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No. of Recommendations: 21
I consider Biglari Holdings as a restaurant business until Biglari proves it is a diversified holding company. To that end I am not going to count the revenue, earnings and cash flow attributed to the miniscule, somewhat convoluted Biglari Capital. Why is everything named after him? Let’s call the business Steak n Shake for now

Steak n Shake had a forgettable quarter. It is now feeling the pain of trying to comp well on high comps from 2010. If I were in the habit of using business jargon I would say the low hanging fruit has been plucked. From here Biglari is going to have to show he knows more about running successful restaurants than trimming the menu, firing employees and cutting employee benefits.

It was my opinion last quarter and at the year-end that Steak n Shake was running out of steam and comps and increased traffic were continuing to diverge and slow. Traffic has increased at bigger percentages than same store sales increases indicating some slipping in pricing. That divergence continues into 2011.

Here is data from last quarter:


BH may have done all it can do with 412 SNS restaurants and 5 Western Sizzlin’ restaurants as far as increasing traffic substantially and increasing same store sales.

They peaked at the end of 2009 and the first Q of 2010. It has been lower in the last 3 quarters

The company has been forced to increase traffic at the expense of lower checks. This results in same store sales that lag traffic. They commented on the lower checks per customer several times over the last few Qs





Customer traffic Same store sales
--------------------------------------------------------------
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4
===================================|===========================
2005 - - - -6.7 | - - - -3.0
2006 -5.1 -5.0 -7.9 -6.5 | -1.1 -0.3 -3.9 -3.4
2007 -3.8 -6.0 -5.7 -6.6 | -1.7 -4.7 -4.3 -3.9
2008 -13.3 -8.8 -8.5 -10.2 | -9.5 -6.3 -5.8 -7.4
2009 -0.9 7.8 13.4 20.0 | -1.4 2.4 5.0 10.1
2010 23.0 7.4 9.6 8.6 | 14.4 5.1 7.5 6.8


It was fairly easy pickings in 2009 beating the awful results set into motion by previous management. As cost cutting took hold and the ceaseless senseless growth by opening new restaurants was stopped, the remaining store revenues and earnings began to look extremely good. Props to Big, he did manage to win back the customer as evidenced by traffic.

By Q4 2010, same store sales were up 6.8% and traffic increased 8.6%. The growth showed definite signs of fatigue and the top had apparently been put in Q1 2010. How does Q1 2011 compare? Granted the comps are very tough.

Net Sales

In Q1 2011, restaurant revenue increased 3.5% from $147,924 to $153,059.

Steak n Shake’s same store sales increased 2.1%

Guest traffic was up 3.5%

Steak n Shake along with Western saw lower average selling prices resulting in slower growth in revenue. The acquisition of Western increased total revenue by $2.95 million or 1.9%. For those who are interested in Steak n Shake performance that works out to a modest 1.6% increase in revenue for the parent company.

There were no new company stores opened or closed and there were four franchises added


Company-owned Franchised Total
=======================================================
Steak n Shake 412 75 487
Western 5 90 95
===================================================
Total 417 165 582



Franchise fees increased $1.126 million or 122.5% primarily because of the inclusion of Western franchised units.

Franchising is Biglari’s growth vehicle of choice. Four units per quarter is not much growth. While franchise margins are good, the fees are low compared to revenue from company owned stores and it will take a much larger growth in franchises to increase revenue growth noticeably. Western as a franchise offering is of questionable value. Western franchises were shrinking yearly before they were acquired.

In 2009 there were 412, company stores and 73 franchises. We are not seeing much progress in getting franchised revenue as a bigger percentage of total revenue. Franchises need to offer prospective profits to buyers to sell. I don’t know how attractive SNS is in the fast casual market for franchises. The slow growth would suggest it is not the hottest franchise product on the market.

At first glance earnings and cash flow appear to have taken off like the proverbial rocket. Diluted EPS Q1 2011 was $7.08 compared to $3.82 for Q1 2010—almost doubled. Cash flow from operations was $27 million compared to $19.7 million in the same quarter last year.

Recalling that we are looking at a restaurant business requires that we examine the earnings and cash flow a little more carefully.

The P&L through the restaurant lens

There is indeed a $7.08 EPS at the bottom of the statement but getting there includes a lot of additions that are not part of the core restaurant business

Total revenue from restaurants was $155.6 million and from Biglari capital we get $3.1 million in revenue. It’s clear this is a restaurant business as Biglari capital and its management fees add very little in revenue. For that reason I think it makes sense to see how restaurant earnings are holding up.

After all restaurant operating costs are taken out, we are left with $9.9 million in operating income or 6.4% operating income margins. Q1 2010 operating income was $10.4 million –- 2011 operating income declined 4.7% year-over-year. Margins Q1 2010 were 7% and 2011 saw a decrease of 0.6% in operating margins.

After operating income we start to see other non-restaurant earnings such as gains on investments that would not be considered core business. If we take out the $3.1 million in investment management revenue [not present in 2010] and the $2.9 million in investment gains [both subjected to the tax rate of 33%] and the $2.5 million incentive fee allocation [not taxed and not present in 2010] we get $6.5 million in after tax net income that is not a product of restaurant operations. Net income attributable to restaurant operations would be an adjusted $2.9 million compared to $5.5 million for Q1 FY 2010.

