Thursday, January 29, 2009

Steak 'N Shake Q1 2009 results

[Note to Andy and everyone else that's reading this: Based on Andy's comment, I fixed the section that describes the adjustments needed to arrive at operational cash flows that are attributable to owner earnings and the corresponding errors in calculation. I figured it'd be easier to fix it here rather than have people drill down the comments section to see the errors. Thanks Andy! I'll leave the original section in as a comment, as an example of how not to describe the required adjustments.]
The 10-Q is here:

SNS reported an operational loss, before taxes, of $5.981 million. This number includes depreciation charges of $7.392 million. The actual maintenance capex for this quarter: $1.974 million. This discrepancy implies that GAAP earnings will understate the economic earnings of this business.

Adjustments to reported net income to arrive at operational cash flows that are attributable to owner earnings:
Net income: -($3.44 million) 
Add back depreciation: +$7.392 million
Add back increased provision for income taxes: +$.733 million
Add back asset impairments and provision for restaurant closings: +$.176 million
Subtract gain on sale of property: -($.59 million). Correction(thanks to Andy again!): -($.059 million)
Subtract cash that resulted from changes in other assets: -($1.104 million)

Items that weren't included in the adjustment to net income: Stock compensation expense and changes in working capital. Adjusted cash flow from operations amounts to $3.698 million. With maintenance capex at $1.974 million, we get an owner earnings estimate of $1.724 million.

The sharp-eyed reader will note that we are ignoring one other cash outflow that should lower this estimate. Remember that in our evaluation of SNS' balance sheet, we only considered interest-bearing debt as long-term debt. The capital lease obligations, while still a liability, wasn't really considered as debt. From our discussion on accounting for capital leases, remember that we agreed to postpone implications of capital lease accounting on classification of cash flows. Not any longer. When a company has debt on it's books, the cash flows relating to that debt are classified as follows:

Interest payments are considered part of operations and are classified as cash flows from operations.
Principal repayments are classified as cash flows from financing activities.

Since the capital leases are accounted for as debt, the principal repayments on this debt are accounted for as financing cash outflows. If we don't consider the capital lease obligations as debt, consistency demands that we factor in the principal repayments on the lease obligations as a recurring claim against owner earnings. The principal repayments, on the long-term debt and the capital lease obligations, are broken out under the section titled 'Financing Activities' in the statement of cash flows. The payments for the lease obligations for this quarter amounted to $1.066 million. This reduces our owner's earnings estimate for this quarter to $.658 million. 

There's another reason that we ought to account for the principal payments on the lease obligations as operational cash flows. The success of SNS as an investment is dependent on Sardar Biglari fixing two things: operations and capital allocation, with much of the value creation likely to be derived from capital allocation. To determine the effect of capital allocation, we'd need a realistic estimate of the capital that will be available for Sardar to allocate. Based on the numbers above, it's clear that there isn't much capital left at present to allocate outside of business operations. This is likely to change as Sardar and co. continue the business turnaround.

With that detour into accounting issues complete, we'll turn our focus onto the balance sheet at the end of Q1. Cash amounting to $11.351 million was received as tax refunds. There was a prepayment on the Prudential Senior Note in the amount of $4.476 million. The borrowings at the end of the quarter were:

Line of credit in the amount of $19.84 million @ 4.1%
Long-term debt in the amount of $11.957 million @ 9%

Against this, we have assets held for sale on the books at $23.24 million and cash and equivalents of $25.636 million. It's reasonable to expect, based on the above, that SNS is a fair chance to be debt-free by the end of the fiscal year.

On to earnings. These were skewed by a couple of items. The prepayment of a portion of the long-term debt resulted in a penalty of $506,000. Assuming that the prepayment happened at the start of the quarter, the interest savings would've amounted to $100,710. So, interest expense is likely overstated by around $405,000, at the very least. Marketing expenses were higher by $1.542 million this quarter compared to the same quarter in fiscal 2008. Management indicates that this was by design although I'd doubt that this is a permanent increase. I suspect we'll see this expense, as a percentage of sales, trend down once sales stabilize.

All things considered, this was a pretty good quarter. Based on Sardar's estimates on Investor Day, I expect that we haven't seen the full benefits of the envisioned cost savings. There's still a lot of work to do with reversing the guest traffic and same store sales trends, but the signs from this quarter are encouraging.

