The Steak n Shake Company
(Years ended September 24, 2008, September 26, 2007, and September 27, 2006)
(Amounts in $000s, except per share data)

In the following discussion, the term "same store sales" refers to the sales of only those units open 18 months as of the beginning of the current fiscal period being discussed and which remained open through the end of the fiscal period.

We have a 52/53 week fiscal year ending on the last Wednesday in September. Fiscal years 2008, 2007, and 2006, which ended on September 24, 2008, September 26, 2007, and September 27, 2006, respectively, each contained 52 weeks.

For an understanding of the significant factors that influenced our performance during the past three fiscal years, the following discussion should be read in conjunction with the consolidated financial statements and related notes found elsewhere in this Annual Report.

Fiscal Year 2008

In fiscal year 2008, total revenues decreased 6.7% to $610,061 as compared to $654,142 in fiscal year 2007. The decrease in revenues resulted from a same-store sales decline of 7.1% during fiscal year 2008. The net loss for fiscal year 2008 was $22,979, or $0.81 per diluted share, compared to net earnings of $11,808, or $0.42 per diluted share in the prior fiscal year. The fiscal year 2008 results included $14,858 ($9,212, or $0.33 per diluted share, net of tax) of non-cash impairment charges and store closing costs, including charges related to a group of stores that we closed in the fourth quarter of fiscal year 2008 and restaurants that were impaired because the carrying values of their underlying assets exceeded their expected future undiscounted cash flows. Also included is a store closure charge of $514 arising from early termination of a lease on a property. In comparison, fiscal year 2007 included an impairment charge of $5,369 ($3,329, or $0.12 per diluted share, net of tax), which was offset by a $193 gain on the sale of two restaurants closed during a prior year.

During fiscal year 2008, we opened nine new Company-owned restaurants, closed 13 underperforming restaurants, and refranchised eight restaurants to franchisees, which brought the total Company-owned units to 423 as of September 24, 2008. Also during fiscal year 2008, our franchisees opened five new restaurants and closed two restaurants, bringing the total number of franchised units to 68 on September 24, 2008. Subsequent to year-end, we closed one Company-owned restaurant and refranchised seven Company-owned restaurants to franchisees.

In fiscal year 2008, we analyzed the impact of modifying the operating hours of certain restaurants that were not profitable during the overnight hours. Our analysis led us to reduce the number of restaurants that operate on a 24-hour, seven-day-a-week platform. Currently, approximately 75% of our restaurants continue to operate 24 hours a day, seven days a week. The remaining 25% of restaurants have varying hours that best suit the demographics and customer demands in the areas in which they operate.

New management, during the fourth quarter of fiscal year 2008, enacted a change in strategic direction under which we began to operate in a manner designed to generate cash. As a result of this shift, we decided to forego certain planned initiatives, including software projects and construction of a new restaurant. In addition to the foregoing, several personnel changes resulted in severance expense. The non-cash write-offs, severance expense, and other expenditures resulting from these strategic changes during fiscal year 2008 was $4,074, net of tax. Refer to Part I, Item I of this Form 10-K for information regarding new management's strategy and turnaround plan.

Management's discussion and analysis of financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of our financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, expenses and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate these estimates and our assumptions based on historical experience and other factors that are believed to be relevant under the circumstances. Actual results may differ from these estimates under different assumptions or circumstances.

We believe the following critical accounting estimates represent our more significant judgments and estimates used in preparation of our consolidated financial statements.

Long-lived Assets - Impairment and Classification as Held for Sale

We review our restaurants for impairment on a restaurant-by-restaurant basis when events or circumstances indicate a possible impairment. 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.

We sell restaurants that have been closed due to underperformance and land parcels that we do not intend to develop in the future. We classify an asset as held for sale in the period during which each of the following conditions is met: (a) management has committed to a plan to sell the asset; (b) the asset is available for immediate sale in its present condition; (c) an active search for a buyer has been initiated; (d) completion of the sale of the asset within one year is probable; (e) the asset is being marketed at a reasonable price; and (f) no significant changes to the plan of sale are expected.

