STAR BUFFET INC - Quarter Report: 2006 May (Form 10-Q)

 

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C.
20549

FORM 10-Q

(Mark One)

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended:  May 22, 2006

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)

 

1312 N. Scottsdale Road,
Scottsdale, AZ 85257
(Address of principal executive offices) (Zip Code)

(480) 425-0397
(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  x    No  o

Indicated by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer. See definition of “accelerated filer” and “large accelerated filer” in Rule 12b-2 of the Exhange Act.

Large accelerated filer  o                   Accelerated filer  o             Non-accelerated filer  x

Indicate by checkmark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes  o    No  x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date. As of June 22, 2006, there were 3,170,675 shares of Common Stock, $ .001 par value, outstanding.

 

 

STAR BUFFET, INC. AND SUBSIDIARIES

INDEX

				Page
PART I. FINANCIAL INFORMATION
Item 1.		Condensed Consolidated Financial Statements:
		Condensed Consolidated Balance Sheets as of May 22, 2006 (unaudited) and January 30, 2006		3
		Unaudited Condensed Consolidated Statements of Operations for the sixteen weeks ended May 22, 2006 and May 23, 2005		5
		Unaudited Condensed Consolidated Statements of Cash Flows for the sixteen weeks ended May 22, 2006 and May 23, 2005		6
		Notes to Unaudited Condensed Consolidated Financial Statements		8
Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations		21
Item 3.		Quantitative and Qualitative Disclosures about Market Risk		29
Item 4.		Controls and Procedures		29
PART II. OTHER INFORMATION
Item 1.		Legal Proceedings		30
Item 6.		Exhibits and Reports on Form 8-K		31
Signatures				32

 

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PART I:  FINANCIAL INFORMATION

Item 1:    Condensed Consolidated Financial Statements

STAR BUFFET, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS

 

		May 22,  2006			January 30,  2006
		(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents		$	585,000		$	491,000
Current portion of notes receivable		54,000			39,000
Receivables		470,000			297,000
Inventories		472,000			429,000
Deferred income taxes		226,000			258,000
Prepaid expenses		314,000			132,000
Total current assets		2,121,000			1,646,000
Property, buildings and equipment:
Property, buildings and equipment, net		17,161,000			15,358,000
Property and equipment leased to third parties, net		3,674,000			3,734,000
Property, buildings and equipment held for future use, net		2,616,000			3,156,000
Property and equipment under capitalized leases, net		844,000			885,000
Property held for sale		931,000			931,000
Total property, buildings and equipment		25,226,000			24,064,000
Other assets:
Notes receivable, net of current portion		3,180,000			4,399,000
Deposits and other		148,000			133,000
Total other assets		3,328,000			4,532,000
Deferred income taxes, net		2,176,000			2,190,000
Intangible assets:
Goodwill		1,677,000			1,677,000
Other intangible assets, net		676,000			715,000
Total intangible assets		2,353,000			2,392,000
Total assets		$	35,204,000		$	34,824,000

 

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)

 

		May 22,  2006			January 30,  2006
		(Unaudited)
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable-trade		$	2,004,000		$	2,178,000
Payroll and related taxes		1,217,000			1,131,000
Sales and property taxes		712,000			666,000
Rent, licenses and other		468,000			508,000
Dividend payable		2,695,000			—
Income taxes payable		702,000			891,000
Current maturities of obligations under long-term debt		600,000			640,000
Current maturities of obligations under capital leases		147,000			142,000
Total current liabilities		8,545,000			6,156,000
Deferred rent payable		1,316,000			1,317,000
Other long-term liability		—			34,000
Capitalized lease obligations, net of current maturities		1,348,000			1,397,000
Long-term debt, net of current maturities		4,862,000			5,636,000
Total liabilities		16,071,000			14,540,000
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 3,170,675 and 3,003,425 shares		3,000			3,000
Additional paid-in capital		17,490,000			16,618,000
Retained earnings		1,640,000			3,663,000
Total stockholders’ equity		19,133,000			20,284,000
Total liabilities and stockholders’ equity		$	35,204,000		$	34,824,000

 

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 OPERATIONS
(Unaudited)

 

