SECURITIES AND EXCHANGE COMMISSION

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

                                    FORM 10-Q

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

       For the quarterly period ended September 29, 1996

[ ]    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 November 6, 1996 - 20,521,840 shares


<PAGE>







  



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

                                                             INDEX


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

                      ITEM 1.                    Consolidated Financial Statements

                                                 Consolidated Balance Sheets as of December 31, 1995 and
                                                 September 29, 1996 (Unaudited)                                          2

                                                 Consolidated Statements of Operations (Unaudited) for the
                                                 Quarters and Nine Months Ended October 1, 1995 and September 29,        3
                                                 1996

                                                 Consolidated Statements of Shareholders' Equity (Unaudited) for
                                                 the Nine Months Ended September 29, 1996                                4

                                                 Consolidated Statements of Cash Flows (Unaudited) for the Nine
                                                 Months Ended October 1, 1995 and September 29, 1996                     5

                                                 Notes to Consolidated Financial Statements (Unaudited)                  6

                      ITEM 2.                    Management's Discussion and Analysis of Financial Condition and
                                                 Results of Operations                                                  13

PART II.              Other Information

                      ITEM 1.                    Legal Proceedings                                                      21
                                                    
                      ITEM 4.                    Submission of Matters to a Vote of Security Holders                    21

                      ITEM 6.                    Exhibits and Reports on Form 8-K                                       21

SIGNATURES                                                                                                              22

                      EXHIBIT 3.1                Restated Certificate of Incorporation, as amended                      23

                      EXHIBIT 11                 Calculation of Earnings Per Share                                      26

                      EXHIBIT 27                 Financial Data Schedule (for SEC use only)                             27


</TABLE>

<PAGE>



PART I.           FINANCIAL INFORMATION

ITEM 1.           Consolidated Financial Statements

<TABLE>
<CAPTION>
                                          RALLY'S HAMBURGERS, INC. AND SUBSIDIARIES
                                                 CONSOLIDATED BALANCE SHEETS
                                       AS OF DECEMBER 31, 1995 AND SEPTEMBER 29,1996
                                    (In thousands, except shares and per share amounts)
                                                                                                                        (UNAUDITED)
                                                                                                     DECEMBER 31,      SEPTEMBER 29,
                                                                                                          1995              1996
                                                                                                    --------------------------------
<S>                                                                                                   <C>               <C> 
ASSETS
Current assets:
   Cash and cash equivalents                                                                          $   8,811         $   9,300
   Restricted cash                                                                                          683               669
   Investments                                                                                            4,933                --
   Royalties receivable, including $483 and $126 from related parties at December 31, 1995 and
     September 29, 1996, respectively, net of a reserve for doubtful accounts of $922 and $1,350 at
     December 31, 1995 and September 29, 1996, respectively                                                 818               407
   Accounts and other receivables, including $555 from related parties at September 29, 1996, net of
     reserve for doubtful accounts of $453 and $315 at December 31, 1995 and September 29, 1996,          2,131             2,679
     respectively
   Inventory, at lower of cost or market                                                                  1,056               771
   Current portion of notes receivable, including $10 from related parties at December 31, 1995, net
     of a reserve for doubtful accounts of $109 and $269 at December 31, 1995 and September 29, 1996,       113                44
     respectively
   Prepaid expenses and other current assets                                                              1,131             1,029
   Assets held for sale                                                                                   2,506               287
                                                                                                      ------------------------------
         Total current assets                                                                            22,182            15,186

Assets held for sale                                                                                      3,517             2,345
Property and equipment, at historical cost, less accumulated depreciation  of $33,391 and $36,765 at
   December 31, 1995 and September 29, 1996, respectively                                                78,683            70,893
Notes receivable, less current portion, including $165 from related parties at December 31, 1995, net
   of a reserve for doubtful accounts of $433 and $305 at December 31, 1995 and September 29, 1996,         676               718
   respectively
Intangible and other assets, less accumulated amortization of $6,888 and $7,326 at December 31, 1995
   and September 29, 1996, respectively                                                                  32,334            30,417
                                                                                                     -------------------------------
         Total assets                                                                                  $ 137,392         $ 119,559
                                                                                                     ===============================

LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities:
   Accounts payable                                                                                   $    8,773         $   4,759
   Accrued liabilities                                                                                    15,959            15,494
   Current maturities of long-term debt and obligations under capital leases                              17,544             1,676
                                                                                                     -------------------------------
         Total current liabilities                                                                        42,276            21,929

Senior notes, net of discount of $768 and $489 at December 31, 1995 and September 29, 1996,               69,034            62,511
  respectively
Long-term debt, less current maturities                                                                    5,749             4,958
Obligations under capital leases, less current maturities                                                  5,631             5,500
Other liabilities                                                                                          8,030             6,184
                                                                                                    --------------------------------
         Total liabilities                                                                               130,720           101,082
                                                                                                    --------------------------------
Commitments and contingencies (Note 6)

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, 15,927,000 and 20,773,000 shares issued at
   December 31, 1995 and September 29, 1996, respectively                                                  1,593             2,077
Additional paid-in capital                                                                                60,804            70,762
Less:  Treasury shares, 273,000 at December 31, 1995 and September 29, 1996, respectively                 (2,108)           (2,108)
Retained deficit                                                                                         (53,617)          (52,254)
                                                                                                    --------------------------------
         Total shareholders' equity                                                                        6,672            18,477
                                                                                                    --------------------------------
         Total liabilities and shareholders' equity                                                    $ 137,392         $ 119,559
                                                                                                    ================================


                                        The accompanying notes to consolidated financial
                                            statements are an integral part of these
                                               consolidated balance sheets.
</TABLE>
                                       2
<PAGE>
                                
<TABLE>
<CAPTION>
                                          RALLY'S HAMBURGERS, INC. AND SUBSIDIARIES
                                            CONSOLIDATED STATEMENTS OF OPERATIONS

                                                         (Unaudited)

                                     (In thousands, except shares and per share amounts)

                                                                QUARTERS ENDED                          NINE MONTHS ENDED
                                                      ------------------------------------------------------------------------------
                                                        OCTOBER 1,        SEPTEMBER 29,        OCTOBER 1,          SEPTEMBER 29,
                                                           1995               1996                1995                 1996
                                                      ------------------------------------------------------------------------------

<S>                                                   <C>               <C>                   <C>               <C>  
REVENUES:
   Restaurant sales                                   $    47,916       $     37,081          $  136,511        $    123,360
   Franchise revenues and fees                              1,935              1,489               5,653               4,479
   Owner fee income                                            --                211                  --                 211
                                                      ------------------------------------------------------------------------------
         Total revenues                                    49,851             38,781             142,164             128,050
                                                      ------------------------------------------------------------------------------

COSTS AND EXPENSES:
   Restaurant cost of sales                                17,536             12,188              47,617              43,053
   Restaurant operating expenses, exclusive of
     depreciation and amortization and other
     operating expenses shown separately below             22,315             16,707              61,946              57,096
   General and administrative expenses                      5,284              3,394              14,296              11,394
   Advertising and promotion expenses                       3,286              1,465               9,659               6,380
   Depreciation and amortization                            3,294              2,318              10,298               7,620
   Owner expenses                                              --                322                  --                 322
   Other charges (credits)                                 12,939               (245)             12,939                 509
                                                      ------------------------------------------------------------------------------
         Total costs and expenses                          64,654             36,149             156,755             126,374
                                                      ------------------------------------------------------------------------------

