Shake Shack' (SHAK) CEO Randy Garutti on Q4 2016 Results - Earnings Call Transcript

| About: Shake Shack (SHAK)

Call Start: 17:00

Call End: 17:55

Shake Shack, Inc. (NYSE:SHAK)

Q4 2016 Earnings Conference Call

March 01, 2017, 17:00 ET

Executives

Randy Garutti - CEO

Jeff Uttz - CFO

Analysts

Jake Bartlett - SunTrust Robinson Humphrey

Matt Curtis - William Blair & Company

Courtney Yakavonis - Morgan Stanley

Alton Stump - Longbow Research

Nick Setyan - Wedbush Securities

Gregg Ormond - Goldman Sachs

Operator

Welcome to the Shake Shack Fourth Quarter 2016 Earnings Call. [Operator Instructions]. Please note that this conference is being recorded today, March 1, 2017. On the call we have Randy Garutti, Chief Executive Officer of Shake Shack and Jeff Uttz, Chief Financial Officer. And now I would like to turn the conference over to Mr. Jeff Uttz. Please go ahead.

Jeff Uttz

Thank you, Operator and good evening, everyone. By now you should all have access to our fourth quarter 2016 earnings release and if not, it can be found at shakeshack.com in the Investor Relations section.

Before we begin our formal remarks, I need to remind everyone that our discussions today will include forward-looking statements. These forward-looking statements are not guarantees of future performance and therefore, you should not put 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 various securities filings, including our annual report on Form 10-K for FY '15 and subsequent quarterly reports on Form 10-Q. 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 also 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 the earnings release. Now I'd like to turn the call over to Randy.

Randy Garutti

Thank you, Jeff and good evening to everyone on the call today. I'm really proud of what our team has achieved in our second full year as a public company. I'm especially pleased, given the challenging industry backdrop in retail and restaurants recently. And we've achieved all this while furthering our commitment to growing in premier locations and building even better team member and guest experience that fosters the long term strength of the Shake Shack brand for years ahead. We're still in the early stages of the Shake Shack story, but today we serve guests in 124 Shacks, 17 states in the United States, 13 countries worldwide and we're just getting started.

In 2016, we grew total revenue by 41% to over to $268 million. We built a record of 20 company-operated Shacks, increasing our annual domestic company-operated unit openings pace by 54% and beating our recent guidance of 19 Shacks. Our Same-Shack sales increased 4.2% for the year, reaching a two-year stacked comp of 17.5%. And our Shack level op profit grew over $20 million, representing a 39% year-over-year increase. For 2016, our Shack level op profit reached 28.3% and we grew adjusted EBITDA by 36%, reaching a record $50 million.

Looking at the fourth quarter, we grew total revenue over last year by 43%, driven mostly by 20 new domestic company-operated Shacks and Same-Shack sales growth of 1.6%. While trends were strong throughout October and November, Same-Shack sales performance softened in December; and this was driven by various factors, primarily the holiday shift contributing approximately 80 Bips of pressure, as well as comparatively colder weather in the Northeast region which makes up a high percentage of sales in our still very limited comp base of just 30 Shacks.

Looking ahead into Q1, we'll be comping against another tough compare at 9.9% Same-Shack sales for the first quarter in 2016. And if you recall, this was also the quarter last year where we launched the Chicken Shack and experienced one of the warmest winters on record in the Northeast. Now as the year goes on, the quarterly comp comparisons soften a bit; and for the full-year 2017, our annual Same-Shack sales guidance remains unchanged, at 2% to 3%.

During the fourth quarter, we made the strategic decisions to better position ourselves for growth in 2017. As we announced in early January, labor expense for the quarter and the full year came in above our stated guidance range. To provide some context around this, we have 13 of our 20 Shacks open in the second half the year, with six opening in the fourth quarter. New Shacks generally carry higher labor costs in their first 6 to 12 months. That impact on our still small total Shack count contributed to a higher-than-expected overall labor cost.

In addition to this concentration of openings, we also invested additional labor in our training team to launch our app which I'll discuss later, as well as raising managers' salaries and hourly wages in Shacks across the Company. And part of our high labor was also attributed to higher-than-expected medical claims, as more team members took advantage of the benefits we offer.

Most important to this high labor, we're choosing to play offense. This year, we'll ramp up development to an expected 22 to 23 domestic company-operated Shacks, representing a company-operated unit growth rate of approximately 35%. And we're staffing up to be sure we have the strongest team in place to meet these increased needs. Our higher labor in the fourth quarter, as well as our guidance of higher labor in 2017, represents our investment in sustained quality growth and maintaining the best team. Within all that important investment, we're proud that the team delivered another quarter of strong Shack level op profit margin of 25.4%, ending the full year at 28.3%.

Our business model remains strong as we head towards our biggest year of growth yet. With 22 to 23 company-operated Shacks and 11 net new licensed Shacks planned for 2017, our new app that's launched now at all domestic company-operated Shacks, as well as focused, exciting new menu innovation, we're executing on our growth strategy and leveraging the strength of the Shake Shack brand better than ever.

Now let's get to the Shack App. As we look into the future of Shake Shack, we know our business will continue to evolve as our guests' expectations change. I'm fairly certain that my own young children will experience retail and restaurants in a very different way than I did. When we look at the digital landscape, our future is focused on removing those constraints and friction points that previous generations have accepted as a way of life, knowing that future generations just won't accept it.

