SECURITIES AND EXCHANGE COMMISSION

                             Washington, D.C. 20549
                              --------------------

                                    FORM 10-Q

Quarterly report pursuant to Section 13 or 15(d) of the Securities  Exchange Act
of 1934

For the quarterly period ended June 29, 1997

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 0-17980

                              --------------------

                            RALLY'S HAMBURGERS, INC.
             (Exact name of registrant as specified in its charter)

     DELAWARE                                             62-1210077
 (State or other jurisdiction of                   (IRS Employer ID Number)
  incorporation or organization)

          10002 Shelbyville Road, Suite 150, Louisville, Kentucky 40223

        Registrant's telephone number, including area code: 502/245-8900

     Indicate  by check  mark  whether  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 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

     Indicate the number of shares  outstanding of each of the issuer's  classes
of common stock as of the latest practicable date.

                 CLASS - Common stock, Par value $.10 per share

                OUTSTANDING AT AUGUST 1, 1997 - 20,567,547 shares


<PAGE>







                    RALLY'S HAMBURGERS, INC. AND SUBSIDIARIES
<TABLE>
<CAPTION>
                                      INDEX


<S>       <C>       <C>                                                                                       <C>    
PART I.   Financial Information                                                                               PAGE NO.

          ITEM 1.   Consolidated Financial Statements

                    Consolidated Balance Sheets as of December 29, 1996 and June 29, 1997 (Unaudited)            2

                    Consolidated Statements of Operations (Unaudited) for the Quarter and Six Months Ended       3
                    June 30, 1996 and June 29, 1997

                    Consolidated Statements of Cash Flows (Unaudited) for the Six Months Ended                   4
                    June 30, 1996 and June 29, 1997

                    Notes to Consolidated Financial Statements (Unaudited)                                       5

          ITEM 2.   Management's Discussion and Analysis of Financial Condition and Results of Operations       12

PART II.  Other Information

          ITEM 1.   Legal Proceedings                                                                           18

          ITEM 6. Exhibits and Reports on Form 8-K                                                              18

SIGNATURES                                                                                                      19


</TABLE>
<PAGE>
PART I.           FINANCIAL INFORMATION

ITEM 1.           Consolidated Financial Statements
<TABLE>
                                          RALLY'S HAMBURGERS, INC. AND SUBSIDIARIES
                                                 CONSOLIDATED BALANCE SHEETS
                                          AS OF  DECEMBER  29, 1996 AND JUNE 29, 1997 
                                          (In  thousands,  except shares and per share amounts)
<S>                                                                                          <C>                <C>    
                                                                                                                   (UNAUDITED)
                                                                                               DECEMBER 29,          JUNE 29,
                                                                                                  1996                 1997
                                                                                             ----------------   -----------------
ASSETS
Current assets:
   Cash and cash equivalents                                                                 $     2,285         $     4,390
   Restricted cash                                                                                 1,649               1,413
   Investments                                                                                     1,958               1,495
   Royalties receivable, net of reserve for doubtful accounts of $1,405 and $939 
     at December 29, 1996 and June 29, 1997, respectively                                            437               1,046
   Accounts and other receivables, including $565 and $821 from related parties at 
     December 29, 1996 and June 29, 1997, respectively, net of reserve for doubtful accounts 
     of $301 and $282 at December 29, 1996 and June 29, 1997, respectively                         1,698               1,446
   Inventory, at lower of cost or market                                                             794                 827
   Prepaid expenses and other current assets                                                         999               1,027
   Assets held for sale                                                                              596                 244
                                                                                             ----------------   -----------------
         Total current assets                                                                     10,416              11,888
Assets held for sale                                                                               1,426               1,076
Property and equipment, at historical cost, less accumulated depreciation of $39,188 and 
  $41,990 at December 29, 1996 and June 29, 1997, respectively                                    69,806              69,894
Notes receivable, including $127 and $112  from related parties at December 29, 1996 and 
  June 29, 1997, respectively, net of reserve for doubtful accounts of $853 and $659 at 
  December 29, 1996 and June 29, 1997, respectively                                                  773                 873
Goodwill, less accumulated amortization of $2,243 and $2,528 at December 29, 1996 and 
  June 29, 1997, respectively                                                                     10,482              10,197
Reacquired franchise and territory rights, less accumulated amortization of $1,984 and 
  $2,434 at December 29, 1996 and June 29, 1997, respectively                                     11,439              11,032
Other intangibles, less accumulated amortization of $2,459 and $2,696 at December 29, 
  1996 and June 29, 1997, respectively                                                             4,769               4,532
Other assets, less accumulated amortization of $1,101 and $1,252 at December 29, 1996 and 
  June 29, 1997, respectively                                                                      3,147               2,780
                                                                                             ----------------   -----------------
         Total assets                                                                        $   112,258         $   112,272
                                                                                             ================   =================
LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities:
   Accounts payable                                                                          $     4,884         $     5,999
   Accrued interest and other accrued liabilities                                                 13,600              14,347
   Current maturities of long-term debt and obligations under capital leases                       1,484               1,226
                                                                                             ----------------   -----------------
         Total current liabilities                                                                19,968              21,572
Senior notes, net of discount of $429 and $377 at December 29, 1996 and June 29, 1997, 
  respectively                                                                                    57,897              57,949
Long-term debt, less current maturities                                                            4,775               4,383
Obligations under capital leases, less current maturities                                          5,408               5,055
Other liabilities                                                                                  4,845               4,260
                                                                                             ----------------   -----------------
         Total liabilities                                                                        92,893              93,219
                                                                                             ----------------   -----------------
Commitments and contingencies (Note 5)
Shareholders' equity:
Preferred stock, $.10 par value, 5,000,000 shares authorized,  no shares issued                     --                  --
Common stock, $.10 par value, 50,000,000 shares authorized, 20,788,000 and 20,836,000 shares 
  issued at December 29, 1996 and June 29, 1997, respectively                                      2,079               2,084
Additional paid-in capital                                                                        71,023              71,566
Less:  Treasury shares, 273,000 at December 29, 1996 and June 29, 1997                            (2,108)             (2,108)
Retained deficit                                                                                 (51,629)            (52,489)
                                                                                             ----------------   -----------------
         Total shareholders' equity                                                               19,365              19,053
                                                                                             ----------------   -----------------
         Total liabilities and shareholders' equity                                          $   112,258         $   112,272
                                                                                             ================   =================

                                         The accompanying notes to consolidated financial statements   
                                      are an integral part of these consolidated financial statements.
</TABLE>
                                        2
<PAGE>


                              


<TABLE>

                                          RALLY'S HAMBURGERS, INC. AND SUBSIDIARIES
                                            CONSOLIDATED STATEMENTS OF OPERATIONS

                                                         (Unaudited)