   Income (loss) from operations                          (14,803)             2,632             (14,591)              1,676
                                                      ------------------------------------------------------------------------------

OTHER INCOME (EXPENSE):
   Interest expense                                        (2,753)            (2,053)             (8,028)             (6,512)
   Interest income                                            188                 23                 481                 402
   Other                                                       51                 12                 188                 (21)
                                                      ------------------------------------------------------------------------------
         Total other (expense)                             (2,514)            (2,018)             (7,359)             (6,131)
                                                      ------------------------------------------------------------------------------

Income (loss) before income taxes and
  extraordinary items                                     (17,317)               614             (21,950)             (4,455)

PROVISION (BENEFIT) FOR INCOME TAXES                           (1)               502                 119                (994)
                                                      ------------------------------------------------------------------------------
Income (loss) before extraordinary items                  (17,316)               112             (22,069)             (3,461)

EXTRAORDINARY ITEMS (net of tax benefit of $302
and tax expense of $1,515 for the 1996 quarter                 --                302                  --               4,824
and nine months ended, respectively)
                                                      ------------------------------------------------------------------------------

Net income (loss)                                     $   (17,316)      $        414          $  (22,069)       $      1,363
                                                      ================  ==================    ==============    ====================


Income (loss) per common share:
   Income (loss) before extraordinary item            $    (1.11)       $        0.01         $   (1.41)        $      (0.22)
   Extraordinary item                                         --                 0.02                 --                0.31
                                                      ----------------  ------------------    --------------    --------------------


Net income (loss)                                     $    (1.11)       $        0.03         $   (1.41)        $       0.09
                                                      ================  ==================    ==============    ====================

Weighted average shares outstanding                        15,631             15,896              15,611              15,833
                                                      ================  ==================    ==============    ====================


                                     The accompanying notes to consolidated financial
                                        statements are an integral part of these
                                                financial statements.
</TABLE>
                                       3
<PAGE>

<TABLE>
<CAPTION>
                                                  RALLY'S HAMBURGERS, INC. AND SUBSIDIARIES
                                               CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY

                                                                 (Unaudited)

                                                                (In thousands)


                                                                             Treasury Stock and
                       Preferred Stock                 Common Stock          Contingent Shares    
                 ---------------------------    ---------------------------  -------------------
                                                                                                  Additional  Retained
                   Shares    Shares               Shares    Shares                                 Paid-In    Earnings     Total
                 Authorized  Issued   Amount    Authorized  Issued   Amount    Shares   Amount     Capital    (Deficit)   Equity
                 ----------  ------   ------    ----------  ------   ------    ------   ------     -------    ---------   ------
<S>              <C>         <C>       <C>         <C>       <C>     <C>         <C>   <C>      <C>           <C>      <C>

Balances at
  December 31, 1995  --        --       --         50,000    15,927    1,593     (273)   (2,108)     60,804    (53,617)      6,672

Amendment to the
  Charter (B)       5,000      --       --          --        --       --        --       --         --          --         --
Issuance of common
  stock              --        --       --          --        4,846      484     --       --          9,958      --         10,442
Net loss             --        --       --          --        --       --        --       --         --          1,363       1,363
                    ----------------------------------------------------------------------------------------------------------------
Balances at
September 29, 1996  5,000      --       --         50,000    20,773 $  2,077     (273) $ (2,108)  $  70,762    (52,254)  $  18,477
                                                                                              
                  ==========  =====   ======== ===========   ====== =========  =======  ========  ==========  ========== =========


(A)        On May 13, 1995,  stockholders of the Company  approved a proposal to
           amend the  Certificate  of  Incorporation  to increase  the number of
           authorized   shares  of  Common  Stock  from  25,000,000   shares  to
           50,000,000.

(B)        On July 10, 1996,  stockholders of the Company approved a proposal to
           amend the Certificate of Incorporation to authorize  5,000,000 shares
           of Preferred Stock, $.10 par value per share.



                                                  The accompanying notes to consolidated financial
                                                     statements are an integral part of these
                                                                financial statements.
</TABLE>
                                       4
<PAGE>

<TABLE>
<CAPTION>
                                       RALLY'S HAMBURGERS, INC. AND SUBSIDIARIES
                                    CONSOLIDATED STATEMENTS OF CASH FLOWS (NOTE 5)
                                                      (Unaudited)

                                                     (In thousands)
                                                                                                    NINE MONTHS ENDED
                                                                                           ----------------------------------
                                                                                            OCTOBER 1,         SEPTEMBER 29,
                                                                                               1995                1996
                                                                                           ----------------------------------

CASH FLOWS PROVIDED FROM (USED IN) OPERATING ACTIVITIES:
 <S>                                                                                        <C>               <C>       
   Net income (loss)                                                                       $  (22,069)       $    1,363
   Adjustments to reconcile net income (loss) to net cash provided by (used in)
     operating activities:
        Depreciation and amortization                                                          10,298             7,940
        Other charges                                                                          12,939               509
        Provision for losses on receivables                                                     1,220               548
        Stock grants                                                                              126                --
        Extraordinary items, before tax expense of $1,515                                          --            (6,339)
        Other                                                                                   1,627               913
        Changes in assets and liabilities, net of effects from business combinations:
          (Increase) decrease in assets:
            Receivables                                                                        (1,613)             (597)
            Inventory                                                                             (90)              285
            Prepaid expenses and other current assets                                              27                69
          Increase (decrease) in liabilities:
            Accounts payable, accrued interest and other accrued liabilities                    7,765            (4,391)
            Deferred income taxes                                                                 (13)               --
            Accrued income taxes                                                                   --                57
            Other liabilities                                                                    (218)           (1,080)
                                                                                           ----------------------------------

              Net cash provided by (used in) operating activities                               9,999              (723)
                                                                                           ----------------------------------

CASH FLOWS PROVIDED FROM (USED IN) INVESTING ACTIVITIES:
   (Increase) decrease in investments                                                          (2,970)            4,933
   Notes receivable                                                                               124               362
   Pre-opening costs                                                                              (45)              (74)
   Capital expenditures                                                                        (2,907)           (1,321)
   Proceeds from the sale of property and equipment and assets held for sale                    3,616             3,903
   (Increase) in other assets                                                                    (671)             (157)
   Acquisition of businesses, net of cash acquired                                             (1,931)               --
   Proceeds from the sale of a business                                                         2,730                --
                                                                                           -----------------------------------

              Net cash provided by (used in) investing activities                              (2,054)            7,646
                                                                                           -----------------------------------

CASH FLOWS PROVIDED FROM (USED IN) FINANCING ACTIVITIES:
   Decrease in restricted cash                                                                     --                14
   Principal payments of debt                                                                  (1,742)           (5,436)
   Senior Notes retirement                                                                         --           (11,053)
   Proceeds from the issuance of common stock, net of costs of issuance                            61            10,442
   Principal payments on capital lease obligations                                               (472)             (401)
                                                                                           -----------------------------------

