally be recognized as a longer periods of time. We will include a like-for-like comparison in our 2018 financial reporting throughout the year.

For fiscal 2018, we expect to open between 32 and 35 new domestic company-operated Shacks, representing a unit growth rate of between 36% and 39%. It's important to understand that our 2018 development schedule is heavily weighted to the second half of the year was approximately 70% of our planned opening scheduled for the third and fourth quarters.

We are opening more Shacks than we have in previous years, but the sales and profit impact of those openings will not be fully solved until 2019. However, the full impact of the associated pre-opening costs will hit in 2018 affecting our overall financials for the fiscal year. 16 to 18 net new licensed Shacks with our international growth is focused on Japan, South Korea, and our upcoming entry to Hong Kong and Macau in 2018 and Shanghai in 2019.

At the end of the 2018 fiscal year, we expect the average unit volume for all company-operated Shacks to be between $4.1 million and $4.2 million. At this time and following my earlier comments around the volatility of this metric, we are guiding to flat 2018 same Shacks sales. Inherent within this assumption is a 1.5% to 2% price increase taken in mid-December 2017 offset by traffic headwinds.

Shack level operating profit margin of between 24.5% and 25.5% impacted by three major factors. Flat [counter] expectations with slight deleveraging possible depending upon this market volatility; labor continuing to deleverage for the foreseeable future, given the increase in lower volume Shacks entering the base, minimum wage increases, regulatory pressures, and investment in our team. We experienced our 120 basis points deleverage in 2017 and we would expect 2018 deleverage to be at a similar level

Other operating expenses to show slight deleverage based on certain fixed expenses on a broader range of sales volume as well as continued increase in facility costs as our Shack base mature. We expect pre-opening costs to be between $12 million and $13 million. Opening in new markets generally carries higher pre-opening costs than existing markets, particularly in the area of marketing and training.

As we move further along in our journey to 450 Shacks, this is an area of spend where we will start to target increased efficiency particularly as it relates to existing markets. Until that time however, our strategy is to create maximum levels of awareness and excitement around Shake Shack coming to a market and for our teams to execute as flawlessly as possible. There is a reason our Shacks hits such high sales levels and guest satisfaction out of the gate and we will continue to spend for those strong results.

On the last call, we talked briefly about the [indiscernible] our infrastructure and support systems are sufficiently robust and scalable to deliver upon our growth opportunities. Notably, we updated certain core financial and operational systems, which we now refer to as Project Concrete. The scope of these upgrades for 2018 will include, but may not be limited to, our general ledger and end to end supply chain management. We are in early stage in the process, and we plan to make our selection early in the second quarter.

As you would expect, there is a broad array of solutions and capabilities in the market and as such our exact spend has not been finalized. At this time, we estimate the 2018 investments, a $4 million to $6 million depending upon the ultimate selection breadths and timing of implementation work. We would expect a significant portion of this to be one-time in nature, albeit there will be some increase in our recurring costs as a result of higher caliber platform.

We will identify Project Concrete spend as a discrete item during 2018 and we will continue to update you on timing and costs as the project gets underway. We expect our core G&A expense to be between $49 million and $61 million, which will gradually ramp up throughout the year in line with our growth. Our 2018 G&A spend includes investments across our key strategic growth initiatives to support our three-year and long-term growth targets.

Specifically, investment in our digital innovation, technology and marketing initiative as we pursue increasing growth from additional channels, investments in our people from a new home office and training center to our biennial leadership retreat, and investments across multiple areas of the business to support our growing footprint. All of our G&A investments is targeted in one of two areas, future revenue growth and future cost leverage.

At this early stage in our journey, we believe it’s critical to continue to deploy capital in those areas which will deliver the most significant and long-term benefits to the business, and to assure, we fully capture the significant value opportunity the lies ahead.

We except depreciation in 2018 of approximately $32 million, interest expense between $2 million and $2.2 million, and we expect to continue to experience some volatility in our tax rates as a result of the accounting treatment to stock-based comp, and as such our tax rate guidance excludes any potential future tax effect of the standard. We expect our annual adjusted pro forma effective tax rate for 2018 to be between 26% and 27%, a reduction from 40% in 2017.

Staying on the subject of tax reform for a momentum. There are two components that we believe will have the most significant impact to our business. Firstly, the federal strategy rate reduction which is a tailwind for our cash flow. And secondly, although we expect to benefit from the total expense and provisions of the bill as it relates to furniture, fixtures, and equipment. The new legislation is currently drafted, extends the timing of tax deductions to certain other classes of assets, such as leasehold improvements.

Over the next few years, we will be spending more on leasehold improvements to build new Shacks than ever before. These new assets will be considered to have a 39-year life and therefore not eligible for accelerated or full expensing. Meanwhile, these same assets had previously been eligible for accelerated depreciation under the former tax budget.