                                           (In thousands except per share amounts)
<CAPTION>
<S>                                                    <C>                <C>                   <C>                 <C>    
                                                               THREE MONTHS ENDED                        SIX MONTHS ENDED
                                                       -----------------------------------      -----------------------------------
                                                         JUNE 30,            JUNE 29,              JUNE 30,            JUNE 29,
                                                           1996                1997                  1996                1997
                                                       --------------     ----------------      ----------------    ---------------

REVENUES:
   Restaurant sales                                    $   45,771          $    36,561           $    86,279         $   67,811
   Franchise revenues and fees                              1,586                1,346                 2,990              2,481
   Owner fee income                                          --                    183                  --                  393
                                                                          ----------------      ----------------    ---------------
                                                       --------------                           ----------------    ---------------
         Total revenues                                    47,357               38,090                89,269             70,685
                                                       --------------     ----------------      ----------------    ---------------

COSTS AND EXPENSES:
   Restaurant cost of sales                                16,064               12,072                30,865             22,008
   Restaurant operating expenses, exclusive of
     depreciation and amortization and advertising
     and promotion expenses shown separately below         19,532               15,064                39,084             28,831
   General and administrative expenses                      4,645                3,205                 9,305              7,157
   Advertising and promotion expenses                       2,067                2,909                 4,915              4,263
   Depreciation and amortization                            2,614                2,236                 5,302              4,524
   Owner expense                                             --                    279                  --                  579
   Provision for restaurant closures and other charges         22                  519                   754                502
                                                       --------------     ----------------      ----------------    ---------------
         Total costs and expenses                          44,944               36,284                90,225             67,864
                                                       --------------     ----------------      ----------------    ---------------

   Income (loss) from operations                            2,413                1,806                  (956)             2,821
                                                       --------------     ----------------      ----------------    ---------------

OTHER INCOME (EXPENSE):
   Interest expense                                        (2,146)              (1,854)               (4,459)            (3,734)
   Interest income                                             34                  264                   379                367
   Other                                                       (4)                  26                   (33)               (14)
                                                       --------------     ----------------      ----------------    ---------------
         Total other (expense)                             (2,116)              (1,564)               (4,113)            (3,381)
                                                       --------------     ----------------      ----------------    ---------------

Income (loss) before income taxes and extraordinary           297                  242                (5,069)              (560)
items

PROVISION (BENEFIT) FOR INCOME TAXES                          186                  150                (1,496)               300
                                                       --------------     ----------------      ----------------    ---------------

Income (loss) before extraordinary items                      111                   92                (3,573)              (860)

EXTRAORDINARY ITEM (net of tax expense of $1,817)            --                   --                   4,522               --
                                                       --------------     ----------------      ----------------    ---------------

Net income (loss)                                      $      111          $        92           $       949         $     (860)
                                                       ==============     ================      ================    ===============

Earnings (loss) per common share:
   Income (loss) before extraordinary item             $     .01           $      --             $    (.23)          $    (.04)
   Extraordinary item                                        --                   --                   .29                 --
                                                       --------------     ----------------      ----------------    ---------------

Earnings (loss) per common share                       $     .01           $      --             $     .06           $    (.04)
                                                       ==============     ================      ================    ===============

Weighted average shares outstanding                        15,934               20,552                15,802             20,545
                                                       ==============     ================      ================    ===============

                                                       The accompanying notes to consolidated financial statements
                                                    are an integral part of these consolidated financial statements
</TABLE>

                                       3
<PAGE>

<TABLE>
<CAPTION>
                              RALLY'S HAMBURGERS, INC. AND SUBSIDIARIES
                           CONSOLIDATED STATEMENTS OF CASH FLOWS (NOTE 4)
                                             (Unaudited)
          
                                           (In thousands)
<S>                                                                                        <C>                 <C>    
                                                                                                  SIX MONTHS ENDED
                                                                                             JUNE 30,           JUNE 29,
                                                                                               1996               1997
                                                                                           ------------        -----------

CASH FLOWS PROVIDED FROM (USED IN) OPERATING ACTIVITIES:
   Net income (loss)                                                                       $      949          $   (860)
   Adjustments to reconcile net income (loss) to net cash provided by (used in)
     operating activities:
        Depreciation and amortization                                                           5,302             5,142
        Provision for restaurant closures and other charges                                       754              (125)
        Provision (benefit) for losses (gains) on receivables                                     372              (350)
        Extraordinary items, before tax expense of $1,817                                      (6,339)              --
        Amortization of compensatory stock options and warrants                                 --                  484
        Other                                                                                     706                29
        Changes in assets and liabilities, net of effects from business combinations:
          (Increase) decrease in assets:
            Receivables                                                                          (234)             (935)
            Inventory                                                                             108               (30)
            Prepaid expenses and other current assets                                              63               (57)
            Other assets                                                                        --                  221
          Increase (decrease) in liabilities:
            Accounts payable, accrued interest and other accrued liabilities                   (1,605)            1,251
            Accrued income taxes                                                                  (22)              (59)
            Other liabilities                                                                    (494)             (557)
                                                                                           ------------        -----------

              Net cash provided by (used in) operating activities                                (440)            4,154
                                                                                           ------------        -----------

CASH FLOWS PROVIDED FROM (USED IN) INVESTING ACTIVITIES:
   Decrease in investments                                                                      4,926               463
   Notes receivable                                                                               318                98
   Pre-opening costs                                                                              (32)             (108)
   Capital expenditures                                                                          (718)           (2,709)
   Proceeds from the sale of property and equipment and assets held for sale                    3,712               783
   Increase in other assets                                                                      (280)              --
                                                                                           ------------        -----------

              Net cash provided by (used in) investing activities                               7,926            (1,473)
                                                                                           ------------        -----------

CASH FLOWS PROVIDED FROM (USED IN) FINANCING ACTIVITIES:
   Decrease in restricted cash                                                                    14                236
   Principal payments of debt                                                                  (2,999)             (679)
   Senior notes retirement                                                                    (11,053)              --
   Proceeds from the issuance of common stock, net of costs of issuance                            28                68
   Principal payments on capital lease obligations                                               (282)             (201)
                                                                                           ------------        -----------

              Net cash used in financing activities                                           (14,292)             (576)
                                                                                           ------------        -----------

              Net increase (decrease) in cash                                                  (6,806)            2,105

CASH AND CASH EQUIVALENTS, beginning of period                                                  8,811             2,285
                                                                                           ------------        -----------

CASH AND CASH EQUIVALENTS, end of period                                                   $    2,005          $  4,390
                                                                                           ============        ===========

                                             The accompanying notes to consolidated financial statements
                                          are an integral part of these consolidated financial statements.

