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Edited Transcript of SHAK earnings conference call or presentation 2-May-19 9:00pm GMT

Q1 2019 Shake Shack Inc Earnings Call

May 8, 2019 (Thomson StreetEvents) -- Edited Transcript of Shake Shack Inc earnings conference call or presentation Thursday, May 2, 2019 at 9:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Leo Rhodes

Shake Shack Inc. - VP of Finance & IR

* Randall J. Garutti

Shake Shack Inc. - CEO & Director

* Tara M. Comonte

Shake Shack Inc. - CFO

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Conference Call Participants

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* Alton Kemp Stump

Longbow Research LLC - Senior Research Analyst

* Andrew Marc Barish

Jefferies LLC, Research Division - MD and Senior Equity Research Analyst

* Andrew Michael Charles

Cowen and Company, LLC, Research Division - Director

* Christopher Thomas O'Cull

Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Senior Analyst

* Jake Rowland Bartlett

SunTrust Robinson Humphrey, Inc., Research Division - Analyst

* Jeffrey Andrew Bernstein

Barclays Bank PLC, Research Division - Director & Senior Equity Research Analyst

* John Stephenson Glass

Morgan Stanley, Research Division - MD

* John William Ivankoe

JP Morgan Chase & Co, Research Division - Senior Restaurant Analyst

* Nicole Miller Regan

Piper Jaffray Companies, Research Division - MD & Senior Research Analyst

* Sharon Zackfia

William Blair & Company L.L.C., Research Division - Partner & Group Head of Consumer

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Presentation

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Operator [1]

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Good evening, and welcome to Shake Shack First Quarter 2019 Earnings Call. Today's conference is being recorded. (Operator Instructions)

It is now my pleasure to turn the floor over to Leo Rhodes, Vice President of Finance and Investor Relations. You may begin.

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Leo Rhodes, Shake Shack Inc. - VP of Finance & IR [2]

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Thank you, operator, and good evening, everyone. Joining me for Shake Shack's conference call is our CEO, Randy Garutti; and our CFO, Tara Comonte.

During today's call, we will discuss non-GAAP financial measures which we believe can be useful in evaluating our performance. A presentation of this additional information should not be considered in isolation or as a substitute for results prepared in accordance with GAAP. Reconciliations to comparable GAAP measures are available on our earnings release and in the Appendix to our supplemental materials.

Some of today's statements may be forward-looking and actual results may differ materially due to a number of risks and uncertainties, including those discussed in the Risk Factors section of our annual report on Form 10-K filed February 25, 2019. Any forward-looking statements represent our views only as of today, and we assume no obligation to update any forward-looking statements if our views change.

By now, you should have access to our first quarter 2019 earnings release, which can be found at investor.shakeshack.com in the News section. Additionally, we have posted first quarter 2019 supplemental earnings materials, which can be found in the Events and Presentation section on our site or as an exhibit to our 8-K for the quarter.

I will now turn the call over to Randy.

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Randall J. Garutti, Shake Shack Inc. - CEO & Director [3]

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Thanks, Leo, and good evening, everyone. We are really pleased with our first quarter results and the momentum our team carried forward from a strong 2018 into the beginning of this year.

We grew total revenue by 34% to $132.6 million; earned adjusted EBITDA of $17.8 million, an increase of 10% over the same quarter last year; and delivered positive same-Shack sales of 3.6%. I'm also pleased to report our strongest traffic in 11 quarters, as we've returned to positive traffic growth of 1.6%.

Our performance was positively impacted by strength from new openings, a favorable holiday shift and warm weather conditions across a number of key markets early in the quarter, and the continued growth of our digital channels where we see significant ongoing opportunity.

During the quarter, we opened 5 domestic company-operated Shacks and 7 licensed Shacks. These strong results are a testament to the hard work of our entire team and the execution of our strategic plan with continued focus across the organization on those key initiatives that will support this business for 2019 and into the future.

So here's where we're focused: committing to excellence in our people; delivering a consistently great guest experience; cultivating a loyal and connected community; and innovating our business for long-term growth. Our most important strategic pillar will always be our commitment to excellence in our people. The macro environment has rarely been as challenging to find and retain great talent. And it's critical for us to continue investing in our teams and ensure Shake Shack remains a great place to work and grow. Our people are our greatest asset, the champions of our culture and the most important ingredient in our guest experience and the heart and soul of our Shacks. We are committed to ongoing innovation and investment in our teams, albeit against very real cost pressures across our industry.

I'm thrilled to highlight some of the initiatives we've been working on. We recently launched All-In, our company-wide diversity and inclusion initiative that seeks to create an environment that provides equal opportunities for success by removing obstacles for progression and fostering a culture of growth and empowerment across all employees at Shake Shack. We're always proud to see our leaders grow and we're particularly proud that almost 60% of promotions in 2018 were earned by women throughout the Shacks. We are piloting women's mentorship program to support health and leadership development. We plan to launch this more formally across our entire team in the future.

In addition, we are honored to have been awarded a score of 100% in the Human Rights Campaign 2019 Corporate Equality Index and designated the Best Place to Work for LGBTQ equality. We are so proud of this recognition of our commitment to be an inclusive workplace where all are welcome and treated equally.

And lastly, we're also looking at how to continue to enhance the benefits across our teams including increasing equity grants with more leaders; an expansion of our 401(k) eligibility earlier in the year; testing various works environments including flex working at our home office; and a 4-day work week that we are testing in several Shacks across the country. We care deeply about our people and we will continue to make impactful investments in their development and welfare today and going forward.

