Biglari Holdings Inc. (BH) FY 2021 MD&A

Item 7.    Management’s Discussion and Analysis of Financial Condition and Results of Operations

(dollars in thousands except per share data)

Biglari Holdings Inc. is a holding company owning subsidiaries engaged in a number of diverse business activities, including property and casualty insurance, licensing and media, restaurants, and oil and gas. The Company’s largest operating subsidiaries are involved in the franchising and operating of restaurants. Biglari Holdings is founded and led by Sardar Biglari, Chairman and Chief Executive Officer of the Company.

Biglari Holdings’ management system combines decentralized operations with centralized finance decision-making. Operating decisions for the various business units are made by their respective managers. All major investment and capital allocation decisions are made for the Company and its subsidiaries by Mr. Biglari.

As of December 31, 2021, Mr. Biglari beneficially owns shares of the Company that represent approximately 66.2% of the economic interest and approximately 70.4% of the voting interest.

Overview of the Impact of COVID-19

The novel coronavirus (“COVID-19”), declared a pandemic by the World Health Organization in March 2020, caused governments to impose restrictive measures to contain its spread. Those shutdowns significantly affected our operating businesses to varying degrees. The risks and uncertainties resulting from COVID-19 and its variants may continue to affect our future earnings, cash flows, and financial condition. Accordingly, estimates used in the preparation of our financial statements, including those associated with the evaluation of certain long-lived assets, goodwill, and other intangible assets for impairment, may be subject to significant adjustments in future periods.

Business Acquisition

On March 9, 2020, Biglari Holdings acquired the stock of Southern Pioneer Property & Casualty Insurance Company and its affiliated agency, Southern Pioneer Insurance Agency, Inc. (collectively “Southern Pioneer”). Southern Pioneer underwrites garage liability and commercial property as well as homeowners and dwelling fire insurance coverage. The Company’s financial results include the results of Southern Pioneer from the date of acquisition.

Discussion of Operations

Net earnings attributable to Biglari Holdings shareholders are disaggregated in the table that follows. Amounts are recorded after deducting income taxes.

The following discussion should be read in conjunction with Item 1, Business and our Consolidated Financial Statements and the notes thereto included in this Form 10-K. The following discussion should also be read in conjunction with the “Cautionary Note Regarding Forward-Looking Statements” and the risks and uncertainties described in Item 1A, Risk Factors set forth above.

Our Management Discussion and Analysis generally discusses 2021 and 2020 items and year-to-year comparisons between 2021 and 2020. Discussions of 2019 items and year-to-year comparisons between 2020 and 2019 can be found in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II, Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2020, filed with the SEC on March 1, 2021.

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Management’s Discussion and Analysis (continued)

Restaurants

Our restaurant businesses, which include Steak n Shake and Western Sizzlin, comprise 577 company-operated and franchise restaurants as of December 31, 2021.

As of December 31, 2021, 42 of the 199 company-operated Steak n Shake stores were closed. Over the past two years, Steak n Shake reopened 50 locations that were previously closed. We plan to refranchise a majority of our closed company-operated restaurants.

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Management’s Discussion and Analysis (continued)

Restaurant operations for 2021, 2020 and 2019 are summarized below.

Cost of food, restaurant operating costs, and occupancy costs are expressed as a percentage of net sales.

General and administrative, marketing, other expenses, impairments, and depreciation and amortization are expressed as a percentage of total revenue.

The COVID-19 pandemic has adversely affected our restaurant operations and financial results. Our restaurants were required to close their dining rooms during the first quarter of 2020.

The majority of Steak n Shake’s dining rooms remained closed through the end of 2020 but were reopened during 2021, and in doing so implemented a self-service model. The transformation has resulted in higher capital expenditures in 2021 as compared to prior years. Steak n Shake has spent approximately $40,000 in capital expenditures related to the conversion of table-service restaurants to self-service restaurants.

Net sales during 2021 were $187,913, as compared to $306,577 during 2020. The decrease in revenue of company-owned restaurants is primarily due to the shift of company units to franchise partner units. For company-operated units, sales to the end customer are recorded as revenue generated by the Company, but for franchise partner units, only our share of the restaurant's profits, along with certain fees, are recorded as revenue. Because we derive most of our revenue from our share of the profits, revenue will continue to decline as we transition from company-operated units to franchise partner units.

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Management’s Discussion and Analysis (continued)

Franchise partner fees were $55,641 during 2021, as compared to $22,213 during 2020. As of December 31, 2021, there were 159 franchise partner units, as compared to 86 franchise partner units as of December 31, 2020. For a franchise partner to be awarded a restaurant, he or she must demonstrate the gold standard in service.

