STAR BUFFET INC - Quarter Report: 2004 November (Form 10-Q)

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STAR BUFFET, INC. AND SUBSIDIARIES INDEX

SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C.
20549

FORM 10-Q

(Mark One)
ý	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended: November 1, 2004
OR
o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to

Commission File Number: 0-6054

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

DELAWARE (State or other jurisdiction of incorporation or organization)		84-1430786 (IRS Employer Identification Number)
420 Lawndale Drive, Salt Lake City, UT 84115 (Address of principal executive offices) (Zip Code)
(801) 463-5500 (Registrant's telephone number, including area code)

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


PART I. FINANCIAL INFORMATION
	Item 1.	Condensed Consolidated Financial Statements:
		Condensed Consolidated Balance Sheets as of November 1, 2004 (unaudited) and January 26, 2004
		Unaudited Condensed Consolidated Statements of Operations for the twelve and forty weeks ended November 1, 2004 and November 3, 2003
		Unaudited Condensed Consolidated Statements of Cash Flows for the forty weeks ended November 1, 2004 and November 3, 2003
		Notes to Unaudited Condensed Consolidated Financial Statements
	Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations
	Item 3.	Quantitative and Qualitative Disclosures about Market Risk
	Item 4.	Controls and Procedures
PART II. OTHER INFORMATION
	Item 1.	Legal Proceedings
	Item 6.	Exhibits and Reports on Form 8-K
Signatures

PART I: FINANCIAL INFORMATION

Item 1: Condensed Consolidated Financial Statements

STAR BUFFET, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS

		November 1, 2004		January 26, 2004
		(Unaudited)
ASSETS
Current assets:
	Cash and cash equivalents	$	83,000	$	445,000
	Current portion of notes receivable		18,000		17,000
	Receivables		221,000		377,000
	Inventories		505,000		494,000
	Deferred income taxes		168,000		162,000
	Prepaid expenses		351,000		124,000
	Property held for sale		—		931,000

	Total current assets		1,346,000		2,550,000

Property, buildings and equipment:
	Property, buildings and equipment, net		18,286,000		18,391,000
	Property and equipment leased to third parties, net		4,405,000		3,734,000
	Property, buildings and equipment held for future use		2,618,000		2,374,000
	Property and equipment under capitalized leases, net		1,052,000		1,153,000
	Property held for sale		931,000		—

	Total property, buildings and equipment		27,292,000		25,652,000

Other assets:
	Notes receivable, net of current portion		2,860,000		2,878,000
	Deposits and other		233,000		276,000

	Total other assets		3,093,000		3,154,000

Deferred income taxes, net			588,000		590,000
Intangible assets:
	Goodwill		2,823,000		2,907,000
	Other intangible assets, net		851,000		931,000

	Total intangible assets		3,674,000		3,838,000

Total assets		$	35,993,000	$	35,784,000

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

(Continued)

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

			November 1, 2004			January 26, 2004
			(Unaudited)
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
	Accounts payable-trade		$	2,050,000		$	2,798,000
	Payroll and related taxes			1,184,000			1,280,000
	Sales and property taxes			1,008,000			806,000
	Rent, licenses and other			374,000			475,000
	Income taxes payable			542,000			356,000
	Revolving line of credit			400,000			1,900,000
	Current maturities of obligations under long-term debt			552,000			329,000
	Current maturities of obligations under capital leases			111,000			96,000

		Total current liabilities		6,221,000			8,040,000

	Deferred rent payable			759,000			896,000
	Other long-term liability			68,000			101,000
	Capitalized lease obligations, net of current maturities			1,566,000			1,655,000
	Long-term debt, net of current maturities			6,116,000			3,987,000

		Total liabilities		15,230,000			14,679,000

Stockholders' equity:
	Preferred stock, $.001 par value; authorized—1,500,000 shares; none issued or outstanding			—			—
	Common stock, $.001 par value; authorized—8,000,000 shares; issued and outstanding—2,950,000 shares			3,000			3,000
	Additional paid-in capital			16,351,000			16,351,000
	Officer's note receivable			(698,000	)		(1,330,000	)
	Retained earnings			5,607,000			6,081,000