Our second strategic commitment is to deliver a consistently great guest experience in each and every Shack. We are working to eliminate those frustrating aspects of yesterday's legacy restaurant model for our guests, both inside and outside of the Shacks. We've completed, or in the midst, of a number of Shack remodels with a particular focus on front house flow and the pickup experience. We also plan to test more pickup shelves over the next few months, where we have a higher proportion of digital sales, and new Shacks are being designed with the omnichannel experience top of mind. We made big strides in the continued enhancement of our digital channels, and with committed investments across our [tech RV], we're feeling really good about the growth opportunity in this part of the business. We are pleased with the positive impact digital had on the first quarter, with all channels delivering growth as a percentage of sales and the continued trend of a higher average check than in Shack. You'll see us continue to test and iterate here, particularly as it relates to making the various channels that now exist operate in a more holistic manner in terms of both the guest experience and the tech infrastructure that supports it.

We're bullish about everything digital means for Shake Shack. Although as we've mentioned before, the introduction of additional channels into already busy Shacks can at times create operational complexity, which we are still working hard to address. In addition, you'll hear this from Tara, many of these channels come with new cost to our business, and you're seeing some of those in our financials in the quarter. Right now, we are focused on execution and guest experience. And as this part of our business gradually grows, we'll be working to ensure efficiency and cost optimization for the longer term.

2019 is a year of innovation, testing, listening and learning from our guests to ensure we're continually improving the end-to-end Shack experience, regardless of the channel in which they choose to engage with us.

On the development front, this year's class of Shacks is going to be another great one. During the first quarter, we opened 5 new domestic company-operated Shacks, executing our strategy of further penetrating existing markets. This time in the Northeast to the West Coast, are also expanding the Shack brand and connect with new guests in markets like Providence, Rhode Island. We've got a solid lineup of Shacks for the rest of the year as we gear up to enter Salt Lake City, New Orleans and Columbus, as well as the recent successful opening of our second Shack in the Bay Area in Marin County.

In our rapidly growing license business, 2019 will be our biggest push into new markets to-date with the Philippines and Mexico coming soon and our first mainland China Shack in Shanghai having opened in January. We opened 4 international Shacks in the first quarter, including our second Shack in Osaka, Japan; our launch in Gotemba, new market outside of Tokyo. We continue to grow deeper in South Korea. And of course, as I just mentioned, our first Shack in Shanghai.

Subsequent to the quarter, we just opened for the first time in Singapore, in the incredible new Jewel Changi development, bridging the city and airport with lines of exciting guests to greet us. This is without a doubt one of the most spectacular Shack locations we've ever opened, nestled next to a stunning botanical garden and the world's largest indoor waterfall.

To further support our growth in Asia, we'll also be opening our first international office in Hong Kong later this year. We'll have permanent resources on the ground there for the first time.

We've also opened 3 domestic airport Shacks at DFW, Phoenix and Cleveland, as we continue our airport expansion strategy here in the U.S. Last month, we're also excited to bring Shake Shack to more baseball fans on opening day for the Philadelphia Phillies with our new Shack in Citizens Bank. Our stadium business continues to be a great brand builder, and we're always thrilled to have Shack be a memorable part of our guest game day experience.

We remain on track to open between 36 and 40 new company-operated Shacks, between 16 and 18 net new license Shacks in 2018, our largest class yet. As a reminder, our domestic company-operated opening schedule remains back-weighted with roughly 60% of our planned openings scheduled for the second half of the year and approximately 80% of those openings in existing markets. There's still so much whitespace for us in this country and abroad to continue to grow Shake Shack one market at a time.

Our third strategic commitment is to cultivate a loyal and connected community. As we near our 15th birthday later this summer, our community is strengthening around the world. The Shake Shack brand continues to resonate with our guests and we're focused on building on an already strong foundation in a broad variety of creative ways. So far this year, we've popped up at South by Southwest, served thousands of hungry music lovers at Coachella. And in April, we even teamed up with HBO for an epic collaboration around the final season of Game of Thrones.

Just a few weeks ago, fans lined up at our Westville at Shack to have a shot at sitting on the actual throne. And as part of this partnership, we launched unique limited time menu items around the country, the Dracarys Burger and the Dragonglass Shake. We've always had a strong community focus, actively partnering with local businesses, engaging with local charities and taking part in key events around our Shacks. Shake Shack is your community gathering place.

The expansion of our business in new digital channels presents a real opportunity for us to expand that concept of community and to engage with our guests and fans in a much broader and more personalized basis. This might be through more relevant and targeted communications, by rewarding our most loyal guests with offers for reasons to engage with many buzz-worthy moments we activate around, or by fun brand partnerships. Our growing digital footprint is a significant one and we are just getting started.

Finally, we're always looking towards a much bigger future and we're committed to innovating our business for long-term growth. We're investing meaningfully across all areas of business as we look towards the many years of significant expansion ahead of us. One of the most meaningful investments this year is in our back office systems and infrastructure upgrade, Project Concrete. And Tara will provide a more detailed update, but I would like to take a moment just to underscore how important this is for our company as a whole. It's a significant undertaking. It is touching every team member in every Shack. I'd like to acknowledge and say thank you for the hard work, long hours and the many teams working on this project right now, which is a sizable list, and critical to our future growth plan.

With our culinary team, our new Innovation Kitchen [humming], we're experimenting and testing both potential LTOs as well as longer-term menu items with a focus on improving our Shack classics as well as the opportunity to drive guest excitement and engagement. Our first quarter special shakes, which are now part of the monthly program, included tiramisu, salt and vanilla toffee and a seasonal cherry blossom. And we've got some fun ones planned for the rest of the year.

The biggest news out of the Innovation Kitchen so far has been the launch of Chick'n Bites as a nationwide LTO in the quarter. It's still really early but we've been pleased with the guest response thus far with guests ordering Bites as both an entrée as well as an add-on, and the launch of this item did come with a cost impact and Tara will touch on this in a moment as it presents a significant near-term impact to the COGS line in Q1 and Q2. We're pleased with the guest adoption and feedback to date. We'll keep you posted as this LTO continues.