		Sixteen Weeks Ended
		May  22, 2006			May  23, 2005
Total revenues		$	18,762,000		$	18,869,000
Costs and expenses
Food costs		6,610,000			6,538,000
Labor costs		6,025,000			5,889,000
Occupancy and other expenses		3,873,000			3,565,000
General and administrative expenses		829,000			658,000
Depreciation and amortization		647,000			674,000
Impairment of long-lived assets		—			121,000
Total costs and expenses		17,984,000			17,445,000
Income from operations		778,000			1,424,000
Interest expense		(179,000		)	(204,000		)
Interest income		58,000			28,000
Other income		105,000			90,000
Gain on sale of assets		234,000			—
Income before income taxes		996,000			1,338,000
Income taxes		324,000			462,000
Net income		$	672,000		$	876,000
Net income per common share — basic		$	0.22		$	0.30
Net income per common share — diluted		$	0.21		$	0.27
Weighted average shares outstanding — basic		3,093,648			2,958,774
Weighted average shares outstanding — diluted		3,128,230			3,206,382

 

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)

		Sixteen Weeks Ended
		May 22, 2006			May 23, 2005
Cash flows from operating activities:
Net income		$	672,000		$	876,000
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Depreciation and amortization		637,000			668,000
Amortization of loan cost		10,000			6,000
Gain on sale of assets		(234,000		)	—
Impairment of long-lived assets		—			121,000
Deferred income taxes		46,000			(67,000		)
Change in operating assets and liabilities:
Receivables		(173,000		)	244,000
Inventories		(43,000		)	(56,000		)
Prepaid expenses		(182,000		)	(240,000		)
Deposits and other		(15,000		)	(12,000		)
Deferred rent payable		(1,000		)	(1,000		)
Accounts payable-trade		(174,000		)	(176,000		)
Income taxes payable		(189,000		)	122,000
Other accrued liabilities		58,000			(605,000		)
Total adjustments		(260,000		)	4,000
Net cash provided by operating activities		412,000			880,000
Cash flows from investing activities:
Proceeds from sale of fixed assets		159,000			—
Interest income		(2,000		)	(2,000		)
Receipts from payments on notes receivable		20,000			39,000
Issuance of note receivable		(100,000		)	(1,000,000		)
Acquisition of property, buildings and equipment		(1,024,000		)	(204,000		)
Net cash used in investing activities		(947,000		)	(1,167,000		)
Cash flows from financing activities:
Stock options		872,000			267,000
Payments on long term debt		(198,000		)	(180,000		)
Capitalized loan costs		—			(2,000		)
Principal payment on capitalized lease obligations		(45,000		)	(36,000		)
Net cash provided by financing activities		629,000			49,000
Net change in cash and cash equivalents		94,000			(238,000		)
Cash and cash equivalents at beginning of period		491,000			692,000
Cash and cash equivalents at end of period		$	585,000		$	454,000

 

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)

 

		Sixteen Weeks Ended
		May 22, 2006			May 23, 2005
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest		$	177,000		$	204,000
Income taxes		$	468,000		$	407,000
Non cash investing and financing activities:
Accrued dividend payable		$	2,695,000		$	2,253,000
Exchange of notes receivable for equipment and leaseholds		$	1,285,500		—
Transfer of debt as a part of the sale of assets		$	616,000		—

 

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 30, 2006. 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 2006 consolidated financial statements to conform to the fiscal 2007 presentation. The accompanying condensed consolidated financial statements include the results of operations and assets and liabilities directly related to the Company’s operations. The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

The following is a summary of the Company’s restaurant properties as of May 22, 2006. The Company has four reporting segments: HomeTown Buffet, North’s Star, Florida Buffets Division and Summit Restaurant Division. The Company’s reportable segments are based on brand similarities. The HomeTown Buffet segment includes the Company’s 14 franchised HomeTown Buffet restaurants. The North’s Star segment includes three JJ North’s Country Buffet restaurants and one North’s Star Buffet restaurant, of which one JJ North’s Country Buffet and one North’s Star Buffet are non-operating units. The Florida Buffets Division includes two BuddyFreddys restaurants, three BuddyFreddys Country Buffet restaurants and two Holiday House restaurants. The Florida Buffet Division also includes four non-operating units. The Company closed one BuddyFreddys Country Buffet on June 9, 2006 without incurring any costs associated with the leaseholds or the lease. The Summit Restaurants Division included the Company’s eight JB’s Restaurants at the beginning of the quarter, which includes two non-operating JB’s Restaurants. One of the two JB’s Restaurant non-operating units in Laramie, Wyoming was sold in March 2006. The Summit Restaurant Division acquired four K-BOB’S Restaurants during the quarter. The Company acquired three K-BOB’S restaurants on January 31, 2006 for $1,285,500 in Tucumcari, New Mexico, Beeville, Texas and Lamesa, Texas. The Company also acquired the K-BOB’S restaurant in Dumas, Texas on February 28, 2006. The Dumas purchase price was approximately $700,000 in cash for the equipment, building and land. The Summit Restaurants Division also includes the Casa Bonita restaurant in Denver, Colorado.