		Total stockholders' equity		21,263,000			21,105,000

Total liabilities and stockholders' equity			$	35,993,000		$	35,784,000

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

STAR BUFFET, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

		Twelve Weeks Ended						Forty Weeks Ended
		November 1, 2004			November 3, 2003			November 1, 2004			November 3, 2003
Total revenues		$	13,269,000		$	14,378,000		$	50,360,000		$	53,073,000
Costs and expenses
	Food costs		4,611,000			4,816,000			17,341,000			17,794,000
	Labor costs		4,577,000			4,943,000			16,767,000			17,919,000
	Occupancy and other expenses		2,876,000			3,121,000			10,025,000			10,829,000
	General and administrative expenses		540,000			645,000			2,070,000			1,978,000
	Depreciation and amortization		531,000			574,000			1,828,000			1,997,000
	Impairment of long-lived assets		262,000			128,000			516,000			617,000

	Total costs and expenses		13,397,000			14,227,000			48,547,000			51,134,000

(Loss) income from operations			(128,000	)		151,000			1,813,000			1,939,000
	Interest expense		(167,000	)		(155,000	)		(493,000	)		(543,000	)
	Interest income		—			50,000			5,000			168,000
	Reversal of litigation accrual		—			—			—			400,000
	Other income		67,000			99,000			213,000			165,000

Income (loss) before income taxes			(228,000	)		145,000			1,538,000			2,129,000
Income taxes (benefit)			(75,000	)		50,000			537,000			735,000

Net (loss) income		$	(153,000	)	$	95,000		$	1,001,000		$	1,394,000

Net (loss) income per common share—basic		$	(0.05	)	$	0.03		$	0.34		$	0.47

Net (loss) income per common share—diluted		$	(0.05	)	$	0.03		$	0.31		$	0.47

Weighted average shares outstanding—basic			2,950,000			2,950,000			2,950,000			2,950,000

Weighted average shares outstanding—diluted			2,950,000			2,950,000			3,184,375			2,950,000

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

STAR BUFFET, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

				Forty Weeks Ended
				November 1, 2004			November 3, 2003
Cash flows from operating activities:
Net income (loss)				$	1,001,000		$	1,394,000
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
	Depreciation and amortization				1,807,000			1,997,000
	Amortization of loan cost				21,000			95,000
	Impairment of long-lived assets				516,000			617,000
	Deferred income taxes				(4,000	)		682,000
	Change in operating assets and liabilities:
		Receivables			156,000			74,000
		Inventories			(11,000	)		72,000
		Prepaid expenses			(227,000	)		(295,000	)
		Deposits and other			43,000			(33,000	)
		Deferred rent payable			(137,000	)		(176,000	)
		Accounts payable-trade			(748,000	)		(565,000	)
		Income taxes payable			186,000			—
		Other accrued liabilities			(26,000	)		(171,000	)

			Total adjustments		1,576,000			2,297,000

		Net cash provided by operating activities			2,577,000			3,691,000
Cash flows from investing activities:
	Loan to officer				632,000			—
	Interest income				(3,000	)		—
	Receipts from payments on notes receivable				20,000			26,000
	Acquisition of property, buildings and equipment				(2,863,000	)		(1,637,000	)
	Proceeds from sale of property, buildings and equipment				—			1,159,000

		Net cash used in investing activities			(2,214,000	)		(452,000	)
Cash flows from financing activities:
	Reduction in bank overdraft				—			(1,306,000	)
	Payments on long term debt				(724,000	)		(7,344,000	)
	Proceeds from issuance of long-term debt				3,075,000			5,349,000
	Payments on line of credit, net				(1,500,000	)		—
	Capitalized loan costs				(27,000	)		(19,000	)
	Principal payment on capitalized lease obligations				(74,000	)		(78,000	)
	Dividends paid				(1,475,000	)		—

		Net cash used in financing activities			(725,000	)		(3,398,000	)

Net (decrease) increase in cash and cash equivalents					(362,000	)		(159,000	)
Cash and cash equivalents at beginning of period					445,000			433,000

Cash and cash equivalents at end of period				$	83,000		$	274,000

(Continued)

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

STAR BUFFET, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)

(Unaudited)

		Forty Weeks Ended
		November 1, 2004		November 3, 2003
Supplemental disclosures of cash flow information:
Cash paid during the period for:
	Interest	$	491,000	$	455,000
	Income taxes	$	354,000	$	52,000
Non cash investing and financing activities:
	Reclassification of property held for sale to property, buildings and equipment	$	—	$	52,000
	Exchange of property, buildings and equipment for notes receivable	$	—	$	100,000
	Exchange of property rental for repair services	$	2,000	$	—

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.