Taken together, the impact of the rate reduction and changes in timing of tax deductions is expected to result in a modest cash tax benefit over the next couple of years. We have another incredible year ahead of us. We’re confident in our plans and in a strong position to move forward. We have a robust balance sheet, no debt, and we plan to fund ongoing strategic initiatives, the development and investments in the business entirely with internally generated funds with no need for external financing.

And with that, I’ll pass it back to Randy, who will take you through our broader strategic growth plans that accompany these numbers for both 2018 and beyond.

[Randall Garutti, President and Chief Executive Officer]

Thanks, Tara. We’re a month in a half in 2018, and looking forward to another great year for Shake Shack. We’ll be continued to build up on and execute our strategic growth plans, as well as laying an even stronger foundation to deliver the significant longer-term opportunity we have in our sites.

With our biggest class of planned Shacks yet, we expect to end 2018 with 122 to 125 domestic company-operated Shacks and 85 to 87 license Shacks. This compares to just 31 and 32 respectively, when we went public three years ago. Longer-term, we continue to target 450 domestic company-operated Shacks and only 20% of that goal today, we are still very early in that journey and have a significant amount of growth ahead of us.

I want to take this opportunity now to share some color around our pace of growth, but specifically by the end of 2020. We intend to have more than doubled our current Shack base to at least 200 domestic company-operated Shacks and at least 120 global license Shacks.

We want to nearly double our total revenue to over $700 million, representing a 25% three year carrier. This is an ambitious and exciting time for Shake Shack with growth planned well beyond levels we imagined possible, just a few short years ago. We are both committed and confident in our ability to deliver both of those three-year targets, and our longer-term growth opportunity.

There are four key strategies will be executing in order to these plants. First, I want to capitalize on the healthy development pipeline we have both domestically and across the rest of the world.

Second, we're relentlessly focused on our continued digital innovation, better connecting with our guests making it easier than ever for them to experience Shake Shack on their terms, whenever and however they wish.

Third, we continue to deliver ongoing in menu innovation, focusing on our core as well as category expansion.

And finally, [indiscernible] ensure foundational infrastructure both our people, our systems are robust and scalable to support the growth that lies ahead.

While do this all in service of continuing to build an improved a great community gathering experience for our Shack brands, who built this brand over the last 14 years and yes with some tailwind from tax reform over the longer-term, we have the opportunity to really accelerate our efforts in the coming year and we in tend too.

First, let’s talk about our Shacks in our strong pipeline, 32 to 35 Shacks for this year. The development strategy remains the balance between deeper penetration of existing markets complemented by about 20% to 25% of Shacks planned as new market launches. Our diversified multi-format approach will continue of roughly one-third urban locations, one-third freestanding pad sites and remainder in premier shopping and lifestyle centers. Every year, we gain more confidence in the strength and ability of the Shake Shack brand to travel further and faster.

And with that in mind, we've got some important markets planned this year, Seattle, San Francisco, Denver and Charlotte to name just a few. Internationally we have another busy year planned continued growth in a more established markets the Middle East in the UK, and significant development in Asia.

We're optimistic about our future growth opportunities here as we continue to expand our footprint in Japan and South Korea. And now, this year also Hong Kong and Shanghai in 2019. The power of the Shake Shack brand increases with every market we enter, more confident our international expansion opportunity in both existing and new market remains significant for many years to come.

With all this global growth, we’ve continued to see some of the most dynamic and experience of Shacks we’ve every build, delivering more community gathering places and more reasons for guests to visit us again or for the first time.

Moving on to our second strategic pillar, continued to evolve and innovate our digital products and capabilities. 2017 was a year of learning and building a foundation for our digital channels. We launched our iOS app in January 2017 followed by the Android version in July. We're continually encouraged by the positive trends throughout our first year in both number of downloads and mobile sales as a percentage of overall sales.

In addition, we remain pleased with the level of repeat guests in the higher average check via the app in traditional in Shack tickets. The app will remain an increasingly important job for us, delivering a frictionless user experience and convenience for our guests as well as enabling more personalized and targeted marketing strategies in the future.

In 2018, we are expanding our digital initiatives across the company, investing in people, systems, and tools. And building on those digital capabilities, we laid the foundations for this year.

Moving ahead, you will see us continue to add functionality to our online experience with desktop and web ordering on the way. We are going to build data management and analytics capabilities to deliver enhanced customer insights, critical to our ongoing digital product roadmap and our other strategic growth initiatives and deliver increasingly personalized marketing, allowing us to connect with our existing and potential guest and to increasingly focus on rewarding our best customers, and incentivizing more frequent visits.