Often wrong but seldom in doubt,


  1. Ragu,

    Enjoy your blog. I have a few questions but I'd like to confirm your calculations so that we are starting with the same numbers. Can you detail the $3.698mm figure? Using your stated adjustments to CFFO I get $5.358mm (-3.440+7.392+.176+1.230) or a difference of $1.660mm.



  2. Here's the original section that attempted to describe the necessary adjustment to net income to come up with operational cash flows attributable to owner earnings:

    "Cash flows from operations(adjusted to ignore changes in working capital and other assets, the loss on sale of property and the increase in the provision for deferred taxes but not stock compensation charges) amounted to $3.698 million."

    Best to ignore this.


  3. Andy,

    Glad you like the blog. I've updated the post with what I hope is a clearer explanation of the necessary adjustments(and other minor edits). Looking forward to your questions.


  4. Ragu,

    Before my questions, the gain on sale is -$0.059 (not -$.59) so the owner earnings calculated above is slightly higher. The missed zero is confirmation that you we up too late to be typing! LOL

    The broader theme of your post is that you can't have it both ways regarding capitalized lease obligations. If you are not going to classify them as debt on the balance sheet, then you must treat P&I lease obligations like rent from a cashflow standpoint and back them out of CFFO to get owner earnings. This is sensible.

    But what about working capital? If SNS (or any company) were to sell some goods and take on an IOU in the form of a receivable, the revenue would be refected in net income. If corresponding change in this non-cash receivable (WC) is not used to reduce net income, isn't that having it both ways and overstating owner earnings? This would argue for including changes in WC to the calculation of core owner earnings.

    (I'm not addressing one-time items like SNS's $10.632mm tax refund, or a temporary inventory reduction as it does make sense to me that these should be exluded when estimating core owner earning.)



  5. Andy,

    Thanks for the correction!

    Re. revenues and corresponding IOU's vs principal payments on lease obligations:

    The purpose of the owner earnings calculation is to determine how much cash can be distributed to owners without affecting current profitability. When you have receivables claims against sales prior, it is reasonable to expect that the cash will be there when you reach for it (in a year or less). So, no overstatement of owner earnings in this case. Ignoring the principal payments on a lease obligation will result in reaching out for cash that won't be there. Clearly an overstatement of owner earnings in this case.

    Trust this answers your question.


  6. Hey Ragu,

    A question on a different topic - is there a way to find executive compensation in SEC filings ?

    I dont see them in annual reports and proxy statements are not available on


  7. Hi Qleap,

    The proxies are available on See on how to find the information you requested. Short answer: If it's not in the annual report, you are most likely to find it in a proxy filing whose type is 'DEF 14A'.


  8. Maybe a simple example will better express my question. Lets say you open a business with $50k and and have no other assets. You buy a piece of inventory for $50k and the next day you sell it for $70k, but the $70k is a receivable and will not come due for 6 months.
    Your income statement shows a $20k profit. So far, so good. Now if you were to ignore changes in working capital to your caluclation, owner earnings would be $20k when the business doesnt have a single dime in free cash. Clearly, owner earnings are overstated. If the $70k increase in working capital were included in the calculation, owner earnings would be $20k-$70k = -$50k and would properly reflect the movement of cash during the relevant period. In six months, owner earnings would be $70k when the receivable is reduced and the money is collected.

    This suggests that changes in WC should be included in the calculation of owner earnings.

  9. Andy,

    I believe we are talking about two different things: you are describing cash flows whereas owner earnings concerns itself with earnings that will result in the generation of cash. The owner earnings calculation is based on the accrual basis of accounting i.e. assigning earnings to the period in which they are actually earned. In your example, the profit of 20k was earned in Q1(say), even though the cash won't come in the door for another 6 months. The timing of the cash flows pertaining to the earnings, while important in it's own right, is not material to the owner earnings calculation for the period in question.

    Hope this clarifies.


  10. Thanks.

    The important take away here is that owner earnings are about valuation, while FCF is all about liquidity. Ignoring either one can lead to bad results. Owner earnings presumes that management is capable and prudent in balance sheet management and that their decision making leaves the firm in a position to continue to be a going concern. FCF (CFFO-cap ex), on the other hand, isnt always appropriate as a valuation measure since some of that cash may be claimed by someone other than shareholders. But it is a very important measure of the firms ability to pay required obligations.

    Ignore either one at your peril!



  11. Ragu,

    You should be very familiar in valuing restaurants.would you help me to evaluate a fast food company in Indonesia (FAST),and generate an estimate of owner's earnings. This is the link to 2008 financial statement.Thanks alot!