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STAR BUFFET, INC. AND SUBSIDIARIES INDEX

SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C.
20549

FORM 10-Q

Commission File Number: 0-6054

STAR BUFFET, INC.
(Exact name of registrant as specified in its charter)

        Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý    No o

        Indicated by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes o    No ý

        Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. As of December 7, 2004, there were 2,950,000 shares of the registrant's Common Stock, outstanding.

STAR BUFFET, INC. AND SUBSIDIARIES
INDEX

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PART I: FINANCIAL INFORMATION

Item 1:    Condensed Consolidated Financial Statements

STAR BUFFET, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS

The accompanying notes are an integral part of the condensed consolidated financial statements.

(Continued)

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STAR BUFFET, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS (Continued)

The accompanying notes are an integral part of the condensed consolidated financial statements.

4

STAR BUFFET, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

The accompanying notes are an integral part of the condensed consolidated financial statements.

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STAR BUFFET, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(Continued)

The accompanying notes are an integral part of the condensed consolidated financial statements.

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STAR BUFFET, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)

(Unaudited)

        During the forty weeks ended November 3, 2003, the Company reclassified net assets totaling $931,000 from property, buildings and equipment to net assets held for sale; these assets were classified as current prior to the third quarter of fiscal 2005. The amount reclassified included land of $567,000 and buildings of $364,000.

The accompanying notes are an integral part of the condensed consolidated financial statements.

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STAR BUFFET, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Note (A) Basis of Presentation

        The accompanying unaudited condensed consolidated financial statements include the accounts for Star Buffet, Inc., together with its direct and indirect wholly-owned subsidiaries Summit Family Restaurants Inc. ("Summit"), HTB Restaurants, Inc. ("HTB"), Northstar Buffet, Inc. ("NSBI") and Star Buffet Management, Inc. ("SBMI") (collectively the "Company") and have been prepared in accordance with accounting principles generally accepted in the United States of America, the instructions to Form 10-Q and Article 10 of Regulation S-X. These financial statements should be read in conjunction with the audited consolidated financial statements, and the notes thereto, included in the Company's Annual Report on Form 10-K for the fiscal year ended January 26, 2004. In the opinion of management, all adjustments, consisting of normal recurring adjustments, necessary for a fair presentation of the financial position and results of operations for the interim periods presented have been reflected herein. Results of operations for such interim periods are not necessarily indicative of results to be expected for the full fiscal year or for any future periods. Certain reclassifications have been made to the fiscal 2004 consolidated financial statements to conform to the fiscal 2005 presentation. The accompanying condensed consolidated financial statements include the results of operations and assets and liabilities directly related to the Company's operations. Certain estimates, assumptions and allocations were made in preparing such financial statements.

        The following is a summary of the Company's restaurant properties as of November 1, 2004. The HomeTown Buffet segment includes the Company's 15 franchised HomeTown Buffet restaurants. The Casa Bonita segment includes two Casa Bonita restaurants. The North's Star segment includes three JJ North's Country Buffet restaurants. This segment also included one non-operating property. The Florida Buffets Division includes two BuddyFreddys restaurants, three BuddyFreddys Country Buffet restaurants and two Holiday House restaurants. The Florida Buffets Division also included four non-operating properties. The JB's Restaurants segment includes the Company's seven JB's Restaurants. This segment also included two non-operating properties.

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        As of November 1, 2004, the Company's operating and non-operating restaurants are located in the following states:

        As of November 1, 2004, the Company's non-operating restaurants are located in the following states:

        The operating results for the 12-week period ended November 1, 2004 included operations shown in the tables above and the fixed charges for five restaurants operating for two, six, six, seven and 11 weeks, respectively, and for five restaurants closed for the entire quarter. One non-operating restaurant is for sale and is recorded as property held for sale. The four remaining closed restaurants have been leased.