 

 

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In addition to the above summary, the Company purchased in September 2005 a restaurant facility in Rexburg, Idaho. The Company leases the restaurant facility to a JB’s franchisee.

As of May 22, 2006, the Company’s operating and non-operating restaurants are located in the following states:

 

As of May 22, 2006, the Company’s non-operating restaurants are located in the following states:

 

 

 

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As of May 23, 2005, the Company’s operating and non-operating restaurants were located in the following states:

 

 

As of May 23, 2005, the Company’s non-operating restaurants were located in the following states:

 

 

The operating results for the 16-week period ended May 23, 2005 included operations shown in the tables above and the fixed charges for seven restaurants closed during the entire quarter and one restaurant closed during the quarter. At the end of the first quarter of fiscal 2006, three non-operating stores were held for repositioning, one non-operating restaurant was held for sale and the three remaining closed restaurants were leased to third parties.

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.

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 the Sarbanes-Oxley Act of 2002. Mr. Wheaton owns approximately 48% of the Company’s outstanding common shares including options to purchase

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stock and may have the effective power to elect members of the board of directors and to control the vote on substantially all other matters, without the approval of the other stockholders. The loans were secured by the common stock and bore interest at the prevailing rate set forth in the Company’s credit facility with M&I Marshall & Ilsley Bank. Repayment terms stipulated that Mr. Wheaton would 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 received a lump sum payment per a termination clause or six month’s after the termination of his employment. Management elected not to record any interest income on the loans until the interest income was paid to the Company. On June 8, 2005, Mr. Wheaton paid the principal balance of $698,000 in full and paid $250,000 in interest. On May 22, 2006, Mr. Wheaton paid the final interest payment of $43,713.

Note (C) Segment and Related Reporting

The Company has four reporting segments: HomeTown Buffet, North’s Star, Florida Buffets Division and Summit Restaurants Division. 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 condensed consolidated balance sheets 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 condensed consolidated statements of operations are not included in the reportable segments.

(Dollars in Thousands)

16 Weeks Ended May 22, 2006		HomeTown Buffet			North’s Star(1)			Florida Buffet(2)			Summit Restaurants(3)			Other			Total
Revenues		$	9,177		$	726		$	3,775		$	5,084		$	—		$	18,762
Interest income		—			—			—			—			58			58
Interest expense		(52		)	—			—			—			(127		)	(179		)
Depreciation & amortization		306			27			140			150			24			647
Income (loss) before income taxes		472			(108		)	351			918			(637		)	996
Total assets		11,654			4,195			7,944			7,867			3,544			35,204
16 Weeks Ended May 23, 2005
Revenues		$	9,484		$	743		$	3,815		$	4,827		$	—		$	18,869
Interest income		—			—			—			—			28			28
Interest expense		(55		)	—			—			—			(149		)	(204		)
Depreciation & amortization		307			26			193			129			19			674
Impairment of long-lived assets		7			31			77			6			—			121
Income (loss) before income taxes		912			(81		)	372			697			(562		)	1,338
Total assets		12,414			4,337			8,732			6,654			3,011			35,148

(1) Included in the reportable segment for the quarter ended May 22, 2006 are two locations closed for the entire quarter. These locations incurred $0 of impairment expense in the quarter ended May 22, 2006. These locations

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have a net book value of equipment of $23,000, buildings and leaseholds of $510,000 and land of $224,000 included in total assets at May 22, 2006.

Included in the reportable segment for the quarter ended May 23, 2005 are two locations closed for the entire quarter. These locations incurred $11,000 of impairment expense in the quarter ended May 23, 2005. These locations have a net book value of equipment of $47,000, buildings and leaseholds of $502,000 and land of $224,000 included in total assets at May 23, 2005.