              Net cash used in financing activities                                            (2,153)           (6,434)
                                                                                           -----------------------------------

              Net increase  in cash                                                             5,792               489

CASH AND CASH EQUIVALENTS, beginning of period                                                  2,707             8,811
                                                                                           -----------------------------------

CASH AND CASH EQUIVALENTS, end of period                                                   $    8,499        $    9,300
                                                                                           ==============    ==================


                                          The accompanying notes to consolidated financial
                                              statements are an integral part of these
                                                        financial statements.
</TABLE>
                                       5
<PAGE>



7

                    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 31, 1995 ("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 October 31, 1996, the Rally's system  included 474
       restaurants  in 19 states,  primarily  in the  Midwest  and the  Sunbelt,
       comprised  of  235   Company-owned   and  239   franchised   restaurants.
       Twenty-eight  of the  Company-owned  restaurants  in Western  markets are
       operated by CKE Restaurants,  Inc. ("CKE"), a significant  shareholder of
       the Company,  under an operating  agreement  which began July,  1996. The
       Company's  restaurants  offer high quality fast food served quickly.  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 acquir-
       ing  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. The manufactur-
       ing business was sold in January 1995 (see Note 2).

       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 useful lives  assigned to  depreciable/amortizable  assets,  fair

                                       6
<PAGE>

       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 the Company's  financial position as of September 29, 1996
       and the results of its  operations  for the quarter and nine months ended
       October 1, 1995 and September 29, 1996, cash flows for the nine months
       ended October 1, 1995 and  September 29, 1996 and the related changes in
       shareholders' equity for the nine months ended September 29, 1996.  The
       results of operations for such interim periods are not necessarily 
       indicative of the results to be expected for the full year.

       Revenue  received  as a result  of the  operating  agreement  with CKE is
       referred  to  as  Owner  fee  income  in  the  accompanying  consolidated
       financial  statements.  Expenses related to the ongoing investment in the
       CKE-operated   restaurants   consist   primarily  of   depreciation   and
       amortization  and are referred to as Owner  expenses in the  accompanying
       consolidated financial statements.

       It is the Company's policy to expense advertising costs as incurred.

       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.    ACQUISITION AND DISPOSITION

       On February  13, 1995,  the Company  acquired all of the shares of common
       stock of Hampton Roads Foods, Inc. (a Louisiana  corporation) and certain
       of the  assets  of  HRF,  Inc.  (a  Virginia  corporation),  collectively
       referred  to  as  "HRF",  for  approximately   $7.2  million,   of  which
       approximately $2.1 million was paid in cash with the remainder to be paid
       over the ensuing six years pursuant to a secured promissory note, bearing
       interest at 9%. In addition,  the Company assumed approximately  $654,000
       of notes  payable  and other  liabilities  and HRF's  lease  obligations,
       including  capital lease obligations of approximately  $1.3 million.  HRF
       owned  and  operated  a total of ten  Rally's  restaurants  and owned the
       exclusive right to develop additional Rally's  restaurants in the Hampton
       Roads and Norfolk,  Virginia areas.  The acquisition of HRF was accounted
       for as a purchase.

       The total purchase price of approximately $9.1 million has been allocated
       in the  accompanying  1995 balance  sheet as net  property and  equipment
       (approximately   $2.1  million)  and  as  intangible   and  other  assets
       (approximately  $6.7  million).  The  remainder  of the  purchase  price,
       approximately  $319,000,  was allocated to various  current  assets.  The
       intangible  and other asset amounts  include a noncompete  (approximately
       $150,000)  which  is being  amortized  over  five  years  and  reacquired
       franchise and territory  rights  (approximately  $6.6 million)  which are
       being amortized over 15 years.

       The impact on operations of this  acquisition was not significant for any
       of the  periods  presented,  and  therefore,  proforma  amounts  are  not
       presented giving effect to this acquisition.

       On January 30,  1995,  the Company sold all of the shares of common stock
       of Beaman Corporation,  its wholly-owned modular building subsidiary, for
       approximately $3.1 million,  of which approximately $2.7 million was paid
       in  cash,  and the  remainder  will be paid  pursuant  to a  non-interest
       bearing, unsecured promissory note with equal payments due on January 30,
       1997 and 1998.

                                       7
<PAGE>



 3.    RESTRICTED CASH

       Restricted cash consists primarily of a $600,000  restricted deposit held
       as a  compensating  balance for daily  Automated  Clearing  House ("ACH")
       transactions.

 4.    INVESTMENTS

       As of December 31, 1995, excess funds were 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 31, 1995.  Provisions for declines in
       market value are made for losses  considered to be other than  temporary.
       No such  provision was necessary for the period ended December 31, 1995.
       The market value of the portfolio was  determined  based on quoted market
       prices for these investments.  Realized gains or losses from the sale of
       investments are based on the specific identification method.

       There were no investments at September 29, 1996.  The carrying  value and
       market value of investments at  December 31,  1995 were as follows:
<TABLE>
<CAPTION>

                                                                       GROSS               GAINS
                                                                     UNREALIZED         UNREALIZED
                                                   CARRYING           HOLDING             HOLDING         MARKET
                                                    VALUE              GAINS              LOSSES          VALUE
                                                ---------------   ------------------- ------------------------------
<S>                                             <C>               <C>                 <C>                <C> 
   DECEMBER 31, 1995

   United States government and its agencies    $   4,933         $     --            $    --           $  4,933        
                                                ===============   =================   ================= ============
</TABLE>

       The proceeds from the sale of  investments  and related gross gains and 
       losses for the quarter and nine months ended October 1, 1996 and 
       September 29, 1996 were as follows:
<TABLE>
<CAPTION>
                                                                QUARTERS ENDED                          NINE MONTHS ENDED
                                                    --------------------------------------------------------------------------------
                                                       OCTOBER 1,         SEPTEMBER 29,         OCTOBER 1,        SEPTEMBER 29,
                                                          1995                1996                 1995                1996
                                                    ------------------ -------------------------------------------------------------

           <S>                                       <C>               <C>                    <C>              <C>        
           Proceeds from the sale of investments     $     1,991       $       --             $     7,595      $     4,933
           Gross gains realized                                7               --                      56               --
           Gross losses realized                            --                 --                    --                 --
</TABLE>

                                       8
<PAGE>




 5.    SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
<TABLE>
<CAPTION>
                                                                                 NINE MONTHS ENDED
                                                                     ----------------------------------------------
                                                                        OCTOBER 1,            SEPTEMBER 29,
                                                                           1995                    1996
                                                                     ------------------    -----------------------
<S>                                                                  <C>                   <C>   
Interest paid (net of amount capitalized)                            $      5,930          $       5,052
Income taxes paid                                                              45                    463
Capital lease obligations incurred                                          1,616                    111
</TABLE>

       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.