</TABLE>
                                       4
<PAGE>



                    RALLY'S HAMBURGERS, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                   (Unaudited)

            (Tabular dollars in thousands, except per share amounts)



1.   FINANCIAL STATEMENT PRESENTATION

     The  accompanying  unaudited  consolidated  financial  statements have been
     prepared in accordance with the rules and regulations of the Securities and
     Exchange Commission for interim financial information. Accordingly, they do
     not  include  all the  information  and  footnotes  required  by  generally
     accepted   accounting   principles  for  complete   financial   statements.
     Therefore,  it is suggested that the accompanying  financial  statements be
     read in  conjunction  with  the  financial  statements  and  notes  thereto
     included in the  Company's  annual  report on Form 10-K for the fiscal year
     ended December 29, 1996  ("10-K").  Except as disclosed  herein,  there has
     been no material  change in the  information  disclosed in the notes to the
     consolidated  financial  statements  included in the 10-K.  Forward looking
     statements  contained  herein  should  be  read  in  conjunction  with  the
     cautionary statements contained in the 10-K.

     The consolidated financial statements include Rally's Hamburgers,  Inc. and
     its wholly-owned  subsidiaries,  each of which is described below.  Rally's
     Hamburgers,  Inc. and its subsidiaries are collectively  referred to herein
     as the context  requires as "Rally's"  or the  "Company".  All  significant
     intercompany accounts and transactions have been eliminated.

     Rally's is one of the largest  chains of double  drive-thru  restaurants in
     the United  States.  At June 29,  1997,  the Rally's  system  included  473
     restaurants  in 18  states,  primarily  in the  Midwest  and  the  Sunbelt,
     comprised of 217 Company-owned and operated, 230 franchised restaurants and
     26  Company-owned  restaurants  in Western  markets  which are  operated as
     Rally's  restaurants  by  CKE  Restaurants,  Inc.  ("CKE"),  a  significant
     shareholder of the Company,  under an operating  agreement which began July
     1996.  Two  additional   Company-owned  stores  covered  by  the  operating
     agreement have been converted to the Carl's Jr. format and are not included
     in the above store count. The Company's restaurants offer high quality fast
     food. The Company  primarily serves the drive-thru and take-out segments of
     the  quick-service  restaurant  industry.  The  Company  opened  its  first
     restaurant in January 1985 and began offering franchises in November 1986.

     Rally's  Hamburgers,  Inc., Rally's of Ohio, Inc., Self Service Drive Thru,
     Inc. and Hampton Roads Foods,  Inc. own and operate Rally's  restaurants in
     various  states.   Additionally,   Rally's  Hamburgers,  Inc.  operates  as
     franchisor of the Rally's brand. Rally's Management,  Inc. provides overall
     corporate management of the Company's businesses. Rally's Finance, Inc. was
     organized for the purpose of making loans to Rally's franchisees to finance
     the acquisition of restaurant  equipment and modular  buildings.  RAR, Inc.
     was  organized  for the  purpose of  acquiring  and  operating  a corporate
     airplane and is currently inactive. The Company's wholly-owned  subsidiary,
     ZDT  Corporation,  was formed to own the Zipps brand and franchise  system.
     MAC I was organized for the purpose of acquiring a manufacturer  of modular
     buildings and is currently inactive. The manufacturing business was sold in
     January 1995.


                                       5
<PAGE>
     The  preparation of the financial  statements in conformity  with generally
     accepted  accounting  principles  requires management to make estimates and
     assumptions  that affect the reported amounts of assets and liabilities and
     disclosures  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  when  actual  transactions   anticipated  are  consummated.   In
     addition,  despite management  diligence,  changes in estimates do and will
     continue  to  occur  due  to  changes  in  available   relevant   data  and
     consummation of the events and transactions. The statements are prepared on
     a going concern basis.  Certain of the most significant  estimates include,
     among  other  things,  useful  lives  assigned  to  depreciable/amortizable
     assets,  fair value less costs to sell of long-lived  assets held for sale,
     fair value of long-lived  assets held for use,  future net occupancy  costs
     related  to  closed/disposable  properties,   accruals  for  the  Company's
     self-insured  and  high  deductible   insurance  programs  and  disclosures
     regarding commitments and contingencies.

     In the  opinion of  management,  the  accompanying  unaudited  consolidated
     financial  statements  include  all  adjustments  considered  necessary  to
     present  fairly,  when read in  conjunction  with the 10-K,  the  Company's
     financial  position as of June 29,  1997 and the results of its  operations
     for the quarter and six months ended June 30, 1996 and June 29,  1997,  and
     cash flows for the six months  ended June 30, 1996 and June 29,  1997.  The
     results  of  operations  for  such  interim  periods  are  not  necessarily
     indicative of the results to be expected for the full year.

     In March 1997, the Financial Accounting Standards Board issued Statement of
     Financial  Accounting Standards No. 128, "Earnings Per Share," ("SFAS 128")
     which is  effective  for both  interim  and  annual  periods  ending  after
     December 15, 1997.  SFAS 128 replaces the standards for computing  earnings
     per share previously  found in Accounting  Principles Board Opinion No. 15,
     "Earnings Per Share" ("APB 15"). Due to the Company's reported  profit/loss
     positions in the periods  presented,  the inclusion of options and warrants
     as  required  by  SFAS  128  result  in  either  an   insignificant  or  an
     antidilutive  impact on all periods presented.  Therefore,  the adoption of
     SFAS 128 is  expected  to have no effect on  earnings  (loss)  per share as
     reported  for the  quarters and six months ended June 30, 1996 and June 29,
     1997.

     Certain  items  have been  reclassified  in the  accompanying  consolidated
     financial  statements for prior periods in order to be comparable  with the
     classification  adopted for the current period. Such  reclassifications had
     no effect on previously reported net income.

2.   RESTRICTED CASH

     Restricted cash consists of amounts held in various Certificates of Deposit
     as collateral  for Letters of Credit and Automated  Clearing  House ("ACH")
     transactions.

3.   INVESTMENTS

     Excess  funds have been  invested in U.S.  Treasury  and  investment  grade
     corporate    debt    securities.    These    securities   are   deemed   as
     "available-for-sale" under SFAS 115, "Accounting for Certain Investments in
     Debt and Equity  Securities"  and are  reported at fair  value.  Unrealized
     holding  gains and losses,  excluding  those losses  considered to be other
     than  temporary,  are  reported as a net amount in a separate  component of
     shareholders'  equity.  There were no unrealized holding gains or losses at
     December  29, 1996 and June 29,  1997.  Provisions  for  declines in market
     value are made for losses  considered to be other than  temporary.  No such
     provision was necessary for any period  presented.  The market value of the
     portfolio  was   determined   based  on  quoted  market  

                                       6
<PAGE>

     prices for these  investments.  Realized  gains or losses  from the sale of
     investments are based on the specific identification method.

