Shake Shack Inc. — Q2 2018 Form 10-Q
Reporting period: 13 and 26 weeks ended June 27, 2018; comparable periods ended June 28, 2017. Amounts below are in U.S. dollars; financial statement figures are in millions unless stated otherwise.
Business context
Shake Shack operated 179 Shacks system-wide at quarter-end: 100 domestic company-operated, 10 domestic licensed and 69 international licensed. It opened five company-operated and six licensed Shacks during the quarter. The company owned 75.9% of SSE Holdings.
Financial performance
| Metric | Q2 2018 | Q2 2017 | Change |
|---|---|---|---|
| Total revenue | $116.3 | $91.3 | +27.3% |
| Shack sales | $112.9 | $88.0 | +28.3% |
| Operating income | $13.0 | $11.7 | +10.9% |
| Operating margin | 11.2% | 12.9% | Down 1.7 pts |
| Net income | $10.6 | $8.2 | +29.2% |
| Net income attributable to Shake Shack Inc. | $7.6 | $4.9 | +55.9% |
| Diluted EPS, Class A | $0.26 | $0.19 | Up $0.07 |
Same-Shack sales rose 1.1% in Q2, reflecting 3.7% growth from price and sales mix, offset by a 2.6% traffic decline. For the first half, revenue was $215.4 million versus $168.1 million, and net income attributable to Shake Shack Inc. was $11.1 million versus $7.1 million.
Q2 Shack-level operating profit, a non-GAAP measure, increased 25.5% to $31.8 million, while its margin declined to 28.2% from 28.8%; excluding a one-time deferred-rent benefit, the 2018 margin would have been 27.5%. Adjusted EBITDA rose 12.9% to $21.9 million, but adjusted EBITDA margin decreased to 18.8% from 21.2%.
For the first 26 weeks, operating cash flow was $40.9 million versus $33.7 million. Capital spending on property and equipment was $36.4 million versus $25.0 million; investing cash outflow was $34.8 million. Cash increased $9.4 million to $30.9 million.
Liquidity and debt
At June 27, cash and cash equivalents were $30.9 million and marketable securities were $61.4 million. Current assets were $102.1 million and current liabilities $38.8 million. No amounts were drawn on the $50 million revolving credit facility; $19.3 million was available after letters of credit. The facility matures in February 2020, and the company reported compliance with its covenants. Deemed landlord financing liabilities were $18.3 million.
Liabilities under the Tax Receivable Agreement totaled $177.4 million, including accrued interest; payments are contingent on realizing tax benefits and sufficient future taxable income. The company stated that cash from operations, available cash and facility capacity should fund operating needs, capital expenditures and other obligations for at least the next 12 months.
Changes, outlook and notable items
- Revenue growth primarily reflected 25 domestic company-operated Shack openings over the year. Q2 licensing revenue increased 2.1%; management cited growth in Asia and continued softness in the Middle East.
- Cost pressures included higher hourly minimum wages, delivery commissions, and repairs and maintenance at some mature, high-volume Shacks. Labor rose to 26.3% of Shack sales from 25.5%, and other operating expenses to 10.9% from 9.6%.
- The effective tax rate fell to 17.5% from 29.3%, primarily following the federal corporate tax-rate reduction under the Tax Cuts and Jobs Act, partly offset by higher company ownership of SSE Holdings and foreign withholding taxes.
- The company adopted ASC 606 in 2018 using the modified retrospective method. Adoption reduced opening equity by $1.6 million; reported Q2 licensing revenue was $0.1 million lower than it would have been under the prior standard.
- Fiscal 2018 outlook: revenue of $446–$450 million; licensing revenue of $12–$13 million; same-Shack sales growth of 0%–1%; 32–35 domestic company-operated openings and 16–18 net licensed openings; domestic average annual sales volume of $4.1–$4.2 million; and Shack-level operating profit margin of 24.5%–25.5%. Compared with prior outlook, depreciation expense was slightly reduced, while pre-opening and interest expense estimates increased. General and administrative expense guidance excludes approximately $6–$8 million of Project Concrete costs across the remainder of 2018 and into 2019.
- The company expects to adopt the new lease accounting standard on December 27, 2018 and said it is likely to materially increase reported lease assets and liabilities. It was still evaluating income-statement and cash-flow effects.
Ordinary-course legal claims were described as generally insured and not material. Management reported effective disclosure controls and no material change in internal control during the quarter. The filing states there were no material changes to the risk factors disclosed in the 2017 Form 10-K.
Investor verification points
- Assess whether Shack openings and sales growth can offset declining guest traffic, particularly as labor and other operating costs rise.
- Review the quality and sustainability of margins, including the deferred-rent benefit and management’s non-GAAP adjustments.
- Monitor capital expenditure needs, lease commitments and the expected balance-sheet impact of the new lease standard.
- Evaluate the size, timing and tax-benefit dependence of the $177.4 million Tax Receivable Agreement obligation.
- Track execution of the 2018 opening and same-Shack sales outlook, Project Concrete spending, and international licensing performance.