       The purchase of HRF, described in Note 2, was recorded as follows:
<TABLE>
<CAPTION>
                                                                    NINE MONTHS ENDED
                                                               -------------------------------
                                                                     OCTOBER 1, 1995
                                                               -------------------------------

<S>                                                                       <C>   
Fair value of assets acquired                                             $9,133
Cash paid                                                                 (2,125)
                                                                        ---------
Liabilities assumed                                                       $7,008
                                                                        =========
</TABLE>

       As a  result  of the sale of  Beaman,  discussed  in Note 2, the  Company
       recorded a note  receivable  of  approximately  $347,000,  discounted  at
       12.5%. The Company recorded $547,000 in notes receivable primarily as the
       result  of  the  sale  of  five  of  its   restaurants.   These  non-cash
       transactions  have been excluded from the consolidated  statement of cash
       flows.

       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.

6.     COMMITMENTS AND CONTINGENCIES

       Litigation


       In January and February  1994,  two putative  class action  lawsuits were
       filed, purportedly on behalf of the stockholders of Rally's in the United
       States  District  Court for the  Western  District of  Kentucky,  against
       Rally's,  Burt  Sugarman  and 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,  among other
       claims,  by issuing  inaccurate  public  statements  about the Company in
       order  to  arbitrarily  inflate  the  price  of  its  common  stock.  The
       plaintiffs seek unspecified  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 despite
       opposition  by the  defendants,  the Court  granted such motion for class
       certification  on April 16, 1996. In October 1995, the plaintiffs filed a
       motion to disqualify  Christensen,  White, Miller, Fink, Jacobs,  Glaser,
       Shapiro, LLP ("Christensen,  White") as counsel for defendants based on a

                                       9
<PAGE>
       purported  conflict of interest allegedly arising from the representation
       of multiple  defendants as well as Ms. Glaser's position as both a former
       director of Rally's and a partner in Christensen, White. Defendants filed
       an  opposition to the motion,  and the motion to disqualify  Christensen,
       White was denied. The action was stayed between May 30 and July 31, 1996
       to facilitate settlement discussions.  One settlement conference has been
       conducted; no others  are currently scheduled.   Management  is unable to
       predict  the outcome of this matter at the present time or whether or not
       certain available  insurance coverages will apply.  The  defendants  deny
       all wrongdoing and intend to defend themselves vigorously in this matter.
       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.


       In July  1994,  the  Company  entered  into an  agreement  with  Red Line
       Burgers,  Inc.  ("Red Line") whereby Red Line leased from the Company all
       of its assets being operated as Rally's  restaurants  in Houston,  Texas.
       Additionally,  the  agreement  called for Red Line to convert  Red Line's
       eight  competing  units in the Houston market to the Rally's  brand.  Red
       Line failed to make certain  lease  payments  and on June 20,  1995,  the
       Company  filed an  action in the  United  States  District  Court for the
       Southern  District  of Texas,  Galveston  Division,  seeking  recovery of
       damages from Red Line for its breach of the leases and subleases  entered
       into with the Company.  The action  alleges that Red Line also  committed
       events of default under the terms of all of its Franchise Agreements with
       the Company.  As a result of such defaults,  the Company  terminated such
       Franchise  Agreements,  and on August 3, 1995,  the Company filed suit in
       the United States District Court, Western District of Kentucky,  alleging
       breach of contract due to Red Line's  failure to pay  royalties and other
       payments  required  by the  Franchise  Agreements  and its failure to pay
       approximately  $400,000 plus interest  owed on certain  promissory  notes
       issued to the Company in lieu of such  payments.  The Company  also seeks
       accountability  for $660,000 in conversion  costs paid by the Company for
       conversion  of  Red  Line's  Houston   restaurants.   Subsequent  to  the
       commencement of the foregoing actions,  Red Line filed for reorganization
       under Chapter 11 of the United States Bankruptcy Code. In connection with
       such  proceedings,  the  Company's  actions  against  Red Line  have been
       stayed. In October,  1996, Red Line filed a Disclosure Statement and Plan
       of  Reorganization  (the "Plan") which disputes Red Line's  obligation to
       pay the  Company any of the  foregoing  monies.  The  Company  intends to
       vigorously oppose the Plan.

       In  February  1996,  Harbor  Finance  Partners  ("Harbor")   commenced  a
       derivative  action,  purportedly  on behalf of Rally's  against GIANT and
       certain of Rally's  officers and directors  before the Delaware  Chancery
       Courts.  Harbor named Rally's as a nominal defendant.  Harbor claims that
       the directors and officers of Rally's,  along with GIANT,  breached their
       fiduciary duties to the public stockholders of Rally's by causing Rally's
       to  repurchase  from GIANT  certain  Rally's  Senior Notes at an inflated
       price.  Harbor seeks  unspecified  damages,  along with rescission of the
       repurchase transaction.  All defendants have moved to dismiss the action,
       and a hearing has been scheduled for November 26, 1996.  Management  does
       not  believe  that this  litigation  will  have a material effect on the 
       Company's results of operations or financial condition.

       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 $400,000.

       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.

                                       10
<PAGE>

 7.    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
       significant  charges  resulting  from  restructurings,  other  restaurant
       closings and certain other charges more fully discussed in the 10-K.


 8.    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.


       During the first  quarter of 1996,  two  additional  restaurants,  due to
       their  continued  poor  operating  performance,  were  determined  to  be
       impaired, resulting in charges of approximately $754,000 included in the
       caption,  Other  charges.  As required by the Standard,  the Company will
       continue  to  periodically   review  its  assets  for  impairment   where
       circumstances indicate that such impairment may exist.


 9.    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  GROUP,  LTD.
       ("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 $4.8 million or $.31 per share.  The
       remaining outstanding Notes are publicly traded and at September 29, 1996
       had a market value of $54.5  million based on the quoted market price for
       such notes.

       The purchases were approved by a majority of the independent Directors of
       the Company. Prior to the purchases,  the Company's independent Directors
       had  received an opinion as to the fairness of the  transactions,  from a
       financial  point of view,  from an  investment  banking  firm of national
       standing.


       These purchases reduced total interest expense by approximately  $329,000
       for the first  quarter  of 1996,  approximately  $513,000  for the second
       quarter of 1996 and approximately $537,000 for the third quarter of 1996,

                                       11
<PAGE>
       net of interest  expense incurred on the short-term note discussed above.
       Such reduction is expected to be approximately  $1.9 million for the full
       year 1996,  net of  interest  expense  incurred  on the  short-term  note
       discussed above.


10.    GIANT GROUP, LTD. CREDIT FACILITY AND LETTERS OF CREDIT

       In  early  February 1996,  GIANT entered into a one-year credit facility
       with the Company.  Concurrent with the completion of its Rights  Offering
       on September 20,1996, this credit facility was terminated by agreement of
       the parties.

       In addition,  GIANT had issued certain  irrevocable  letters of credit to
       secure the obligation of the Company under its large deductible  workers'
       compensation  insurance  program  and  to  secure  certain  surety  bonds
       previously  issued  by the  Company.  In  total,  at the end of the third
       quarter  1996,  such  letters  of  credit  were  approximately  $800,000.
       Subsequent to September 29, 1996, the Company replaced those  irrevocable
       letters of credit  with  letters of credit  secured  by  certificates  of
       deposit purchased by the Company.