In addition to launching and learning though the app, we enter into a number of integrated pilots with key delivery service partners through 2017. And last four months of the year, we conducted pilots with Postmates, DoorDash and Caviar as we further explore guest demand for our food to be delivered. Right now, we are currently testing new delivery packaging at the Shacks and we will continue to gather and learn from our guests feedback around this and our other delivery initiatives.

So far in 2018, we have continued to explore this new channel for our industry with multi-partner integrated pilot in January. And for now, we're going to continue to test and learn. We’ve also make sure that if and when the time comes for us to entered into formal partnership and we do so having fully evaluated the criteria important to us and to the guest experience. Included within our criteria is of course an acceptable, sustainable economic model in order to build a strong and healthy business for the long-term.

Also in the fourth quarter, in 2017 we introduced self-serve kiosks for in-Shack ordering in a couple of our New York City locations. Our newest New York Shack at Astor Place and Manhattan opened in October with no cashiers. We built the Shack with eight kiosks with the user experience similar to the app resulting in a highly visual, engaging ordering process for our guests. We are in the early days for kiosks and we’re certainly in a period of testing and learning, but we do believe they represent a potential opportunity for enhanced guest experience as well as an important tool to mitigate increasing labor costs.

Longer-term, we are targeting opportunity to redeploy those cost savings to sales driving initiatives. In the meantime, we are planning a few more kiosks test Shacks in the first half of this year and we will update you on our planned and learning here as we go through the year.

All these digital initiatives are just the beginning for us, as we continue to transition to a company that captures our guests, human need to gather in our Shacks, while embracing the opportunity to transition towards a digitally connected hospitality that grows our business wherever and whenever our guests want to have their Shack.

Thirdly, it was committed ever to continue the innovation across our menu. In 2017, we brought delicious new items such as Hot Chick'n, summer barbecue menu, feature Shakes, and other items on and off the menu through LTOs and Chef Collaborations, we recently completed our limited time on our Texas style Chili, the multi category approach for hot dogs, fries and burgers.

In last month, we rolled out the Grilled Chicken Club in all-natural chicken breasts, topped with smoked Niman Ranch bacon, lettuce, tomato and buttermilk herb mayo. We are excited to see how this option potentially expand the chicken category alongside our already successful Fried Chicken Shack. Its well across all domestic company average Shacks today and we'd love to hear what you think once you've tried it.

We will continue to focus on menu initiatives that drive excitement, frequency of visits, and guest satisfaction. All those things operationally effective in our Shacks with our new test kitchen opening this summer at our new home office will have more ability to drive innovation across our menu for years to come.

And finally, strengthen our infrastructure, our core systems, and our teams with 2020 and beyond in our sites. We're at a stage in our growth where some of our existing, operational and financial systems in both the home office and our Shacks will benefit from upgrades to support our ongoing expansion plans. We're excited and committed to make this important step effectively and efficiently to scale towards that three-year 200 Shack goal and beyond.

Our people are and always will be our most important asset and that's why we're going to continue invest in hiring, training, and developing the best people to execute our growth plans and to provide them with future development opportunities. We're also pleased to be able to expand our employee benefits this year in 2018 in a number in a number of key areas as well as the full rollout of the Shake Shack [HUD fund], which provides financial assistance to employees who are impacted by unexpected hardship.

We are leaders, training future leaders and have so many examples of team members today who have developed into managers, general managers, even area directors. These amazing individuals lead our operations every day, the heart and soul of our Company.

And important value part of being a leader at Shake Shack is the opportunity to attend our biannual leadership retreat, a truly special, fantastic event, one that incredibly important for building on the strength and unity of the Shake Shack culture. In this year, we'll hold our retreat in May and have over 700 of our Shack leaders from around the world come together to celebrate with and learn from each other.

It also time for us to move to a new Shack home office not far from our current office here in New York, as well as the much need space for growing central theme. We are really excited to have finally a dedicated testing center for menu innovation, kitchen design, and leadership development. As a bonus, ground floor will be opening a Shack adding to our New York City base.

All in all 2018 is going to be a busy year. We are ambitious, we are committed, and we are going to execute the key strategic initiatives that are described. We know there is significant growth ahead, and we are building this Company for a long and bright future, we will make the necessary investments along the way to ensure we fully capture that opportunity. This is what you should expect from us as we run hard towards our three-year target of at least 200 Shacks and over $700 million in total revenues.

Finally, I just want to thank nearly 5,000 team members who work so hard to deliver such strong results in 2017. We're going to continue to hire and develop world-class leaders for what we believe is a world-class company with an exceptional opportunity ahead. This is going to be a fun year at Shake Shack.