        The following is a summary of the Company's restaurant properties as of November 3, 2003. The HomeTown Buffet segment includes the Company's 16 franchised HomeTown Buffet restaurants. The Casa Bonita segment includes two Casa Bonita restaurants. The North's Star segment includes five JJ North's Country Buffet restaurants and one North's Star Buffet Restaurant. The Florida Buffets Division includes two BuddyFreddys restaurants, three BuddyFreddys Country Buffet restaurants and two Holiday House restaurants. The Florida Buffets Division also included four non-operating

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properties. The JB's Restaurants segment includes the Company's eight JB's Restaurants. This segment also included one non-operating property.

        As of November 3, 2003, the Company's operating and non-operating restaurants are located in the following states:

        As of November 3, 2003, the Company's non-operating restaurants are located in the following states:

        The operating results for the 12-week period ended November 3, 2003 included operations shown in the tables above and the fixed charges for six restaurants closed for the entire quarter. During the forty weeks ended November 3, 2003, one operating store was closed resulting from a dispute with a landlord. The Company does not expect to incur any expenses as a result of this restaurant closure. One non-operating store continues to be closed at the end of the third quarter of fiscal 2004 for repositioning and one non-operating restaurant is for sale and is recorded as property held for sale. The three remaining closed restaurants have been leased.

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        The Company utilizes a ⁵²/53 week fiscal year which ends on the last Monday in January. The first quarter of each year contains 16 weeks while the other three quarters each contain 12 weeks, except the fourth quarter has 13 weeks if the fiscal year has 53 weeks.

        Certain prior period amounts have been reclassified to conform to the current year financial statement presentation.

Note (B) Related Party Transactions

        In connection with the Company's employment contract with Mr. Robert E. Wheaton, the Company's President and Chief Executive Officer, the Company agreed to provide Mr. Wheaton with certain loans solely for the purchase of the Company's common stock prior to the enactment of Sarbanes-Oxley Act of 2002. Mr. Wheaton owns approximately 49% of the Company's outstanding common shares and may the effective power to elect members of the board of the director and to control the vote on substantially all other matters, without the approval of the other stockholders. The loans are secured by the common stock and bear interest at the prevailing rate set forth in the Company's credit facility with M&I Marshall & Ilsley Bank. Repayment terms stipulate that the president will repay principal and interest on or before the later of the fifth anniversary date of the initial advance under the loan agreement, the date he receives a lump sum payment per a termination clause or six month's after the termination of his employment. It is anticipated that the loans will be repaid in cash from the personal assets of Mr. Wheaton. Management has elected not to record any interest income on the loans until the interest income is paid. The current rate is approximately 4.2% for the third quarter of fiscal 2005. At November 1, 2004, the loans totaled $698,000 ($1,330,000 at January 26, 2004).

Note (C) Segment and Related Reporting

        The Company has five reporting segments: HomeTown Buffet, Casa Bonita, North's Star, Florida Buffets Division and JB's Restaurants. The Company's reportable segments are aggregated based on brand similarities of operating segments.

        The accounting policies of the reportable segments are the same as those described in Note 1 of the audited consolidated financial statements included in the Company's Annual Report on Form 10-K. The Company evaluates the performance of its operating segments based on income before income taxes.

        Summarized financial information concerning the Company's reportable segments is shown in the following table. The other assets presented in the consolidated balance sheet and not in the reportable segments relate to the Company as a whole, and not individual segments. Also certain corporate

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overhead income and expenses in the consolidated statements of operations are not included in the reportable segments.

(1)

Included in the reportable segment for the 40 weeks ended November 1, 2004 is one location opened for two weeks during the third quarter and two locations opened for six weeks during the third quarter. These locations represent $184,000, $510,000 and $224,000 of net book value of equipment, buildings and land included in total assets, respectively, and incurred $141,000 in depreciation and amortization expense. These locations contributed revenues of $1,283,000 and incurred $51,000 in impairment of long-lived assets and $85,000 of goodwill impairments.