11.    SHAREHOLDER RIGHTS OFFERING

       A Shareholder Rights Offering (the "Offering") was completed on September
       20,  1996.  The  Company  distributed  to holders of record of its Common
       Stock,  as of the close of business on July 31, 1996 (the "Record Date"),
       transferable   subscription   rights   ("Right(s)")   to  purchase  Units
       consisting  of one share of Common  Stock and one  Warrant to purchase an
       additional  share of Common  Stock.  Stockholders  received one Right for
       each share of Common Stock held on the Record Date.  For each 3.25 Rights
       held,  a holder had the right to purchase  one Unit for $2.25  each.  The
       Offering  consisted of 4,825,805 Units.  Each Warrant may be exercised to
       acquire an additional share of Common Stock at an exercise price of $2.25
       per share and expires on September  26, 2000.  The Company may redeem the
       Warrants,  at $.01 per Warrant, upon 30 days' prior written notice in the
       event the closing  price of the Common Stock equals or exceeds  $6.00 per
       share for 20 out of 30  consecutive  trading days ending not more than 30
       days  preceding  the date of the notice of  redemption.  The Offering was
       fully  subscribed and raised over $10.8 million in gross proceeds  offset
       by legal and other issuance costs of approximately  $437,000. In addition
       to the $10.8 million provided by the Rights Offering, the Warrants issued
       could  provide an  additional  $10.8  million  for the  Company's  future
       growth.  The Company had 15,683,869 shares of Common Stock outstanding on
       the Record Date.  Immediately  after the Offering,  20,509,674  shares of
       Common Stock and 4,825,805 Warrants were outstanding.

12.    SUBSEQUENT EVENT

       Bondholder Consent

       On  September  5, 1996 by Consent  Solicitation  Statement,  the  Company
       solicited consent of its bondholders whereby the beneficial  ownership of
       35% or more  of the  voting  stock  of the  Company  by  GIANT,  Fidelity
       National  Financial,  Inc., CKE and/or any of their  affiliates would not
       constitute  a change of  control  for  purposes  of  Section  4.14 of the
       Indenture.  On October 21, 1996, the bondholder consent was approved by a
       majority  of the  holders  of  record  as of  the  date  of  the  Consent
       Solicitation.


                                       12
<PAGE>



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

The  Company  reported  net income of  $414,000  or $.03 per share for the third
quarter of 1996 compared with a net loss of $17.3 million or $1.11 per share for
the same period of the prior year. For the nine months ended September 29, 1996,
the Company  reported net income of $1.4 million or $.09 per share compared with
a net loss of $22.1  million or $1.41 per share for the prior year period.  Year
to date results were favorably impacted by an extraordinary gain, net of tax, of
$4.8 million or $.31 per share from the early  extinguishment of debt during the
first quarter of 1996. Prior year quarter and year to date results were impacted
by significant  other charges of $12.9 million related to the closure of certain
restaurants  and to  writedowns  related to assets held for sale.  Current  year
results included  $245,000 in income and $509,000 in expense for the quarter and
year to date, respectively, related to the writedown and sale of assets.

Total  revenues  decreased to $38.8 million in the quarter from $49.9 million in
the third  quarter of the prior year.  Total  revenues for the nine month period
decreased to $128.1 million in 1996 compared with $142.2  million in 1995.  This
decrease in  revenues  for the quarter and for the first nine months of the year
is  primarily  attributable  to (i) a  year-over-year  decrease in the number of
Company  units  operating  during  the  periods,  (ii) the  Company's  operating
agreement  with CKE,  which  took  effect in July,  1996,  whereby  CKE  assumed
operating  responsibility  for 28 Company-owned  units in the Company's  Western
markets,  (iii)  Company  same store sales  declines for the quarter and for the
first nine months,  and (iv) lower  royalties from  franchisees.  See discussion
under Liquidity and Capital Resources.

The  third  quarter  of  1996 is the  Company's  second  consecutive  profitable
quarter,   excluding  extraordinary  gains,  after  the  Company  posted  eleven
consecutive  quarterly  losses  dating  back  to  the  third  quarter  of  1993.
Management  attributes the continued  profitability in a period of negative same
store  sales to (i)  reduced  fixed costs  resulting  from the prior  closure or
writedown of  underperforming  stores,  (ii) reduced interest expense  resulting
from the first  quarter  retirement  of certain of the Senior  Notes,  and (iii)
continued  implementation  of  controllable  cost reduction  programs  impacting
advertising,  general and  administrative  expenses  and store level costs (e.g.
food, paper, labor,  controllables)  discussed in more detail below.  Management
had  anticipated a significant  decrease in revenues  during the third  quarter,
1996 as  compared to the prior year third  quarter  due to its  decision to less
aggressively  discount  its product in the  current  year.  However,  management
recognizes the necessity of increasing revenues on an ongoing basis.  Management
expects the new  advertising  campaigns and enhanced menu offerings that will be
introduced in the Company's fourth quarter offer the best opportunity to reverse
current  same store sales  growth  trends.  The  anticipated  actions  reflect a
significant repositioning of the Company's brand and are expected, therefore, to
require  coordination  of new menu items,  new menu  boards,  a new  advertising
campaign and effective store level operations  execution.  Management  currently
anticipates that the Company-wide  rollout of the repositioning can be completed
during the first  quarter of 1997.  Management  also  expects  continued  effort
focused on further  reduction in costs and currently  plans to continue  testing
and implementing cost saving strategies in its stores.

On January 29, 1996, the Company  repurchased  $22.0 million face value of its 9
7/8% Senior Notes for $11.1  million in cash and a $4.1 million short term note.
The repurchase  resulted in an extraordinary  gain, net of tax, of $4.5 million,
subsequently revised to $4.8 million in the third quarter to reflect a change in
the available tax benefit on book losses before  extraordinary items, due to net
income in  subsequent  quarters.  In addition  to the  extraordinary  gain,  the
repurchase had two  significant  impacts on the Company.  First,  the repurchase
decreased the Company's annual interest  expense by approximately  $2.0 million.
Second, the repurchase reduced the Company's 1999 33 1/3% sinking fund indenture
requirement to approximately $6 million, from $28 million.

                                       13
<PAGE>



The Company's  liquidity was favorably  impacted by the completion of its Rights
Offering (the "Offering") in September,  1996. The Offering raised $10.8 million
in new capital before approximately $437,000 in offering costs and will raise an
additional $10.8 million in new capital if the related common stock warrants are
exercised  over their four year life.  The Company may redeem the  warrants,  at
$.01 per warrant,  upon 30 days' prior  written  notice in the event the closing
price of the common  stock  equals or  exceeds  $6.00 per share for 20 out of 30
consecutive  trading days ending not more than 30 days preceding the date of the
notice of redemption. The additional cash flows generated from the Offering will
allow the Company to modestly  accelerate new store  development as well as fund
other important  initiatives.  See Note 11 for further  discussion of the Rights
Offering.