And with that, I want to thank you all for joining the call. And operator, you may go ahead and open the line for questions.

[Operator]

Thank you. [Operator Instructions] And we will take our first question today from Jake Bartlett with SunTrust Robinson Humphrey.

[Kevin Robinson, SunTrust Robinson Humphrey]

Thanks for taking the question. This is Kevin Robinson on for Jake Bartlett. Our first question is do you expect for Project Concrete costs to continue in 2018? And the second question is why do you expect flat same-store sales is because of the weak start to the year or is it just being conservative?

[Tara Comonte]

Hey, Kevin. This is Tara. So at the moment there are $46 million that we mentioned in our outlook for 2018. We are hoping to spend in 2018. But as I mentioned, we're really early days of this process and it wouldn't be surprising if some of those costs kicks in when it comes to face implementation do end up slipping into 2019. But at the momentum, we’re at the stage in the process that we just don’t have that level of visibility right now.

[Randall Garutti, President and Chief Executive Officer]

As we go to doubling the size of the company in the next three years, we can expect continue investment from us, a largest chunk of that will be this year. We're keeping posted throughout the year, each quarter how that’s tracking and what it looks like for 2019. As it pertains for comp, we’re really happy with the return to positive comp that we saw in the fourth quarter really ended the year with a lot of strength, we are happy about that.

We’re not going to get into talking about first quarter on this call; we will come back to you in the next call with that. But we’re remaining cautious. It's been a volatile time for us. We've got our largest class of restaurants coming yet. And as the industry continues to evolve, we're going to remain cautious in our outlook. And for us that looks like a flat guidance at this time. And we're putting a lot of strategies in place to do our best to beat that, but that’s the expectation we want to share right now.

[Tara Comonte]

And as a reminder, we mentioned it in our prepared remarks, and really around half of our Shack that’s in that metrics. This is important to remember that and that still fairly heavily in New York and Northeast terminated.

[Kevin Robinson, SunTrust Robinson Humphrey]

Excellent. Thanks for answering my questions.

[Tara Comonte]

You’re welcome.

[Operator]

We’ll take our next question from John Glass with Morgan Stanley.

[John Glass, Morgan Stanley]

Thanks very much. Randy or Tara on your 2020 guidance if you will, what’s the assumed underlying AUV of domestic Shacks at that point, when you look in your model? If you did the simple math, that would be like $3.5 million and I'm including licensing revenues maybe below that. How do you think about AUVs over that longer time period?

[Randall Garutti, President and Chief Executive Officer]

Yes. John, you’re in the range, right, if you look at it, what we wanted to do on this call was breakout the difference of trying to get class AUV and more of what the full AUV looks like, right. Today that’s sits around mid-to-high 4s. That will come down to low 4s later. If we’re sitting here a year from now that's our expectation, and that will continue to come down slightly as we add those low 3s.

As you look at the 110 Shacks that we expect - we expect them to be in a long-term average we talked about for a long time in that low 3s average and that just about get to the 700 million mark. And again there's a lot between here and there that will get us there as a lot of factors, but generally those are the Shacks we're targeting. I will say as we look at each class, each one is different, right.

We obviously outperformed that in the past few years in 2017, significantly outperforming with some strong Shacks and some strong starts. And then this year coming up, we've got San Francisco, Seattle, Charlotte, Denver, we've got some good cities coming up, some great cities that we’re excited about. But as you know we think that that average starts to look into low 3s as the classes move forward towards that larger goal.

[John Glass, Morgan Stanley]

That's helpful. And Tara, can you just clarify on the G&A spend is Project Concrete. Is that just the term for the systems upgrade that you're doing in the other investment that you're putting into G&A that's already included in the $49 million to $51 million, is that how you think about it?

[Tara Comonte]

Correct. Yes, that that is exactly right John. Project Concrete is just a name we've given it internally so that we can sort of [indiscernible] and track it. And as I mentioned, we do expect a decent chunk of that to be one-time in nature and then the $49 million to $51 million, we guided on our core G&A includes investment across the board. As we mentioned our people and our just renovation, our new office in terms of growth.

[John Glass, Morgan Stanley]

And do you think you can leverage G&A in 2019 and beyond excluding those one-time costs. Is that run rate that you think will grow slower than revenue in out years?

[Randall Garutti, President and Chief Executive Officer]

Yes, I think we do intend. I think as you look at the long-term margin opportunities for Shake Shack, G&A without question is something we intend to lever. We just don't want to do it at the expense of growth opportunities, nothing there is a whole lot of companies in our space that intend to double who they are and see now in the next three years and it takes investment to do that.

We're not going to miss that opportunity. We are all about growth. We're all about driving sales and revenue and we're going to spend what it takes. So while we're very focused on long-term G&A leverage. We don't expect this year and we will keep you updated in 2019. We're not going to name what that might be in 2019, but it's important for us to make these investments are now.