(2) Included in the reportable segment for the quarter ended May 22, 2006 are four locations closed for the entire quarter. These four locations incurred $52,000 of depreciation and amortization and $0 of impairment expense in the quarter ended May 22, 2006. These locations have a net book value of equipment of $536,000, buildings of $1,785,000 and land of $1,559,000 included in total assets at May 22, 2006.

Included in the reportable segment for the quarter ended May 23, 2005 are four locations closed for the entire quarter. These four locations incurred $75,000 of depreciation and amortization and $18,000 of impairment expense in the quarter ended May 23, 2005. These locations have a net book value of equipment of $618,000, buildings of $1,828,000 and land of $1,559,000 included in total assets at May 23, 2005.

(3) Included in the reportable segment for the quarter ended May 22, 2006 are two locations closed for the entire quarter. The locations represent $0 in land in total assets. These locations represent $92,000, 517,000 and $228,000 of net book value of equipment, buildings and land included in total assets, respectively, and incurred $8,500 in depreciation and amortization expense and $0 of impairment expense.

Included in the reportable segment for the quarter ended May 23, 2005 are two locations closed for the entire quarter and one location opened for 10 weeks during the quarter. The locations have a net book value of $386,000 for land included in total assets. These locations represent $44,000 and $905,000 of net book value of equipment and buildings included in total assets, respectively, and incurred $8,700 in depreciation and amortization expense and $5,000 of impairment expense. The location opened for 10 weeks had revenues of $113,000.

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:

16 Weeks Ended May 22, 2006		Net Income			Shares		Per Share Amount
Weighted average common shares outstanding — basic		$	672,000		3,093,648		$	0.22
Dilutive stock options		—			34,582		—
Weighted average common shares outstanding — diluted		$	672,000		3,128,230		$	0.21

 

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16 Weeks Ended May 23, 2005
Weighted average common shares outstanding — basic		$	876,000		2,958,774		$	0.30
Dilutive stock options		—			247,608		—
Weighted average common shares outstanding — diluted		$	876,000		3,206,382		$	0.27

 

Average shares used in the sixteen weeks ended May 22, 2006 and May 23, 2005 to calculate diluted earnings per share exclude stock options to purchase 489,000 shares of common stock due to the market price of the underlying stock being less than the exercise price.

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. The Company reviews goodwill for possible impairment on an annual basis or when triggering events occur in accordance with SFAS 142. Goodwill is tested for impairment at the reporting unit level. The Company reviews goodwill for possible impairment by restaurant.

The Company utilizes a two-part impairment test. First, the fair value of the reporting unit is compared to carrying value (including goodwill). If the carrying value is greater than the fair value, the second step is performed. In the second step, the implied fair value of the reporting unit goodwill is compared to the carrying amount of goodwill. If the carrying value is greater, a loss is recognized. The goodwill impairment test considers the impact of current conditions and the economic outlook for the restaurant industry, the general overall economic outlook including market data, governmental and environmental factors, in establishing the assumptions used to compute the fair value of each reporting unit. We also take into account the historical, current and future (based on probability) operating results of each reporting units and any other facts and data pertinent to valuing the reporting units in our impairment test.

The Company has an independent evaluation of goodwill conducted every three years. The most recent independent valuation was conducted as of February 1, 2005. There were not any goodwill impairment losses for the 16-week periods ended May 22, 2006 and May 23, 2005.

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

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 undiscounted 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 exceeds the fair value of the assets.

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The components of property, buildings and equipment used in restaurant operations, not including property under capitalized leases, are as follows:

 

 

The components of property under capitalized leases are as follows:

 

 

Total property, buildings and equipment includes the following land, equipment and buildings and leaseholds currently in seven non-operating units. Three of the seven units are leased to third-party operators, three units are closed for remodeling and repositioning and one unit is included in property held for sale at May 22, 2006. In addition to the above summary, the Company purchased in September 2005 a restaurant facility in Rexburg, Idaho. The Company leases the restaurant facility to a JB’s franchisee. The components are as follows:

 

 

 

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The Company recorded impairment expense of $0 and $121,000 in the first quarter of fiscal 2007 and fiscal 2006, respectively, as a result of decreasing the carrying value of assets held for future use.