The Company  opened two units,  closed six units,  and  transferred  operational
responsibility  to CKE for 28 units  during the  quarter.  Five of the six units
closed were poor performing units located in Montgomery,  Alabama, the assets of
which  were  sold to a  non-affiliated  restaurant  operator  during  the  third
quarter.  Franchise  operators  opened three units during the quarter and closed
seven units.  By the end of the year, the Company expects to open at least three
additional units, two of which were under construction as of September 29, 1996.
The Company may open  several  additional  units which would be  conversions  of
existing  restaurants if lease  negotiations are completed in the near term. The
Company also anticipates  several additional  franchised new store openings over
the balance of the year.

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.  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
restaurants.  General and  administrative  expenses relate to both Company-owned
restaurants  and franchise  operations.  Owner expenses  relate to  CKE-operated
restaurants and consist primarily of depreciation and amortization.


                                       14
<PAGE>



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                          NINE MONTHS ENDED
                                                        ----------------------------------------------------------------------------
                                                           OCTOBER 1,         SEPTEMBER 29,        OCTOBER 1,         SEPTEMBER 29,
                                                              1995                1996                1995                1996
                                                        ----------------------------------------------------------------------------

<S>                                                           <C>                <C>                    <C>               <C>    
Revenues
     Restaurant sales                                          96.1%              95.6%                 96.0%             96.3%
     Franchise revenues and fees                                3.9                3.8                   4.0               3.5
     Owner fee income                                          --                   .6                 --                   .2
                                                        ----------------------------------------------------------------------------
                                                              100.0%             100.0%                100.0%            100.0%
                                                        =================  ====================  ================  =================

Costs and expenses
  Restaurant cost of sales (1)                                 36.6%              32.9%                 34.9%             34.9
  Restaurant operating expenses (1)                            46.6               45.1                  45.4              46.3
  General and administrative expenses                          10.6                8.8                  10.0               8.9
  Advertising and promotion
    expenses (1)                                                6.9                4.0                   7.1               5.2
  Depreciation and amortization (1)                             6.9                6.3                   7.5               6.2
  Owner expenses (2)                                           --                152.6                  --               152.6
  Other charges (credits)                                      26.0                (.6)                  9.1                .4
  Income (loss) from operations                               (29.7)               6.8                 (10.3)              1.3
  Total other (expense)                                        (5.0)              (5.2)                 (5.2)             (4.8)

  Net income (loss) before income taxes and
    extraordinary items                                       (34.7)%              1.6%                (15.5)%            (3.5)%
                                                        =================  ====================  ================  =================

Number of restaurants:
  Restaurants open at the beginning of period                 526                485                   542               481
                                                        ----------------------------------------------------------------------------

  Company restaurants opened (closed or
     transferred), net during period                            1                 (4)                    5                (4)
  Franchised restaurants opened (closed or
     transferred), net during period                          (29)                (4)                  (49)                0
                                                        ----------------------------------------------------------------------------
  Total restaurants opened (closed or transferred),
     net during period                                        (28)                (8)                  (44)               (4)
                                                        ----------------------------------------------------------------------------
  Total restaurants open at end of period                     498                477                   498               477
                                                        =================  ====================  ================  =================
</TABLE>

(1)      As a percentage of restaurant sales.
(2)      As a percentage of owner fee income.

                                       15
<PAGE>



Three Months Ended October 1, 1995  Compared  with Three Months Ended  September
29, 1996.

Systemwide  sales  decreased 15% to $81.3 million for the quarter  compared with
$96.0 million a year ago. This  decrease is primarily  attributable  to 21 fewer
restaurants being in operation at the end of the third quarter and to systemwide
same store sales  declines  of 10%.  As  previously  discussed,  management  had
anticipated  significant  same store  declines due to its  decisions  (i) not to
match the deep discount offers which greatly impacted store margins in the prior
year and (ii) to limit media spending until work with the new advertising agency
on new  creative  and  brand  positioning  was  completed.  The new  advertising
campaigns and enhanced menu will begin late in the Company's  fourth quarter and
are not expected to significantly improve same store sales until 1997.

Total Company  revenues  decreased 22% to $38.8 million for the quarter compared
with $49.9 million a year ago.  Company-owned  restaurant  sales decreased $10.8
million to $37.1  million  primarily  due to 48 fewer Company units in operation
and an 11.9% decline in same store sales during the quarter.  Over $5 million of
the  decline  is  due  to  the  transfer  of  operating  responsibility  for  28
restaurants in the Company's Western markets to CKE under an operating agreement
which took effect July, 1996. Under the operating agreement,  CKE is responsible
for all operations of the  restaurants  and pays the Company a percentage of the
sales of the restaurants which is separately  reported as Owner fee income.  For
the first half of the current  year and all of the prior year,  the revenues and
operating  expenses of these  units were  included  in the  Company's  financial
statements.  Franchise  revenues and fees  decreased by 23% in the third quarter
primarily  because there were 14 fewer equivalent  franchised units in operation
for the quarter and franchise  same store sales  declined by 9%. Units closed by
the Company from October,  1995 through June,  1996 had aggregate  sales of $1.9
million for the prior year quarter.

Restaurant cost of sales, as a percentage of sales,  decreased to 32.9% for 1996
compared  with  36.6%  for  the  comparable  quarter  of the  prior  year.  This
significant  decline is primarily due to reduced  levels of  discounting  in the
current year quarter,  discussed  above,  and to the impact of implemented  cost
reduction strategies. These 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  savings   strategies  in  its  stores,   where
appropriate.

Restaurant  operating  expenses were 45.1% of sales  compared with 46.6% 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 open during the current year quarter.  This better fixed cost
coverage is the result of closing poorer  performing  units and of  transferring
operational  responsibility for certain higher fixed cost restaurants in Western
markets to CKE. 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 increases in the minimum wage.

General  and  administrative  expenses in the third  quarter of 1996,  on both a
dollar and  percentage of sales basis,  were lower than 1995.  This decrease was
primarily  due to lower  levels of bad debt  expense,  reduction  in real estate
project  write-offs  related  to  development  slowdowns  in the prior  year and
reductions in the corporate and field operation staffs.

Advertising  expenses decreased  approximately $1.8 million in the third quarter
of 1996  compared to the same  quarter of 1995 due  primarily to lower levels of
television  and  other  media   advertising.   Management  expects  to  continue
conservative  levels of spending  until the new creative and enhanced  menu work
can be implemented.

Depreciation  and  amortization  decreased  approximately  $980,000 in the third
quarter of 1996 compared to the same quarter of 1995. This decrease is primarily
due to  asset  writedowns  associated  with  the  adoption  of  SFAS  121 at the
beginning of the fourth quarter, 1995, to a decrease in the number of properties
being  operated  by the  Company,  and to a  segregation  to  Owner  expense  of
depreciation and amortization associated with CKE-operated properties.

                                       16
<PAGE>
Owner  expenses of $322,000 in the third quarter of 1996 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.

Other  charges were  expenses of $12.9  million in the third quarter of 1995 and
income of $245,000 in the current year. The prior year charges related primarily
to asset writedowns and expected future occupancy costs on 25 units targeted for
closure and  writedowns on assets held for sale. The income for the current year
quarter is primarily  attributable  to a $232,000  favorable  change in estimate
associated  with the sale of the  assets  of the  Company's  5 store  Montgomery
market during the quarter.

