Business context and reporting period
Shake Shack Inc.’s Form 10-K covers fiscal 2016, the 52-week year ended December 28, 2016, with comparisons to fiscal 2015. The company operates and licenses premium “fine casual” burger restaurants. At year-end it had 114 Shacks: 64 domestic company-operated, seven domestic licensed and 43 international licensed. Shake Shack Inc. is a holding company and owned 69.1% of SSE Holdings, LLC at year-end.
Although the request references 2016 Q4, this filing reports the full fiscal year. It also provides unaudited fourth-quarter results.
Financial results and key metrics
| Metric | FY 2016 | FY 2015 |
|---|---|---|
| Total revenue | $268.5 million | $190.6 million |
| Operating income | $27.8 million | $6.8 million |
| Net income, consolidated | $22.1 million | $3.1 million |
| Net income (loss) attributable to Shake Shack Inc. | $12.4 million | $(8.8) million |
| Diluted EPS attributable to Shake Shack Inc. | $0.53 | $(0.65) |
| Operating cash flow | $54.3 million | $41.3 million |
| Cash and cash equivalents, year-end | $11.6 million | $70.8 million |
| Marketable securities, year-end | $62.0 million | $0.3 million |
Revenue rose 40.9%; company-operated Shack sales increased 41.6% to $259.4 million, while licensing revenue increased 23.8% to $9.1 million. Same-Shack sales growth was 4.2%, comprising 3.1% from price and mix and 1.1% from traffic. Shack-level operating profit, a non-GAAP measure, was $73.3 million, or 28.3% of Shack sales, versus $52.9 million and 28.9%. Adjusted EBITDA, also non-GAAP, was $50.2 million, up 35.7%, with an 18.7% margin versus 19.4%.
Food and paper costs improved to 28.4% of Shack sales from 29.5%, but labor costs rose to 25.3% from 24.4%. GAAP operating margin increased to 10.4% from 3.5%. The 2015 comparison included substantial IPO-related and other non-recurring compensation expense; management reported 2016 adjusted pro forma net income of $16.8 million, or $0.46 per fully exchanged diluted share, up from $12.0 million, or $0.32.
Fourth-quarter 2016 revenue was $73.3 million, operating income $5.0 million, consolidated net income $5.5 million and net income attributable to Shake Shack Inc. $3.9 million. The comparable 2015-quarter figures were $51.1 million, $3.7 million, $3.0 million and $1.2 million, respectively.
Net cash used in investing activities was $114.8 million, including $54.4 million of property and equipment purchases and net purchases of marketable securities. The company reported $2.0 million of total debt, consisting of deemed landlord financing; it had no revolving-credit borrowings and $19.9 million of facility availability. Year-end current assets were $83.9 million and current liabilities $31.7 million. Cash plus marketable securities totaled approximately $73.6 million.
Material changes versus the prior comparable period
- Growth was driven primarily by 20 new domestic company-operated Shacks and 10 net licensed openings. The system-wide count increased 35.7% to 114.
- Same-Shack sales growth slowed to 4.2% from 13.3%; domestic company-operated average unit volume remained approximately $5.0 million.
- Shack-level profit margin declined 0.6 percentage points, as labor and other operating costs rose relative to sales, partly offset by improved food costs.
- General and administrative expense fell 19.2% to $30.6 million, largely because fiscal 2015 included $12.8 million of non-recurring IPO-related compensation, $0.6 million of IPO expenses and a legal-settlement charge.
- Cash and cash equivalents fell by $59.2 million, principally reflecting investment in marketable securities and capital spending; marketable securities rose to $62.0 million.
- The company’s ownership of SSE Holdings rose to 69.1% from 54.6% at year-end 2015, primarily through exchanges of LLC interests. The resulting non-controlling-interest attribution affects reported parent-company earnings.
Outlook, risks, contingencies and unusual items
For fiscal 2017, management’s preliminary outlook was revenue of $349–$353 million, same-Shack sales growth of 2%–3%, 22–23 domestic company-operated openings and 11 net licensed openings. It projected a 26.5%–27.5% Shack-level operating profit margin, $38–$40 million of G&A, $22 million of depreciation, $1.6–$2.0 million of interest expense and a 40%–41% adjusted pro forma effective tax rate. The same-Shack outlook includes approximately 1.5%–2% of menu price increases and nominal traffic and mix gains. Fiscal 2017 openings were expected to average at least $3.2 million in annual sales and achieve at least 21% Shack-level operating margins. Management cautioned that longer-term expansion into lower-volume markets could reduce company-wide AUVs and Shack-level margins.
Management identified rising wages as a key near-term margin challenge and cited macroeconomic and political pressure on Middle East licensed-Shack traffic and currency headwinds in the U.K. It expected these pressures to continue in 2017. Japan and South Korea were described as strong markets. The January 2017 nationwide launch of the iOS Shack App was viewed as an opportunity to improve guest experience and potentially drive incremental sales; the filing notes results were still early.
Key risks include execution of rapid expansion, site availability, new-Shack ramp-up and possible sales cannibalization; labor and commodity inflation; dependence on a limited number of suppliers and one primary U.S. distributor; food safety and reputational risk; competitive pressure; regional concentration in the Northeast; and geopolitical, currency and supply-chain issues affecting licensed operations. All domestic company-operated Shacks are leased, with long-term lease commitments.
The $272.5 million Tax Receivable Agreement liability is a significant contractual obligation, not conventional funded debt. Under the agreement, Shake Shack generally owes non-controlling holders 85% of certain realized or deemed tax benefits; $4.6 million was expected to be paid in fiscal 2017. The filing’s contractual-obligations table totals $615.2 million, including lease, purchase and tax-receivable obligations. Management stated available operating cash flow, cash and revolver availability should fund needs for at least the next 12 months and the foreseeable future.
An employment-related wage-and-hour settlement was approved for $0.8 million, including legal expenses, and accrued at year-end; the court granted final approval in March 2017. Management reported no material ultimate liability for other ordinary-course legal matters. No impairment charges were recorded in fiscal 2016. The company also disclosed that the CFO planned to retire in March 2017. Management assessed internal control over financial reporting as effective; the auditor did not provide an attestation on internal control because the company was an emerging growth company.
Most important facts for investors to verify
- Whether fiscal 2017 revenue, same-Shack sales and opening targets were achieved, and whether new units delivered the projected sales and margins.
- Whether labor inflation and weaker margins at newer or lower-volume locations offset scale benefits and food-cost efficiencies.
- Cash generation and capital spending needs, including the distinction between cash and marketable securities and any future revolver usage.
- The timing and assumptions behind the $272.5 million Tax Receivable Agreement liability, including the company’s ability to realize the associated tax benefits.
- Reliance on concentrated suppliers and distribution, and the performance and financial health of international licensees in pressured markets.
- The effect of LLC-interest exchanges, non-controlling interests and related share issuance on reported EPS and potential dilution.