        Included in the reportable segment for the 40 weeks ended November 3, 2003 is one location closed for the entire 40-week period and one location opened for 12 weeks during the first quarter. These locations represent $217,000 and $0 of net book value of equipment and leasehold improvements included in total assets, respectively, and incurred $97,000 in depreciation and amortization expense. The location opened for 12 weeks contributed revenues of $138,000 and incurred $166,000 in impairment of long-lived assets. Leases on both locations expired prior to August 11, 2003.

(2)

Included in the reportable segment for the 40 weeks ended November 1, 2004 are four locations closed for the entire 40 weeks of fiscal 2005. These four locations incurred $319,000 of depreciation and amortization, and represented a net book value of equipment of $1,076,000, buildings of $1,876,000 and land of $1,559,000 included in total assets.

        Included in the reportable segment for the 40 weeks ended November 3, 2003 are five locations closed for the entire 40 weeks and two locations closed during the first half of fiscal 2004. These seven locations contributed revenues of $291,000, incurred $365,000 of depreciation and amortization, and represented $14,000 in impairment of long-lived assets. These closed locations comprised a net book value of equipment of $1,470,000, buildings of $1,960,000 and land of $1,559,000 included in total assets and $931,000 included in property held for sale.

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(3)

Included in the reportable segment for the 40 weeks ended November 1, 2004 is one location closed for the entire 40-week period and one location operating 11 weeks of the third quarter. These locations represent $45,000, $920,000 and $158,000 of net book value of equipment, buildings and land included in total assets, respectively, and incurred $37,000 in depreciation and amortization expense. One location contributed $353,000 in revenues and the other location has a land value of $228,000 and was leased to a third party during the quarter.

        Included in the reportable segment for the 40 weeks ended November 3, 2003 is one location closed for the entire 40-week period and two closed locations that were operated for one and five weeks, respectively, during the first quarter. These locations represent $51,000 and $542,000 of net book value of equipment and buildings included in total assets, respectively, and incurred $30,000 in depreciation and amortization expense. One location closed for the entire 40-week period had land value of $228,000. The two locations closed during the first half of fiscal 2004 had revenues of $69,000.

Note (D) Net Income per Common Share

        Net income per common share is computed based on the weighted-average number of common shares and, as appropriate, dilutive common stock equivalents outstanding during the period. Stock options are considered to be common stock equivalents.

        Basic net income per common share is the amount of net income for the period available to each share of common stock outstanding during the reporting period. Diluted net income per common share is the amount of net income for the period available to each share of common stock outstanding during the reporting period and to each share that would have been outstanding assuming the issuance of common shares for all dilutive potential common shares outstanding during the period. The following is a reconciliation of the denominators used to calculate diluted earnings per share on net income for the respective fiscal periods:

        Had the Company recognized net income in the twelve week period ended November 1, 2004, incremental shares attributable to the assumed exercise of outstanding options would have increased diluted shares outstanding by 234,375.

        Average shares used in the 12 weeks ended November 1, 2004 and November 3, 2003 diluted earnings per share computations exclude stock options to purchase 497,000 shares and 733,000 shares, respectively, of common stock due to the market price of the underlying stock being less than the exercise price. Average shares used in the 40 weeks ended November 1, 2004 and November 3, 2003 diluted earnings per share computations exclude stock options to purchase 497,000 shares and 733,000 shares, respectively, of common stock due to the market price of the underlying stock being less than the exercise price. The effects of common stock equivalents have not been included in the third quarter 2005 diluted loss per share, as their effect would have been anti-dilutive.

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Note (E) Goodwill

        Goodwill and other intangible assets primarily represent the excess of the purchase price paid over the fair value of the net assets acquired in connection with business acquisitions. As of January 29, 2002, the Company adopted SFAS No. 142, Goodwill and Other Intangible Assets ("SFAS 142"). In accordance with SFAS 142, the Company has ceased amortizing goodwill recorded in past business combinations effective as of January 29, 2002.