[John Glass, Morgan Stanley]

Thank you.

[Operator]

[Operator Instructions] Next, we'll go to John Ivankoe with JPMorgan.

[John Ivankoe, JPMorgan]

Hi, thank you. Just a clarification, the $49 million to $51 million of core G&A, does that include or not include the $4 million to $6 million from Project Concrete?

[Tara Comonte]

It is not include John.

[John Ivankoe, JPMorgan]

Okay. All right. Thank you. That's what I thought. So if we look at…

[Tara Comonte]

Sorry, I was going to say which as I mentioned, we do expect significant piece of that $4 million to $6 million to be non-recurring.

[John Ivankoe, JPMorgan]

Yes. Loud and clear, I just what I thought and then I thought I heard something else and I just want to clarify it. I guess my benefit as much as anything. And then secondly, when we look at the number of units that that you've talked about in 2020 and the fact that 70% of your unit this year are going to be back-end weighted.

Do you think we're starting to hit kind of the least the near-term maximum in terms of the number of Shake Shacks that should be developed. I know this year has 32 to 35 a new maybe over the next couple of years, you're kind of implying something like 35 to 40. I mean is that kind of at the level where from an HR and site and just an overall control perspective that you're beginning to be comfortable with the number of units as opposed to being a kind of taking it up on an annual basis the way you have been?

[Randall Garutti, President and Chief Executive Officer]

Well, John I’ll say this. I don't think there's been a year where I haven't been supplied with our own capabilities and where we can go, right. If you look back very short time ago, we had 30 restaurants. We tripled that in three years since our IPO. And with each year and each success of achievement, we get more and more confident. Our ability to go a little bit further and little bit faster.

Again, we stated what we believe is an appropriate target, which put you around 35, mid-30 Shack for the next three years. I think what we want to do to get through this year, we want to level that off and see how we feel and make sure that real estate opportunities continue to be as great as we believe them to be for the next few years.

And we will say what we always said. If we get comfortable with that and we think there is opportunity to ramp that further, we will. But we want to make sure that we can execute on that. That said, we never put a lid or limit on any opportunity we have for the future, especially the size of the class.

[John Ivankoe, JPMorgan]

Understood. And that certainly one place for where you have consistently beaten in surprise throughout the years. And then just a couple of small clarifications, you actually did make some progress already in pre-opening on a per unit basis. I mean when we look out the next couple of years, what do you think the right pre-opening per unit is for units like Shake Shack? I mean how are you guys feeling the benchmark of that?

[Randall Garutti, President and Chief Executive Officer]

Yes. We have and we will continue to do. Each time we open, look we go to a new market, like a couple years ago LA, or this year San Diego as we look at some of them that we will spend a significant amount on this year. Where we do a new market, we spend a lot of money.

I'm fairly confident to say the sales that we capture out of the gate had a Shake Shack selling $5 hamburgers, rival anyone's ability to execute out of the gate. That cost money to do so, but with marketing with team and with intense training. So long-term, this is absolutely a target for us to lever and we intend to. We're in the mid, not counting deferred rent and non-cash item, okay, we're in the – you got to add that to the significant.

But when we count that, we're sort of in this 250,000 a little bit less and per Shack and it will start sometimes more, sometimes less, but over time we think that number each year will kick that down a little bit at a time.

And even this year we’re going to be testing some shorter opening duration. We usually have about seven to nine-day training period as we get in markets where we have five, six, 10 Shacks in a market. We can take that down a little bit. So it's absolutely a target for us and something I think you'll see us lever over the long-term.

[John Ivankoe, JPMorgan]

That's great. And Tara just one final question for you and it’s just a little bit of an education question from my perspective. You mentioned some changes in taxes that you would have to depreciate your leasehold improvement over 39.5 years, is that the case even if your lease isn't that long?

I mean I think you probably have basically zero leases that would go out that far and are we talking about the difference in this case of tax depreciation versus GAAP depreciation? I would assume that GAAP depreciation is still very much aligned in terms of what your lease life is?

[Tara Comonte]

Yes. You've got it exactly right. And we believe it to be today, John I mean we are still working through this as many people are. But yes, it's really our leasehold improvement and leasehold improvements that we are focused on here, which is obviously a significant part of our CapEx and which did qualify until this accelerated expensing rules previously and now just a way the law is written and revert to 39 year like. You’re absolutely right. We are talking about tax depreciation here, not GAAP.

[John Ivankoe, JPMorgan]

Okay. Thank you.

[Randall Garutti, President and Chief Executive Officer]

You are welcome.

[Operator]

We will take our next question from Joshua Long with Piper Jaffray.