For Shake Shack, that evolution begins now with our Shack App. Today, it's focused on mobile pre-ordering. And before I get into the details, I do have to acknowledge the incredible work of our VP of IT, Phil Crawford and our VP of Marketing, Edwin Bragg, whose creativity and incredible teams helped bring this custom app to life. Now it's too early to report on major trends, with the limited amount of time the Shack App has been available, but I do want to give you some early insights into what we've seen and what it might mean for us.

The app launched nationwide throughout the fourth quarter of 2016. We were deliberately quiet about it in January and we focused on working out the technology, some of the kinks and prepared operations for a larger launch. In mid-January, we turned on the gas and for the first time in Shack history, we chose to reward guests with a free Shack burger anytime they downloaded the app. Through February, the Shack App has been downloaded over 200,000 times and we've given away nearly 90,000 free Shack burgers which has translated into approximately 6% of our total orders nationwide. We do expect that percentage to decline now that the free burger promotion has ended and as we've set on to a more normal user rhythm. And if you exclude the free burger promotion, our average mobile app transaction during this time period has been approximately 15% higher than a normal Shack transaction. Additionally, since the launch, over 25% of app users have already come back for repeat visits.

In these early days of the app, we have also learned that when we launch the app at a brand-new Shack, we see some the highest rates of adoption across the system, increasing our confidence for what mobile will mean in the future. However, this new stream of orders does not come without challenges. The influx of app orders can, at times, have a slowdown impact at our highest volume Shacks at peak. This is not a surprise to us, especially during this free burger promo in Q1 and we've experienced many days where we've given out over 5,000 free burgers.

Our work now is continuing to evolve our operations, our kitchens and our app flow for the for the long term which we're confident we'll do as we learn more. In short, the Shack App is off to an incredible start. It is just one part of our long term strategy to meet our guests whenever and wherever they are. Stay tuned for more in future quarters, as we listen, learn and report back on the Shack App.

Turning to menu innovation which remains a key pillar of our sales driving strategy this year and beyond, the Bacon Cheddar Shack which ran through Q4 and ended in January, was one of our highest performing LTOs to date. Right now, we're really excited about our current state of Barbecue menu items which launched in the middle of February, leading with the Barbecue ShackMeister Burger, Barbecue Chicken Shack and Barbecue Fries. For the very first time, we're using the canvas of burgers and chicken together and we're really excited about the early guest response. Just another way we're providing our guests with new special offerings that drive engagement.

Also during the fourth quarter, we strategically replaced our weekly customer calendar and began our program of a new seasonal trio of shakes. For Q1 2017, we're really excited for you to come taste our Mud Pie, Mint Cookies and Cream and Salted Vanilla Coffee shakes. This strategy provides the opportunity for a premium item to stay on the menu for a longer period of time. It eases execution for our operations and gives our guests more to look forward to for a sustained period of time.

Additionally, I always enjoy reminding you of our fine casual roots here at Shake Shack and reporting on the differentiating and unique chef collaborations we work up. This past quarter, we've done some fun collabs with Michael Schwartz at Michael's Genuine in Miami, as well as teaming up with Mast Brothers Chocolate in London. But probably our most fun excursion was just recently in Toronto, where we created a little excitement and gave our fans in Canada a taste of Shack. We teamed up with David Chang and Momofuku in Toronto for a one-day pop up, nearly 1,000 fans lining up. Now we have no plans, at this time, to go to Canada, but it's yet another testament to our opportunity there and abroad, as the Shack brand continues to strengthen globally.

Looking back now at our largest development year ever in 2016, during the fourth quarter we opened six new domestic company-operated Shacks. This brings our 2016 total to 20 new domestic company-operated Shacks, surpassing our guidance of 19 and representing unit growth of 45% year-over-year. We could not be more proud of the hard work of our team, the success of recent openings and our real estate opportunities for 2017 and beyond.

We continued our expansion into the LA area, with our third California Shack in the heart of Hollywood. We also deepened our roots in Atlanta, with our second Georgia location. And following a strong opening in Dallas earlier in the year, we would launched the brand in Houston in the Galleria. Both Dallas and Houston are set for further growth in 2017, in addition to a launch in San Antonio, as we further build our fan base in Texas.

Also during the quarter, we opened our second Maryland Shack, in the heart of the MGM National Harbor, the East Coast's largest new casino. And this further expands our successful partnership with MGM following our first Vegas Shack.

In December, we opened a Shack in Penn Station, New York, one of the business transit hubs in the country, where we created a smaller footprint with less seats, more grab-and-go options, as well as breakfast. There are so many learnings to be gathered from this Shack that will help us as we continue to evolve our multi format growth strategy, including airports, train stations and transit centers. Following your next Knicks and Rangers game or the next time you're on the Long Island Railroad, Amtrak or New Jersey Transit, now you can preorder on the app, name your pickup time, grab your Shack and make your train home.

Now due to favorable real estate conditions, we were also able to surpass our guidance with our 20th Shack of the year, opening our very first Shack in Delaware, in the town of Christiana, ahead of schedule and this Shack showcases an important beautiful new freestanding model for us.

Kicking off 2017 and subsequent to the quarter, we extended our footprint in California, opening our fourth Shack in the LA market in Century City. Our West Coast Shacks continue to perform well, paving the way for serious growth through 2017 and beyond. We're more bullish than ever about the white space opportunities ahead for Shake Shack in this market, with Shacks planned in the LA area, as well as our first Shack in the San Diego market in La Jolla at UTC towards the end of the year.