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.

		HomeTown Buffet	Casa Bonita	North's Star	Florida Buffets	JB's	Total
Owned		3	—	1	5	4	13
Leased		12	2	3	6	5	28

	Total	15	2	4	11	9	41

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

		Number of Restaurants
State		HomeTown Buffet	Casa Bonita	North's Star	Florida Buffets	JB's	Total
Arizona		8	—	1	—	1	10
Colorado		1	1	—	—	—	2
Florida		—	—	—	11	—	11
Idaho		—	—	1	—	—	1
Montana		—	—	—	—	2	2
New Mexico		2	—	—	—	1	3
Oklahoma		—	1	—	—	—	1
Oregon		—	—	1	—	—	1
Utah		3	—	—	—	4	7
Washington		—	—	1	—	—	1
Wyoming		1	—	—	—	1	2

	Total	15	2	4	11	9	41

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

		Number of Non-Operating Restaurants
State		HomeTown Buffet	Casa Bonita	North's Star	Florida Buffets	JB's	Total
Arizona		—	—	1	—	—	1
Florida		—	—	—	4	—	4
Utah		—	—	—	—	1	1
Wyoming		—	—	—	—	1	1

	Total	—	—	1	4	2	7

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

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

		HomeTown Buffet	Casa Bonita	North's Star	Florida Buffets	JB's	Total
Owned		2	—	1	4	3	10
Leased		14	2	5	7	6	34

	Total	16	2	6	11	9	44

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

		Number of Restaurants
State		HomeTown Buffet	Casa Bonita	North's Star	Florida Buffets	JB's	Total
Arizona		8	—	1	—	1	10
Colorado		2	1	—	—	—	3
Florida		—	—	—	11	—	11
Idaho		—	—	2	—	—	2
Montana		—	—	—	—	2	2
New Mexico		2	—	—	—	1	3
Oklahoma		—	1	—	—	—	1
Oregon		—	—	1	—	—	1
Utah		3	—	—	—	4	7
Washington		—	—	2	—	—	2
Wyoming		1	—	—	—	1	2

	Total	16	2	6	11	9	44

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

		Number of Non-Operating Restaurants
State		HomeTown Buffet	Casa Bonita	North's Star	Florida Buffets	JB's	Total
Florida		—	—	—	4	—	4
Utah		—	—	—	—	1	1

	Total	—	—	—	4	1	5

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.

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

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

40 Weeks Ended November 1, 2004	HomeTown Buffet			Casa Bonita		North's Star(1)			Florida Buffet(2)			JB's(3)		Other			Total
	(Dollars in Thousands)
Revenues	$	24,677		$	8,050	$	3,578		$	7,987		$	6,068	$	—		$	50,360
Interest income		—			—		—			—			—		5			5
Interest expense		(148	)		—		—			—			—		(345	)		(493	)
Depreciation & amortization		835			184		278			681			181		(331	)		1,828
Impairment of long-lived assets		—			—		136			—			—		380			516
Income (loss) before income taxes		1,492			1,905		(775	)		229			487		(1,800	)		1,538
Total assets		13,703			1,545		5,258			9,668			5,549		270			35,993
40 Weeks Ended November 3, 2003
Revenues	$	26,004		$	7,637	$	4,750		$	8,092		$	6,590	$	—		$	53,073
Interest income		—			—		—			—			—		168			168
Interest expense		(155	)		—		—			—			—		(388	)		(543	)
Depreciation & amortization		949			190		320			742			206		(410	)		1,997
Impairment of long-lived assets		—			—		166			14			—		437			617
Income (loss) before income taxes		1,832			1,576		(704	)		(13	)		411		(973	)		2,129
Total assets		12,917			1,567		6,116			10,813			4,916		85			36,414

(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.