2019 is off to a strong start as we remain focused on the execution of our key strategic commitments that will continue to drive growth.

And with that, I'll turn it over to Tara who will walk you through the numbers.

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Tara M. Comonte, Shake Shack Inc. - CFO [4]

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Thanks, Randy, and good evening to everyone on the call today. As you've heard, we had a strong start to the year and we're very pleased with our sales performance across the business, albeit we encountered a number of short-term headwinds, Shack-level profitability in the quarter.

Total revenue increased approximately 34% in the first quarter to $132.6 million as we delivered positive same-Shack sales growth of 3.6% and added 34 new domestic company-operated Shacks since the same period last year. In addition, our licensed business continued to deliver strong results with revenue growth of 34% in the first quarter and an increase of 16 net licensed Shacks since the same period last year. Given our performance in the first quarter, we're raising our 2019 guidance of total revenue to between $576 million and $582 million, and within this, maintaining our licensing revenue guidance of $15 million to $16 million.

With respect to our development schedule, we remain on track with prior guidance to open between 36 and 40 new company-operated Shacks and 16 to 18 net new licensed Shacks in 2019. Our same-Shack sales growth of 3.6% consisted of a 2% increase in price and mix, a traffic increase of 1.6% and was on top of 1.7% same-Shack sales growth in the same quarter last year. This was driven primarily by performance early in the quarter during which we experienced warmer weather in the Northeast and New York City, combined with a favorable holiday shift, in addition to the continued growth of momentum across our digital channels, particularly delivery.

Taking into account these first quarter results, at this time, we're increasing our same-Shack sales guidance for the year from 0% to 1% to 1% to 2%. Our average unit volume remains strong at 4.3 million on a trailing 12-month basis with first quarter average weekly sales of $79,000. These metrics will continue to gradually reduce as we expand and broaden the sales volumes in the system, opening new Shacks across the country and going deeper in existing markets, all while delivering significant top and bottom line growth.

We're maintaining our expectation for company-operated AUV to be between $4 million and $4.1 million for the full year. As Randy touched on, some of the strong revenue growth came with short-term increases in costs, and these are reflected in our Shack-level operating profit, a non-GAAP measure which increased 12.5% to $27 million in the first quarter, with Shack-level operating margin of 21%. There were a number of specific items impacting these numbers, some temporary and some a result of the changing dynamics within our business. And I'll take you through them now.

Food and paper costs in the first quarter increased 140 basis points to 29.5%. We're committed to menu innovation and see significant opportunities in continued category expansion. As part of this innovation and with a focus on the chicken category following our successful launch of the ChickenShack 3 years ago, we launched Chick'n Bites as an LTO in the quarter. This is a menu item much asked for by our guests and with broad potential guest acquisition and frequency opportunities. We made the decision to test this item with reduced promotional pricing focusing primarily on guest uptake and feedback. We've been pleased with the reaction and, as a result, saw the opportunity to increase pricing at the end of March. Chicken is a high cost item in our basket, particularly the high-quality, fresh, hormone and antibiotic-free supply that we insist upon. In the first quarter, the combination of adding a high-class item to our basket and the corresponding promotional pricing caused an increase in our food costs and was the most significant contributor to our overall COGS deleverage.

As we continue to test Chick'n Bites, we'll see this pressure lessen with the new pricing naturally rolled out combined with supply chain improvements we're making during this current quarter, which will result in cost efficiencies going forward while maintaining all our stringent quality requirements. On that basis, we'd expect Chick'n Bites to contribute less of a material impact to food costs during the second half of the year.

In addition to specific impact of the testing around this LTO, we also experienced some commodity inflation in the quarter primarily within beef, as well as an increase in packaging costs associated with our digital channel growth. While commodity costs can and will continue to fluctuate, the trends of higher packaging costs with higher levels of delivery revenue is something we expect to continue.

Labor and related expenses increased 110 basis points to 28.9% as a result of 2 primary factors, namely: continued significant inflation in the labor market across the country, especially in our home market of New York City, where we continued to see double-digit increases in hourly and salaries team member compensation combined with the administrative burden of legislation such as the Fair Workweek and the impact of higher labor costs in the majority of our new Shacks that opened at the end of 2018 and through the first quarter that are still normalizing operations and optimizing executional process.

The impact of this has been more acute than in the past, primarily as a result of back-to-back opening schedule in the last few weeks of the year, causing a longer-than-typical period of normalization of those Shacks' starting levels. Over the long term, as we continue with an aggressive development schedule, new Shack label will at times have a material impact on profitability.

Our opening schedule for this year remains back half-weighted and any expected impact from that is incorporated in our Shack-level operating profit going for the year.

Other operating expenses increased 90 basis points to 12.1%, driven predominantly by delivery commissions as a result of our digital growth, together with an increased overall marketing spend targeted primarily at LTOs.

Occupancy and related expenses increased 50 basis points to 8.5%, driven by the adoption of the new lease accounting standard that went into effect at the beginning of this fiscal year. This impact on our occupancy line will continue throughout the year and, additionally, in this current second quarter, will lap a noncash deferred rent adjustment that had a favorable 70 basis point impact in the second quarter 2018 and a favorable 20 basis point impact on the full year 2018 results that will not recur in 2019.

There are a lot of moving parts within our Shack-level operating profit margins, both from the first quarter results and our full year outlook. However, taking them in total, we expect -- we continue to expect to deliver between 23% and 24% Shack-level operating margin for the full year, consistent with our prior guidance, although likely towards the lower end of that range.

Total G&A for the first quarter was $13.9 million and included approximately $500,000 relating to Project Concrete and $1.6 million relating to noncash equity compensation. Our G&A expense will continue to increase as the year progresses as a result of continued investments across the business to support our strong growth and the ongoing implementation of Project Concrete, our back office or ERP upgrade.