        SFAS 142 required that goodwill initially be tested for impairment by comparing the fair value of goodwill on a reporting unit basis to the carrying amount of the goodwill as of January 29, 2002. The Company performed the transitional impairment test and determined that the carrying amount of goodwill was in excess of the fair value of the Company's net assets. This has resulted in a transitional impairment loss of $849,000 which has been reported as a cumulative effect of a change in accounting principle net of a tax benefit of $289,000 reported in the first quarter of fiscal 2003. SFAS 142 also requires goodwill and indefinite life intangible assets to be tested for impairment on an annual basis or when triggering events may occur. We review these assets annually and when a triggering event occurs for potential impairment issues. The Company identified $85,000 and $0 of goodwill impairment losses for the 40-week periods ended November 1, 2004 and November 3, 2003, respectively.

Note (F) Inventories

        Inventories consist of food, beverage, gift shop items and restaurant supplies and are valued at the lower of cost or market, determined by the first-in, first-out method.

Note (G) Properties, Buildings and Equipment

Properties, Buildings and Equipment and Real Property Under Capitalized Leases

        The Company evaluates impairment of long-lived assets in accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. The Company determines that an impairment write-down is necessary for locations whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future net cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceed the fair value of the assets.

Property and Equipment Leased to Third Parties

        The Company has four locations currently leased to third parties and had three locations leased to third parties on January 26, 2004. The four locations have equipment, buildings and land value of $208,000, $2,410,000 and $1,787,000, respectively, on November 1, 2004 and $234,000, $1,941,000 and $1,559,000, respectively, on January 26, 2004.

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Properties, Buildings and Equipment Held for Future Use

        The other property and equipment includes the following land, equipment and buildings and leaseholds currently in non-operating units at November 1, 2004:

        The property and equipment includes the following land, equipment and buildings and leaseholds currently in non-operating units at January 26, 2004:

Property Held for Sale

The Company currently has one location in Florida held for sale.

Note (H) Contingencies

        On November 25, 1998, the Company filed an action against North's in the United States District Court, District of Utah, Case No. 2-98-CV-893, seeking damages for breach of a promissory note and an Amended and Restated Credit Agreement (collectively, the "Credit Agreements") in the amount of $3,570,935. On December 31, 1998, North's filed an answer to the Company's Complaint, denying generally the allegations, and filed counterclaims against the Company alleging (1) the Company fraudulently induced North's to enter into various agreements with the Company relating to the Company's acquisition of seven JJ North's Grand Buffet Restaurants and an option to acquire nine additional restaurants operated by North's and (2) the Company had breached the Business Services Agreement. On January 26, 2001, the parties entered into a Settlement Agreement (the "Settlement Agreement"). The Settlement Agreement provides, among other things, that the Credit Agreement and Revolving Note terminate concurrently with the execution of the Settlement Agreement, that the Term Note be amended and restated, that the terms of the prior Term Note have no further force or effect and that the security interest transferred to the Company pursuant to the Assignment Agreement dated September 30, 1997 between the Company and U.S. Bank National Association be amended and restated pursuant to an Amended and Restated Star Buffet Security Agreement (the "Security Agreement"). The Company and North's agreed that the Star Buffet Debt be reduced to a total amount of $3,500,000 and that such reduced obligation be payable by North's pursuant to the terms of the Amended and Restated Promissory Note ("Star Buffet Promissory Note"). The Company recorded

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no gain or loss on the settlement as the recorded balance of the note was approximately $3.5 million at the time of the settlement. The Company and North's agreed that the Company's existing liens encumbering certain property of North's remained in place and continue to secure North's obligations to the Company, and the Company and North's reserved all rights, claims and defenses with respect to the extent and validity of such existing liens.