(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:

	Twelve Weeks Ended November 1, 2004	Twelve Weeks Ended November 3, 2003	Forty Weeks Ended November 1, 2004	Forty Weeks Ended November 3, 2003
Weighted average common shares outstanding—basic	2,950,000	2,950,000	2,950,000	2,950,000
Dilutive effect of stock options	—	—	234,375	—

Weighted average common shares outstanding—diluted	2,950,000	2,950,000	3,184,375	2,950,000

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.

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.

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:

	Carrying Value of Asset		Current Year to Date Impairment Expense
Land	$	382,000	$	—
Equipment		1,339,000		6,000
Buildings and leaseholds		897,000		374,000

	$	2,618,000	$	380,000

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

	Carrying Value of Asset		Prior Year to Date Impairment Expense
Land	$	228,000	$	—
Equipment		1,608,000		16,000
Buildings and leaseholds		538,000		421,000

	$	2,374,000	$	437,000

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

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.

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.

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.

			Twelve Weeks Ended				Forty Weeks Ended
			November 1, 2004		November 3, 2003		November 1, 2004		November 3, 2003
Total revenues			100.0	%	100.0	%	100.0	%	100.0	%
Costs and expenses
	Food costs		34.7		33.5		34.4		33.5
	Labor costs		34.5		34.4		33.3		33.8
	Occupancy and other expenses		21.7		21.7		19.9		20.4
	General and administrative expenses		4.1		4.5		4.1		3.7
	Depreciation and amortization		4.0		4.0		3.7		3.8
	Impairment of long-lived assets		2.0		0.9		1.0		1.1

		Total costs and expenses	101.0		99.0		96.4		96.3

Income from operations			(1.0	)	1.0		3.6		3.7
	Interest expense		(1.3	)	(1.1	)	(1.0	)	(1.0	)
	Interest income		—		0.4		—		0.3
	Reversal of litigation accrual		—		—		—		0.7
	Other income		0.5		0.7		0.4		0.3

	Income before income taxes		(1.8	)	1.0		3.0		4.0
Income taxes			(0.6	)	0.3		1.0		1.4

Net income			(1.2	)%	0.7	%	2.0	%	2.6	%

Effective income tax rate			(32.9	)%	34.5	%	34.9	%	34.5	%

40 Weeks Ended November 1, 2004	HomeTown Buffet(1)			Casa Bonita(2)		North's Star(3)			Florida Buffet(4)			JB's(5)		Other			Total
	(Dollars in Thousands)
Revenues	$	24,677		$	8,050	$	3,578		$	7,987		$	6,068	$	—		$	50,360
Food cost		9,015			1,877		1,529			2,909			2,011		—			17,341
Labor cost		7,724			2,561		1,416			2,730			2,336		—			16,767
Interest income		—			—		—			—			—		5			5
Interest expense		(148	)		—		—			—			—		(345	)		(493	)
Depreciation & amortization		835			184		278			681			181		(331	)		1,828
Impairment of long-lived assets		—			—		136			—			—		380			516
Income (loss) before income taxes		1,492			1,905		(775	)		229			487		(1,800	)		1,538
40 Weeks Ended November 3, 2003
Revenues	$	26,004		$	7,637	$	4,750		$	8,092		$	6,590	$	—		$	53,073
Food cost		9,149			1,790		1,858			2,873			2,124		—			17,794
Labor cost		8,179			2,594		1,813			2,889			2,444		—			17,919
Interest income		—			—		—			—			—		168			168
Interest expense		(155	)		—		—			—			—		(388	)		(543	)
Depreciation & amortization		949			190		320			742			206		(410	)		1,997
Impairment of long-lived assets		—			—		166			14			—		437			617
Income (loss) before income taxes		1,832			1,576		(704	)		(13	)		411		(973	)		2,129

(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.

Total revenues decreased $1,109,000 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 primarily attributable to declines in comparable same store sales. Management believes the same store sales decrease is primarily due to the slower economy and increased competition in certain areas.

Food costs as a percentage of total revenues increased from 33.5% during the 12-week period ended November 3, 2003 to 34.7% during the 12 weeks ended November 1, 2004, and from 33.5% during the 40-week period ended November 3, 2003 to 34.4% during the 40 weeks ended November 1, 2004. The increase for the 12 and 40 weeks as a percentage of total revenues was primarily attributable

to higher wholesale food prices in all major food categories, especially meats and dairy, as compared to the same period last year.