We continue to expect our full year G&A expense to be between $66.4 million and $68.2 million, inclusive of Project Concrete and equity-based comp. Within this amount, our prior guidance breakout still stands: core G&A spend of between $56 million and $57 million; equity-based compensation between $7.4 million and $7.7 million; and Project Concrete G&A spend of between $3 million and $3.5 million, with approximately $4 million of additional capital costs. This very significant enterprise-wide project is progressing well, with key modules in both financial operations and people resources scheduled for go-live during the second half of the year.

As a result of our ongoing expansion and increasing pace of new Shack openings, we continue to record significant increases in our depreciation expense, a major impact to EPS. Depreciation increased 38% in the quarter to $9 million, driven primarily by the addition of those 34 new Shacks, together with existing Shack remodels and ongoing enterprise-wide capital investment, primarily in digital tools and technology. We continue to expect depreciation of $41 million to $42 million for the year, consistent with prior guidance.

Preopening expenses in the quarter were $2.6 million. For the full year, we continue to expect preopening costs to be between $13 million and $14 million, with our biggest class of Shack openings to date occurring in 2019.

Interest expense declined by approximately $500,000 year-on-year to $72,000, driven by the change in accounting treatment related to build-to-suit leases which have previously been accounted for in this slide and are now being recorded within occupancy. For the full year, we continue to expect interest expense of between $300,000 and $400,000, in line with prior guidance.

Adjusted EBITDA in the first quarter increased 10% from the same quarter last year to $17.8 million and adjusted EBITDA margin in the quarter was 13.5%. On an adjusted pro forma basis, we earned $4.9 million or $0.13 for fully exchanged and diluted share compared to $5.7 million or $0.15 in the same quarter last year. Our pro forma effective tax rate was 19.5% from the adjusted pro forma basis. Our underlying effective rate was 27%, which excludes the effect of excess tax benefits from stock-based compensation.

Page 20 in our supplemental materials shows the impact of these excess tax benefits on our effective rate. And as a reminder, our tax guidance excludes any potential impact from such excess benefits, given the unpredictability of the timing of exercise activities. And on that basis, we continue to expect a range of 26.5% to 27.5% for our pro forma effective tax rate for the full year.

Overall, we're extremely pleased of the momentum we have across the business and, in particular, the strong top line performance we delivered in the first quarter. We continue to execute against those strategic growth initiatives, centered on domestic and international expansion, testing and learning around our core menu and expanding digital innovation, all while investing in our teams and ensuring they have strong foundational infrastructure to support them as well as to further enable scale for the long term. We certainly saw cost pressures impact the business in the first quarter as we accelerated openings and tested new menu items and have taken steps to address many of those going forward. In addition, as we expanded into new channels that can carry different cost structures had also resulted in operational complexity, which we're very focused on and working through. But ultimately, and with a strong balance sheet, you should expect to see us continue to test and learn as we grow as well as continue to invest where we see compelling long-term returns for the company. We do intend to deliver cost leverage in the future with a long-term lens and ensuring we pursue critical initiatives that we believe will continue to build this company for generations to come.

And with that, I'll pass you back to Randy who will open the call.

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Randall J. Garutti, Shake Shack Inc. - CEO & Director [5]

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Thanks, Tara. As we near our 15th birthday this summer, we believe that Shake Shack has an opportunity to become one of America's and the world's most iconic and beloved restaurant brands. We never take for granted what we've created. I want to say another thank you to our dedicated teams who wake up excited to serve you, understanding that every day we must earn and reearn that privilege. We're looking forward to a strong 2019.

With that, I'd like to thank all of you for joining today's call. And operator, please go ahead and open the line for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And we'll take our first question from Nicole Miller from Piper Jaffray.

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Nicole Miller Regan, Piper Jaffray Companies, Research Division - MD & Senior Research Analyst [2]

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I'll stick to just one question, with 2 parts, admittedly, if okay. I want to understand new unit performance in new markets and just kind of guide us back to how you're identifying those locations. And then the second part is how are you transferring the Shack culture into those new territories, how are you identifying staff and employees? Thanks.

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Randall J. Garutti, Shake Shack Inc. - CEO & Director [3]

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Thanks, Nicole. It's crucial to what we do. Let's start with the team because that's where everything begins. Look, we have done a lot of growth in these last few years. As you see in my strategic commentary, we want to do less new markets in this coming year or 2. We have definitely learned that we should continue to do a lot of new markets, but going deeper has helped us quite a bit. It's helped us see that culture. And when we do go to new markets or even go deeper in other markets, we try to make sure that we have some of our leaders from other Shacks help us open those. Sometimes, that's the General Manager, sometimes it's other leadership. All the time, it is leaders from around the Shack world who go there and help us open and stay somewhere between 2 to 4 to 6 weeks, at least. So we really see that culture.

While I -- in my comments I made it very clear, it's never been harder for us to find and retain great talent. I think that's true of everyone in our industry. I also think it's our sweet spot. And it's the thing we do best and we're going to continue to work on really hard.

When it comes to how we choose those, we have an incredible development team who is out there all the time with a very long-term lens, market by market, with a 3- to 5-year plan, making sure we're going after the opportunities that we want; always making sure that when we launch, we do it in a way that builds a community gathering place for that place. I think the Shacks you will see this year in markets like Columbus, Salt Lake City, New Orleans and others to find that for us. We just -- I was just last week in San Francisco, where we have our Palo Alto Shack, which is just rocking; and our newest one in Marin County, which just already feels like it's a part of the community.

So we want to create real estate that can do all the things that a great community gathering place can do. And we build for the digital future where we can find and take care of our guests anywhere and anytime.

When we talk about the performance of those units, we've continued to outperform our expectations over the years in AUVs and the strength of those openings, and that cost money. To Tara's point in her commentary, when we really want to set these Shacks up to achieve those sales and achieve great guest satisfaction out of the gate, that cost us money. We spend a lot of money on the initial setup of those restaurants and the ongoing, certainly, first few months and really into that first year. It takes time to level out that business plan and make sure that our #1 priority is always take care of our guests and grabbing those sales.