All of the items I removed were new in Q1 2011 compared to last year. The numbers point to restaurant operations that are not growing.

Taking it to the last step, EPS on just restaurant net are $2.20 and the rest is attributable to Biglari Capital

EPS in Q1 2010 were $3.82 and that is all restaurant revenue and earnings since Biglari Capital did not exist

I do realize this is a holding company and earnings are earnings and it all counts. This exercise was to show how restaurants are doing and it appears they are seeing higher expense and slower growth. The other consideration is the addition of Western Sizzlin’ that had poorly performing company stores operating at a loss for years. This may have increased expense while adding little to growth.

You could point out that it is a great step forward that such a small sliver of the company can add an outsized amount to earnings and that can’t be denied. But some of this revenue is not a predictable source of income and that would include the gains on sales at $3 million and the incentive fee reallocation at $2.5 million.

Cash flow through the same lens

Cash flow from operations was an impressive $27 million compared to the $19.7 million in Q1 2010.

The cash flow statement starts with a net of $8.8 million that includes management income and the gain on sales [but not the incentive fee] the gain on sale is backed out, as it should be. Where the cash flow statement parts company with my understanding of cash flow from operations is the section that adds in investment operations of consolidated affiliated partners

In thousands

Investment operations of consolidated
affiliated partnerships:


Purchases of investments (16,997)
Sales of investments 31,447
Realized investment (gains), net (2,462)
Unrealized losses on marketable securities (225)
held by consolidated affiliated partnerships
Changes in cash equivalents held by consolidated
affiliated partnerships 401
=========================================================
total 12,164


I wonder if this would not be more accurately placed in investing activities?

Cash flow from operations ideally should give the investor an idea of what could be expected to be a sustainable amount generated by the core businesses. If investments in debt and equity are classified as available for sale then they belong in the cash from investing activities. On the BH balance sheets assets are described as available for sale.

The exception to this is if we are looking at a company that makes money by high activity trading and classifies its assets as trading assets. In my perhaps uneducated opinion BH has overstated cash flow by $12.2 million. That makes cash flow from operations $14.8 million compared to $19.7 million last year. While still a nice positive CFFO it is in decline. Again, in Q1 2010 there was no investment operations of consolidated affiliated partnerships that added to CFFO.



Finally

There is the unattractive matter of Sardar Biglari’s pay scale. The results to date would suggest he is not worth a lot more for running the 2011 restaurant business than he was when he was earning $900,000 and no incentive. His pay was increased from $280,000 to $900,000 in FY 2010. Any guesses on what he took home for 2010? You may be surprised.

Here it is in all its gory detail

High Water Mark

Mr. Biglari will not receive incentive compensation under the Incentive Agreement unless the Corporation’s book value exceeds the previous highest level in book value, or the “high water mark,” plus a 6% growth in book value, i.e., the hurdle rate. As such, in a fiscal year in which book value declines, the marker for subsequent fiscal years will require the complete recovery of the deficit from the last high water mark plus attaining the stated 6% hurdle rate before Mr. Biglari is eligible for a bonus.


This is an incentive that is in addition to his $900,000 voted in during 2009. I read the incentive as he has to hit the hurdle for the year, but that is not how it works—it is prorated.

the pay package that was

For fiscal 2010, Mr. Biglari’s incentive bonus was determined solely with respect to the fourth fiscal quarter, during which the Company’s adjusted book value grew by 3.2%. Accordingly, a pro rata adjusted book value growth hurdle of approximately 1.4% (based on the number of days in such quarter) was used to determine the incentive bonus payment to Mr. Biglari with respect to such quarter, and the 3.2% increase in the Company’s adjusted book value during such quarter resulted in an incentive bonus payment to Mr. Biglari of $1,206,896. Mr. Biglari’s current base salary of $900,000 was set during fiscal 2009 by the Compensation Committee of the Board of Directors (prior to being merged with the Governance and Nominating Committee).

Here is the summary

Compensation

                              
Who Year salary non-equity other total
========================================================
Sardar
Biglari 2010 $900,000 $1,206,896 $15,660 $2,122,556
2009 $467,231 $48,214 $515,445
2008 $30,105 $14,535 $44,640

CFO/VP
Duane bonus
Geiger 2010 $200,000 $160,000 $11,389 $371,389
2009 $194,712 $90,000 $8,185 $292,897

salary stock options other total
2008 $187,500 $77,792 $68,555 $15,992 $349,836



In 3 short years salary has gone from $44,640 to $2.1 million.

I don’t know adjusted book value is. At the end of FY 2010 shareholder equity was $248.99 million and in Q3 2010 it was $242.39 for an increase of 6.6% from Q3 2010 to Q4 2010. September 2009 equity was $291.9 million.


If Steak n Shake continues to lag previous growth, shareholders will need to see Biglari step into his role as master allocator of capital and make some profitable acquisitions to realize the promise built into betting on the jockey and not the existing business.
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