Labor costs as a percentage of total revenues increased from 34.4% during the 12-week period ended November 3, 2003 to 34.5% during the 12-week period ended November 1, 2004 and actual costs decreased by $366,000. Labor costs as a percentage of total revenues decreased from 33.8% during the 40-week period ended November 3, 2003 to 33.3% during the 40-week period ended November 1, 2004 and actual labor costs declined by $1,152,000. The decrease in labor dollars and as a percentage of revenue resulted from the elimination of labor inefficiencies from the now closed locations.

Occupancy and other expenses as a percentage of total revenues remained at 21.7% for both 12-week periods ended November 3, 2003 and November 1, 2004. Occupancy and other expenses as a percentage of total revenues decreased from 20.4% during the 40-week period ended November 3, 2003 to 19.9% during the 40-week period ended November 1, 2004. Though the percentage of total revenues for the 12-week periods ended November 3, 2003 and November 1, 2004 remained the same, the Company's actual costs decreased by $245,000 due to fewer locations and lower revenue in the 12 weeks ended November 1, 2004 compared to the same period of the prior year. The decrease as a percentage of total revenues for the 40-week period ended November 1, 2004 was primarily attributable to lower property rental costs of $275,000, lower insurance costs of $107,000, lower other controllable costs consisting primarily of janitorial and supply costs of $174,000 and lower advertising of $99,000 due primarily to fewer locations and lower revenue.

General and administrative expenses as a percentage of revenues decreased from 4.5% during the 12-week period ended November 3, 2003 to 4.1% during the 12-week period ended November 1, 2004. General and administrative costs as a percentage of revenues increased from 3.7% during the 40-week period ended November 3, 2003 to 4.1% during the 40-week period ended November 1, 2004. The decrease was primarily attributable to lower field overhead expenses of $10,000 and lower corporate insurance costs of $35,000 for the 12-week period ended November 1, 2004 as compared to the same period of the prior year. The increase for the 40-week period ended November 1, 2004 was primarily attributable to higher corporate insurance costs of $351,000 partially offset by lower corporate payroll of $93,000 and lower other corporate expenses of $150,000 which includes travel, audit fees, royalties and telephone, among other expenses.

Depreciation and amortization as a percentage of total revenues remained approximately the same as a percentage of revenues during the 12-week period ended November 3, 2003 and November 1, 2004. Depreciation and amortization as a percentage of total revenues decreased from 3.8% during the 40-week period ended November 1, 2003 to 3.7% during the 40-week period ended November 1, 2004. The decrease is primarily attributable to certain equipment and impaired assets being fully depreciated for the 40-week period ended November 1, 2004.

Impairment of long-lived assets as a percentage of total revenues increased from 0.9% during the 12-week period ended November 1, 2003 to 2.0% during the 12-week period ended November 1, 2004. Impairment of long-lived assets as a percentage of total revenues decreased from 1.1% during the 40-week period ended November 1, 2003 to 1.0% during the 40-week period ended November 1, 2004. The impairment in fiscal 2005 was a result of the closure of three JJ North's Country Buffet restaurants in the third quarter. The impairment in fiscal 2004 was a result of the closure of one JJ North's Country Buffet in the first quarter.

Interest expense as a percentage of total revenues increased from 1.0% during the 12-week period ended November 3, 2003 to 1.3% during the 12-week period ended November 1, 2004, and remained the same during the 40-week periods ended November 3, 2003 and November 1, 2004. The increase as a percentage of total revenues was primarily attributable to higher debt balances. The average balance was approximately $7,000,000 and approximately $6,300,000 for the 12-week periods ended November 1, 2004 and November 3, 2003, respectively.

Interest income decreased $50,000 for the 12-week period ended November 1, 2004. Interest income decreased from $163,000 for the 40-week period ended November 3, 2003 to $5,000 for the 40-week period ended November 1, 2004. The interest income was generated by the Company's cash and outstanding notes receivable balances. The decrease in interest income is primarily attributable to the Company's decision not to record interest income on the note receivable with North's Restaurants, Inc. The Company has not recorded approximately $48,000 and $161,000 for the 12- and 40-week periods ended November 1, 2004, respectively, of interest income due from North's. 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.