        On March 2, 2004, the Company filed an action against North's in the United States District Court, District of Utah, Central Division, Case No. 2:04CV00211, demanding judgment against North's for failure to repay obligations under the Star Buffet Promissory Note in a total amount not less than $2,934,453 plus interest at the default rate as set forth in the Star Buffet Promissory Note. A trial date has not been set. Since January 26, 2004, the note receivable has been recorded as a long-term receivable. The Company has not recorded interest income due from North's since August 2003. The Company's note is secured. Security for the note includes all real and personal property, landlord leases, trademarks and all other intellectual property associated with seven restaurants. The Company believes current and future cash flows are adequate for recovery of the principal amount of the note receivable. The Company therefore has not provided an allowance for bad debts for the note as of November 1, 2004.

        In connection with the Company's employment contract with Robert E. Wheaton, the Company's Chief Executive Officer and President, the Company has agreed to pay Mr. Wheaton six years salary and bonus if he resigns related to a change of control of the Company or is terminated, unless the termination is for cause. Mr. Wheaton's employment contract also includes an annual bonus of $25,000.

        The Company is from time to time the subject of complaints or litigation from customers alleging injury on properties operated by the Company, illness or other food quality, health or operational concerns. Adverse publicity resulting from such allegations may materially adversely affect the Company and its restaurants, regardless of whether such allegations are valid or whether the Company is liable. The Company also is the subject of complaints or allegations from employees from time to time. The Company believes that the lawsuits, claims and other legal matters to which it has become subject in the course of its business are not material to the Company's business, financial condition or results of operations, but an existing or future lawsuit or claim could result in an adverse decision against the Company that could have a material adverse effect on the Company's business, financial condition and results of operations.

Note (I) Income Taxes

        The Company is able to take advantage of the Credit for Employer Social Security and Medicare Taxes Paid on Certain Employee Tips resulting in a lower effective federal tax rate of approximately 35% as of November 1, 2004 and November 3, 2003.

Note (J) Insurance Programs

        The Company is self-insured for general liability claims. The Company has commercial insurance for casualty claims in excess of $2 million per claim and $3 million per year as a risk reduction strategy. Self-insurance accruals include estimates based on historical information and expected future development factors. If actual claims differ from estimates and assumptions, our actual accrual requirements may be materially different from the calculated accruals. The Company had general liability insurance reserves of $31,000 and $100,000 for the 40-week periods ended November 1, 2004 and November 3, 2003, respectively.

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STAR BUFFET, INC. AND SUBSIDIARIES

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

        The following Management's Discussion and Analysis should be read in conjunction with the unaudited condensed consolidated financial statements, and the notes thereto, presented elsewhere in this report and the Company's audited financial statements and Management's Discussion and Analysis included in the Company's Annual Report on Form 10-K for the fiscal year ended January 26, 2004. Comparability of periods may be affected by the closure of restaurants or the implementation of the Company's acquisition and strategic alliance strategies. The costs associated with integrating new restaurants or under performing or unprofitable restaurants, if any, acquired or otherwise operated by the Company may have a material adverse effect on the Company's results of operations in any individual period.

        This Quarterly Report on Form 10-Q contains forward looking statements, which are subject to known and unknown risks, uncertainties and other factors which may cause the actual results, performance, or achievements of the Company to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. Such factors include, among others, the following: general economic and business conditions; success of integrating newly acquired under performing or unprofitable restaurants; the impact of competitive products and pricing; success of operating initiatives; advertising and promotional efforts; adverse publicity; changes in business strategy or development plans; quality of management; availability, terms and deployment of capital; changes in prevailing interest rates and the availability of financing; food, labor, and employee benefits costs; changes in, or the failure to comply with, government regulations; weather conditions; construction schedules; implementation of the Company's acquisition and strategic alliance strategy; the effect of the Company's accounting polices and other risks detailed in the Company's Form 10-K for the fiscal year ended January 26, 2004, and other filings with the Securities and Exchange Commission.