     The carrying  value is equal to the market value of investments at December
     29, 1996 and June 29, 1997 and consists of the following:


          December 29, 1996
          -----------------
          United States government and its agencies        $      500
          Corporate debt instruments                            1,458
                                                           =============
          Total                                            $    1,958
                                                           =============

          June 29, 1997
          -------------
          United States government and its agencies        $      500
          Corporate debt instruments                              995
                                                           =============
          Total                                            $    1,495
                                                           =============

     The  proceeds  from the sale of  investments  and  related  gross gains and
     losses  for the  quarters  ended  June 30,  1996 and June 29,  1997 were as
     follows:
<TABLE>
<CAPTION>
                                                       QUARTERS ENDED                         SIX MONTHS ENDED
                                            --------------------------------------    ---------------------------------
                                                JUNE 30,             JUNE 29,            JUNE 30,          JUNE 29,
                                                  1996                 1997                1996              1997
                                            -----------------    -----------------    ---------------    --------------
         <S>                                 <C>                 <C>                  <C>                <C>    
         Proceeds from the sale of
            investments                     $        --          $   1,476            $   4,933          $   1,644
         Gross gains realized                        --                   --                  --                --
         Gross losses realized                       --                   --                  --                --
</TABLE>

4.   SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION

                                                        SIX MONTHS ENDED
                                                --------------------------------
                                                 JUNE 30, 1996    JUNE 29, 1997
                                                ---------------  ---------------

     Interest paid (net of amount capitalized)    $  4,550         $     3,533
     Income taxes paid                                 342                 331
     Capital lease obligations incurred                111              --

     Interest  incurred during the construction of restaurants is capitalized as
     a  component  of  the  cost  of  the  restaurants  and  is  amortized  on a
     straight-line basis over the estimated useful lives of the restaurants. The
     amount of interest capitalized in all quarters was insignificant.

     For purposes of the  statement  of cash flows,  the Company  considers  all
     highly liquid debt instruments with an original maturity of three months or
     less at the date of purchase to be cash  equivalents.  

                                       7
<PAGE>
5.   COMMITMENTS AND CONTINGENCIES

     Litigation

     In January and February  1994,  two putative  class  action  lawsuits  were
     filed,  on behalf of the  shareholders  of  Rally's  in the  United  States
     District Court for the Western District of Kentucky,  against Rally's, Burt
     Sugarman and GIANT GROUP, LTD. ("GIANT") and certain of Rally's present and
     former  officers and  directors  and its auditors.  The  complaints  allege
     defendants violated the Securities Exchange Act of 1934, as amended,  among
     other claims, by issuing  inaccurate public statements about the Company in
     order to arbitrarily  inflate the price of Rally's  common stock,  and seek
     unspecified damages, including punitive damages. On April 15, 1994, Rally's
     filed a motion to  dismiss  and a motion to strike.  On April 5, 1995,  the
     Court struck  certain  provisions of the  complaint  but  otherwise  denied
     Rally's motion to dismiss. In addition, the Court denied plaintiffs' motion
     for class certification;  the plaintiffs renewed this motion, and the Court
     certified  the class on April 16, 1996.  In October  1995,  the  plaintiffs
     filed a motion to disqualify  Christensen,  Miller,  Fink, Jacobs,  Glaser,
     Weil & Shapiro, LLP ("Christensen, Miller") as counsel for defendants based
     on  a  purported   conflict  of  interest   allegedly   arising   from  the
     representation of multiple defendants,  as well as Ms. Glaser's association
     with Christensen, Miller. That motion was denied on September 19, 1996. The
     action was stayed  briefly  between May 30 and June 21, 1996 to  facilitate
     settlement discussions. Two settlement conferences have been conducted; the
     parties are presently in the process of scheduling a third conference. Fact
     discovery is now set to be completed in late August 1997. No trial date has
     been  scheduled  yet.  Management  is unable to predict the outcome of this
     matter at the present  time or whether or not certain  available  insurance
     coverages will apply. Discovery is proceeding. Because these matters are in
     a  preliminary  stage,  the  Company  is  unable  to  determine  whether  a
     resolution  adverse  to the  Company  will  have a  material  effect on its
     results of operations or financial  condition.  Accordingly,  no provisions
     for any liabilities that may result upon adjudication have been made in the
     accompanying  financial statements.  The defendants deny all wrongdoing and
     intend to defend  themselves  vigorously  in this  matter.  An  estimate of
     defense costs  reimbursable  under the Company's  directors'  and officers'
     insurance is included in "Other  Assets" in the  accompanying  consolidated
     financial statements.

     In February 1996, Harbor Finance Partners ("Harbor") commenced a derivative
     action,  purportedly on behalf of Rally's,  against  GIANT,  Burt Sugarman,
     David Gotterer and certain of Rally's other  officers and directors  before
     the Delaware Chancery Court.  Harbor named Rally's as a nominal  defendant.
     Harbor  claims that the  directors  and officers of both Rally's and GIANT,
     along  with  GIANT,   breached  their   fiduciary   duties  to  the  public
     shareholders  of Rally's by causing  Rally's to repurchase  certain Rally's
     Senior Notes at an inflated  price.  Harbor seeks  "millions of dollars" in
     damages, along with rescission of the repurchase  transaction.  In the fall
     of 1996, all defendants moved to dismiss the action.  On April 3, 1997, the
     Chancery Court denied defendants'  motions.  GIANT and the other defendants
     deny all wrongdoing and intend to vigorously  defend the action.  It is not
     possible to predict the outcome of this action at this time.

     Rally's  filed a lawsuit on August 12,  1996  against  Arkansas  Investment
     Group,  Inc.  ("AIGI"),  a franchisee  that currently  operates ten Rally's
     restaurants  located in Arkansas.  The lawsuit sought to recover  royalties
     and  contributions  to the Rally's  National  Advertising Fund owed by AIGI
     pursuant to the applicable franchise agreements,  which total approximately
     $540,000 with accrued  interest as of March 30, 1997.  AIGI filed an Answer
     and  Counterclaim in which it alleged that it did not owe the royalties and
     advertising  contributions due to its alleged disagreement with operational
     and marketing  decisions of Rally's and Rally's  alleged  failure to rebate
     sums obtained 

                                       8
<PAGE>

     from  suppliers.  The  Counterclaim  alleged  that AIGI has been damaged in
     excess of  approximately  $75,000  (the minimum  jurisdictional  amount for
     federal  court),  but no specific  amount of damages is  identified  in the
     Counterclaim. Rally's denied AIGI's allegations.  Subsequently, the parties
     entered  into  settlement  negotiations  which  resulted in the sale of the
     market to the  Company.  The sale  closed on July 9, 1997,  and the parties
     have  agreed to dismiss  the  litigation.  See Note 10 to the  accompanying
     consolidated financial statements.

