Steak n Shake expects ‘rebuilding year’

For a company built on such a simple formula, the last few years at Steak n Shake Co. have seemed exceedingly complicated.

CEO Peter M. Dunn methodically analyzed and measured just about everything, from drive-through times to employee turnover.
All the talk of research and testing was welcome when the company was thriving a few years ago. But the seemingly endless
analysis–and the lack of evidence it was paying off–gradually eroded Wall Street's confidence in the 52-year-old, Harvard-educated
executive.

Dunn resigned last week, a few days after the Indianapolis-based restaurant chain reported an eighth consecutive quarter
of declining same-store sales–bleak results that sent shares to a 52-week low.

Observers say Steak n Shake executives had become so bogged down in studies, tests and metrics that they'd lost their
nerve to act decisively.

The company wasn't nimble enough to respond to quick-service competitors such as Arby's, Wendy's and McDonald's,
which improved their offerings to compete more directly with full-service restaurants.

"They seemed to be throwing things against the wall. There didn't seem to be any strategic direction," said
Michael W. Gallo, senior vice president of New York-based C.L. King & Associates, who has covered the company for three
years. "It's like they were on six different parallel tracks and had no idea where they would end up."

Steak n Shake was especially vulnerable since 85 percent of its customers "trade up" from quick-service joints.
The competition in that "trade-up" range also has heated up, thanks to national players such as Red Robin Gourmet
Burgers Inc. and local upstart 96th Street Steakburgers.

High gas prices and a weak housing market made matters worse, since both led customers to eat more meals at home.

The situation is so grim for the 496-restaurant chain that David E. Tarantino, a senior research analyst who follows the
company for Milwaukee-based Robert W. Baird & Co., said 2008 is shaping up as a "rebuilding year."

So how did a chain that seemed to be on such strong footing falter so dramatically? And why did a man praised for his attention
to detail fail to halt the slide?

Disappointment after disappointment

For Dunn, frustration had been building for months.

In each of his last three quarterly conference calls with analysts, he opened with some variation of the word "disappointment".
Disappointing earnings. Disappointing same-store sales. Disappointing reaction to a new line of thin chicken sandwiches.

It wasn't always that way. After Dunn became president of Steak n Shake in 2002, he won a reputation as a smart, persuasive
leader.

At the time a newcomer to restaurants who hailed from jobs at packaged food giants Kraft Foods and Borden, he correctly predicted
the company was poised for a hot streak.

For 2-1/2 years during his tenure, same-store sales improved every quarter, and the share price soared 80 percent. The gains
were fueled by blockbuster new-product introductions such as side-by-side milkshakes and sippable sundaes.

But as results soured, the tenor of conference calls with analysts changed dramatically. Questions began to rise about the
usefulness of all the studies.

In a May 2006 call, A.G. Edwards analyst Jack Russo observed that "something is missing."

"You had that magic early on, and of late it has been tougher to come by," he said.

Asked in an Aug. 9 call about why the initiatives didn't seem to be working, Dunn said the company was able to "pick
up some low-hanging fruit" in the first three years. Then he launched into a rambling description of progress on a variety
of research initiatives.

Dunn, who made $596,154 last year, did not return messages left by IBJ on his home telephone.

On some level, the chain's struggles can be blamed on the economy, but there also have been issues in terms of "execution
of the concept," acknowledged Jeffrey A. Blade, Steak n Shake's executive vice president, CFO and chief administrative
officer. Blade previously worked with Dunn at Kraft Foods.

Management missteps

Most analysts acknowledge external challenges have made 2007 a tough year, but mistakes in the executive suite have compounded
matters.

A few examples:

Last fall, during the NFL season, Steak n Shake ran promotional inserts touting its sponsorships of the Indianapolis Colts
and Dallas Cowboys. Trouble is, the company swapped the inserts, promoting the wrong teams in the wrong markets. Steak n Shake
blamed its ad agency but failed to fire it for a mistake C.L. King's Gallo called "totally inexcusable."

Dunn responded to an analyst's question about store closings by saying a store had been losing money for three years,
Gallo said. Incredulous analysts wondered why it took so long.

In a conference call on May 9, shortly before the new chicken sandwiches were released, Dunn described the test results as
"mildly positive." Yet company executives acted surprised when sales weren't as strong as expected.

Gallo sees two possible paths Steak n Shake could take: Seek a permanent replacement for Dunn, or sell the company.

Takeover rumors have swirled since June, when a Dallas-based investment group led by HBK Investments and Lone Star Funds
disclosed it has accumulated about 9.4 percent of the company and wants to explore an acquisition or other "potential
transactions to maximize shareholder value." The group did not respond to requests for comment.

Gallo believes if Dunn hadn't been thrown out, the new investors would have run for board seats.

Yet Blade, the company's executive vice president, said Steak n Shake will embark soon on its search for a new CEO.

"We will fill the role, absolutely," he said.

Meanwhile, board Chairman Alan Gilman, 77, is temporarily filling in as CEO, a position he held from 1992 until Dunn took
over in 2004. Gilman declined, through Blade, to speak with IBJ for this story.

Strategy for a turnaround

Analysts expect Steak n Shake will continue many of Dunn's efforts to reduce turnover, improve service and enhance menus.
In the long term, those efforts will pay dividends if accompanied by a clearer sense of focus and priorities.

Even with the recent drop in the stock's value, shares still trade at a premium to peer restaurants. Steak n Shake's
price-to-earnings ratio is about 22, compared with nine for Denny's Corp. and 14 for Ruby Tuesday Inc.

The best move in the CEO search would be to hire a "quick-service veteran who knows the competition," said Conrad
Lyon, a senior analyst for Cleveland-based FTN Midwest Securities Corp., in a report dated Aug. 14.

"Someone coming from the casual dining ranks would likely be looked upon unfavorably [given the poor performance of
that sector]," Lyon wrote.

Gallo would like to see a shift in the company's marketing strategy: positioning Steak n Shake as an affordable alternative
to full service as opposed to a trade-up from quick service.

He wants to see drastic improvements in the breakfast menu, along with a slowdown in the addition of new restaurants.

Others wonder whether Steak n Shake's board needs to take a hard look at its own ranks and decide whether some younger
talent, with more restaurant experience, might be beneficial.

Absent Dunn, the board's average age is 64. Members include former IU President John W. Ryan, current IU-Kokomo Chancellor
Ruth J. Person, ACNielsen CEO Steven M. Schmidt and Borders Group Inc. CEO Edward W. Wilhelm.

The cure-all in the eyes of Steve Huse, a former president of Steak n Shake and current co-owner of St. Elmo Steak House,
is a burger that isn't thin enough to see through.

He'd like to see a gourmet burger that "hangs out of the bun an inch all the way around."

"It's a tougher market out there, and I think they need to be more aggressive about updating their core menu,"
Huse said. "There are only so many flavors of shakes they can sell."