So the impact of that, we noted in the fourth quarter, we noted it again, when we have large classes of Shacks, which we continue to have in record-setting numbers this year, when they open, they impact our Shack-level op profit in the near term, and then that generally levels off.

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Operator [4]

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We'll take our next question from Sharon Zackfia from William Blair.

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Sharon Zackfia, William Blair & Company L.L.C., Research Division - Partner & Group Head of Consumer [5]

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So a couple of questions on the Chick'n Bites. First, I guess, in terms of customer outreach. I'm assuming that, that's bringing in more families and children, but if you could talk about what kinds of new customers you're seeing with those Bites. And then, secondarily, could you quantify some of the specific cost impact from the Chick'n Bites in the first quarter and then how that should lessen in the second quarter, and then it sounds like neutralized by the back half of the year, if I'm understanding correctly.

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Randall J. Garutti, Shake Shack Inc. - CEO & Director [6]

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Yes, almost. I'll start with that or the Chick'n Bites. We're really excited about this. We know -- for a long time, as we know it, we wanted to test, we're excited to be testing it right now. I don't know that it's changing the makeup of our guests. I think what's interesting, and take my own kids as an example, right? They might have gotten a hotdog in the past, well, they might sometimes get a Chick'n Bites now. Sometimes they do that. Sometimes they might trade it with a cheeseburger or sometimes they might get it in addition as a snack or a side. So it's really too early to say what its impact is going to be on our guest makeup, certainly on frequency or any of the impact over time on menu mix. Those things are too early.

What I will say, obviously, we made a lot of notes about the cost. We, throughout the process of launch, made these products better and better and better. And over time, we ended up with a higher cost product than anticipated through the first quarter, and now into the second quarter. What's been great is now we've got our arms around this item a little bit. We've also felt really comfortable about some of the promotional pricing that we started with. We've been able to raise that and such recently in the last month, while getting our supply chain in a stronger place and getting the food product better and better and better. So with all of that, it will -- it had a significant impact to COGS in Q1. We called that out. It will have a significant impact to COGS in Q2. We do believe over time that is lessening. And by the end of Q2, we should be exiting some of the initial higher COGS stuff on that.

So the whole idea is no one is making them like these, right? These are hormone and antibiotic-free, hand-battered, hand-fried to order, one by one. This is not a frozen product. This is not a product that comes in breaded. This is something that we do on the line, and we've got a lot of learning in how to do that, on the labor line and the COGS line. We're getting better and we'll see. We're still treating this as a test. There's still so much we want to know. And -- but we're excited about it. We like what we're seeing so far.

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Operator [7]

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We'll take our next question from Jake Bartlett from SunTrust.

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Jake Rowland Bartlett, SunTrust Robinson Humphrey, Inc., Research Division - Analyst [8]

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Great. I had a question about the mix, Randy. At roughly 0.5 was the lowest mix in about 1.5 years. Yet it sounds like you're getting a boost from digital sales, which is -- which should be boosting mix. So trying to understand that, whether it had anything to do with the Chick'n Bites or if there's any other factors to consider.

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Randall J. Garutti, Shake Shack Inc. - CEO & Director [9]

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Well, remember, it's still a growing number and it's definitely impacted, as you said, by the digital channels. The items per check, the things within that. But again, we only have launched chicken in February. That was a rollout through the company. So there's a lot of noise in there in this quarter that I'm not sure we're ready to point to any exact reason there. But I think, in general, what's encouraging news there, we were pretty gentle on price, especially compared to the industry right now, at or about 1.5%, and traffic was really positive. So we'll take a smaller win in mix than some of the bigger ones that we've had in the past. But I think lots of options to see how that shakes out. That's a long-term metric we will keep an eye on, not just for one quarter.

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Jake Rowland Bartlett, SunTrust Robinson Humphrey, Inc., Research Division - Analyst [10]

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Got it. And I know you're kind -- don't love focusing on the near-term, same-store sales trends. But just so we can understand and maybe get a gauge as to how conservative or not your guidance is, could you help us understand how much the weather impacted the quarter? And I'm also -- just, I guess, wanted to better understand how the calendar shift is impacting, I assume that's April weather, how much that will be a hurt to or was a hit, the Easter shift?

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Randall J. Garutti, Shake Shack Inc. - CEO & Director [11]

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Thanks. So all of that is baked into our increased guidance, again, from 1% to 2%. Let's start where we would start no matter what the comp number was. Still a small base, still not a vast majority of our company, still highly impacted regionally from time to time on certain things. Like weather in the first 2 weeks, really with the holiday shift of the end of the year going into New Year's, we had really favorable weather, much warmer, much nicer weather in the Northeast and New York City area, which is the majority of our comp base, which is not the majority of our company. That has impact. And that was a part of Q1. So as we look at -- there's other things, there's Easter shift noise, too early to talk about that, we don't give mid-quarter guidance. But we expect to be around 1% to 2% for the year, which is an increase in how we're thinking about it earlier. So great first quarter, great to see traffic continue to improve.

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Operator [12]

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

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John Stephenson Glass, Morgan Stanley, Research Division - MD [13]

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First, can you just talk maybe about your use of both more promotional activity and promotional pricing? I don't think in the past I've heard you talk about that. In particular, why did you use promotional pricing for Chick'n Bites? I know you wanted to get a trial, but maybe you hadn't used that in the past. Did it result -- net of the cost, did it result in the benefit that you thought it was going to? And just how do you think more about promotional pricing or promotional activity now maybe versus a few years ago when I didn't -- I don't think you had as much of it?