Overview

        Consolidated net income for the 12-week period ended November 1, 2004 decreased $248,000 to a loss of $153,000 or ($0.05) per share on a basic and diluted basis as compared with net income of $95,000 for the comparable prior year period. Consolidated net income for the 40-week period ended November 1, 2004 decreased $393,000 to $1,001,000 or $0.34 on a basic per share basis—or $0.31 per share on a diluted basis as compared with net income of $1,394,000 for the comparable prior year period. The decrease in net income for the 12-week period ended November 1, 2004 is primarily due to impairment costs of $136,000 from closing five restaurants and lower interest income of $50,000. The decrease in net income for the 40-week period ended November 1, 2004 is primarily due to the settlement of a legal action and the related $400,000 reversal of a litigation accrual in the Company's accounts with Alliant in the first quarter of last year. The first quarter of last year also included impairment charges of $180,000 primarily related to closing one restaurant in the first quarter. Total revenues decreased $1.1 million or 7.7% from $14.4 million in the 12 weeks ended November 3, 2003 to $13.3 million in the 12 weeks ended November 1, 2004. Total revenues decreased $2.7 million or 5.1% from $53.1 million in the 40 weeks ended November 3, 2003 to $50.4 million in the 40 weeks ended November 1, 2004. The decrease in revenues was attributable to declines in comparable same store sales, primarily in the HomeTown Buffet and the North's Star divisions, and the result of five fewer restaurants in operation this year versus the same period of the prior year. The decline in sales in operating restaurants significantly impacts net income (loss) because occupancy, salaries, benefits, and other expenses are primarily fixed in nature other than increased rental payments based on exceeding minimum revenue amount, and generally do not vary significantly with restaurant sales volume. Occupancy and other expenses include major expenditures such as rent, insurance, property taxes, utilities, maintenance and advertising.

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Components of Income from Operations

        Total revenues include a combination of food and beverage sales and are net of applicable state and city sales taxes.

        Food costs primarily consist of the costs of food and beverage items. Various factors beyond the Company's control, including adverse weather and natural disasters, may affect food costs. Accordingly, the Company may incur periodic fluctuations in food costs. Generally, these temporary increases are absorbed by the Company and not passed on to customers; however, management may adjust menu prices to compensate for increased costs of a more permanent nature.

        Labor costs include restaurant management salaries, bonuses, hourly wages for unit level employees, various health, life and dental insurance programs, vacations and sick pay and payroll taxes.

        Occupancy and other expenses are primarily fixed in nature and generally do not vary with restaurant sales volume, other than certain leases that provide for additional rent based on sales volume over specified minimums. Rent, insurance, property taxes, utilities, maintenance and advertising account for the major expenditures in this category.

        General and administrative expenses include all corporate and administrative functions that serve to support the existing restaurant base and provide the infrastructure for future growth. Management, supervisory and staff salaries, employee benefits, data processing, training and office supplies are the major items of expense in this category.

        Depreciation and amortization includes depreciation on assets for closed stores that management is evaluating for future remodeling and repositioning.

Results of Operations

        The following table summarizes the Company's results of operations as a percentage of total revenues for the 12 and 40 weeks ended November 1, 2004 and November 3, 2003.

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        Summarized financial information concerning the Company's reportable segments is shown in the following table. The other assets presented in the consolidated balance sheet and not in the reportable segments relate to the Company as a whole, and not individual segments. Also certain corporate overhead income and expenses in the consolidated statements of operations are not included in the reportable segments.

(1)

The same store sales declined this year together with higher wholesale food cost resulted in higher food costs for HomeTown Buffet as a percentage of sales.

(2)

Significant sales increases resulted in much lower labor as percent of sales in Casa Bonita this year.

(3)

The same store sales declined and with fewer stores operating the sales were significantly lower. With lower sales this year, the food and labor costs increased as a percentage of sales in North's Star.

(4)

Same store sales increased and the Florida Division had lower labor costs as a percentage of sales this year.

(5)

Same store sales decreased resulting in higher food and labor costs as a percentage of sales this year.