Because depreciation and amortization expense is based upon useful lives of assets and the net salvage value at the end of their lives, significant judgment is required in estimating this expense. Additionally, 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. There is also judgment involved in estimating timing of completing the sale of an asset. Accordingly, we believe that accounting estimates related to long-lived assets are critical.

Insurance Reserves

We self-insure a significant portion of expected losses under our workers' compensation, general liability, and auto liability insurance programs. In 2006, we began to self-insure our group health insurance risk. We purchase reinsurance for individual and aggregate claims that exceed predetermined limits. We record a liability for all unresolved claims and our estimates of incurred but not reported ("IBNR") claims at the anticipated cost to us. The liability estimate is based on information received from insurance companies, combined with management's judgments regarding frequency and severity of claims, claims development history, and settlement practices. Significant judgment is required to estimate IBNR claims as parties have yet to assert a claim, and therefore the degree to which injuries have been incurred and the related costs have not yet been determined. Additionally, estimates about future costs involve significant judgment regarding legislation, case jurisdictions, and other matters. Accordingly, management believes that estimates related to self-insurance reserves are critical. Our reserve for self-insured liabilities at September 24, 2008 and September 26, 2007 were $6,374 and $7,037, respectively. The decrease reflects a reduction in the size and number of open workers' compensation claims.

We record deferred tax assets or liabilities based on differences between financial reporting and 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 would be 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 expected to apply to tax differences that are expected to reverse 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. Accordingly, we believe estimates related to income taxes are critical. Based on 2008 results, a change of 1% in the annual effective tax rate would have an impact of $348 on net loss.

We adopted the provisions of Financial Accounting Standards Board ("FASB") Interpretation No. 48, "Accounting for Uncertainty in Income Taxes, an Interpretation of FASB Statement No. 109" ("FIN 48"), on September 27, 2007, the beginning of fiscal year 2008. FIN 48 addresses the determination of how tax benefits claimed or expected to be claimed on a tax return should be recorded in the financial statements. Under FIN 48, we must recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position are measured based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate resolution. As a result of the implementation of FIN 48, we recognized an increase of $614 in the liability for unrecognized tax benefits, which was accounted for as a reduction of $312 to retained earnings and $302 to deferred taxes as of the adoption date. Our estimates of the tax benefit from uncertain tax positions may change in the future due to new developments in each matter.

For additional information regarding the adoption of FIN 48, see Note 10 of Notes to Consolidated Financial Statements in Part II, Item 8 of this Form 10-K.

Goodwill and Other Intangible Assets

Under SFAS No. 142, "Goodwill and Other Intangible Assets," we are required to assess goodwill and any indefinite-lived intangible assets for impairment annually, or more frequently if circumstances indicate impairment may have occurred. The analysis of potential impairment of goodwill requires a two-step approach. The first step is the estimation of fair value of each reporting unit. If step one indicates that impairment potentially exists, the second step is performed to measure the amount of impairment, if any. Goodwill impairment exists when the estimated fair value of goodwill is less than its carrying value. We use both market and income approaches to derive fair value. The valuation methodology and underlying financial information included in our determination of fair value require significant judgments to be made by management. The judgments in 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. Changes in such estimates or the application of alternative assumptions could produce significantly different results. Accordingly, we believe that accounting estimates related to goodwill and other intangible assets are critical.

Our calculation of the fair value of the reporting units considers current market conditions existing at the assessment date. Due to the significant decline in the market price of our common stock subsequent to the end of our fiscal year 2008, it is probable that we will need to update our impairment analysis during our first quarter of fiscal year 2009. We can provide no assurance that a material impairment charge will not occur in future periods as a result of these analyses.

