Shake Shack Inc. annual report, FY2017

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Shake Shack Inc. — Fiscal 2017 Form 10-K

Reporting period: Fiscal year ended December 27, 2017 (52 weeks). The filing also reports unaudited fourth-quarter results. Amounts below are in U.S. dollars; financial figures are rounded to millions unless stated otherwise.

Business context

Shake Shack operates premium fast-casual restaurants and licenses the brand. At year-end, it had 159 Shacks: 90 domestic company-operated, 10 domestic licensed, and 59 international licensed. The company’s reported revenue consists primarily of company-operated Shack sales and licensing revenue; licensed restaurants’ sales are not recorded as company revenue.

Financial performance and liquidity

  • Revenue: $358.8 million, up 33.6% from $268.5 million. Shack sales rose 33.6% to $346.4 million; licensing revenue increased 36.1% to $12.4 million.
  • Profit: Operating income was $33.8 million, up 21.6%, but operating margin declined to 9.4% from 10.4%. Consolidated net income was $8.9 million, while net loss attributable to Shake Shack Inc. was $0.3 million, or $0.01 per diluted share, versus attributable income of $12.4 million in 2016.
  • Unusual tax effects: Fiscal 2017 other income of $128.1 million included a $125.9 million benefit from reducing tax receivable agreement liabilities after U.S. tax reform. Income tax expense included a provisional $138.6 million charge for remeasuring deferred tax assets. The resulting 94.5% effective tax rate and reported net income are materially affected by these items.
  • Operating metrics: Same-Shack sales fell 1.2%, with guest traffic down 3.2%, partly offset by a 2.0% combined price and mix increase. Shack-level operating profit was $92.3 million, with a 26.6% margin versus 28.3%. Adjusted EBITDA, a non-GAAP measure, increased 28.7% to $64.7 million; its margin eased to 18.0% from 18.7%.
  • Cash flow: Operating cash flow was $70.9 million, compared with $54.3 million. Investing cash outflow was $61.9 million, including $61.5 million of property and equipment purchases. Financing provided $1.0 million. Cash and cash equivalents ended at $21.5 million.
  • Liquidity and debt: Cash plus short-term marketable securities totaled $84.5 million. There were no borrowings under the revolving credit facility, with $19.3 million available after letters of credit. Total debt of $14.5 million was deemed landlord financing. The company reported compliance with credit facility covenants.
  • Commitments: Contractual obligations totaled $650.7 million, including $271.8 million of operating lease obligations, $50.0 million of deemed landlord financing obligations, and $159.4 million under the tax receivable agreement. Management said available cash, operating cash flow, and credit availability should fund needs for at least 12 months and the foreseeable future.

Changes versus the prior comparable period

  • Fiscal 2017 revenue growth was driven mainly by 26 new domestic company-operated Shacks; total system count increased by 45 net openings to 159.
  • Same-Shack sales reversed from 4.2% growth in 2016 to a 1.2% decline in 2017; domestic company-operated average unit volume fell to $4.6 million from $5.0 million.
  • Labor costs rose to 26.5% of Shack sales from 25.3%, and other operating costs rose to 10.3% from 9.6%. Food and paper costs remained 28.4% of Shack sales.
  • Capital spending increased to $61.5 million from $54.4 million. Deemed landlord financing rose to $14.5 million from $2.0 million as more leases met accounting criteria for financing treatment.
  • Fourth-quarter revenue was $96.1 million versus $73.3 million; operating income was $5.8 million versus $5.0 million. Fourth-quarter net loss was $11.0 million versus net income of $5.5 million, and loss attributable to Shake Shack Inc. was $12.5 million versus income of $3.9 million, primarily reflecting the tax-reform accounting effects.

Outlook, commentary, risks, and unusual items

  • Fiscal 2018 outlook: Revenue of $444–$448 million; licensing revenue of $12–$13 million; same-Shack sales growth of 0%; 32–35 domestic company-operated openings and 16–18 net licensed openings. Management projected domestic company-operated AUV of $4.1–$4.2 million and Shack-level operating profit margin of 24.5%–25.5%.
  • Management expected labor-cost pressure to continue and Shack-level margins to decline, even as operating profit increased in absolute terms. It also expected company-wide AUV to trend lower as growth extends into markets and locations with differing sales volumes.
  • Longer-term targets: By fiscal 2020, at least 200 domestic company-operated Shacks, at least 120 globally licensed Shacks, and more than $700 million in total revenue.
  • Growth plans depend on new-site availability, construction execution, hiring and training, and effective management of rapid expansion. The company identified competition, possible sales cannibalization, commodity inflation, minimum-wage increases, food safety, and reliance on concentrated suppliers and a primary domestic distributor as material risks.
  • Other risks include international licensee performance and geopolitical or currency conditions, long-term lease commitments, cyber and technology disruptions, and the Tax Receivable Agreement. The company leases all domestic company-operated Shacks and reported $159.4 million of related agreement liabilities; payments depend partly on future taxable income and tax benefits.
  • A $0.8 million employment-related settlement was paid in May 2017. Other ordinary-course legal matters were not considered material at year-end. Management and the auditor reported effective internal control over financial reporting; the auditor issued unqualified opinions on the financial statements and controls.

Important facts for investors to verify

  • How much of the reported earnings volatility reflects the tax-reform remeasurement and tax receivable agreement adjustments, and whether fiscal 2018 tax estimates change.
  • Whether same-Shack sales and guest traffic stabilize, and how the stated 0% fiscal 2018 comparable-sales outlook performs against actual results.
  • Whether labor and other operating costs compress margins beyond management’s projected 24.5%–25.5% Shack-level range.
  • Whether planned openings meet cost, timing, and unit-volume expectations, given $61.5 million of 2017 property and equipment purchases and substantial lease commitments.
  • Whether cash generation can support expansion and tax receivable agreement payments, and how the $159.4 million agreement liability changes as tax benefits are used or tax assumptions evolve.
  • Whether supplier and distributor concentration, international operating conditions, and the company’s delivery and digital initiatives create material service, cost, or execution impacts.