Interest  expense  decreased  25% in the third  quarter of 1996 to $2.1  million
compared to $2.8 million in 1995  primarily due to the early  extinguishment  of
debt, as previously discussed.  See "Liquidity and Capital Resources" and Note 9
to the accompanying consolidated financial statements, for further discussion.

Interest  income  was  lower in the  third  quarter  of 1996  compared  with the
comparable  quarter a year ago due to  decreases in the average  daily  invested
amounts.

The net tax provision of $200,000 in the current quarter (obtained by adding the
tax  provision  line to the  reduction  in tax  applicable  to the current  year
extraordinary item reflected on the extraordinary item line) is related to state
taxes expected to be payable.  The reported total  provision for the quarter was
$502,000.  This amount consist of the state taxes plus the $302,000  decrease in
previously recorded tax benefit available due to the extraordinary gain recorded
in the Company's first quarter.  There is no impact on net income in the quarter
arising  from  the  $302,000,  as  a  corresponding  increase  in  the  gain  on
extraordinary  item  (actually a reduction  of the  estimated  tax impact on the
extraordinary  item) has also been  recorded.  Given our  current  expected  tax
position,  the tax expense on the extraordinary item is limited to the lesser of
tax at a normal tax rate on the  extraordinary  item or the total  available tax
benefit  on  our  annual  loss  before  income  taxes  and  extraordinary  items
calculated  at the  Company's  effective  tax rate.  Since net  income  has been
generated in ensuing  quarters of the current year,  the  available  book losses
have  declined  creating the  adjustment  to the provision and to the net of tax
extraordinary  item,  which had  first  been  recorded  in the  Company's  first
quarter.

Nine Months Ended October 1, 1995 Compared with Nine Months Ended  September 29,
1996.

Systemwide sales declined 7% for the first nine months of 1996 to $254.7 million
compared with $275.1  million a year ago. This  decrease is  attributable  to 21
fewer  restaurants  being in  operation  at the end of the third  quarter of the
current  year of which 17 were  closed  in the  fourth  quarter,  1995 and first
quarter, 1996 and to same store sales declines of 6% systemwide. Systemwide same
store sales were essentially flat in the first quarter,  showed a 3% decline for
the first six months and showed a larger  decline for the nine months due to the
rollover of the prior year's 10th anniversary deep discount promotion.

Total Company  revenues  decreased  10% to $128.1  million in 1996 compared with
$142.2 in 1995.  Company-owned  restaurant sales decreased 10% to $123.4 million
due primarily to fewer Company units in operation,  a 4.5% decline in same store
sales and an over $5 million  decline due to the Company's  operating  agreement
with CKE, as previously  discussed.  The Company units closed  subsequent to the
third  quarter of 1995 and prior to the  beginning of the third  quarter of 1996
had  aggregate  sales of $5.7 million for the nine month period ended October 1,
1995.  Company-owned  same store sales increased  slightly in the first quarter,
were essentially flat for the first six months,  and showed a larger decline for
the nine months,  for the reasons discussed above.  Franchise  revenues and fees
decreased by 21% for the year  primarily  because  there were fewer  equivalents
franchised units in operation for the nine months and franchise same store sales
declined  by 7%. For the  year-to-date,  the Company  opened four units,  closed
eight  units and  transferred  operational  responsibility  to CKE for 28 units.
Franchisees opened 14 units and closed 14 units.

                                       17
<PAGE>

Restaurant  cost of sales, as a percentage of sales, of 34.9% for the first nine
months was negatively impacted by higher food and paper costs as a percentage of
sales in the first  six  months  of 1996,  offset by lower  cost of sales in the
third quarter,  as explained  previously.  Essentially these factors resulted in
flat cost of sales when  compared  with the same nine month period of 1995.  The
increase in food cost in the first six months resulted  primarily from the shift
of product mix sold, reflecting the impact of a larger percent of Big Buford(TM)
sandwich sales in the second quarter of 1996 compared to the same quarter, 1995.
While this product  carries a  significantly  higher  dollar profit per unit, it
does  carry a  higher  food  cost  percentage  than  did the  products  formerly
comprising its share of the total product mix.

Restaurant  operating  expenses  expressed as a percentage of sales increased to
46.3% for the first  nine  months of 1996  compared  with  45.4% for 1995.  This
increase as a percentage of sales is primarily  attributable  to increased bonus
costs associated with service manager compensation during the first half of 1996
offset by third quarter decreases discussed in the quarterly results.  The bonus
plan was revised in the third  quarter to reward  improvements  in  controllable
profit,  year over  year.  Management  believes the  implemented  changes  have 
improved accountability, as well as reduced overall bonus costs.

General and administrative expenses on a year-to-date basis are lower than 1995,
on both a dollar and a percentage of Company  revenues  basis.  This decrease is
caused primarily by reductions in the corporate and field operation  staffs,  in
bad debt expense and in real estate  project  write-offs  related to development
slowdowns in the prior year, partially offset by higher legal fees.

Advertising  expenses  decreased  approximately  $3.3 million for the first nine
months of 1996 compared to the same period in 1995 due primarily to decreases in
levels of radio advertising, outdoor advertising, and television advertising.

Depreciation and amortization on a year-to-date  basis decreased to $7.6 million
as  compared to $10.3  million for the same period in the prior year,  primarily
related to asset  writedowns  associated with SFAS 121, a decrease in the number
of properties and to a reclass to Owner expense, as previously  discussed in the
quarterly results.

See earlier  discussion of Owner expenses and Other charges as the  year-to-date
trends are consistent with the quarterly results.

Interest  expense  decreased  19% on a  year-to-date  basis to $6.5  million  as
compared to $8.0 million for the same period in the prior year, due primarily to
the January, 1996 reduction in Senior Notes outstanding.

Interest  income  was lower on a  year-to-date  basis for 1996 as  compared  to
the same  period in the  prior  year,  consistent  with the quarterly results.

The Company's  decrease in Other is due primarily to lower gains on  investments
and to the current year storage costs related to excess modular buildings.

The Company's net tax provision on a year to date basis is $521,000 (obtained by
adding the tax provision  line to the tax expense of  $1,515,000  which has been
netted against the extraordinary gain) and is related to state taxes expected to
be payable.  See earlier  discussion  above  concerning the tax treatment of the
extraordinary item.


                                       18
<PAGE>



Liquidity and Capital Resources

The Company's cash flow used in operating activities was approximately  $723,000
for the first nine months of 1996  compared with cash flow provided by operating
activities of $10.0 million for the same period in the prior year. This decrease
resulted  primarily from unfavorable  changes in working capital which more than
offset  higher  net  income in 1996.  The  change  in  working  capital  related
primarily  to  decreased  balances in accounts  payable in 1996 due to decreased
food and paper costs as a percentage of sales,  decreased  overall sales volumes
and due to the timing of cash transfers between accounts.  The decreased overall
sales volumes are  attributed to the factors  discussed  above in the nine month
comparison.