The franchise royalties and fees generated by the traditional franchising business were $21,736 during 2021, as compared to $18,794 during 2020. The increase in franchise royalties and fees was primarily due to the reopening of dining rooms in 2021.

Our drive-through, carryout, and delivery capabilities positioned us to improve profitability in 2021 and 2020; however, our business has been challenged by COVID-19 related labor availability.

The cost of food in 2021 was $55,315, or 29.4% of net sales, as compared to $88,698, or 28.9% of net sales in 2020. Restaurant operating costs during 2021 were $92,543, or 49.2% of net sales, as compared to $137,574, or 44.9% of net sales in 2020. The decreases in the cost of food and operating costs are mainly attributable to the transitioning of company-operated units to franchise partner units. The increase in operating costs as a percentage of net sales is mainly attributable to increasing wages — in our pursuit to become the maximum-wage employer in our category.

Selling, general and administrative expenses during 2021 were $57,186, or 21.1% of total revenues compared to $60,401, or 17.2% of total revenues during 2020. General and administrative expenses increased as a percentage of net sales during 2021, as compared to 2020, primarily because of an increase in legal fees. Marketing expenses decreased by $7,584 in 2021 as compared to 2020, primarily by shifting to a digital strategy.

Asset impairments decreased $19,011 during 2021 compared to 2020. Higher asset impairments were recorded in 2020 primarily because of dining room closures and uncertainties caused by the pandemic.

Interest on obligations under leases was $6,039 during 2021, versus $6,274 during 2020. The year-over-year decrease in interest expense is primarily attributable to the maturity and retirement of lease obligations.

Insurance

We view our insurance businesses as possessing two activities: underwriting and investing. Underwriting decisions are the responsibility of the unit managers, whereas investing decisions are the responsibility of our Chairman and CEO, Sardar Biglari. Our business units are operated under separate local management. Biglari Holdings’ insurance operations consist of First Guard and Southern Pioneer.

Underwriting results of our insurance operations are summarized below.

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Management’s Discussion and Analysis (continued)

Earnings of our insurance operations are summarized below.

Insurance premiums and other on the consolidated statement of earnings includes premiums earned, investment income, other income, and commissions. Commissions are in other income (expense) in the above table.

First Guard

First Guard is a direct underwriter of commercial truck insurance, selling physical damage and nontrucking liability insurance to truckers. First Guard’s insurance products are marketed primarily through direct response methods via the Internet or by telephone. First Guard’s cost-efficient direct response marketing methods enable it to be a low-cost insurer. A summary of First Guard’s underwriting results follows.

Southern Pioneer

Southern Pioneer underwrites garage liability and commercial property insurance, as well as homeowners and dwelling fire insurance. The financial results for Southern Pioneer are from the date of acquisition March 9, 2020. A summary of Southern Pioneer’s underwriting results follows.

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Management’s Discussion and Analysis (continued)

Insurance – Investment Income

A summary of net investment income attributable to our insurance operations follows.

We consider investment income as a component of our aggregate insurance operating results. However, we consider investment gains and losses, whether realized or unrealized, as non-operating.

Oil and Gas

Southern Oil primarily operates oil and natural gas properties offshore in the shallow waters of the Gulf of Mexico. Southern Oil was acquired on September 9, 2019. Earnings for Southern Oil are summarized below.

Initially, the COVID-19 pandemic caused oil demand to significantly decrease, creating oversupplied markets that have resulted in lower commodity prices and margins. In response, the Company cut production and expenses in its oil and natural gas business during 2020. In 2021, however, the significant increase in average crude oil and natural gas prices resulting from the lifting of COVID-19 restrictions, the resumption of normal economic activity, and the resulting improvement in supply and demand fundamentals caused Southern Oil to return to full production.

Brand Licensing

Maxim’s business lies principally in licensing and media. Earnings of operations are summarized below.

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Management’s Discussion and Analysis (continued)

We acquired Maxim with the idea of transforming its business model. The magazine developed the Maxim brand, a franchise we are utilizing to generate nonmagazine revenue, notably through licensing, a cash-generating business related to consumer products, services, and events.

Investment Gains and Investment Partnership Gains

Investment gains were $6,401 ($4,832 net of tax) in 2021 and $3,644 ($2,877 net of tax) in 2020. Investment gains in 2021 included a gain from the sale of real estate of $5,047 ($3,785, net of tax). Dividends earned on investments are reported as investment income by our insurance companies. We consider investment income as a component of our aggregate insurance operating results. However, we consider investment gains and losses, whether realized or unrealized, as non-operating.