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Randall J. Garutti, Shake Shack Inc. - CEO & Director [14]

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Yes. Thanks, John. And maybe it's even -- as I hear you say it, maybe it's even too strong a word to consider what we're talking about. I think to put that in a category of what fast food promotion might be doing, let's be real clear. That's not what we've ever done, that's not what we've done here. So when we talk about kind of promotional pricing, the Chick'n Bites started around $4.39 in our Tier A markets. And that is a price that we looked at and said, what we want to learn is do people want to eat Chick'n Bites, period, at Shake Shack? And at what price does that not confuse the issue of trying to figure out do they want to eat it? And we really like that low $4 price. Turns out, the answer is people want to eat Chick'n Bites at Shake Shack. And we feel so good about the value that we are giving there, that we felt comfortable taking it off a little bit to try the next tier of pricing, which, so far, we feel pretty good about what we're seeing there as well. But it's not giveaways. This is not discounting. This is not promos in the sense that you might be thinking about for other brands. This is still a premium product at a premium price that we feel we can charge an even more premium price for in the near term.

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John Stephenson Glass, Morgan Stanley, Research Division - MD [15]

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Yes. Sorry, I didn't mean to scare you about promotional pricing. Digital is a really important part of your business, and yet I still feel like, at least, I don't understand what the real contribution here is. And in the past, you've been reticent to provide specific metrics. But is there any way you can help understand what the role of digital played this quarter or what's it played in the last couple of quarters, percentage of sales, type of check? Can you give any sort of further quantification of what you think digital is really doing to your business right now?

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Tara M. Comonte, Shake Shack Inc. - CFO [16]

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John, how are you? Yes. No, I mean, you're right. We're not at the stage yet where we are sort of breaking out or reporting specific digital metrics. I mean, I think, at some point in the future, we will. And the only reason we're not right now is we're just so early in that process and that part of our business being built out. I mean, the app, obviously, is the most mature of our digital channels and it's barely 2 years old. Our most recent channel, web ordering, we just launched in December.

So I think it's not -- it's really not intended to be a lack of transparency. It's just that it's early. And there's a lot of testing and a lot of learning going on, and that's, obviously, where a lot of our investment is going this year. It's a critical part of our business. As we continue to talk to you, we're very bullish about it. We really want to provide a holistic experience when it comes to Shake Shack, the ability to provide convenience as well as experience to interact with those in a variety of formats. But we feel good about it. So in general terms, it's a growing part of our business. It's a critical part of our future growth. It's a key part of our investment strategy. We see growth across all channels and it continues to deliver a higher average check than in Shack. But we'll see where we go in reporting the metrics. As I say, I am sure at some point we'll start reporting them when all these things begin to be somewhat mature -- more mature parts of our business.

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Operator [17]

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We'll take our next question from Andy Barish from Jefferies.

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Andrew Marc Barish, Jefferies LLC, Research Division - MD and Senior Equity Research Analyst [18]

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Yes. I know it's obviously early in the year, but are you willing to kind of quantify what you think the '19 opening volumes will be kind of within the long-term context that you've laid out?

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Randall J. Garutti, Shake Shack Inc. - CEO & Director [19]

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Well, they're all -- that's all baked into -- in the $4 million to $4.1 million AUV that we've given guidance for that's unchanged for the end of the year. As we exit the year, that's our expectation. I think, obviously, you can look at that and say, "Well, the outperformance in Q1 will likely be at the higher end of that range as we look at those expectations today." So we don't break out class by class. It's all varied, Andy. I think that's what we want you to understand. We're going to have some of these premier big Shacks. We're going to have smaller market Shacks. It's so varied across what we do. And I think the strength of Shake Shack, one thing that people should understand is not just getting sucked into the AUV as great a number as it is, is the only thing to look at. We're doing all kinds of AUVs and we're making really good money at all those levels. And I think that's the power of this business over the long term. So that's where we're focused on.

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Andrew Marc Barish, Jefferies LLC, Research Division - MD and Senior Equity Research Analyst [20]

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And can you just give us a sense -- obviously, the background of where the business came from is a little bit different than a lot of other players out there. But how are you managing sort of menu complexity and new challenges and maybe some of the key things you're doing to help the team be able to handle a lot of the new things that are getting thrown at them, whether it's shakes or chicken or delivery, what have you?

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Randall J. Garutti, Shake Shack Inc. - CEO & Director [21]

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It's an important question. And we were born from a fine dining company. Many of the people who are leaders of this company today have that background. Our new chef, John Karangis, is both a fine dining person and someone who understands execution and volume. So I think the process now is about using our new Innovation Kitchen, testing, learning, listening. I think we're new at learning, how to learn, honestly. It's something we've got to take our time with. Chick'n Bites was a great first example of that. And it's not easy to do Chick'n Bites the way we like to do them. And that causes some challenges in our restaurants. No question about it. And we've noted those today on this call. And so, I think, we're going to -- always going to lead with quality, we're going to lead with things that the guests really are asking for and will come back for, and we want to be the next generation's burger joint. We're going to look at those classic menu items and say, "How can that simple classic thing be done better, whoever wrote the rule that needs to be done the way we've accepted, and we're going to go ahead and just do it a little bit better." We want to do the things that other people are unwilling or aren't able to do. And that starts right here in our Innovation Kitchen, and then it spreads to Shacks around the country. And everything we do may not be perfect, but we're going to have fun testing, trying and then training to roll those things out so that we can execute them better and better every day.

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Operator [22]

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We'll take our next question from Chris O'Cull from Stifel.

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Christopher Thomas O'Cull, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Senior Analyst [23]

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ROM declined about 400 basis points in the first quarter and it sounds like you're seeing similar performance, you're expecting similar performance in the second and you've got more openings in the back half. So can you give us a little bit more color on what's going to change in the back half of the year to cause the margin to show better performance to hit your guidance?