Other income is rental income from the Company's leased properties. Rental income was $57,000 and $203,000 for three properties leased for the entire 12 and 40-week periods ended November 1, 2004, respectively. For the 12 and 40-week periods ended November 3, 2003, rental income was $99,000 and $165,000 which included three properties leased for 40, 30 and 26 weeks, respectively.

Impact of Inflation

The impact of inflation on the cost of food, labor, equipment and construction and remodeling of stores could affect the Company's operations. Many of the Company's employees are paid hourly rates related to the federal and state minimum wage laws. Legislation increasing state and local minimum wages has resulted in higher labor costs to the Company. In addition, the cost of food commodities utilized by the Company are subject to market supply and demand pressures. Shifts in these costs may have an impact on the Company's food costs. The Company anticipates that modest increases in these costs can be offset through pricing and other cost control efforts; however, there is no assurance that the Company would be able to pass more significant costs on to its customers or if it were able to do so, it could do so in a short period of time.

Liquidity and Capital Resources

The Company has historically financed operations through a combination of cash on hand, cash provided from operations and available borrowings under bank lines of credit.

As of November 1, 2004, the Company had $83,000 in cash. Cash and cash equivalents decreased by $362,000 during the 40 weeks ended November 1, 2004. The net working capital deficit was $(5,375,000) and $(5,490,000) at November 1, 2004 and January 26, 2004, respectively. Total cash provided by operations in the 40 weeks ended November 1, 2004 was approximately $2.6 million as compared to approximately $3.7 million in the 40 weeks ended November 3, 2003. The Company used approximately $492,000 on capital expenditures and $2,371,000 for property acquisitions during the 40 weeks ended November 1, 2004. Total debt decreased by approximately $307,000 in the third quarter of fiscal 2005 and increased by approximately $1,162,000 in the second quarter of fiscal 2005 and decreased by approximately $3,000 in the first quarter of fiscal 2005 for an increase of approximately $852,000 for the 40-weeks ended November 1, 2004, net of repayments.

The Company intends to modestly expand operations through the acquisition of regional buffet chains or through the purchase of existing restaurants which would be converted to one of the Company's existing restaurant concepts. In many instances, management believes that existing restaurant locations can be acquired and converted to the Company's prototype at a lower cost than those associated with the start of a new restaurant. Management estimates the cost of acquiring and converting a leased property to one of the existing concepts to be approximately $150,000 to $450,000. These costs consist primarily of exterior and interior appearance modifications, new tables, chairs and

food bars and the addition of certain kitchen and food service equipment. There can be no assurance that the Company will be able to acquire additional restaurant chains or locations or, if acquired, that these restaurants will have a positive contribution to the Company's results of operations.

On October 31, 2004, the Company continued with a $1.0 million 1-year Revolving Line of Credit with M&I Marshall & Ilsley Bank (the "Revolving Line of Credit"). The Revolving Line of Credit refinanced a revolving credit facility the Company previously had with FleetBoston Financial Corporation and provides working capital for the Company. The Revolving Line of Credit bears interest at LIBOR plus two percent per annum. The Revolving Line of Credit requires the Company to maintain specified minimum levels of net worth, limit the amount of capital expenditures, maintain certain fixed charge coverage ratios, and to meet other financial covenants. The Company is currently in compliance with these covenants. All outstanding amounts under the Revolving Line of Credit become due October 31, 2005. The Company will seek to renew or replace the Revolving Line of Credit by October 2005. The Revolving Line of Credit balance was $400,000 and $275,000 on November 1, 2004 and December 7, 2004, respectively. The Company had $600,000 and $725,000 available for borrowing on November 1, 2004 and December 7, 2004, respectively.

The Company believes that available cash and cash flow from operations will be sufficient to satisfy its working capital and capital expenditure requirements during the next 12 months. Management does not believe the net working capital deficit will have any effect on the Company's ability to operate the business and meet obligations as they come due in the next 12 months. The Company believes that it will spend less than $3 million a year on capital expenditures for the next few years. The Company believes that the combination of capital spending and an acquisition strategy that is not projected to require significant amounts of capital suggests that the Company may generate operating cash flow in excess of expected needs. In such event, the Company plans to consider the return of some capital to its stockholders through a stock repurchase program or a cash dividend or both. There can be no assurance that cash and cash flow from operations will be sufficient to satisfy its working capital and capital requirements for the next 12 months or beyond.