Capital  expenditures of  approximately  $1,321,000 for the first nine months of
1996 were funded primarily through sales of surplus properties and existing cash
balances. Approximately $678,000 of these expenditures were for the construction
of new stores.  Four of these stores opened in the first nine months of 1996 and
two stores were under construction at September 29, 1996. The Company expects to
open a total of at least  seven units this year.  The  Company may open  several
additional  units which would be  conversions  of existing  restaurants if lease
negotiations  are completed in the near term.  The Company  spent  approximately
$220,000 for the replacement of three existing store  buildings,  constructed in
the late eighties,  with surplus modular  buildings.  Such actions were taken to
provide  increased  operational  flexibility and to reduce  maintenance costs in
these  units  given the low cash  outflow  necessary  to utilize  certain of the
surplus modular buildings. Remaining capital expenditures were primarily for the
purchase and installation of certain  replacement  equipment.  Full year capital
expenditures  are  expected  to be  approximately  $2.4  million,  inclusive  of
replacement capital.

In January 1996, the Company repurchased, in two transactions,  $22 million face
value of its 9 7/8% Senior Notes due in the year 2000.  The Notes were purchased
from GIANT  GROUP,  LTD.  ("GIANT")  at a price of $678.75 per $1,000  principal
amount,  representing the market closing price on the last business day prior to
the  repurchase  date.  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 the Notes in
exchange  for a $4.1  million  short-term  note  due in  three  installments  of
principal and interest,  bearing  interest at prime.  The Company paid the final
installment  together with accrued  interest on this note on September  27,1996.
Prior to the Senior Notes  repurchases,  the  Company's  Board of Directors  had
received  an  independent  opinion  from an  investment  banking  firm as to the
fairness  of the  transactions.  As a result  of  these  debt  repurchases,  the
annualized  ongoing  interest  payments on the Senior Notes have been reduced by
approximately $2.2 million per year to approximately $6.2 million.

Principal  payments  of debt and  capital  leases  totaled  approximately  $18.5
million during the first nine months of 1996,  inclusive of the $11.1 million in
cash  and  the  $4.1  million  short-term  note  related  to  the  Senior  Notes
repurchased in the first quarter, as discussed above. 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. The repurchase  discussed  above reduces such sinking
fund requirement to approximately $6 million from approximately $28 million.

In February 1996, the Company  obtained a one-year  credit  facility from GIANT.
Concurrent  with the  completion  of its Rights  Offering on September 20, 1996,
this credit facility was terminated by agreement of the parties.

The Company is actively marketing the assets included in the caption Assets held
for sale, in the accompanying consolidated balance sheet and expects realization
in cash over the next 3 to 24 months,  although actual timing of such cash flows
cannot be  predicted.  The  remaining  balances  consist  primarily  of  modular
restaurant  buildings  and land which the  Company is  actively  marketing.  The
assets  contained in this caption are recorded at management's  current estimate
of fair market value less costs to sell.  There can be no assurances  that these
values will be realized.  Approximately  $3.5 million was  generated  during the
first nine months of 1996 from the sale of land and buildings.

                                       19
<PAGE>

During the first nine months of the year, the Company  received funds  ($90,000)
on land contracts  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%.  The holder of such  contracts  has been unable to  complete  contractual
requirements to fund such  transactions.  The Company has notified the holder of
default under this  agreement.  The Company  continues to consider  alternatives
offered by the holder  including  substitution of a different buyer or extension
of time available to fund the agreements.

On July 1, 1996, the Company  entered into a ten-year  operating  agreement with
Carl Karcher Enterprises,  Inc., a subsidiary of CKE. Pursuant to the agreement,
28  Rally's-owned  restaurants  located  in  California  and  Arizona  are being
operated by CKE. The Company  retains  ownership of the restaurants and receives
from CKE a percentage of gross revenues referred to in the financial  statements
as Owner fee income. This income is offset by the Company's segregated ownership
costs  related to these units,  referred to as Owner  expenses in the  financial
statements,  consisting  primarily  of  noncash  expenses  of  depreciation  and
amortization. The agreement has improved profitability and cash flow, generating
approximately $209,000 cash flow in the quarter.

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 $10.8 million of
gross proceeds  provided by the Offering,  the Warrants  issued could provide an
additional $10.8 million for the Company's future growth.  The proceeds from the
Offering  have been used to pay off debt of  approximately  $2.1 million and the
remainder  will  be used  for  new  store  construction,  refurbishment  of some
existing  restaurants  and  for  other  general  corporate  purposes,  including
possible further debt reduction.

On October 21, 1996, the Company was notified by the indenture  trustee that the
bondholder  consent it had been  soliciting  had been  approved by the  required
majority  of the  holders  of record of its 9 7/8%  Senior  Notes due 2000.  The
consent will allow two of the Company's current  stockholders,  CKE and Fidelity
National Financial,  Inc. and/or their affiliates, to acquire 35% or more of the
outstanding  shares of the Company's common stock without  triggering "Change in
control" provisions  requiring the Company to offer to purchase the Senior Notes
at 101% of their face value. This gives the Company greater flexibility to raise
capital in the future, and it gives two of its largest  stockholders the ability
to increase their investment in the Company.

The third quarter of 1996 is the Company's third consecutive  profitable quarter
and second quarter of profitability  before  extraordinary items since the third
quarter of 1993. 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 the  Company,  among other  factors,
successfully increasing revenues and profits.

                                       20
<PAGE>



PART II.  OTHER INFORMATION

ITEM 1.       Legal Proceedings - See Note 6 to the financial statements.


ITEM 4.       Submission of Matters to a Vote of Security Holders

              On  September  5,  1996 by  Consent  Solicitation  Statement,  the
              Company   solicited   consent  of  its  bondholders   whereby  the
              beneficial  ownership  of 35% or more of the  voting  stock of the
              Company by GIANT,  Fidelity National  Financial,  Inc., CKE and/or
              any of their  affiliates  would not constitute a change of control
              for  purposes  of Section  4.14 of the  Indenture.  On October 21,
              1996,  the  bondholder  consent was  approved by a majority of the
              holders of record as of the date of the Consent Solicitation.

              Results of the voting (in bond dollars held) were as follows:

                  For                    Against         Abstained/Unvoted/Other
              32,941,000                2,743,000               27,316,000


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

              (a) Exhibits:
<TABLE>
<CAPTION>
                   EXHIBIT NUMBER
                                                                       DESCRIPTION OF DOCUMENT
                   --------------------   ------------------------------------------------------------------------------------------
                        <S>               <C>                                              
                         3.1              Restated Certificate of Incorporation

                         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.

                         11               Calculation of Earnings Per Share.

                         27               Financial Data Schedule (for SEC use only)

              (b) Reports on Form 8-K:

                  July 24, 1996
                  September 20, 1996

</TABLE>
                                       21
<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: 11/13/96     By:          /s/ Donald E. Doyle

                                ------------------------------------------------
                   Donald E. Doyle
                   President and Chief Executive Officer





Date: 11/13/96      By:         /s/ Michael E. Foss

                               -------------------------------------------------
                    Michael E. Foss
                    Senior Vice President and Chief Financial Officer
                    (Principal Financial and Accounting Officer)


                                       22
<PAGE>