We also continue to grow in the New York Metro area, opening our third Connecticut Shack in Darien in January. We're also thrilled that just last week, we entered the resurging new market of downtown Detroit, in the heart of Woodward Avenue at the base of the city's central gathering place, Campus Marshes Park. We're so proud to be a part of the future and revitalization of downtown Detroit.

Looking ahead to the rest of 2017, we will execute our company-operated development schedule with a strong line-up of Shacks within our existing markets, as well as new markets, St. Louis, Danny Meyer's hometown, San Antonio, Lexington and San Diego. We also recently announced we'll be climbing higher with our first-ever Denver, Colorado Shack in the RiNo Art District in late 2017. With our domestic pipeline stronger and larger than ever, this will be our biggest year of growth yet.

Meanwhile, we continue to execute our strategy of licensed revenue growth through key partnerships here and abroad. In the fourth quarter, we continued our growth in the Middle East, with Shacks opening in Kuwait and Qatar. And subsequent to the quarter, we opened five Shacks throughout the Middle East market. Now as we've discussed on previous calls, while we continue to moderately grow in the Middle East, we still continue to experience softness in sales in this market which is our largest licensed market, due to continued volatility in the region for a number of macro factors. As such, we expect Middle East sales and our royalty revenues to continue to feel pressure through 2017.

In the UK market, we opened a flagship Shack in December in Leicester Square, Central London, as well as new Shacks that opened subsequent to the quarter in Canary Wharf and Victoria Nova, bringing our UK total now to seven Shacks.

Moving on to Asia, our greatest opportunity moving forward, our Shacks in Japan continue to perform. We now have three Shacks in Tokyo, with plans to continue growth in this important market. In Korea, we opened our second Shack in Seoul in Cheongdam, following our successful launch in the Gangnam District last summer. We're looking forward to more growth in Korea in 2017 and beyond. Our brand is off to a really strong start in Asia, reinforcing the widespread global appeal for Shake Shack abroad.

Looking at our domestic license business, during the quarter we opened at the Wells Fargo Arena in Philadelphia and we continue to expand our brand in sporting arenas and we're also excited to work with HMS Host, as we continue to grow in airport locations around the country. For 2017, our guidance for licensed Shack growth of net 11 will include 2 domestic openings, a just announced airport Shack in LAX Terminal 3, as well as our newest baseball stadium addition at Minute Maid Park, ready for our Houston Astros opening day. And with that update, I'll turn it back over to Jeff, who will take you through the numbers.

Jeff Uttz

Thanks, Randy. I'm excited to share with all of you the results of our fourth quarter and our fiscal year December 28, 2016.

Total revenue which includes Shack sales and licensing revenue, increased 43.5% to $73.3 million during the fourth quarter, from $51.1 million in fourth quarter last year. Shack sales increased 43.8% to $70.9 million during the quarter, versus $49.3 million in the prior-year quarter. The increase was driven by the addition of 20 new domestic company-operated Shacks.

For FY '16, total revenue increased 40.9% to $268.5 million, compared to $190.6 million in the prior year. If you recall, in November we raised our total revenue guidance for the year to $264 million to $265 million and are pleased to have exceeded that range and in addition, surpassed our 2016 development guidance of 19 domestic company-operated Shack openings. This was based on the additional strength of new openings and also favorable real estate conditions.

Same-Shack sales increased 1.6% during the fourth quarter, versus an 11% increase in the same quarter last year. This consisted of a 1.4% decrease in traffic which was more than offset by a 3% increase in price and mix. Remember, our comparable Shack base is still very small, with only 30 Shacks in the fourth quarter, of which approximately 33% are high volume Shacks in the Northeast. As a result, our Same-Shack sales growth is sensitive to changes from a small number of Shacks. With each successive quarter, as we successfully grow around the country, this impact will smooth out. As Randy noted, we're pleased with comps in October and November, but we did experience some softness in December, due to the calendar shift and comparatively unfavorable weather in the Northeast.

Average weekly sales for domestic company-operated Shacks increased 1.1% to $90,000 for the fourth quarter of 2016, up from $89,000 in the same quarter last year, primarily driven by menu price increases. Licensing revenue increased to $2.4 million during the fourth quarter, compared to $1.7 million in the prior-year quarter.

Since the fourth quarter of last year, we opened 10 net new licensed Shacks. Internationally, the current business environment is mixed, despite the significant long term opportunity for growth. While we continue to enjoy great success in Japan and South Korea, we did experience sales pressures in the Middle East and Turkey, due to the macro economic and political challenges in the areas causing declining traffic throughout the region. Additionally, currency headwinds persisted in the UK in the fourth quarter. We expect these trends to continue through 2017, adding pressure to our overall international royalty stream.

Now I'll give you some detail on the expenses for the quarter. Food and paper costs. As a percentage of Shack sales, food and paper costs were 28.5% in the fourth quarter, down 80 basis points from the prior-year fourth quarter. This improvement was primarily driven by the menu price increase that we took at the end of last year, as well as lower commodity costs, primarily in beef and dairy, compared to last year.

Our beef costs have decreased both sequentially quarter-over quarter and on a year-over-year basis. Beef was down approximately 8% over the prior-year fourth quarter. Our outlook for next year is that beef and dairy will continue to be down slightly on a year-over-year basis for the first half, but up on a sequential basis, with prices remaining flat in the back half of the year. As we've mentioned before, we generally experience higher distribution costs when we enter new markets. And with our planned expansion into a number of new markets next year, food costs for those new markets will offset some of these efficiencies.