If the Company requires additional funds to support its working capital requirements or for other purposes, it may seek to raise such additional funds through public or private equity and/or debt financing or from other sources. There can be no assurance, however, that changes in the Company's operating plans, the unavailability of a credit facility, the acceleration of the Company's expansion plans, lower than anticipated revenues, increased expenses or potential acquisitions or other events will not cause the Company to seek additional financing sooner than anticipated. There can be no assurance that additional financing will be available on acceptable terms or at all.

Critical Accounting Policies and Judgments

The Company prepares its consolidated financial statements in conformity with accounting principles generally accepted in the United States of America. The Company's consolidated financial statements are based on the application of certain accounting policies, the most significant of which are described in Note 1—Summary of Significant Accounting Policies included in the Company's Annual Report filed on Form 10-K. Certain of these policies require numerous estimates and strategic or economic assumptions that may prove inaccurate or subject to variations and may significantly affect the Company's reported results and financial position for the reported period or in future periods. Changes in underlying factors, assumptions or estimates in any of these areas could have a material impact on the Company's future financial condition and results of operations. The Company considers the following policies to be the most critical in understanding the judgments that are involved in preparing its consolidated financial statements.

Property, Buildings and Equipment

Property and equipment and real property under capitalized leases are carried at cost less accumulated depreciation and amortization. Depreciation and amortization are provided using the straight-line method over the following useful lives:

		Years
Buildings		40
Building improvements		15–20
Furniture, fixtures and equipment		5–8

Leasehold improvements are amortized over the lesser of the life of the lease or estimated economic life of the assets. The life of the lease includes renewal options determined by management at lease inception for which failure to renew options would result in a substantial economic penalty.

Repairs and maintenance are charged to operations as incurred. Remodeling costs are generally capitalized.

The Company's accounting policies regarding buildings and equipment include certain management judgments regarding the estimated useful lives of such assets, the residual values to which the assets are depreciated and the determination as to what constitutes increasing the life of existing assets. These judgments and estimates may produce materially different amounts of depreciation and amortization expense than would be reported if different assumptions were used. As discussed further below, these judgments may also impact the Company's need to recognize an impairment charge on the carrying amount of these assets as the cash flows associated with the assets are realized.

Impairment of Goodwill

SFAS 142 requires 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 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 in the first quarter of 2003. The Company evaluates goodwill for impairment each quarter, annually and when a triggering event occurs for potential impairment issues.

Impairment 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.

Judgments made by the Company related to the expected useful lives of long-lived assets and the ability of the Company to realize undiscounted cash flows in excess of the carrying amounts of such

assets are affected by factors such as the ongoing maintenance and improvements of the assets, changes in economic conditions, and changes in operating performance. As the Company assesses the ongoing expected cash flows and carrying amounts of its long-lived assets, these factors could cause the Company to realize a material impairment charge.

Insurance Programs

Item 3. Quantitative and Qualitative Disclosures about Market Risk

Interest Rate Risk

The Company's principal exposure to financial market risks is the impact that interest rate changes could have on its $1.0 million Revolving Line of Credit, of which $725,000 remained outstanding as of December 7, 2004. The Revolving Line of Credit interest rate is LIBOR plus two percent per annum (averaging approximately 4.2% in the third quarter of fiscal 2005). A hypothetical increase of 100 basis points in short-term interest rates would result in a reduction of approximately $2,750 in annual pre-tax earnings. The estimated reduction is based upon the outstanding balance of the Company's line of credit and assumes no change in the volume, index or composition of debt at December 7, 2004. The balance outstanding on the Revolving Line of Credit at November 1, 2004 was $400,000. All of our business is transacted in U.S. dollars. Accordingly, foreign exchange rate fluctuations have never had a significant impact on the Company and are not expected to in the foreseeable future.