Earnings from our investments in partnerships are summarized below.

Investment partnership gains include gains/losses from changes in market values of underlying investments and dividends earned by the partnerships. Dividend income has a lower effective tax rate than income from capital gains. These gains and losses have caused and will continue to cause significant volatility in our periodic earnings.

The investment partnerships hold the Company’s common stock as investments. The Company’s pro-rata share of its common stock held by the investment partnerships is recorded as treasury stock even though these shares are legally outstanding. Gains and losses on Company common stock included in the earnings of the partnerships are eliminated in the Company’s consolidated financial results.

Interest Expense

The Company’s interest expense is summarized below.

Interest expense during 2021 decreased by $8,141 compared to 2020 due to the repayment of Steak n Shake’s term loan in full on February 19, 2021.

Income Taxes

Consolidated income tax expense was $6,789 in 2021 versus a benefit of $12,212 in 2020. Income tax expense increased during 2021 compared to 2020, primarily due to a tax benefit of $10,526 for investment partnership losses of $43,032 in 2020.

Corporate and Other

Corporate expenses exclude the activities of the restaurant, insurance, brand licensing, and oil and gas businesses. Corporate and other net losses of $9,829 during 2021 increased compared to 2020 due to higher legal expenses.

Financial Condition

Our consolidated shareholders’ equity on December 31, 2021 was $587,696, an increase of $22,868 compared to the December 31, 2020 balance. The increase was primarily due to net income of $35,478 offset by an increase in treasury stock of $12,234.

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Management’s Discussion and Analysis (continued)

Consolidated cash and investments are summarized below.

Unrealized gains/losses of Biglari Holdings’ stock held by the investment partnerships are eliminated in the Company’s consolidated financial results.

Liquidity

Our balance sheet continues to maintain significant liquidity. Consolidated cash flow activities are summarized below.

In 2021, cash from operating activities increased by $111,211, as compared to 2020. The increase was primarily attributable to distributions from investment partnerships of $180,170 for 2021 and $98,330 for 2020. The distributions during 2021 were primarily used to repay Steak n Shake’s term loan.

Net cash used in investing activities decreased during 2021 by $70,962, as compared to 2020. The decrease was primarily due to the acquisition of Southern Pioneer and purchases of limited partner interests during 2020.

Net cash used in financing activities increased by $127,048 in 2021, as compared to 2020. The increase was primarily due to the repayment of Steak n Shake’s outstanding balance of its term debt during 2021.

We intend to meet the working capital needs of our operating subsidiaries, principally through cash flows generated from operations and cash on hand. We continually review available financing alternatives.

Steak n Shake Credit Facility

On March 19, 2014, Steak n Shake and its subsidiaries entered into a credit agreement that provided for a senior secured term loan facility in an aggregate principal amount of $220,000. The term loan was scheduled to mature on March 19, 2021. As of December 31, 2020, $152,506 was outstanding. The Company repaid Steak n Shake’s outstanding balance in full on February 19, 2021.

Western Sizzlin Revolver

As of December 31, 2021 and 2020, Western Sizzlin had no debt outstanding under its revolver.

Critical Accounting Policies

Certain accounting policies require us to make estimates and judgments in determining the amounts reflected in the consolidated financial statements. Such estimates and judgments necessarily involve varying, and possibly significant, degrees of uncertainty. Accordingly, certain amounts currently recorded in the financial statements will likely be adjusted in the future based on new available information and changes in other facts and circumstances. A discussion of our principal accounting policies that required the application of significant judgments as of December 31, 2021, follows.

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Management’s Discussion and Analysis (continued)

Consolidation

The consolidated financial statements include the accounts of Biglari Holdings Inc. and the wholly owned subsidiaries of Biglari Holdings Inc. The analysis as to whether to consolidate an entity is subject to a significant amount of judgment. All intercompany accounts and transactions are eliminated in consolidation.

Our interests in the investment partnerships are accounted for as equity method investments because of our retained limited partner interest in the investment partnerships. The Company records gains from investment partnerships (inclusive of the investment partnerships’ unrealized gains and losses on their securities) in the consolidated statement of earnings based on our proportional ownership interest in the investment partnerships.