Labor and related expenses. As a percentage of Shack sales, labor and related expenses were 26.6%, an increase of 160 basis points compared to the prior year. And as we noted, we experienced higher than expected labor in the fourth quarter, due to a combination of factors. As Randy mentioned earlier, new Shacks typically run higher on labor during the first 6 to 12 months and the concentration of openings during the quarter negatively impacted our labor. There were six this year, compared to three last year; and 13 out of the year's total 20 openings were in the back half.

We also increased staffing in preparation of our ramped up growth. We've added additional layers of staffing, new managers, shift managers and team members, to be ready for a year of increased growth. We also incurred additional labor from training in anticipation of the national launch of our app. And lastly, although the impact was small in the fourth quarter, we implemented manager pay raises in December. this is in addition to the companywide increase to the starting hourly wage that we implemented at the beginning of the year.

Looking forward, for 2017 we fully expect that labor pressures will continue. Minimum wages are up in the majority of our current and future markets and we continue to invest in our leaders at all levels to prepare for the growth ahead. Labor will be a headwind for this year and will trend higher year-over-year.

Other operating expenses as a percentage of Shack sales increased 90 basis points to 10.5% versus the prior year, primarily driven by higher repair and maintenance expenses and utilities costs, as well as the introduction of more target volume Shacks into the system which generally carry higher operating expenses as a percentage of total sales. Occupancy and related expenses as a percentage of Shack sales increased 90 basis points to 8.9% versus the prior year, similarly due to the introduction of more target volume Shacks into the system.

Shack level operating profit which is a non-GAAP measure, grew 29.9% to $18 million, from $13.9 million last year in the fourth quarter, mostly due to the flow-through captured on the higher Shack sales. As a percentage of Shack sales, Shack level operating margins decreased approximately 280 basis points to 25.4%, primarily due to the labor pressures, other operating expenses and occupancy that we mentioned previously. These things were offset by the benefit we achieved in food costs.

For FY '16, Shack level operating profit grew 38.6% to $73.3 million, from $52.9 million last year and as a percentage of Shack sales, Shack level operating margins decreased approximately 60 basis points to 28.3%, primarily due to the aforementioned items.

As we stated previously on our last quarter call, given the visibility into the pipeline for 2017 and the balance of growth in both new and existing markets, we believe that the Shacks that we open in 2017 are likely to produce average sales volumes and Shack level operating margins at the high end of our long term ranges. Therefore, as stated on our last call, we expect the 2017 openings to average at least $3.2 million in annual revenue and achieve at least 21% Shack level operating profit margins.

General and administrative expenses increased $600,000 to $8.3 million during the fourth quarter from $7.7 million in the same quarter of 2015. As a percentage of total revenue, G&A expenses decreased to 11.3% for the quarter of 2016 from 15% from the fourth quarter last year which included $770,000 in costs related to a legal settlement. If you exclude this cost, G&A as a percentage of total revenue decreased 220 basis points.

Adjusted EBITDA which is a non-GAAP measure, increased 31.6% to $11.4 million in the fourth quarter, compared to $8.7 million in the prior-year period. And as a percentage of total revenues, our adjusted EBITDA margin decreased roughly 140 basis points to 15.6% for the fourth quarter. On a full-year basis, adjusted EBITDA increased 35.7%, from $37 million to $50.2 million. And as a percentage of total revenue, adjusted EBITDA decreased 70 basis points to 18.7%, compared to 19.4% in the prior year.

We reported net income of $3.9 million or $0.15 per diluted share for the fourth quarter of 2016, compared to $1.2 million or $0.07 per diluted share for the same period last year. Included in our tax expense for the quarter was a $1.5 million benefit from the revaluation of our deferred tax assets based on rate changes and our changing state mix. Also included in our fourth quarter results is $688,000 of other income related to an adjustment to our tax receivable agreement liability.

On an adjusted pro forma basis which excludes these two items and also assumes that all of our outstanding LLC interests have been exchanged for Class A common stock whereby we would no longer present a non-controlling interest, we earned $3.3 million or $0.09 per fully exchanged and diluted share, compared to a net income of $2.9 million or $0.08 per fully exchanged and diluted share in the fourth quarter last year.

On a full-year basis, net income was $12.4 million or $0.53 per diluted share, compared to a net loss of $8.8 million or $0.65 per diluted share, in 2015. On an adjusted pro forma basis, net income increased 39.2% to $16.8 million or $0.46 per fully exchanged and diluted share, compared to $12 million or $0.32 per fully exchanged and diluted share.

Additionally, as we enter into more new build spaces rather than existing spaces, more of our leases will be classified as build-to-suit under accounting rules. As we move into 2017, we expect to be entering into more of these new build spaces, especially as we seek those premier A sites and as such, due to the accounting rules, this will result in higher depreciation expense, higher interest expense and slightly lower rent expense than you've seen from us in the past.

So now let's move on to guidance for FY '17. We're raising our previous total revenue guidance and now expect total revenue for FY '17 to be between $349 million and $353 million, an increase of approximately 30%. We're increasing our total expected openings from previous guidance to be between 22 and 23 domestic company-operated Shacks in 2017, representing a company operated unit growth rate of approximately 35% and we'll be opening a net 11 new licensed Shacks. We expect the average sales volumes for these 2017 company-operated units to be at least $3.2 million, with Shack level operating profit margins of at least 21%.

Long term, our guidance remains at $3 million in revenue and 21%. Also, we expect 2017 Same-Shack sales growth of 2% to 3% which consists of nominal traffic and mix increases, as well as roughly 1.5% to 2% menu price increase which we took in early January and was implemented under a new tiered pricing model.