     In December 1994, Rally's entered into two franchise  agreements with Kader
     Investments,  Inc.  ("Kader") for the  development and operation of Rally's
     Hamburgers  restaurants  in Anaheim,  California  and  Tustin,  California.
     Rally's  assisted the franchisee in developing and opening the restaurants.
     On November 27, 1996, Kader filed a six-count  Complaint against Rally's in
     the California  Superior Court for Orange County (Case No. 772257) alleging
     material misrepresentation, respondent superior, breach of contract, breach
     of the implied  covenant of good faith and fair  dealing,  fraud and unfair
     competition. These claims arise out of allegations concerning Rally's offer
     and sale of two franchises (under a two-store development  agreement),  and
     Rally's actions during the term of the  agreements.  The Complaint seeks as
     relief  rescission of the parties'  franchise and  development  agreements;
     general  damages of at least  $1,494,277  and  $1,400,000  for the material
     misrepresentation  and  fraud  counts,  respectively;  general  damages  in
     unspecified amounts as to the other counts; punitive damages in unspecified
     amounts;  and  attorneys'  fees.  Rally's filed an Answer,  and has filed a
     Cross-Complaint  alleging  breach of contract.  The court has permitted the
     parties to hold discovery in abeyance for a short period pending settlement
     discussions.  Rally's is currently attempting to settle the claim. However,
     the  outcome of such  settlement  discussions  is  uncertain  at this time.
     Should  discussions  not  result  in  a  settlement,   Rally's  intends  to
     vigorously  defend  against the claims.  Trial has been set for October 27,
     1997.  Because the  litigation  is in a preliminary  stage,  the Company is
     unable to determine whether a resolution adverse to the Company will have a
     material  effect on its  results  of  operations  or  financial  condition.
     Accordingly,  no  provisions  for any  liabilities  that  may  result  upon
     adjudication have been made in the accompanying financial statements.

     The Company is  involved  in other  litigation  matters  incidental  to its
     business. With respect to such other suits, management does not believe the
     litigation  in which it is  involved  will have a material  effect upon its
     results of operation or financial condition.

     Other Commitments

     The  Company  is  contingently  liable  on  certain  franchisee  lease/loan
     commitments totaling approximately $331,000.

     The Company,  from time to time,  negotiates purchase contracts for certain
     items used in its  restaurants  in the normal course of business.  Although
     some  of  these  contracts  contain  minimum  purchase   quantities,   such
     quantities do not exceed expected usage over the term of such agreements.

6.   ASSETS HELD FOR SALE

     Assets held for sale include land and modular  buildings idled by the prior
     years' slowdowns in the Company's  expansion plans and land associated with
     the  closure  of  stores.  The  Company  has  recorded,   in  prior  years,
     significant  charges  resulting  from   restructurings,   other  restaurant
     closings and certain other charges more fully discussed in the 10-K.

                                       9
<PAGE>
7.   IMPAIRMENT OF LONG-LIVED ASSETS

     The Company adopted  Statement of Financial  Accounting  Standards No. 121,
     "Accounting for the Impairment of Long-Lived  Assets and Long-Lived  Assets
     to Be Disposed of " (SFAS 121),  at the  beginning  of the fourth  quarter,
     1995. This Statement establishes accounting standards for the impairment of
     long-lived assets, certain identifiable intangibles and goodwill related to
     those  assets to be held and used,  and for  long-lived  assets and certain
     identifiable  intangibles  to  be  disposed  of.  SFAS  121  requires  that
     impairment for long-lived  assets and  identifiable  intangibles to be held
     and used,  if any,  be based on the fair  value of the  assets.  Long-lived
     assets and  certain  identifiable  intangibles  to be disposed of are to be
     reported at the lower of  carrying  amount or fair value less cost to sell.
     For purposes of applying this Statement,  the Company determines fair value
     utilizing the present value of expected  future cash flows using a discount
     rate commensurate with the risks involved.

     Long-lived  assets considered for impairment under SFAS 121 are required to
     be grouped at the "lowest level for which there are identifiable cash flows
     that are  largely  independent  of the cash  flows  of other  groups."  The
     Company believes the most correct  application of this standard is obtained
     by examining  individual  restaurants where circumstances  indicate that an
     impairment  issue may exist.  In  addition,  if an asset  being  tested for
     recoverability was acquired in a business  combination  accounted for using
     the  purchase  method,  the  goodwill  that  arose in that  transaction  is
     included as part of the asset being evaluated and in determining the amount
     of any impairment.

     The $754,000  charge for the six months ended June 30, 1996 included in the
     caption,  "Provision for restaurant  closures and other  charges,"  relates
     primarily  to  two  additional  restaurants  which  were  determined  to be
     impaired in 1996. No additional  long-lived  assets have been determined to
     be impaired in 1997. As required by the Standard, the Company will continue
     to  periodically  review  its  assets for  impairment  where  circumstances
     indicate that such impairment may exist.

8.   REPURCHASE OF SENIOR NOTES

     On January 29, 1996, the Company  repurchased,  in two  transactions,  at a
     price of $678.75 per $1,000 principal amount, $22 million face value of its
     9 7/8% Senior Notes due in the year 2000 from GIANT. The price paid in each
     transaction  represented  the market closing price on January 26, 1996. The
     first transaction  involved the repurchase of $16 million face value of the
     Notes for $11.1  million  in cash.  The  second  transaction  involved  the
     purchase of $6 million  face value of Notes in exchange  for a $4.1 million
     short-term  note,  due in three  installments  of principal  and  interest,
     issued by Rally's.  The Company  paid the final  installment  on this note,
     together  with  accrued  interest  thereon,  on  September  27,  1996.  The
     repurchase  resulted in an extraordinary  gain, net of tax, of $4.5 million
     or $.29 per share.  An  additional  $4.7  million face amount of the Senior
     Notes were retired during the fourth quarter,  1996 at an aggregate gain of
     $200,000.  The remaining  outstanding Notes are publicly traded and at June
     29, 1997 had a market  value of $54.6  million  based on the quoted  market
     price for such notes.

     These purchases  reduced total interest expense by  approximately  $513,000
     and  $842,000  for  the  quarter  and  six  months  ended  June  30,  1996,
     respectively,  and $703,000 and $1.4 million for the quarter and six months
     ended June 29, 1997, respectively.

                                       10
<PAGE>
9.   PROPOSED MERGER

     On March 25, 1997, the Company announced that it had agreed in principle to
     a merger  transaction  pursuant  to which the  Company  would have become a
     wholly   owned   subsidiary   of  Checkers   Drive-In   Restaurants,   Inc.
     ("Checkers").   On  June  16,  1997,  the  Company  and  Checkers  Drive-In
     Restaurants,   Inc.  announced  the  termination  of  the  proposed  merger
     negotiations.   All   expenses   associated   with  the   planned   merger,
     approximately   $222,000,  are  reflected  in  the  accompanying  financial
     statements  and are  included in the  caption,  "Provision  for  restaurant
     closures and other charges."

10.  SUBSEQUENT EVENT

     On July 9, 1997, the Company acquired from Arkansas  Investment Group, Inc.
     ("AIGI") (an Arkansas  corporation)  substantially all the operating assets
     employed in the  operation of AIGI's  franchised  Rally's  restaurants  for
     approximately  $2.7 million.  The cash disbursed in payment of the purchase
     price was reduced by certain  amounts owed by AIGI to the  Company.  Actual
     cash disbursed was $2.2 million.  In addition,  the Company assumed five of
     AIGI's ground lease  obligations  and five of its ground and building lease
     obligations,  and entered into three additional  ground leases.  AIGI owned
     and  operated  a total  of ten  Rally's  restaurants  in the  Little  Rock,
     Arkansas  market.  The  acquisition  of the AIGI  operating  assets will be
     accounted  for as a purchase.  The Company  believes  that the $2.7 million
     represents  the fair value of the acquired  assets and does not expect this
     acquisition  to  have  a  material   effect  on  the  Company's   financial
     statements.