[Joshua Long, Piper Jaffray & Co.]

Great. Thank you for taking the questions. I wanted to circle back to what you've learned or seen with the guest engagement on the Kiosks side? You mentioned that would be something you would be maybe leaning into here in 2018 with a couple more units. So just curious on the early reads of what you learned that works doesn't work or maybe how you're thinking about picking new sites for the use of the kiosks going forward to the extent that if you want to share that? Thank you.

[Randall Garutti, President and Chief Executive Officer]

Yes, Josh, we're encouraged by what we're seeing, I'll say that. We pushed everything pretty far with Astor Place, right? We had no cash at all, no cashiers, only kiosks. We really wanted to push that learning to see where it shook out. What we're going to try in this next phase and with all of that learning here and we'll probably do a handful of Shacks in the coming two quarters to test further.

What we’re going to do there is more of a hybrid approach. We want to try mostly kiosk with a little bit of cash here. We want to see how people react. What they choose to use? See the impact and cost of accepting, dealing with cash versus 100% credit card. So that is still early learning.

A couple things, the feedback has been really good. We're still learning what the check average might be, but what we love about it is over the long-term. It's a huge opportunity for us to connect with our guests for us to recognize our guests with hospitality over time to connected to our app. So we know when Josh shows up for the eighth time at a kiosk, at a Shack. This is a long-term strategic goal.

And lastly, and potentially most importantly there is a lot of importance, but the biggest one is we've got labor headwinds. We continue name that for everyone and we do believe that this will help us to redistribute our labor in the sales driving initiatives and save labor over the long-term and that’s what we’re still trying to learn. So it's going to open up a whole lot of fun opportunities for us, but lots of learning to be out.

[Joshua Long, Piper Jaffray & Co.]

Thank you for that, and having [indiscernible] that could certainly see the picture that you're building there, curious in just how you think about, this is really a tool more or so for those higher labor cost market like your Northeast core base. And then we think about kind of using the Shack app to bring some of that convince and technology to maybe some of the more suburban or lower cost labor markets, is that for the time being that’s how we should think about it and seeing most of those kiosk’s still kind of in that core Northeast market?

[Randall Garutti, President and Chief Executive Officer]

Not entirely, I think our belief is that it’s a core part of the very many pieces of our digital and innovation strategy, and this is just one of them. Some Shacks may make more sense for, but it’s not just about labor, it's really about guest experience, and the opportunity for all the other connection or digital infrastructure. So we will see, and again, early we have 1.5 Shacks rolling out with it. So we're going to keep going.

[Joshua Long, Piper Jaffray & Co.]

Great. Thank you.

[Operator]

And we’ll take our next question from Andrew Charles with Cowen.

[Andrew Charles, Cowen & Co. LLC]

Great. Thanks. Quick housekeeping. How much of the $4 million to $6 million in the Project Concrete cost you guys plan on adjusting the one-time nature?

[Tara Comonte]

Hi, Andrew. Obviously, it’s too early to say. I know piece of it that is one-time, we will obviously be adjusting for non-recurring. But right now, like I said – with super early days, we are talking to whole bunch of different potential solution providers. And as you know, there are many different models with system these days and there is many different ways to join implement, but either way within that number, a decent chunk will be one-time and anything is classified as one-time, will be identifying and carving out adjusted EBITDA as non-recurring and you can also see that clearly in our reconciliation.

[Andrew Charles, Cowen & Co. LLC]

So just to be clear, the truly one-time items will be adjusted out, but things that might be more recurring will be included in the reported G&A?

[Tara Comonte]

Correct.

[Andrew Charles, Cowen & Co. LLC]

Okay. Moving on just obviously you spoke very favorably and encouraged by the delivery pilots, you guys are progressing obviously with new packaging to obviously accommodate these. So it's truly starting to ramp. I just want to learn a little bit more about what you'd like to see? Or you really take the pilots and really start to run with them a little bit more? Is it that penetration? Is it signing the right partner? How are you guys thinking about it and what you are looking for before you would more maturely rollout delivery?

[Randall Garutti, President and Chief Executive Officer]

Well, this has been a process of understanding a number of things starting with our guest need and desire. So what did we learned? Turns out people really want our food delivered. So that's great. Our number one focus is a great guest experience. That has a million pieces to it, most of which is about time, right, some of which is about packaging, some is about heat retention.

A lot of it then is about our partner choices and that differs in strength regionally, it differs in strength by partner, and we've got to have great tech integration within that to make sure that seamless experience for the guests for the career and for whoever we choose to partner with. So bottom line for us is we are a coveted delivery partner for delivery companies.