As Randy mentioned, we will be comping against some tough compares in Q1, as we lap some of the traffic building events in 2016, such as the launch of Chicken. However, our annual Same-Shack sales guidance remains unchanged, at 2% to 3% for the full year FY '17.

Now let's move to expenses. We expect Shack level operating profit to be between 26.5% and 27.5%, primarily driven by the labor pressures that we talked about earlier. For 2017, we now expect G&A expenses to be between $38 million and $40 million. As previously mentioned in regards to our real estate strategy of moving into more new build spaces and the associated accounting impact of doing so, we expect an increase in depreciation which is now expected to be approximately $22 million.

We also want to provide you with guidance on a new item, due to the impact of the build-to-suit accounting rules. We expect total interest expense for FY '17 to be between $1.6 million and $2 million, based on our current pipeline of leases that will be accounted for as build-to-suit. As our development schedule shifts, this number will change and we'll update you throughout the year.

And lastly, our adjusted pro forma effective tax rate is expected to be between 40% and 41%. And there may be some volatility in this tax rate due to the new accounting standard that changes how we will account for taxes associated with stock-based compensation. I hope this has given you greater insight into our performance and what lies ahead for us at Shake Shack. With that, I'll turn it over to Randy.

Randy Garutti

Thanks, Jeff. I'd like to take a moment to address two announcements we made in early January. I'm thrilled to announce Zach Koff has been named Shake Shack's first ever Chief Operating Officer. Zach's been leading operations at Shake Shack over the last six years, since the fourth Shack opened in Miami Beach, Florida. He's built the team and system that run our restaurants today and has been at the foundation of Shake Shack's unique and powerful people culture. I'm excited for Zach to further his impact around the greater strategy and execution of our rapid growth ahead.

We also announced that Jeff Uttz will retire as CFO. He will remain in his current role through mid-March to continue overseeing the Company's FY '16 reporting period. And for those of you have known us over the last few years, you've seen we've had a great partnership, a ton of fun and Jeff will be missed. On behalf of myself, our Board of Directors, all of our team members, I wish to thank Jeff for his many contributions during his time here. Jeff set a very high standard, leading Shake Shack through its IPO and beyond and we've been lucky to have him. We have no doubt now that we will find a premier CFO to help lead us through what will be an unparalleled period of growth for our Company. In the meantime, Jeff's built a great leadership team in Josh Helman and Vicky She, who will lead our financial teams as we complete our CFO search.

And with that, I want to thank all of you for taking the time to follow our story by joining today's call. Now, Operator, you can go ahead and open the line for questions.

Question-and-Answer Session

Operator

[Operator Instructions]. We will take our first question from Jake Bartlett with SunTrust Robinson Humphrey. Please go ahead.

Jake Bartlett

Great. Thanks for taking the question. First, on the build-to-suit, can you maybe go into more details of how that affects things like free cash flow? Is this a situation where you're not going to be putting up as much money to open the new stores?

Jeff Uttz

Jake, it's Jeff. I'm sorry, I'm choking. It doesn't really, it doesn't change the accounting rules. It doesn't change our strategy.

Randy Garutti

I'll start while Jeff clears his throat. No, he's good. Don't worry, everybody. He's fine. The way it works, it's not really about free cash flow in the investment, it's really about how the expense is recorded. So where with normal lease, you have the expense recorded fully to occupancy cost, now because of build-to-suit, it's treated differently. And much more of the expense is picked up in our depreciation and interest expense. That's why you've seen us increase depreciation and give you, for the first time, our interest expense number which is much higher than in the past. So unfortunately, it's not a one-for-one trade. It's some fun accounting, so it doesn't necessarily decrease our occupancy costs. But it's not a change to cash, Jake.

Jeff Uttz

Jake, I'm sorry. I've been fighting this cough for like a month. So I apologize. But it also doesn't change, our real estate strategy of what we choose to go into will not be driven by accounting rules. So if something is classified as a build-to-suit, because of where we choose, so be it.

Randy Garutti

And this is important, because this is so new for Shake Shack. Why is it so new for us? Because we were born in New York and the majority of what we've done over this last few years has been second-generation restaurants turned into Shake Shacks. So that's generally not a build-to-suit lease accounting. So as we go into more of the rest of the country, more pad sites, more things that end up classified build-to-suit, it's a new, a big, new change for Shake Shack. And again, not cash and not performance, not strategy related, it's just accounting and that's why you'll see it tick up in those depreciation and interest numbers this year.

Jeff Uttz

And as the year goes on and units move in and out of the development schedule, that estimate could change, too. The numbers that we gave in the guidance is based on where the development schedule is right now and how they will be classified.

Jake Bartlett

Got it. And then, I understand still the difficult compare in the first quarter could weigh on this first quarter result. Would also the fact that you did the switch over to the new promotions, Barbecued LTOs, mid quarter versus prior when you had done it earlier in the quarter, do you think that's also going to have a weigh on the first quarter results?

Randy Garutti

We're not going to get into mid quarter guidance at this point, Jake, but look, we're excited about the menu innovation. It goes on top of other great menu innovation that we did last year, as well as the app. But again, we feel like a balanced 2% to 3% for the year is the right answer here. And last year, this was an exciting time. It was incredibly warm in the Northeast for all of Q1. And in the middle of January of last year, we launched the Chicken Shack which we know drove quite a bit of traffic. So it's definitely a tough compare. You also have the Easter switch coming up in March. That's another thing that may or may not impact us. And it did impact us in Q4, with the holiday shift and it may impact us as well in Q1 here. Because Easter was in Q1 last year. It will not be in Q1 this year. And generally, vacations and those sort of things lead favorably to Shake Shack. So that's why we're giving you the comments we did.