                                       11
<PAGE>
ITEM 2. Management's  Discussion and Analysis of Financial Condition and Results
        of Operations

The Company  reported  net income of $92,000 or less than one cent per share for
the second  quarter of 1997  compared  with net income of  $111,000  or $.01 per
share for the same period of the prior year.  For the six months  ended June 29,
1997,  the Company  reported a net loss of  $860,000 or $.04 per share  compared
with net income of $949,000 or $.06 per share for the prior year period.

Total  revenues  decreased  to $38.1  million  from $47.4  million in the second
quarter of the prior year.  Total revenues for the six-month period decreased by
21% to $70.7 million in 1997  compared with $89.3 million in 1996.  This decline
in  revenues  for the  quarter  and for the first half of the year is  primarily
attributable  to 22 fewer  Company  stores in operation at the end of the second
quarter and lower same store sales.  The agreement with CKE Restaurants  ("CKE")
for the  operation of the  Company's 28 West Coast  restaurants  was the primary
reason for the decline in the number of Company units in operation.

For the six  months  ended June 29,  1997,  the  Company  reported  income  from
operations  of $2.8  million  compared  with a net loss of $956,000 for the same
period of the prior year. The Company  attributes this  improvement to favorable
store level cost  performance  year to date.  Food,  paper and labor costs, as a
percentage  of sales,  improved six  percentage  points in the first half of the
year versus the same period of the prior year.  Income from  operations  for the
quarter decreased to $1.8 million from $2.4 million in the second quarter of the
prior year.  This  quarter-over-quarter  decline is due to (i) higher  levels of
advertising spending resulting from the relaunch of the brand in Company markets
and  $405,000  related  to a  program  under  which  the  Company  chose to fund
incremental  franchisee  advertising  spending  during  the  re-launch  and (ii)
$222,000  in costs  related to  terminated  merger  negotiations  with  Checkers
Drive-In  Restaurants,  Inc.,  partially offset by higher bad debt recoveries in
the quarter and overall lower general and administrative expenses.

Management  believes  the  Company's  primary  challenge  continues to be one of
improving  same store sales  trends.  Changing  toward more  promotion  oriented
advertising  programs in June resulted in a significant  improvement  as Company
same store sales  declined by only 3% versus 17%  experienced  in April and May.
Same store sales again  declined at double  digit rates in July when the Company
was "off-air."  Management  will continue to fine-tune its marketing  program to
improve average unit volumes through increased guest traffic,  while maintaining
margins.

On June 16, 1997, the Company and Checkers Drive-In Restaurants,  Inc. announced
that  merger  negotiations  had been  terminated.  The  Boards of the  combining
companies  felt that the  goodwill  that would have been  recorded if the merger
were  accounted for as a "purchase"  (versus a "pooling" as  anticipated  in the
letter of intent) would inhibit the value that the  post-merger  shareholders of
the combined entity could reasonably  expect to realize,  as the amortization of
the intangibles was expected to materially  offset the expected savings from the
synergies created by the merger.

During the quarter,  the Company opened four units,  including the re-opening of
two units based on the Company's  attainment of improved  store level  economics
and the  acquisition  of one  unit  from a  franchisee,  and  closed  one  unit.
Franchisees  opened five units and closed  four units,  one of which was sold to
the Company.


                                       12
<PAGE>
Results of Operations

Rally's revenues are derived primarily from  Company-owned  restaurant sales and
royalty fees from franchisees. The Company also receives revenues from the award
of exclusive rights to develop Rally's  restaurants in certain  geographic areas
(area  development  fees) and the award of licenses to use the Rally's brand and
confidential  operating  system  (franchise  fees).  Systemwide sales consist of
aggregate  revenues  of  Company-owned  and  franchised  restaurants  (including
CKE-operated).   Company  revenue  also  includes  payments  resulting  from  an
operating   agreement  with  CKE,  referred  to  as  Owner  fee  income  in  the
accompanying  consolidated  financial  statements.  Restaurant  cost  of  sales,
restaurant  operating expenses,  depreciation and amortization,  and advertising
and promotion relate directly to Company-owned and operated restaurants. General
and   administrative   expenses  relate  to  both   Company-owned  and  operated
restaurants  and franchise  operations.  Owner expenses  relate to  CKE-operated
restaurants and consist primarily of depreciation and amortization.

The table below sets forth the percentage relationship to total revenues, unless
otherwise  indicated,  of certain items  included in the Company's  consolidated
statements of operations and operating data for the periods indicated:
<TABLE>
<CAPTION>
                                                             QUARTER ENDED                   SIX MONTHS ENDED
                                                    --------------------------------  --------------------------------
                                                        JUNE 30         JUNE 29,        JUNE 30,           JUNE 29,
                                                         1996             1997            1996               1997
                                                    ----------------  --------------  --------------    ---------------
<S>                                                 <C>               <C>             <C>               <C>                  
Revenues
     Restaurant sales                                      96.7%             96.0%           96.7%             95.9
     Franchise revenues and fees                            3.3               3.5             3.3               3.5
     Owner fee income                                        --               0.5             --                0.6
                                                    ----------------  --------------  --------------    ---------------
                                                          100.0%            100.0%          100.0%            100.0%
                                                    ================  ==============  ==============    ===============
Costs and expenses
  Restaurant cost of sales (1)                             35.1%             33.0%           35.8%             32.5%
  Restaurant operating expenses (1)                        42.7              41.2            45.3              42.5
  General and administrative expenses                       9.8               8.4            10.4              10.1
  Advertising and promotion expenses (1)                    4.5               8.0             5.7               6.3
  Depreciation and amortization (1)                         5.7               6.1             6.2               6.7
  Owner expense (2)                                          --             152.5             --              147.3
  Provision for restaurant closures and other               0.1               1.4             0.8               0.7
  Income (loss) from operations                             5.1               4.7            (1.1)              4.0
  Total other (expense)                                    (4.5)             (4.1)           (4.6)             (4.8)
                                                    ----------------  --------------  --------------    ---------------

  Net loss before income taxes and
    extraordinary items                                     0.6%              0.6%           (5.7)%            (0.8)%

   Net income (loss)                                        0.2               0.2             1.1              (1.2)
                                                    ================  ==============  ==============    ===============

Number of restaurants:
  Restaurants open at the beginning of period             482               469             481               467
                                                    ----------------  --------------  --------------    ---------------

  Company restaurants opened (closed or
     transferred), net during period                        1                 3              --                 8
  Franchised restaurants opened (closed or
     transferred), net during period                        2                 1               4                (2)
                                                    ----------------  --------------  --------------    ---------------
                                                  
  Total restaurants opened (closed or
     transferred), net during period                        3                 4               4                 6
                                                    ----------------  --------------  --------------    ---------------
                                                                      
  Total restaurants open at end of period                 485               473             485               473
                                                    ================  ==============  ==============    ===============
</TABLE>
(1)      As a percentage of restaurant sales.
(2)      As a percentage of owner fee income.