Impairment of Restaurant Long-lived Assets

We review company-operated restaurants for impairment on a restaurant-by-restaurant basis when events or circumstances indicate a possible impairment. Assets included in the impairment assessment generally consist of property, equipment and leasehold improvements directly associated with an individual restaurant as well as any related finance or operating lease assets. We test for impairment by comparing the carrying value of the asset to the undiscounted future cash flows expected to be generated by the asset. If the total estimated future cash flows are less than the carrying amount of the asset, the carrying value is written down to the estimated fair value, and a loss is recognized in earnings. Determining the future cash flows expected to be generated by an asset requires significant judgment regarding future performance of the asset, fair market value if the asset were to be sold, and other financial and economic assumptions.

Oil and Natural Gas Reserves

Crude oil and natural gas reserves are estimates of future production that impact certain asset and expense accounts. Proved reserves are the estimated quantities of oil and gas that geoscience and engineering data demonstrate with reasonable certainty to be economically producible in the future under existing economic conditions, operating methods and government regulations. Proved reserves include both developed and undeveloped volumes. Proved developed reserves represent volumes expected to be recovered through existing wells with existing equipment and operating methods. Proved undeveloped reserves are volumes expected to be recovered from new wells on undrilled proved acreage, or from existing wells where expenditure is required for recompletion. We estimate our proved oil and natural gas reserves in accordance with the guidelines established by the SEC. Due to the inherent uncertainties and the limited nature of reservoir data, estimates of reserves are subject to change as additional information becomes available.

Income Taxes

We record deferred tax assets or liabilities based on differences between financial reporting and the tax basis of assets and liabilities using currently enacted rates and laws that will be in effect when the differences are expected to reverse. We record deferred tax assets to the extent we believe there will be sufficient future taxable income to utilize those assets prior to their expiration. To the extent deferred tax assets are unable to be utilized, we would record a valuation allowance against the unrealizable amount and record that amount as a charge against earnings. Due to changing tax laws and state income tax rates, significant judgment is required to estimate the effective tax rate applicable to tax differences arising from reversal in the future. We must also make estimates about the sufficiency of taxable income in future periods to offset any deductions related to deferred tax assets currently recorded.

Goodwill and Other Intangible Assets

We evaluate goodwill and any indefinite-lived intangible assets for impairment annually, or more frequently if circumstances indicate impairment may have occurred. Goodwill impairment occurs when the estimated fair value of goodwill is less than its carrying value. The valuation methodology and underlying financial information included in our determination of fair value require significant managerial judgment. We use both market and income approaches to derive fair value. The methods behind these two approaches include, but are not limited to, comparable market multiples, long-term projections of future financial performance, and the selection of appropriate discount rates used to determine the present value of future cash flows.

Leases

We determine whether a contract is or contains a lease at contract inception based on the presence of identified assets and our right to obtain substantially all of the economic benefit from, or to direct the use of, such assets. When we determine a lease exists, we record a right-of-use asset and corresponding lease liability on our consolidated balance sheets. Right-of-use assets represent our right to use an underlying asset for the lease term. Lease liabilities represent our obligation to make lease payments arising from the lease. Right-of-use assets are recognized at commencement date at the value of the lease liability and are adjusted for any prepayments, lease incentives received, and initial direct costs incurred. Lease liabilities are recognized at the lease commencement date based on the present value of remaining lease payments over the lease term. As the discount rate

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Management’s Discussion and Analysis (continued)

implicit in the lease is not readily determinable in most of our leases, we use our incremental borrowing rate based on the information available at commencement date in determining the present value of lease payments. Our lease terms include options to extend or terminate the lease when it is reasonably certain that we will exercise that option. We do not record lease contracts with a term of 12 months or less on our consolidated balance sheets. We recognize fixed lease expense for operating leases on a straight-line basis over the lease term. For finance leases, we recognize amortization expense on the right-of-use asset and interest expense on the lease liability over the lease term.

Cautionary Note Regarding Forward-Looking Statements

This report includes forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. In general, forward-looking statements include estimates of future revenues, cash flows, capital expenditures, or other financial items, and assumptions underlying any of the foregoing. Forward-looking statements reflect management’s current expectations regarding future events and use words such as “anticipate,” “believe,” “expect,” “may,” and other similar terminology. A forward-looking statement is neither a prediction nor a guarantee of future events or circumstances, and those future events or circumstances may not occur. Investors should not place undue reliance on the forward-looking statements, which speak only as of the date of this report. These forward-looking statements are all based on currently available operating, financial, and competitive information and are subject to various risks and uncertainties. Our actual future results and trends may differ materially depending on a variety of factors, many beyond our control, including, but not limited to, the risks and uncertainties described in Item 1A, Risk Factors set forth above. We undertake no obligation to publicly update or revise them, except as may be required by law.

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