Jake Bartlett

Okay. And then on that point, have you been able to quantify the impact of the holiday shifts or the weather that you mentioned in December?

Randy Garutti

Yes, we quantified -- hard to quantify weather exactly, but we quantified for the holiday shift by about 80 Bips. So it was significant. You basically lost two Saturdays and Sundays relative to last year. You saw everybody else talking about the same thing. That was an impact on that comp number in Q4.

Jake Bartlett

Okay. And that 80 Bips for the whole quarter.

Randy Garutti

That's right.

Jake Bartlett

Okay. And then lastly, the app, maybe just go into whether you think that, what your experience has been so far and whether you think this is going to be a material traffic driver in 2017 or if it's something that will build over time as it becomes adopted or what are your expectations to how this is going to change the trajectory of sales?

Randy Garutti

Well, we're really excited about it. I think there's no question the expectation will be for the Shack of the future where, if you choose to order that way and you want to do it, you should be able to do it and pick up your food without those friction points. Not everybody is going to take us up on that, as you've seen and at any other company who's leading with a great experience. Our whole world here is based on the community gathering experience of Shake Shack. The app is just one tool to make that better for our guests.

It is way too early to comment on what it might mean. What we did see in that first six weeks of the promo was it took nearly 6% of our total transactions. That's a huge number to come out of nowhere with. Now again, as I mentioned, that should decline. When we stop giving away free burgers for downloads, we expect that to decline over time. It is our expectation that then it will come back up. And I think it's going to continue every day to be more and more a piece of our life here at Shake Shack that we're going to continue to work a lot on. And as I said, our incredible team who built the app custom has just been doing fabulous work. So it's pretty exciting.

Operator

We will take our next question from Sharon Zackfia with William Blair. Please go ahead.

Matt Curtis

This is Matt Curtis on for Sharon. Now that you have the new pricing tiers in place, are you guys comfortable with where you are right now on labor costs or are you evaluating another price increase for later this year?

Randy Garutti

No, we do not intend another price increase. But as we said, labor was quite up in Q4 and we've guided that quite clearly for you that labor is going to be up and we had a lot of minimum wage increases here in 2017. We're going to have them again in 2018 and 2019. And we do business and the majority of our businesses will be in the highest minimum wage areas. We'll also continue to pay our managers better. And as I said, we're playing offense. We're building the best team we can to continue to ramp up growth. You look at 40% sales growth that we posted for last year, we're doing that with the great human beings who lead our restaurants. And we're going to pay them. And that will be part of what's baked into our op profit of 26.5%, 27.5% for the full year here this year. Labor pressure continues, for sure.

Matt Curtis

Okay. And maybe a related question. What's the customer reaction been like to the new price tiers? Has there been any noticeable impact on traffic in the markets where you raised prices?

Randy Garutti

Well, we're not going to comment on traffic yet mid quarter, but we really haven't heard a whole lot. And we do this really judiciously. We mostly raised prices on some of our burgers, didn't really touch fries, didn't really touch most of our frozen custard shakes. So it was really not a huge increase. It's under 2%. In some markets, we didn't increase at all. In others, the average, as we've said, is in that 1.5% to 2% price range. So that's not a huge number and a huge impact, so we don't expect there to be a guest perception necessarily at this stage, at least we haven't heard it.

Matt Curtis

Okay. Fair enough. And maybe one last one for me. On the increased G&A guidance for 2017, the fourth quarter G&A looked like it came in a little bit light, so did something shift into 2017 or is something else driving the guidance increase?

Randy Garutti

Not necessarily. That's mostly based on some of the technology we expect, the money we expect to spend to drive the app. We'll be spending a lot of money on that. And then just general bulking up our teams for the increased growth. As we add more Shacks, we add more operators, we add more area directors that hit our G&A. We're building our team. And we've got a lot to do here to continue to ramp our systems and our team to meet that high growth percentage we're hitting.

Operator

We will take our next question from Alton Stump with Longbow Research. Please go ahead.

Alton Stump

As I talk about store growth which I always do at the heart of the Shake Shack story and if I recall, when you guys IPO'ed, you had talked at that time about doing 10 units. A company here actually stayed in the U.S. actually just doubled that number. Is there any reason to believe the current guidance which you just raised again for 2017 at 22 to 23, but is there any potential upside to that number, given the fact that you guys have been beating almost every quarter over the last 10 to 12 months anyway?

Randy Garutti

Not yet, Alton. We always -- you've seen a pattern of us making sure, as we believe those sites can get leases signed and they're great sites, we'll certainly update you on that. Look, 22 to 23 is by far the largest year we've ever had. We feel really good about the class of 2017 that's coming in. We've talked about that. But it's still too early to say that. There's a lot of things that can happen here in just the beginning of March. And look, we're very disciplined. As you know, you're right, you said it. The long term story for Shake Shack is the growth of the Shack unit that has great unit economics and continue, that will continue to drive our future. We want our development team out there finding the best sites, not just trying to hit a number. And that's how we manage it. We manage it through quality real estate with the best developers in the best sites around the country where we can do the best sales. That's what we've done. That's what we're going to continue to do. So if we're going to increase that, we will certainly let you know when we feel comfortable with that.