We drive traffic, we help engagement, and we like it. So we want to make sure all the things that happen for us that can ultimately drive sales are there for the long-term before we go forward with any official partnership. In the meantime, when you keep testing, keep tweaking a little bit and make sure we can meet the demand that’s out there in a really good way.

[Andrew Charles, Cowen & Co. LLC]

Got it. And my last question is, you talked about the similar deleverage in 2018 labor margin line. How much of that would you say is due to the Fair Workweek Act?

[Randall Garutti, President and Chief Executive Officer]

We haven't broken it out. It’s really hard to say. Fair Workweek rate is significant, but it is early. We’ve only been dealing with it for less than three months. So the biggest pieces of that number are about minimum wage increases, which are happening in the majority of markets by which we operate, and it's about the various levels of Shacks. As we've always said when we bring in the $3 million Shack AUV that carries a higher labor percentage of sales and that equals pressure on the percentage line. And that's a dynamic of Shake Shack we talk about for years that we expect to continue.

[Andrew Charles, Cowen & Co. LLC]

Appreciate. That’s help. Thank you.

[Operator]

And we'll take our next question from Jeffrey Bernstein with Barclays.

[Jeffrey Bernstein, Barclays Capital, Inc.]

Great. Thank you very much, a couple questions, one just following up on the labor. I think you said in 2018 would to be similar to 2017, so down or deleverage 120 basis points or so. Just wondering what you are modeling in terms of the expected inflation in total as a percent? And then just wondering qualitatively how much you think of that is due to regulation that you're forced to comply with versus your own discretion in terms of just keeping ahead of the competition?

[Randall Garutti, President and Chief Executive Officer]

Yes, I think we're looking at about mid single-digit inflation. If you look at it that way across the Shacks, nearly all of which is minimum wage increases so mandated increases. We are looking where our company is, New York, New York area, Boston, Connecticut, Mid-Atlantic, California, Chicago, pretty much named the vast majority of our Company all of those places have increases in minimum wage, this year, next year, and will be opening in Seattle, San Francisco and other high minimum wage states.

We love that. We think we do the best sales in places like that. That's where we're going to keep going. It’s not a non-issue for us. It just is an impact, so all of that combined. We additionally continue to pay more to our managers, right. To our ship managers, make a hourly wage in minimum of course, into our managers. All of that impacts labor line, which is part of why we're guiding the way we're guiding.

And again, this is where we're going to invest in our team. We excited to invest. Make sure we have great people and great Shacks we're building sales and got an amazing numbers that we continue to build. Even with that, we're delivering really strong our profits across the company.

[Jeffrey Bernstein, Barclays Capital, Inc.]

Got it. And as you think about the tax rate benefit, Tara, I’m just wondering how you think about flowing through the significantly lower tax EPS in 2018. How you balance that I guess would be reinvesting in labor. I know you talk about how people are the most important asset. I’m just wondering how you balance those two things or how we should expect you to spend some of that tax savings whether some of it does go back into the labor line?

[Tara Comonte]

Yes, I mean as I said, we obviously do have the benefit from the right change. But we've also got a couple of fairly major moving parts of this and accelerated expensing that I talked about where we have an asset that qualified for generally a 15-year life and I will revert to 39-year life.

So when we look at our cash flow, both of EPS and we look at our cash flow we’re in expecting a modest positive impact from cash reform over the next couple of years. It’s a tailwind nonetheless and it’s certainly allows us to continue to invest with confidence in the business.

And for those investments, strategically our investment that we'll been making development. So as you rightly point in our people, in our retreat, in our training, in our various – in our systems upgrade and particularly in the marketing and technology as it relate to that digital innovation agenda that Randy laid out.

[Jeffrey Bernstein, Barclays Capital, Inc.]

Got it. And just lastly Tara, the confidence around achieving that restaurant margin, especially you’re talking about labor being down 120, I think at the mid point you’re talking about restaurant margins down maybe 150 or so considering the flattish type comp and I guess the lack of commodity deflationary longer and the modest pricing, how comfortable are you with that restaurant margin range?

[Tara Comonte]

Yes, I mean as of today this is our estimate for the year. So we’re quite familiar with confident. We feel good about our plan. We feel good about our step up in development schedule and we’ve explained to the volatility around that comp number in particular. And so no, we’re focusing ahead, but as things changes a level of confidence in increases or decreases or those numbers – we believe will change. We’ll update you as the year goes on. But we’re still good about these numbers today.

[Jeffrey Bernstein, Barclays Capital, Inc.]

Great, thank you.

[Operator]

And we’ll take our next question from Andy Barish with Jefferies.

[Andrew Barish, Jefferies & Co. Inc.]

Hi, guys. Just a couple things on any more color just on why the pipeline is pushing a little more second half than you’ve seen historically?

