Shake Shack 2016 Annual Report Download - page 67

Table of Contents
a greater amount of claims are reported, or if medial costs increase beyond what we expect, our liabilities may not be sufficient and we could recognize additional
expense, which could adversely affect our results of operations.
Equity-Based Compensation
Equity-based compensation expense is measured based on fair value. We recognize compensation expense on a straight-line basis over the requisite service period.
For awards with graded-vesting features and service conditions only, compensation expense is recognized on a straight-line basis over the total requisite service
period for the entire award. The total compensation expense is reduced by estimated forfeitures expected to occur over the vesting period of the awards. We
estimate the grant date fair value of stock options using the Black Scholes valuation model. Calculating the grant date fair value of stock-based awards is based on
certain assumptions and requires judgment, including estimating stock price volatility, forfeiture rates, and expected life. At the time of the stock option grant in
fiscal 2015 , we had no historical data of our own to utilize in determining our assumptions. We selected a peer group and based our volatility assumption on the
historical volatility of the selected peer group. The weighted-average volatility used in determining the grant date fair value of awards granted in fiscal 2015 was
35.1% . We estimate that a 250 basis point increase in the volatility assumption would increase our stock-based compensation expense for fiscal 2015 by
approximately $0.2 million, or 5%.
Income Taxes
We record valuation allowances against our deferred tax assets when it is more likely than not that all or a portion of a deferred tax asset will not be realized. We
routinely evaluate the realizability of our deferred tax assets by assessing the likelihood that our deferred tax assets will be recovered based on all available positive
and negative evidence, including scheduled reversals of deferred tax liabilities, estimates of future taxable income, tax planning strategies and results of operations.
Estimating future taxable income is inherently uncertain and requires judgment. In projecting future taxable income, we consider our historical results and
incorporate certain assumptions, including projected Shack openings, revenue growth, and operating margins, among others. As of December 30, 2015 , we had
$202.3 million of deferred tax assets, net of valuation allowances. We expect to realize future tax benefits related to the utilization of these assets. If we determine
in the future that we will not be able to fully utilize all or part of these deferred tax assets, we would record a valuation allowance through earnings in the period the
determination was made, which would have an adverse effect on our results of operations and earnings in future periods.
Liabilities Under Tax Receivable Agreement
As described in Note 14 to the consolidated financial statements included in Item 8, we are a party to the Tax Receivable Agreement under which we are
contractually committed to pay the Continuing SSE Equity Owners 85% of the amount of any tax benefits that we actually realize, or in some cases are deemed to
realize, as a result of certain transactions. Amounts payable under the Tax Receivable Agreement are contingent upon, among other things, (i) generation of future
taxable income over the term of the Tax Receivable Agreement and (ii) future changes in tax laws. If we do not generate sufficient taxable income in the aggregate
over the term of the Tax Receivable Agreement to utilize the tax benefits, then we would not be required to make the related TRA Payments. Therefore, we would
only recognize a liability for TRA Payments if we determine if it is probable that we will generate sufficient future taxable income over the term of the Tax
Receivable Agreement to utilize the related tax benefits. Estimating future taxable income is inherently uncertain and requires judgment. In projecting future
taxable income, we consider our historical results and incorporate certain assumptions, including projected Shack openings, revenue growth, and operating
margins, among others. During fiscal 2015 , as a result of the Special Distribution and redemptions of LLC Interests, we recognized liabilities totaling $173.1
million relating to our obligations under the Tax Receivable Agreement, after concluding that it was probable that we would have sufficient future taxable income
to utilize the related tax benefits. If we determine in the future that we will not be able to fully utilize all or part of the related tax benefits, we would derecognize
the portion of the liability related the benefits not expected to be utilized.
Additionally, we estimate the amount of TRA Payments expected to be paid within the next 12 months and classify this amount as current on our Consolidated
Balance Sheets. This determination is based on our estimate of taxable income for the next fiscal year. To the extent our estimate differs from actual results, we
may be required reclassify portions of our liabilities under the Tax Receivable Agreement between current and non-current.
65 | Shake Shack Inc. Form 10-K