Alton Stump

Thanks, Randy. And then just on the new store AUV which continues to impress, it's at over $4 million, I think, at the quarter, if I recall, over the last 12 months, is there anything that, as I look ahead to next year and beyond, as to why it will come down to $3.2 million or -- I know your guidance is for at least $3.2 million -- but is it a matter of, is it the higher percentage of stores in your existing markets this year versus what you did in 2016 or is there anything else I should be thinking about as I model out new store productivity going forward?

Randy Garutti

Yes, it's a great question. The reason it was high in 2016 and again, our AUV is nearly $5 million right now, as we've said since day one, that will come down. Why was it so good in 2016? We outperformed in a few high volumes Shacks. You look at our West Hollywood, you look at Penn Station starting off, you look at Herald Square, Fulton Center.

We opened three big Shacks in New York City and then we started to hit California pretty hard. So those were high volumes that drove that AUV a lot higher. But if you look at the class of 2017, we will have that same number. That's why we're telling you $3.2 million. That's a number we feel really comfortable with for the year. So you should model $3.2 million, on average, run rate for those Shacks for this year, because there's really not any of those, not as many, certainly, as the heavy hitting high volume Shacks as we had in 2016.

Operator

We will take our next question from Courtney Yakavonis with Morgan Stanley. Please go ahead.

Courtney Yakavonis

Hello, guys. I just had one quick follow-up on the build -to-suit and I think you said that it wasn't exactly one for one coming out of occupancy and into interest. But does that mean effectively that the restaurant margin would have decreased had that change not gone into effect in your guidance?

Jeff Uttz

Courtney, we give the depreciation, we give the interest which are two of the big lines effects. And then the occupancy effect is built into the Shack level operating profit guidance that we gave. So we're not going to give specific guidance on the occupancy line. But when you look at our Shack operating profit guidance, it is built into that. And that number remained the same as we gave in November.

Randy Garutti

And that's mostly due to labor being up and as we said, rent being down. But again, it's kind of like a mortgage, like the way this build-to-suit accounting works, it's not, you don't win as much on the occupancy line as you lose on the depreciation interest lines, initially. So that's what it looks like over time and it's just a greater impact to us, because we're still a small base of Shacks. And when you have a number of those headed towards our future development, it's just going to have a greater impact on those below the line.

This is yet another reason why we encourage you to continue to look at adjusted EBITDA as a measure as we report it. Because it's one of the best ways that we look at how we're growing the company in the true, successful way. GAAP accounting sometimes can confuse an issue like this, especially as it pertains to build-to-suit.

Courtney Yakavonis

Got you. And then I know you addressed how you won't have as many high volume hitting openings next year, but I think you started opening some pad formats. Just curious how many we should be expecting in the units that you will be building for next year and if there's any difference in sales or the cost to build that we should be thinking as we model it in?

Randy Garutti

Well, a couple things. There's about a handful. They're not necessarily, you shouldn't think of pads necessarily as higher or lower volume or higher or lower build out costs. It really depends on the site. On average, we expect to spend about $2 million per Shack this year. That's been our trend. Even with inflation and construction costs, we've been continuing to find better ways to save some money to hold that line. So we'll be around $2 million for the class of 2017 of build out. Some of those are pads.

So I'd call it a handful of pads. And it will absolutely depend on the site. So we did one at the end of the year in Christiana, Delaware. We did one in Darien, Connecticut in January. We'll do another pad in Melville, Long Island coming up here and then we may have some later in the year. So because of our multi format strategy, we don't want to do all pads. We don't want to do all malls. We don't want to do all of anything. We've got a really diverse strategy that continues to spread out the kind of Shacks that we do.

Courtney Yakavonis

Got you. And then just finally, what percentage of your footprint is in malls right now? And did you see any impact from holiday traffic on your sales?

Randy Garutti

Well, there's very few in traditional malls. It's less than 10% of our footprint. We're in a lot of great lifestyle centers that you may not classify as a traditional mall. Those malls that we're in are really the premier A malls in the country, with Century City, Garden State Plaza New Jersey, King of Prussia. So when you look at traditional malls, we obviously know traffic continues to be down in all retail and restaurants generally in malls. But that's a small part of our business. We do want to keep growing in malls, in the best ones, at the best times, with the best developers. But it is not our strategy to become a mall brand, certainly. But we like that it's a piece of what we do.

Operator

We will take our next question from John Ivankoe with JPMorgan. Please go ahead.

Unidentified Analyst

This is Michael on for John. I just had a question, you made a comment about Shack of the future and presumably that's about store design evolving over time. And with the Shack App launch, how does store design change for Shack going forward?

Randy Garutti

It's a great question, Michael. It's really about making sure that the guest, the community gathering guest experience at Shake Shack only gets better. How that happens, the only thing we're excited to talk to you about is the app right now. And that's a shift. You need a little bit of a different kitchen flow, you need some space for those people to come pick up and you start to see a very small, but I expect to grow over time, transition from people waiting on line to people waiting to pick up.

So as we think about that, we're right now in the conversations of the next Shack models and how they're going to feel. I don't think you're going to see a material difference, a notable difference necessarily for you as a guest walking in. But for us and how we prepare food, how we move through the kitchen, that's our goal. And we've got a lot to learn. It's way too early to even tell you what exactly those plans are, but we know that we've got to continue to find space at peak times. We've got to continue to allow for more app orders to come in as people transition to that form of ordering. So we're excited about it and there's a lot of work to do. It's real early. All right.

Operator

We will take our next question from Nick Setyan with Wedbush Securities. Please go ahead.

Nick Setyan

As more and more stores come into the comp this year and you've got maybe a bigger data set, has your thinking evolved at all around year two and year three growth rates of those stores? Are you still seeing those stores enter the comp base years three up?