[Randall Garutti, President and Chief Executive Officer]

Well, I'd love to tell you that. It was true historically. I mean if you look at this year, we opened five restaurants in the two weeks right before the holidays in December and 11 in the quarter. So 11 of our 26 in the quarter. I'm not sure why the retail restaurant industry – industry [whatever] when we seen that give birth more often in the second half of the year, but that is how we do it. We wish we could smooth it out a little bit better, sometimes it is what it is.

It's almost entirely based on the timing of landlords’ development and our ability to get in and execute. We have a great construction development team, who's ready to pounce as soon as we can get in. We got a great design team that's designing our restaurants, ready to go.

So this year it just happened to be a little bit more of an extreme and much more heavily weighted toward that back half of the year. And that impacts our sales. That impacts the expectations we have for total sales for the year. But here's the good news, by the end of that time next year, even though it’s back weighted we’ll have all those restaurants running into 2019.

[Andrew Barish, Jefferies & Co. Inc.]

Gotcha. And then just finally a little more color on the same-store sales both for the 4Q, anything holiday related in terms of a call out that shift there, or – and then looking forward just on the negative traffic for the year, can you give us a sense of what the primary issues are there? Is it cannibalization? Are you willing to sort of quantify that that aspect of what's going on or maybe a little more color just on the negative traffic?

[Randall Garutti, President and Chief Executive Officer]

Sure. As Q4 – as it relates to that question, I think the holidays didn't really change much this year in terms of its impact on us. So really Tara mentioned in her remarks about a little bit of warmer weather in October helped out a bit, but that balanced out through the quarter really was the delivery that in relation to anything else that gave us a little bit of pop.

But when we look at our expectations for this year in negative traffic, it's just been cautious and making sure we're balanced. That obviously happening in our industry. We had last year a little bit of negative traffic, so we want to make sure we can achieve the results we want to and we think getting us flat overall. We look at that comp number is good.

But again, it's all based on a small and still Northeast related. If you look at the supplemental materials we gave today, 41% of our sales were in the Northeast New York region in the comp base. And that's not a well distributed base, and that will continue through this year.

The main focus we have is market share. We talked about this in previous calls. We want to capture as much sales in a market as possible. Sometimes that means some of our Shacks in that market might take a little hit, but the numbers that we do that's a great decision and a great trade, every single time we're going to keep on doing it.

[Andrew Barish, Jefferies & Co. Inc.]

Thank you.

[Operator]

And we'll take a follow-up from John Ivankoe with JPMorgan.

[John Ivankoe, JPMorgan]

Hi. Thanks for that. The questions on delivery, Tara, I think it was you in your prepared remarks, talked about delivery actually being additive to comps for the quarter. I was wondering if you could, if not necessarily quantify it for the system, could you quantify it in the stores that you're particularly focused on for delivery in the fourth quarter.

And I do know that there were some weekly promotions, which run that presumably drove a lot of delivery sales, if there is a way to kind of talk about how much the stores would have benefited from delivery both on the normal weeks and the promotional weeks, just seeing how much of a sales lift your control group actually got from the efforts?

[Tara Comonte]

Yes. I mean, I don't think we of course remember, is it delivery is happening to us and has for a period of time already. So what we're really talking about when we do these pilots, the integrated pilot where we are partnering with these delivery service providers to have the orders pass through into our POS.

And so on that basis, the remarks that I gave were more – that was more sort of general color. We definitely felt that they went really well in the fourth quarter and we felt that there was really some positive sales impact from that. We haven't quantified it and quite frankly, it’s virtually impossible to quantify because you can't see the starting point because of delivery guy turns up in and joins the Shake Shack line like everyone else does today outside of these pilots.

[Randall Garutti, President and Chief Executive Officer]

And John, when you look at it, we are not going to break it out Shack by Shack, obviously, but this is the very reason we're doing the pilots, right because there's been some really good and interesting learning and surprises from Shacks that we may not have expected that it would be stronger delivery or weaker in delivery. And that's probably why we've extended our earnings here to make sure as we grow this is as an important channel for our business, we know and can learn from who's going to do what and with what impact moving forward.

[John Ivankoe, JPMorgan]

Thank you.

End of Q&A

[Operator]

And that will conclude today's question-and-answer session. I'd now like to turn the conference back over to Randy Garutti for any additional or closing remarks.

[Randall Garutti, President and Chief Executive Officer]

I just want to say thanks again to our team and to everyone. We ended the year with really strong momentum. We're excited for 2018 and beyond. We look forward to be in touch. Thanks for taking the time with us on this call today. Take care.

[Tara Comonte]

Thank you.

[Operator]

And that does conclude today's conference. Thank you for your participation and you may now disconnect.