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Tara M. Comonte, Shake Shack Inc. - CFO [24]

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Chris, yes. I mean, I think a lot of what you're seeing in our [swap] for the year, which as I mentioned in my remarks, we're holding our Shack-level guidance for the year. As it relates to restaurant-level margins at 23% to 24%, albeit likely at the lower -- towards the lower end of that range. So -- and really, when you look at that first quarter margin, and Randy touched on it again in the last question, but Chick'n Bites and that launch had a sizable impact on COGS. We're making some changes not least the pricing rolling through, but supply chain changes during this quarter. So that will lessen quite meaningfully in the back half of the year. There's also the weight of the seasonality in our business, with summer tending to be those summer months -- summer quarters tending to be our higher-margin quarters. And so those are sort of the main drivers.

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Randall J. Garutti, Shake Shack Inc. - CEO & Director [25]

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And Chris, I'll just jump in. And we have a lot of work to do to make that happen. And we acknowledge there's a lot of work to do, and everything Tara mentioned, and our labor and all the work that we're doing. This is -- it's not an easy thing when we have pressure like we did in the first quarter. But we are committed to doing that work and we will do better.

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Christopher Thomas O'Cull, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Senior Analyst [26]

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And then just -- it sounded like the other operating costs or other operating expenses was up primarily because of delivery commissions. Was that -- did I hear that correctly? And then, should we see a similar year-over-year impact the remaining quarters?

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Tara M. Comonte, Shake Shack Inc. - CFO [27]

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Yes. You heard it correctly. And yes, that is a new cost in our business. Unfortunately, delivery comes with a cost.

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Christopher Thomas O'Cull, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Senior Analyst [28]

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So that rate of increase is reasonable for the balance of the year?

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Tara M. Comonte, Shake Shack Inc. - CFO [29]

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It's all -- yes. I mean, our OpEx for the back of this year almost -- the total line items is all incorporated within our [swap] guidance.

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Operator [30]

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We'll take our next question from Andrew Charles from Cowen and Company.

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Andrew Michael Charles, Cowen and Company, LLC, Research Division - Director [31]

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Randy, I know you're reluctant to discuss when you're looking to formalize the delivery partnership. But can you speak to what the benefit a formal delivery partnership will allow you that you currently don't have today?

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Randall J. Garutti, Shake Shack Inc. - CEO & Director [32]

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Well, really, Andrew, no new news since the last call, right? We're continuing to pilot. I think there's benefits on all sides of how we consider the ultimate answer to that and how we will ultimately finalize any of that. So honestly, I think what we know today is people -- our guests are telling us they like delivery. We're doing more of it quarter-over-quarter and year-over-year, and it's something we're spending a lot of time thinking about. And again, no new updates different from what we said in past quarters on that one.

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Andrew Michael Charles, Cowen and Company, LLC, Research Division - Director [33]

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Let me ask you, are the intended benefits from an exclusive agreement with a delivery provider worth it? Or can you achieve your long-term vision for delivery within a brand with 3 separate partners?

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Randall J. Garutti, Shake Shack Inc. - CEO & Director [34]

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We'll let you know when we make that -- when we may have news to report.

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Andrew Michael Charles, Cowen and Company, LLC, Research Division - Director [35]

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Okay. Last quarter, you warned about the sophomore Shacks in 2018 that opened at high volumes were getting pretty close to the end of their honeymoon period. Did 1Q's strong top line results suggest that perhaps these stores didn't fall off harder than the 5% decline you typically see in year 2?

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Tara M. Comonte, Shake Shack Inc. - CFO [36]

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Yes. But I think we continue to be pleased with the results of the Shacks across the board. I mean, sophomore declines are still a reality, Andrew, in the business and they certainly will be this year. We've got -- as we mentioned in the last call -- and it's incorporated within our guidance for the year. We continue to expect that. We've got some Shacks that are sophomore this year that started really high with really, really incredible sales. So it's absolutely still a dynamic, but I think it's fair to say that we continue to outperform our own expectations across the board, including sophomore.

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Operator [37]

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We'll take our next question from Alton Stump from Longbow Research.

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Alton Kemp Stump, Longbow Research LLC - Senior Research Analyst [38]

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Congrats from me as well on the quarter. I think -- I just have a quick question and I'll hop back in the queue. But of course, you mentioned beef costs being a pressure point, Tara. Is that also going to wane as we move into that past the year? Or -- and what's your expectations from a quarter-to-quarter basis as far as the cost pressures this year?

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Tara M. Comonte, Shake Shack Inc. - CFO [39]

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Yes. No. I mean, I think, we're coming off sort of years of beef coming down. We've seen it start to creep back up, and I think we'll probably see that continue to some degree in the back half of this year. It's, obviously, relatively challenging to forecast commodities, but we're expecting it to potentially continue to increase throughout the year.

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Operator [40]

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We'll take our next question from Jeffrey Bernstein from Barclays.

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Jeffrey Andrew Bernstein, Barclays Bank PLC, Research Division - Director & Senior Equity Research Analyst [41]

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Great. Two questions. Just first kind of piggybacking off of all the cost questions. I'm wondering how you think about the menu pricing. I mean, I think, we're still in the 1% to 2% range as what you think is reasonable for '19. But with the labor inflation you're talking about and now the -- what sounds like rising food inflation, just wondering whether you contemplate an outsized or a slightly greater increase. It seems like you have the pricing power, it sounds like maybe you took it on the chicken after your initial promotional activity. I'm just wondering how you think about when would be the time to push it above that 1% to 2% whilst still keeping an affordable option for the consumer? And then I have one follow-up.