Commodity Price Risk

The Company purchases certain products which are affected by commodity prices and are, therefore, subject to price volatility caused by weather, market conditions and other factors which are not considered predictable or within our control. Although many of the products purchased are subject to changes in commodity prices, certain purchasing contracts or pricing arrangements contain risk management techniques designed to minimize price volatility. Typically the Company uses these types of purchasing techniques to control costs as an alternative to directly managing financial instruments to hedge commodity prices. In many cases, the Company believes it will be able to address commodity cost increases which are significant and appear to be long-term in nature by adjusting its menu pricing, menu mix or changing our product delivery strategy. However, increases in commodity prices could result in lower operating margins for our restaurant concepts.

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

The Company's chief executive officer and its principal accounting officer, based on their evaluation of the Company's disclosure controls and procedures (as defined in the rules under the Securities Exchange Act of 1934) as of the end of the quarterly period covered by this report on Form 10-Q, have concluded that the Company's disclosure controls and procedures are effective and sufficient to ensure that the Company records, processes, summarizes and reports information required to be disclosed by the Company in its periodic reports filed under the Securities and Exchange Act within the time period specified by the Securities and Exchange Commission's rules and forms. Even an

effective internal control system, no matter how well developed has inherit limitations, including the possibility of the circumvention or overriding of controls. Therefore, our internal control over financial reporting can provide only reasonable assurance with respect to the reliability of our financial reporting and financial statement preparation.

Changes in Internal Control Over Financial Reporting

The Company's chief executive officer and its principal accounting officer, in the course of evaluating the Company's disclosure controls and procedures, did not identify any change in the Company's internal control over financial reporting (as defined in the rules under the Securities Exchange Act of 1934) that occurred during the most recent fiscal quarter covered by this report on Form 10-Q that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting.

PART II: OTHER INFORMATION

Item 1. Legal Proceedings

On November 12, 1998, North's Restaurants, Inc. ("North's") filed a Demand for Arbitration against the Company with the American Arbitration Association, Irvine, California (District No. 949-251-9840), alleging breach of contract in connection with the Company's failure to perform under a Business Services Agreement between North's and the Company dated July 24, 1997. On June 22, 1999, the parties agreed to dismiss the Arbitration Proceeding without prejudice since the issues related to the Business Service Agreement were being litigated in the Utah action described below.

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 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 have 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 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 have agreed that the Company's existing liens encumbering certain property of North's remain in place and continue to secure North's obligations to the Company, and the Company and North's reserve 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 a Settlement Agreement dated January 26, 2001 ("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.

On March 21, 2002, Alliant Foodservice, Inc. ("Alliant") filed a breach of contract complaint against the Company in the Superior Court for the State of Arizona in and for the County of Maricopa (No. CVZ002-005195), alleging breach of the Master Distribution Agreement ("MDA") executed between the Company and Alliant on or about December 1, 1999. Alliant sought $2,479,000 for alleged amounts owed by the Company plus attorneys' fees and costs. The Company included approximately $2,000,000 for this alleged amount owed in relation to this litigation in accounts payable-trade at January 27, 2003 net of any amounts receivable from Alliant. The Company denied the allegations and vigorously defended the alleged breach of contract. On April 29, 2002, the Company filed an answer and counterclaim in Superior Court for the State of Arizona in and for the County of Maricopa citing among other things, breach of the MDA. The Company sought over $7,250,000 in damages. On February 27, 2003, the Company and Alliant entered into a Settlement Agreement that dismissed

charges against both parties and required the Company to pay Alliant $1,600,000 which resulted in a $400,000 reversal of a litigation accrual in the first quarter of fiscal 2004.

Item 6. Exhibits and Reports on Form 8-K

(a): The following exhibits are attached to this report:

		Exhibit Number		Description of Exhibit
		31.1		Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
		31.2		Certification of Principal Accounting Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
		32.1		Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
		32.2		Certification of Principal Accounting Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
		99.1		Press Release dated December 16, 2004.

(b): Current Reports on Form 8-K:

The Company did not file a report on Form 8-K during the quarter ended November 1, 2004.

There were no other items to be reported under Part II of this report.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized.

	STAR BUFFET, INC. AND SUBSIDIARIES
December 16, 2004	By:	/s/ ROBERT E. WHEATON Robert E. Wheaton Chairman of the Board, President, Chief Executive Officer and Principal Executive Officer
December 16, 2004	By:	/s/ RONALD E. DOWDY Ronald E. Dowdy Group Controller, Treasurer, Secretary and Principal Accounting Officer