Note (H) Stock-Based Compensation

In 2004, the FASB issued a revision to SFAS No. 123 “Share Based Payment” (“SFAS 123R”), which requires the measurement of all share-based payments to employees, including grants of employee stock options, using a fair value-based method and recording of such expense in our condensed consolidated statements of income. In April 2005, the Securities and Exchange Commission adopted a rule delaying the effective date for recording the compensation expense in the statement of operations under SFAS 123R until the beginning of the first annual period after June 15, 2006.

On January 31, 2006 we adopted Statement of Financial Accounting Standards No. 123(R), “Share Based Payment” (SFAS 123(R)). SFAS 123(R) requires the recognition of compensation costs relating to share based payment transactions in the financial statements. We have elected the modified prospective application method of reporting. Prior to the adoption of SFAS 123(R) we elected to account for stock-based compensation plans using the intrinsic value method under Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees,” under which no compensation cost is recognized and the pro forma effects on earnings and earnings per share are disclosed as if the fair value approach had been adopted. Our stock-based compensation plans are summarized in the table below:

 

Stock options issued under the terms of the plans have, or will have, an exercise price equal to, or greater than, the fair market value of the common stock at the date of the option grant, and expire no later than ten years from the date of grant, with the most recent grant expiring in 2015. The 1997 Plan provides for “incentive stock options,” within the meaning of section 422 of the Internal Revenue Code of 1986, as amended (the “Code”) and non-statutory options to directors, officers, employees and consultants of the Company, except that incentive stock options may not be granted to non-employee directors or consultants. The 1997 Plan provides participants with incentives which will encourage them to acquire a proprietary interest in, and continue to provide services to, the Company. The Board of Directors has sole discretion and authority, consistent with the provisions of the 1997 Plan, to determine which eligible participants will receive options, time when options will be granted, terms of options granted and number of shares which will be subject to options granted under the 1997 Plan.

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The stock option transactions and the options outstanding are summarized as follows:

		16 Weeks Ended
		May 22, 2006						May 23, 2005
		Options			Weighted Average Exercise Price			Options			Weighted Average Exercise Price
Outstanding at beginning of period		696,000			$	8.90		701,000			$	9.88
Granted		—			—			49,000			$	6.70
Exercised		167,000			$	5.22		53,000			$	5.00
Forfeited		—			—			0			$	5.00
Outstanding at end of period		529,000			$	11.56		697,000			$	10.04
Exercisable at end of period		529,000			$	11.56		697,000			$	10.04
Weighted average fair value of options granted during the period		$	N/A					$	6.70

 

We have elected the Black-Scholes method of valuation for fiscal 2006 and used the following assumptions:

 

To estimate expected lives for this valuation, it was assumed that options will be exercised at varying schedules after becoming fully vested. It is initially assumed that all options will vest. Fair value computations are highly sensitive to the volatility factor assumed; the greater the volatility, the higher the computed fair value of the options granted.

Total fair value of options granted was approximately $0 and $330,000 for the 16 weeks ended May 22, 2006 and May 23, 2005, respectively. The amounts are amortized ratably over the vesting period of the options. The effect of the change from applying the original provisions of SFAS 123 to the adoption of SFAS 123(R) was a charge of $61,000 to income before income taxes. There was no tax effect on the income statement due to a full valuation allowance recorded against the deferred tax assets. As a result of the valuation allowance,

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the adoption of SFAS 123(R) had no effect on cash flows. The effect of the adoption of SFAS 123(R) on basic and diluted earnings per share was a negative $0.02 for the 16 weeks ended May 23, 2005.

There were no options granted during the 16 weeks ended May 22, 2006. The following table illustrates the pro-forma effect on net income and on the net income per share, as if we had applied the fair value recognition provisions of SFAS No. 123.

 

 

The following summarizes information about stock options outstanding at May 22, 2006:

 

		Options Outstanding							Options Exercisable
Range of Exercise Prices		Number Outstanding		Remaining Contractual Life		Weighted Average Exercise Price			Number Exercisable		Weighted Average Exercise Price
$ 5.00		12,000		3.4		$	5.00		12,000		$	5.00
$ 6.70		28,000		8.7		$	6.70		28,000		$	6.70
$12.00		489,000		1.3		$	12.00		489,000		$	12.00
		529,000							529,000

 

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For options granted during the quarter ended May 23, 2005, the weighted average fair value at the date of grant for options granted was estimated using the Black-Scholes pricing model with the following assumptions:

 

 

During the first quarter of fiscal 2006, the Company granted 49,200 fully vested stock options at an exercise price equal to the current fair value of the stock. The Company did not grant any stock options in the first quarter of fiscal 2007.