                                       13
<PAGE>


Three Months Ended  June 30, 1996 Compared with Three Months Ended June 29, 1997

Systemwide  sales  decreased 11% to $77.1 million for the quarter  compared with
$86.3  million a year ago.  This  decrease is primarily  attributable  to twelve
fewer stores in operation  at the end of the quarter and  systemwide  same store
sales  declines  of 10%.  Systemwide  same store  sales  declines  of 3% in June
somewhat offset 14% declines in April and May. Management believes that changing
toward a more trial oriented  advertising approach with a "2 Big Bufords for $3"
promotion  in late May  resulted  in the same store sales  improvement  in June.
Management  anticipates  using  this  promotion  oriented  approach  during  the
remainder of the year in order to boost same store sales.

Total Company  revenues  decreased 20% to $38.1 million for the quarter compared
with $47.4 million a year ago.  Company-owned  restaurant  sales  decreased $9.2
million to $36.6  million due to a 12%  decline in same store  sales  during the
quarter and to a decline of  approximately  $5.1  million  due to the  Company's
operating  agreement  with  CKE,  as  discussed  in  Note 1 to the  accompanying
consolidated financial statements.

Restaurant cost of sales, as a percentage of sales,  decreased to 33.0% for 1997
compared with 35.1% for the comparable  quarter of the prior year.  This decline
is primarily due to the impact of implemented  cost reduction  strategies and to
reduced levels of discounting in the current year quarter.  These cost reduction
strategies   include   selective   changes  in  some   product   and   packaging
specifications  as well as  renegotiation  of purchase  terms and  selection  of
alternative  vendors.  Management  intends  to  continue  to  consumer  test and
implement such cost saving strategies in its stores, where appropriate.

Restaurant  operating  expenses were 41.2% of sales  compared with 42.7% for the
comparable  quarter  of the  prior  year.  The  reduction  is  primarily  due to
management's  cost  reduction  actions in the labor  area and better  fixed cost
coverage  in stores  operated by the Company  during the current  year  quarter,
primarily the result of the CKE operating  agreement covering certain high fixed
cost restaurants in Western markets.  The identified and implemented  changes in
staffing levels and labor  deployment in certain stores are yielding  savings in
management and crew labor. Management believes that these cost reduction actions
should favorably influence ongoing operating expense performance; however, their
impact may be partially  offset by recent and upcoming  increases in the minimum
wage.

General and  administrative  expenses  were lower than 1996 on both a dollar and
percentage of revenues  basis.  This decrease was primarily  attributable to the
transfer  of  operational  responsibility  for  certain  restaurants  in Western
markets to CKE, to a reduction in overhead  staffing  levels,  to a reduction in
bonuses  payable and to lower bad debt expense for the quarter,  somewhat offset
by the  amortization  of warrants  granted to CKE.  See  "Liquidity  and Capital
Resources."

Advertising  expenses  were  higher,  on both a dollar and  percentage  of sales
basis,  for the second  quarter  of 1997  compared  to the same  period in 1996.
Advertising  spending  rose during the quarter to 8% of sales as a result of the
acceleration of television  spending on  repositioning  Rally's as THE place for
bigger, better burgers.

Depreciation and  amortization  decreased  approximately  $400,000 in the second
quarter of 1997 compared to the same quarter of 1996. This decrease is primarily
due to a  segregation  into  Owner  expense  of  depreciation  and  amortization
associated with the CKE-operated properties.

Owner expenses of approximately $300,000 in the second quarter of 1997 represent
the Company's segregated ownership cost related to the 28 units operated by CKE.
These expenses consist  primarily of depreciation  and  amortization  associated
with the properties.

                                       14
<PAGE>
The  Provision  for  restaurant  closures  and other  charges of $519,000 in the
second quarter of 1997 resulted  primarily from charges of $405,000 and $222,000
for expenses  related to a program whereby the Company chose to fund incremental
franchisee  advertising spending and for expenses associated with the terminated
merger  negotiations with Checkers  Drive-In  Restaurants,  Inc.,  respectively.
These  charges  were  somewhat  offset by a credit of  $150,000  resulting  from
favorable changes in expected recoveries related to surplus properties.

Interest  expense  decreased  $292,000  in the  second  quarter  of 1997 to $1.9
million   compared  to  $2.1  million  in  1996   primarily  due  to  the  early
extinguishment  of debt in late  January  1996.  See Note 8 to the  accompanying
consolidated financial statements for further discussion.

Interest income increased by $230,000 in the second quarter of 1997 to $264,000,
due primarily to increases in the average daily invested amounts and interest on
a refund received from the Internal Revenue Service.

The  Company's  net  tax  provision  was  essentially  flat  between  years  and
represents  state taxes expected to be payable for both years. The Company's tax
position to not recognize the benefit on currently recordable book losses due to
the uncertainty of ultimate realizability remained unchanged.

Six Months Ended  June 30, 1996 Compared with Six Months Ended June 29, 1997

Systemwide sales declined 11% for the first six months of 1997 to $145.3 million
compared with $162.9 million a year ago. This decrease is primarily attributable
to twelve  fewer  stores  in  operation  at the end of the  second  quarter  and
systemwide same store sales declines of 11%.

Total  Company  revenues  decreased  21% to $70.7  million in 1997 compared with
$89.3 million in 1996. Company-owned restaurant sales decreased $18.5 million to
$67.8  million due to a 13% decline in same store sales during the first half of
1997 and to a  decline  of  approximately  $10.5  million  due to the  Company's
operating  agreement  with  CKE,  as  discussed  in  Note 1 to the  accompanying
consolidated financial statements.  Franchise revenues and fees decreased by 17%
for the year  primarily  due to  fewer  franchise  stores  in  operation  and to
franchise same store sales declines of 7%.

Restaurant cost of sales, as a percentage of sales,  decreased to 32.5% for 1997
compared  with 35.8% for 1996.  This decline is  primarily  due to the impact of
implemented  cost  reduction  strategies and to reduced levels of discounting in
the current year quarter, as discussed above in the quarterly comparison.

Restaurant  operating  expenses were 42.5% of sales  compared with 45.3% for the
comparable  period of the  prior  year.  See  previous  discussion  above as the
decrease is consistent with the quarterly results.

General and  administrative  expenses  were lower than 1996 on both a dollar and
percentage  of  revenues  basis.  See  earlier  discussion  as the  decrease  is
consistent with the quarterly results.

Advertising  expenses were approximately  $650,000 lower than the prior year but
represented  6.3% of sales compared with 5.7% for the  comparable  period of the
prior year due to lower overall sales levels. This dollar decrease was primarily
due to fewer weeks "on air" in the current  year,  as the Bigger,  Better Burger
campaign was not rolled out to the majority of the Company's  markets until late
February.