We lease certain properties under operating leases. We also have many lease agreements that contain rent holidays, rent escalation clauses and/or contingent rent provisions. We recognize rent expense on a straight-line basis over the expected lease term, including cancelable option periods when failure to exercise such options would result in an economic penalty. We use a time period for our straight-line rent expense calculation that equals or exceeds the time period used for depreciation. In addition, the rent commencement date of the lease term is the earlier of the date when we become legally obligated for the rent payments or the date when we take access to the grounds for build out. As the assumptions inherent in determining lease commencement and expiration dates and other related complexities of accounting for leases involve significant judgment, management has determined that lease accounting is critical.

In the following table is set forth the percentage relationship to total revenues, unless otherwise noted, of items included in Consolidated Statements of Operations for the periods indicated:

                                                     2008          2007       2006
   Revenues:
   Net sales                                           99.3 %       99.4 %     99.4 %
   Franchise fees                                       0.7          0.6        0.6
   Total revenues                                       100          100        100

   Costs and expenses:
   Cost of sales (1)                                   24.9         23.1       22.6
   Restaurant operating costs (1)                      55.7         51.8       50.3
   General and administrative                           8.3          8.8        8.3
   Depreciation and amortization                        5.5          4.9        4.5
   Marketing                                            4.7          4.4        4.3
   Interest                                             2.3          2.1        1.8
   Rent                                                 2.4          2.1        1.9
   Pre-opening costs                                    0.2          0.4        0.6
   Asset impairments and provision for restaurant       2.4          0.8          -
   closings
   Other income, net                                  (0.3)        (0.3)      (0.4)

   (Loss) earnings before income taxes                (5.7)          2.3        6.6

   Income taxes                                       (1.9)          0.5        2.2

   Net (loss) earnings                                (3.8) %        1.8 %      4.4 %

(1) Cost of sales and restaurant operating costs are expressed as a percentage of net sales.

Fiscal Year 2008 compared with Fiscal Year 2007

Net (Loss) Earnings

We recorded a net loss of ($22,979), or ($0.81) per diluted share for the current fiscal year, as compared with net earnings of $11,808, or $0.42 per diluted share in fiscal year 2007. The decrease was primarily driven by the decline in same store sales, increases in cost of sales and restaurant operating costs, and $14,858 ($9,212, net of tax) of non-cash impairment and store closing costs, which had an impact of $0.33 per diluted share. Comparatively, fiscal year 2007 earnings included $5,176 ($3,209, net of tax) of net non-cash impairment, which had an impact of $0.11 per diluted share.

Net Sales

In fiscal year 2008, net sales decreased 6.8% from $650,416 to $606,076 primarily due to the decline in same store sales. Same store sales decreased 7.1% due to a decline in guest traffic of 10.0%, which was partially offset by a 2.9% increase in average guest expenditure. The increase in average guest expenditure results primarily from menu price increases of 3.3%, which are made up of the annualization of fiscal year 2007 price increases in addition to a 2.1% increase in the first quarter of fiscal year 2008. These price increases were implemented to offset minimum wage and commodity cost pressures.

Cost and Expenses

Cost of sales was $151,188 or 24.9% of net sales, compared with $150,286 or 23.1% of net sales in fiscal year 2007. The increase as a percentage of net sales reflected higher commodity costs (primarily dairy, beef, and fried products), new menu items with higher percentage food cost (including improved entrée salads, chicken sandwiches, and the introduction of fruit sides), and operational inefficiencies from implementing the new product mix.

Restaurant operating costs were $337,786 or 55.7% of net sales compared to $336,955 or 51.8% of net sales in fiscal year 2007. Higher utility costs and repairs and maintenance caused an increase of $2,510 over the prior fiscal year, which included $355 of incremental repairs and maintenance related to strategic changes executed in the fourth fiscal quarter. Outside services increased $1,060 in fiscal year 2008 due to the addition of a new contractor and more frequent snow removal services attributable to unfavorable weather conditions during the second fiscal quarter. These increases were offset by a decline in labor and fringes of $2,640 during fiscal year 2008.