Note (I) Commitments and Contingencies

The Company is engaged in ordinary and routine litigation incidental to its business. Management does not anticipate that any resolution of any of these proceedings will require payments that will have a material effect on the Company’s consolidated statements of operations or financial position or liquidity.

HTB entered into a franchise agreement for each location which requires among other items, the payment of a continuing royalty fee paid to HomeTown Buffet, Inc. The royalty fee is based on 2% of the aggregate gross sales of all the Company’s HomeTown Buffet restaurants. Each of the franchise agreements has a 20-year term (with two five-year renewal options). HTB provides weekly sales reports to the HomeTown franchisor as well as periodic and annual financial statements. HTB is obligated to operate its Hometown Buffet restaurants in compliance with the franchisor’s requirements. The franchisor requires HTB to operate each restaurant in conformity with Franchise Operating Manuals, Recipe Manuals and Menus and HTB is to use it best effort to achieve the highest practicable level of sales, promptly make royalty payments and restricts operating restaurants within a geographic radius of the franchisor’s restaurants. The HomeTown franchisor may terminate a franchise agreement for a number of reasons, including HTB’s failure to pay royalty fees when due, failure to comply with applicable laws or repeated failure to comply with one or more requirements of the franchise agreement. Many state franchise laws limit the ability of a franchisor to terminate or refuse to renew a franchise. Generally, a franchisor may terminate a franchise agreement only if the franchisee violates a material and substantial provision of the agreement and fails to remedy the violation within a specified period.

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

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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 a second 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. In January 2005, the court granted the Company’s motion for summary judgment, ruling that North’s had failed to pay amounts owed to the Company. The Company obtained a judgment against North’s in the amount of $3,059,905.78, plus $15,980.45 in attorney’s fees and costs.

In a related proceeding, North’s other secured creditor, Pacific Mezzanine, initiated litigation against North’s seeking a monetary judgment and the appointment of a receiver. On October 4, 2004, the Circuit Court of the State of Oregon for the County of Jackson approved an order appointing a receiver.

Since his appointment, the receiver has remitted only approximately $56,000 in loan repayments and no payments have been made since September of 2005. The Company initiated certain legal actions designed to expedite the liquidation of North’s assets and repay amounts owed to Star Buffet. On April 25, 2006, the Company noticed all relevant parties of its intent to foreclose. Subsequent to the notice, the receiver moved to have the Company’s foreclosure of North’s assets set aside so that certain of North’s assets could be sold to a third party. The motion was approved and at this point Star Buffet awaits the completion of this sale.

On February 1, 2005, the Company announced in a press release that it had entered into a strategic alliance with K-BOB’S USA Inc. and related affiliates (“K-BOB’S”). In accordance with the terms of the strategic alliance, Star Buffet agreed to lend K-BOB’S up to $1.5 million on a long-term basis. The Company has loaned K-BOB’S $1.5 million and the current balance is $214,500. In exchange, K-BOB’S granted Star Buffet an option to purchase as many as five corporate owned and operated K-BOB’S restaurants located in New Mexico and Texas, as well as rights to develop K-BOB’S in other areas in the United States. On January 31, 2006, the Company exercised its option under the terms of the strategic alliance and purchased three K-BOB’S restaurants.

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

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resigns related to 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.

Note (J) 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 tax rate of approximately 32.6% and 35% as of May 22, 2006 and May 23, 2005, respectively. The quarter ending May 22, 2006 also included a state income refund for the prior year.

Note (K) 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 $53,500 and $42,500 for the 16-week periods ended May 22, 2006 and January 30, 2006, respectively.

Note (L) Subsequent Events

On June 1, 2006, the Company entered into a $564,000 five year real estate mortgage with Dalhart Federal Savings and Loan Association. The mortgage has monthly payments beginning July 1, 2006 with a balloon payment on June 1, 2011. The mortgage is secured by the Company’s K-BOB’S Restaurant in Dumas, Texas.

On February 24, 2006, the Board of Directors approved the Company’s third annual dividend of $0.60 per common share, a $0.10 increase from the prior year, and a special dividend of $0.25 per common share. Both were paid on June 7, 2006 to shareholders of record on May 11, 2006.

 

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