Randy Garutti

So generally we continue to see evidence of and we continue to model and encourage you to model whatever Shack does in year one, we generally see the sophomore year of Shack down 5%. And then, as long term expectations of up 2% to 3% has not changed. There's all kinds of different variables that get involved with that. You're going to open in West Hollywood last year, it's going to be a huge opening, that Shack will likely be down a lot more than 5%.

It was just a huge opening. But those second, third, fourth Shacks in the LA area, they may be up. They may be down less than 5%. But what it works out to generally over this last few years for us is a negative 5% the sophomore year and as it comes out in year three, a plus 2% to 3%. And that's where we've always said the long term Shack growth story is a low single-digit comp with exciting sales in unit growth. That's the story.

Nick Setyan

You touched on [indiscernible] the other operating and occupancy deleverage, is there anything that was one-time in nature in terms of deleverage there that may not repeat going forward?

Jeff Uttz

No, it was really just driven by more of those target volume Shacks coming in and driving those -- we have the same costs at each Shack, for the most part and some of the fixed costs and as a percentage of sales, unfortunately comes in a little bit higher when you have lower volume. And I say lower volume, it's target volume and so $3 million to $3.2 million, as we talked about. But there are more and more of those coming into the system which will affect that line over time. And also, that's why our guidance is where it is on Shack level operating profit for the full year of 2017, as well, the 26%% to 27.5% builds in those target volume checks coming in and affecting a lot of those fixed costs.

Nick Setyan

And lastly, in terms of the cadence of the openings in 2017, is it going to be as backend loaded or more even as the year progresses?

Randy Garutti

We've got three open so far. We should have a pretty strong in in the first and second quarter. But more of the 23 will likely open towards the back half, so I think, I would say slightly back weighted.

Operator

We will take our next question from Jake Bartlett with SunTrust. Please go ahead.

Jake Bartlett

I had a quick question. I was in Toronto in January and it was actually the same day that you doing pop-up with, mispronounce it, Momofuku. So that just made me wonder, one, what you're doing up there, doing pop-ups? Are you looking at Canada as more of a growth market? And then also, the 450 target we have, that's really just U.S., correct? And anything in Canada is additive that?

Randy Garutti

Yes, so the 450 is just domestic company-operated in the U.S.. Anything in Canada would be addition. We have zero plans to do it. I'm glad you were there that day. And I don't know if you walked by and saw it, it was crazy and amazing. And it literally happened -- David Chang is a friend and one of the most talented chefs in the world and we were just saying, wouldn't it be fun to create some madness up at your restaurant in Canada, you guys have a lot of fun up there, we've never sold a Shack burger in Canada, let's get up there and do it and see what Canada thinks. And we learned real quick what Canada thinks. We had a great day, teamed up with his amazing team and our team and we just had a blast.

And Jake, that's part of our fine dining heritage. We just like doing cool stuff like that. We spend a lot of effort, time and money just fostering the power of the unique Shake Shack brand. We're not just selling burgers in this company. We have a brand that is extremely powerful for reasons like that. And that's the kind of fun stuff we're going to continue to do whenever we have the chance. And hey, maybe someday we'll go to Canada, but today, zero plans.

Jake Bartlett

Operator

We will take our next question from Karen Holthouse with Goldman Sachs. Please go ahead.

Gregg Ormond

This actually Gregg Ormond for Karen today. So related to the mobile app, I was just wondering which line item the food cost related to the promotions are going to hit and if you have an estimate for how much the impact is going to be and whether that's baked into the restaurant margin guidance?

Jeff Uttz

The cost of the free burgers will be in cost of goods sold. And we haven't given any guidance as to what the impact of that will be, perhaps 20, 30 Bips to cost of goods sold. But yes, the revenue associated with the free burgers is comped out on the revenue line, so that's a net of zero, but then the cost of the free burger ends up in cost of goods sold.

Gregg Ormond

Okay. And then, again related to the mobile app, I was wondering if you had any feedback from the store managers related to the app rollout, whether they're noticing any operational impacts and whether they're able to share any best practices?

Randy Garutti

Yes, I think there's a lot of feedback, believe me. The good news is it's working real well. I think the greatest challenge for them is when you're at peak time and you've got a line out the door and you've got a line in the cloud coming in through apps, it's busy. It's real busy. I've been in many Shacks during those peak times watching it myself and with Zach, our COO, spending most of his time with his operators, just saying, okay, this is great news, a lot of people want to use Shake Shack in a lot of various ways, now how are we going to take care of all of them?

So I think the teams are really excited about it. They understand and know what a great new transition for our business this will be. But it's not without its challenges and it's going to take time. It's going to take time to figure that out. That's a step we're working on to make it a great experience for our team, too. The good news is, a lot of people seem to want to order on the app.

Gregg Ormond

Okay. And then one final question around labor. I was just wondering how much exactly was wage inflation in the fourth quarter and then more broadly for 2016?

Jeff Uttz

Wage inflation for the fourth quarter, we hadn't really quoted the number in the past, but mid to high single digits for us.

Operator

It appears there are no further questions at this time. Mr. Randy Garutti, I'd like to turn the conference back over to you for any additional or closing remarks.

Randy Garutti

I just want to thank everyone for being on the call again. And again, want to end by thanking Jeff Uttz for nearly four years of incredible service to Shake Shack and wish him the best in the next phase of his life. So thanks to all and we'll look forward to seeing you out there. Take care.

Operator

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

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