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Randall J. Garutti, Shake Shack Inc. - CEO & Director [42]

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Sure, Jeff. That's a -- it's a great question, something we talk about a lot. We're studying and thinking about it a lot. As you know for 15 years of this company's history, we have been very cautious and very much in the 1% to 2% range for the most part every year. That's -- we're not stuck with that for any good reason other than making sure we continue to keep the exceptional pricing power we believe Shake Shack has, at our quality, what we provide, and the overall experience, we feel really strong about making sure our guests get a great value. We're giving that today and we want to be able to give that for the long term. Look, there's a lot of companies out there that have taken a lot of price right now. We, obviously, have had an impact to our margins with some of the creeping costs that we've had. But we're in this for the long haul. We're on this for the next quarter. We're on this for the next year. We're in this to have a sustainable long-term business that's offering a fantastic product at a great price for many years to come, and we're not going to rush to that. We're going to guide you to where we think it will land and we'll keep you posted. So at this time, we don't have any expectation of an increased price in the near term.

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Jeffrey Andrew Bernstein, Barclays Bank PLC, Research Division - Director & Senior Equity Research Analyst [43]

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Got it. But do you think you have the pricing power if you were so inclined at a certain point later this year into next year or do you get a feeling that maybe there is some pushback that you kind of want to be more careful?

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Randall J. Garutti, Shake Shack Inc. - CEO & Director [44]

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Yes. We actually do and we have over for a very long time. I think we've got -- we retain a lot of great pricing power. When you really look at us versus options that are out there, we feel great about it. So we do and we are cautious and we are patient.

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Jeffrey Andrew Bernstein, Barclays Bank PLC, Research Division - Director & Senior Equity Research Analyst [45]

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Got it. My other question was just on G&A. Just wondering how you think about spend through 2019, whether it's steady relative to levels we're seeing now or maybe it might be weighted to particular quarters and whether future years might also be outsized. Just wondering -- trying to figure out what the underlying run rate is. I think you said $56 million to $57 million, but I wasn't sure if that was intended to be what we should think about as kind of a core underlying run rate or how we should think about it over the next year or 2?

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Tara M. Comonte, Shake Shack Inc. - CFO [46]

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Hey, I would not call it a run rate in a business that's growing as fast as this one. So yes, the $56 million, $57 million is our core guidance for this year within a $66.5 million to $68.2 million. We've obviously got equity-based comp within that and Project Concrete spend. So I think what you should expect to see is G&A increase from Q1 as we continue to spend to that $56 million, $57 million throughout the year. And I think you'll continue to see us spend more as time goes on, one, as a result of just the significant size of growth that the business has for the foreseeable future on top of the fact that we'll continue to invest where we see -- we'll continue to invest outside of just current state growth. We'll be investing in long-term growth, as we see those opportunities continue to arise. So I would not call $56 million, $57 million a run rate. But I do think you'll start to see -- you'll start to see leverage in that base at some point, but in the long term, I mean, come back to the fact that we're 132 Shack -- company-operated Shacks today in a number of 450 that we gave at the time of the IPO. So we've got a lot of growth ahead of us and we're really excited about it and we're going to continue to spend to deliver returns that we like.

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Operator [47]

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(Operator Instructions) And we'll take John Ivankoe from JPMorgan.

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John William Ivankoe, JP Morgan Chase & Co, Research Division - Senior Restaurant Analyst [48]

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Hopefully, you can hear me. The Game of Thrones promotion that you guys are running, premium price sits right on the top of the rest of your menu. So I wonder kind of what that's telling you in terms of the pricing power that you have on the very, very premium end of the menu? And I'll also ask that -- and a question as your menu prices over time have kind of dragged higher, whether it makes sense to kind of think about an entry-level meal of some type that can drive frequency for your lower and middle income customers as well? And I have a follow-up.

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Randall J. Garutti, Shake Shack Inc. - CEO & Director [49]

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Yes. Game of Thrones has been a lot of fun. We've definitely tested the shake. We've tested kind of the higher end of what we've done for shakes in the past. I think it's such a one-off special thing. So hopefully, we do things like that in the future as well. We have such a strong fan base for Game of Thrones, and people want to try this and the fun creation of the Dragonglass. It's really a tasty and cool invention and innovation that our team made. A lot of us do feel really good about charging that. The visuals are beautiful, the cup, just a really cool thing. And it's a fun way to have people be thinking about Shake Shack, have new audiences be thinking about Shake Shack.

So on the lower end of the pricing, I think Chick'n Bites is an interesting example of that, John. Even at the newer price, it's still below $5. So that's an interesting entry-level point, and we've got our eyes on that very closely. I like us to be considering around the core menu how we can tinker at both ends of high and low pricing over time. Generally, I think you'll probably see us go higher as you have. Not sure how many low-priced things we're looking for. We want to compete on quality and experience and not just on price.

So we'll keep our eyes on it, though, but we've got some things on both categories, I think, that are leading your question.

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John William Ivankoe, JP Morgan Chase & Co, Research Division - Senior Restaurant Analyst [50]

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Helpful. Thank you. And then, secondly. There have been so many questions about delivery incrementality and the cost of delivery. Have you thought about changing the price of Shake Shack on the delivery apps that basically cover your cost in packaging and delivery fees? I mean, are you allowed to do it? Do you think it's in the spirit of the brand? Do you think the customer would accept that to the extent that there were different prices for delivery versus in-store?

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Randall J. Garutti, Shake Shack Inc. - CEO & Director [51]

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Yes. I think it's all wrapped up in the total delivery cost, right? And each product has different models, as you look at that right now as we're piloting. But I absolutely think there's options there. Today, our menu pricing does not change on any channel. That said, we're wide open to considering those things. I think there seems to be a great willingness to pay on digital channels that is a little bit different. So I think we've got that upside as a potential. It's not something we're going to jump on today. We're mostly concerned about continuing to just grow traffic, grow the channels successfully, make sure they go well, and then we'll see. Maybe something we'll look at.

Yes. I think, operator, that's the last of the questions. And I just want to say thank you to everyone for being on the call today. We really appreciate your time, and have a great night. We'll see you at a Shack soon.

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Operator [52]

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