General and administrative expenses decreased $7,100 (12.3%) to $50,425 for fiscal 2008. Specifically, $5,360 of the decrease resulted from lower salaries, wages, and fringes due to reductions in staffing that occurred during the fourth quarter of fiscal year 2007 and during fiscal year 2008. Planned cutbacks in outside consulting services and bonuses and stock compensation contributed an additional $3,450 of cost savings, and travel and relocation expenses declined $1,270. These reductions were partially offset by a $2,540 increase in the loss on disposal and abandonment of assets and a $1,780 increase in legal and professional services. In fiscal year 2008, General and administrative expense included severance costs of approximately $2,400, $500 in proxy-related fees, and $435 in consulting fees for a fixed asset tax study. Fiscal year 2007 General and administrative expense included $1,900 of restructuring and severance expenses.

Depreciation and amortization expense was $33,659 or 5.5% of total revenues, versus $32,185 or 4.9% of total revenues in fiscal year 2007. The increase was primarily due to the addition of nine new restaurants, the new POS system put in service during fiscal year 2008, restaurant equipment, and the impact of negative same store sales on fixed costs.

Rent expense increased slightly as a percentage of total revenues primarily as a result of the decline in same store sales, as well as increases in rental rates for new unit leases.

Pre-opening expense decreased 52.7% to $1,272 due to opening fewer new restaurants in fiscal year 2008 compared to fiscal year 2007. We opened nine new restaurants during fiscal year 2008 compared to 16 in fiscal year 2007. The decrease is also due to variances in the timing of when pre-opening costs are incurred in relation to when the stores are opened. All the Company-owned restaurant openings for fiscal year 2008 were completed in the first and second quarters, and there are no planned Company-owned restaurant openings for fiscal year 2009.

Asset impairments and provision for restaurant closings for fiscal year 2008 was $14,858 or 2.4% of total revenues, versus $5,176 or 0.8% of total revenues in fiscal year 2007. The fiscal year 2008 charge includes $8,858 related to restaurants for which current operating performance is significantly below our expectations, and the carrying values of these properties exceed the expected future undiscounted cash flows to be generated by the underlying assets; $5,009 related to stores we closed during the fourth fiscal quarter; $514 related to a fee for early termination of a lease for a store that was closed subsequent to year-end; and $477 related to stores involved in a sale-leaseback transaction whose net book values exceeded their fair values. The fiscal year 2007 asset impairment and provision for restaurant closings of $5,176 related to the planned closure or sale of 14 restaurant properties and was offset by the impact of net gains on properties sold in excess of previously recorded impairments.

Our fiscal year 2008 effective income tax rate increased to 33.9% from 20.6% in the prior fiscal year. The prior fiscal year's effective tax rate was lower primarily due to the proportionate effect of increased federal income tax credits when compared to annual pre-tax (loss) earnings. For the current fiscal year, we elected to forego claiming any federal income tax credits in order to maximize the cash refund generated from the net operating loss carryback of the fiscal 2008 taxable loss. This resulted in recording substantially less income tax benefit in fiscal 2008 versus fiscal year 2007. The current fiscal year decrease in income tax benefit for electing to forego claiming any federal income tax credits is approximately $3,000 when compared to the prior year.

Net Earnings

Net earnings decreased in fiscal year 2007 by 57.8% to $11,808, or $0.42 per diluted share, compared with $28,001, or $1.00 per diluted share, for fiscal year 2006. The decrease was primarily driven by the decline in same store sales noted below, $5,176 ($3,209, net of tax) of net non-cash impairment, which had an impact of $0.11 per diluted share, and $1,900 ($1,178, net of tax) of restructuring and severance expenses which had an impact of $0.04 per diluted share.

Net Sales

For fiscal year 2007, net sales increased 2.4% from $634,941 to $650,416.
The net sales gains were due to the opening of 16 new Company-owned stores, partially offset by a 3.8% same store sales decline. That decrease in same store sales was due to a declining guest count of 5.6% partially offset by a 1.8% increase in average guest expenditure. Fiscal year 2007 net sales also benefited from a full year of sales relating to the acquisition of eight franchised restaurants from Creative Restaurants, Inc. ("CRI") in the fourth quarter of fiscal year 2006. CRI sales during fiscal years 2007 and 2006 were $15,842 and $3,990, respectively.