Depreciation and amortization on a year-to-date  basis decreased to $4.5 million
compared  with $5.3  million for the same period of the prior year.  See earlier
discussion above as the decrease is consistent with the quarterly results.

                                       15
<PAGE>
Owner  expenses  of  approximately  $600,000  for the first  six  months of 1997
represent  the  Company's  segregated  ownership  cost  related  to the 28 units
operated  by  CKE.  These  expenses   consist   primarily  of  depreciation  and
amortization associated with the properties.

The  Provision  for  restaurant  closures and other  charges of $502,000 for the
first six months of 1997 resulted primarily from charges for expenses related to
a program whereby the Company chose to fund incremental  franchisee  advertising
spending and for expenses  associated  with the terminated  merger  negotiations
with Checkers Drive-In Restaurants,  Inc., somewhat offset by a credit resulting
from favorable changes in expected recoveries related to surplus properties. The
Provision  of  $754,000  for the  comparable  period in the prior  year  relates
primarily to a charge for the estimated impairment of two restaurants under SFAS
121. No additional  long-lived assets have been determined to be impaired in the
first six months of 1997.

Interest  expense  decreased  $725,000 on a  year-to-date  basis to $3.7 million
compared to $4.5 million for the same period in the prior year,  consistent with
the quarterly results.

Interest income on a year-to-date basis was essentially flat between years.

The Company's total net tax provision  (including the tax expense related to the
extraordinary  gain) was  essentially  flat between years and  represents  state
taxes  expected to be payable for both years.  The Company's tax position to not
recognize  a tax  benefit  on  currently  recordable  book  losses  due  to  the
uncertainty of ultimate realizability remained unchanged.

The  extraordinary  item in the first six  months  of 1996  represents  the gain
recognized,  net of taxes,  on the early  retirement of debt.  See Note 8 to the
accompanying consolidated financial statements, for further discussion.

Liquidity and Capital Resources

The Company's cash flow provided by operating  activities was approximately $4.2
million  for the first half of 1997  compared  with cash flow used in  operating
activities of approximately $440,000 for the same period in the prior year. This
increase  resulted  primarily from higher net income from operations in 1997 and
favorable  changes in working  capital  related  primarily to differences in the
timing of accounts payable.

Capital  expenditures of  approximately  $2.7 million for the first half of 1997
were funded primarily through operating activities,  sales of surplus properties
and existing cash balances.  Approximately $2 million of these expenditures were
for the  construction or conversion of new stores and for the reopening of three
units previously  closed.  Eight of these stores opened in the first half of the
year,  including  three  units  reopened.  The Company had three new units under
construction at June 29, 1997. Remaining capital expenditures were primarily for
the addition of side dining  areas for two  selected  units and the purchase and
installation of certain replacement equipment.

The Company  plans to open 15 new units in 1997,  excluding  3 units  previously
closed which have been re-opened. Full year capital expenditures are expected to
be in the range of  approximately  $6 to $8 million,  inclusive  of  replacement
capital.

                                       16
<PAGE>
Principal  payments of debt and capital  leases totaled  approximately  $880,000
during the first six months of 1997. The Company is required to make a mandatory
sinking fund payment on June 15, 1999  calculated to retire 33 1/3% in aggregate
principal  amount of the Senior Notes  issued with the balance  maturing on June
15, 2000. Such sinking fund  requirement,  due to debt  repurchases in the prior
year, is now approximately $1.6 million.

The Company is actively  marketing  the assets  included in the caption  "Assets
held for sale" in the  accompanying  consolidated  balance  sheets  and  expects
realization in cash over the next 3 to 24 months, although actual timing of such
cash  flows  cannot be  predicted.  The assets  contained  in this  caption  are
recorded at management's  current estimate of net realizable value. There can be
no assurances that these values will be realized. Approximately $783,000 in cash
was generated during the first six months of 1997 from the sale of such assets.

During the first  half of the year,  the  Company  continued  to  receive  funds
($146,000) on land contracts  covering four fee properties which are the subject
of an aggregate amount of $1.8 million of sale/leaseback financing. The interest
rate on such  facility  is  approximately  12.5%.  Subsequent  to the end of the
second quarter, the Company canceled one contract in the amount of $376,000. The
holder  of the  contracts  has  continued  to  make  payments  on the  remaining
balances.  The  inability by the holder to fulfill the contracts is not expected
to impact the Company's overall liquidity in any material respect.

The Company completed its Shareholder Rights Offering on September 20, 1996. The
Offering raised over $10.8 million in gross proceeds,  offset by legal and other
issuance costs of approximately  $437,000.  In addition to the approximate $10.8
million of gross proceeds provided by the Offering,  the Warrants issued as part
of the Offering, exercisable at $2.25, could provide approximately $10.8 million
for the Company's future growth,  if all warrants are exercised.  As of June 29,
1997,  4,814,068  Warrants were  outstanding.  Any proceeds  generated  from the
exercise of such warrants may be used for new store construction,  refurbishment
of some existing restaurants and for other general corporate purposes, including
possible further debt reduction.

On December 20, 1996,  the Company  issued  warrants to purchase an aggregate of
1,500,000  restricted  shares of its Common Stock to CKE and  Fidelity  National
Financial,  Inc. These warrants have a three-year  term and are not  exercisable
until  December 20, 1997.  The exercise  price is $4.375 per share,  the closing
price of the Common Stock on December 20, 1996. The underlying  shares of Common
Stock have not been registered with the Securities and Exchange  Commission and,
therefore, are not freely tradable. If these warrants are exercised, the Company
will receive approximately $6.6 million in additional capital.

The Company believes existing cash balances and cash flow from operations should
be sufficient to fund its current operations and obligations. The ability of the
Company to satisfy its obligations under the Senior Notes, however, continues to
be dependent  upon,  among other factors,  the Company  successfully  increasing
revenues and profits.

                                       17
<PAGE>
PART II.  OTHER INFORMATION

ITEM 1. Legal  Proceedings - See Note 5 to Part I, Item 1 which is  incorporated
        herein by reference.

ITEM 6. Exhibits and Reports on Form 8-K.

        (a) Exhibits:
<TABLE>
<CAPTION>
                EXHIBIT NUMBER                                        DESCRIPTION OF DOCUMENT
               ----------------       ----------------------------------------------------------------------------------
                    <S>               <C>    <C>    <C>    <C>    <C>    <C>
                    4.5               Other Debt  Instruments - Copies of debt  instruments  for which the related debt
                                      is  less  than  10% of the  Company's  total  assets  will  be  furnished  to the
                                      Commission upon request.
</TABLE>
        (b) Reports on Form 8-K:

            There were no Form 8-K reports filed during the second quarter of 
            1997.



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<PAGE>


                                   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 thereunto duly authorized.


                   RALLY'S HAMBURGERS, INC.





Date: August 13, 1997         By:  /s/ Donald E. Doyle
                              --------------------------------------------------
                                   Donald E. Doyle
                                   President and Chief Executive Officer











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