Franchise fees decreased slightly during fiscal year 2007 primarily due to a decrease in franchisee same store sales of 3.0%, which resulted in lower royalty fees accrued.

Cost and Expenses

In fiscal year 2007, cost of sales was $150,286 or 23.1% of net sales, compared with $143,360 or 22.6% of net sales in fiscal year 2006. The increase as a percentage of net sales was primarily due to new menu items with higher percentage food cost, including improved entrée salads, chicken sandwiches, and Fruit n Frozen yogurt shakes, and to operational inefficiencies from implementing the new product mix.

Restaurant operating costs were $336,955 or 51.8% of net sales in fiscal year 2007, compared to $319,070 or 50.3% of net sales in fiscal year 2006. The largest portion of the increase related to labor and fringes, which increased $10,144 or 0.7% as a percent of net sales over fiscal year 2006. The increase in labor costs was primarily due to federal and state mandated minimum wage rate increases in states where we operate numerous stores, including Florida, Georgia, Illinois, Indiana, Missouri, and Ohio. Other restaurant operating costs,including utilities and repairs and maintenance, increased as a percentage of net sales due to the impact of negative same store sales on fixed costs.

General and administrative expenses for fiscal year 2007 were $57,525 or 8.8% of total revenues, compared to $52,949 or 8.3% of total revenues in fiscal year 2006. The increase as a percentage of revenues was attributable to $1,900 of restructuring and severance expenses not incurred in fiscal year 2006 and to approximately $1,600 of compensation and $1,400 of incremental consulting expenses, including "Guest Winning Promise" research.

Depreciation and amortization expense for fiscal year 2007 was $32,185 or 4.9% of total revenues, versus $28,967 or 4.5% of total revenues in the prior fiscal year. The increase was primarily due to the addition of units, including the eight restaurants acquired from CRI in the fourth quarter of fiscal year 2006, to software placed in service during fiscal year 2007, and to the impact of negative same store sales on fixed costs.

Rent expense increased slightly as a percentage of total revenues primarily as a result of the decline in same store sales, as well as increases in rental rates for new unit leases.

Interest expense in fiscal year 2007 was $14,015 or 2.1% of total revenues, versus $11,373 or 1.8% of total revenues in the prior fiscal year. The increase in interest expense was due to increased borrowings under the Senior Note Agreement and Private Shelf Facility ("Senior Note Agreement") and to lower capitalized interest from decreased land acquisition and unit construction, partially offset by lower average borrowings under leases.

Pre-opening expense was $2,689 or 0.4% of total revenues in fiscal year 2007, versus $3,579 or 0.6% of total revenues in fiscal year 2006. The reduction was driven by a decrease in new units from 26 in fiscal year 2006 to 16 in fiscal year 2007. Pre-opening costs per restaurant increased slightly due to differences in the timing of when pre-opening costs are incurred compared to when the stores are opened.

Income tax expense was recorded at an effective tax rate of 20.6%in fiscal 2007, versus 33.8% in fiscal year 2006. The decrease in the tax rate in fiscal year 2007 was due primarily to the proportionate effect of federal income tax credits when compared to annual pre-tax earnings and the impact of the extension of the Work Opportunity and Welfare to Work tax credits retroactive to January 1, 2006. The benefit recorded related to the tax credit extension totaled approximately $650.

Restaurant Closings

We permanently closed thirteen and eight Company-owned restaurants in fiscal years 2008 and 2007, respectively. Ten of the restaurants closed in fiscal year 2008 and six of the restaurants closed in fiscal year 2007 were located near other Company-owned stores that continue to operate, and we expect significant sales to transfer to the other existing locations. Therefore, the results of operations of these restaurants are not presented as discontinued operations and continue to be included in continuing operations in the Consolidated Statement of Operations.

The assets of three restaurants closed in fiscal year 2008 and two restaurants . . .