SECURITIES AND EXCHANGE COMMISSION
                             Washington, D. C. 20549



                                FORM 10-K/A NO. 2


(Mark One)

[X]  ANNUAL REPORT  PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES  EXCHANGE
     ACT OF 1934 [FEE REQUIRED] for the fiscal year ended December 29, 1996 OR

[ ]  TRANSITION  REPORT  PURSUANT  TO SECTION  13 OR 15(d) OF THE  SECURITIES
     EXCHANGE ACT OF 1934 [ FEE REQUIRED]

        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            (I.R.S. Employer
          incorporation or organization)             Identification No.)

          10002 Shelbyville Road, Suite 150, Louisville, Kentucky   40223
                    (Address of principal executive offices)      (Zip Code)

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





     Purpose:  This revision to Form 10-K,  "Item 8.  Financial  Statements  and
     Supplementary  Data" for the year ended  December  29,  1996  contains  the
     auditor's name on the Report of Independent  Public  Accountants.  No other
     changes have been made from the previously dated filed 1996 Form 10-K.






<PAGE>


Item 8.    Financial Statements and Supplementary Data
<TABLE>
<CAPTION>
                    RALLY'S HAMBURGERS, INC. AND SUBSIDIARIES
                           CONSOLIDATED BALANCE SHEETS
                  AS OF DECEMBER 31, 1995 AND DECEMBER 29, 1996
               (In thousands, except shares and per share amounts)

                                                                                                    December 31,    December 29,
                                                                                                        1995           1996
                                                                                                   -------------  --------------
<S>                                                                                                <C>            <C>
ASSETS
Current assets:
   Cash and cash equivalents                                                                       $   8,811      $   2,285
   Restricted cash                                                                                       683          1,649
   Investments                                                                                         4,933          1,958
   Royalties receivable, including $483 and $0 from related parties at December 31, 1995 and
     December 29, 1996, respectively, net of a reserve for doubtful accounts of $922 and
     $1,405 at December  31, 1995 and December 29, 1996, respectively                                    818            437
   Accounts and other receivables including $23 and $565 from related parties at December 31,
     1995 and December 29, 1996, respectively, net of a reserve for doubtful accounts of $453
     and $301 at December 31, 1995 and December 29, 1996, respectively                                 2,131          1,698
   Inventory, at lower of cost or market                                                               1,056            794
   Prepaid expenses and other current assets                                                           1,131            999
   Assets held for sale                                                                                2,506            596
                                                                                                   -------------  --------------
         Total current assets                                                                         22,069         10,416

Assets held for sale                                                                                   3,517          1,426
Net property and equipment, at historical cost                                                        78,683         69,806
Notes receivable, including $175 and $127 from related parties at December 31, 1995 and
   December 29, 1996, respectively, net of a reserve for doubtful accounts of $542 and $853 at
   December 31, 1995 and December 29, 1996, respectively                                                 789            773
Goodwill, less accumulated amortization of $1,704 and $2,243 at December 31, 1995 and
  December 29, 1996, respectively                                                                     10,921         10,482
Reacquired franchise and territory rights, less accumulated amortization of $1,202 and $1,984
  at December 31, 1995 and December 29, 1996, respectively                                            12,261         11,439
Other intangibles, less accumulated amortization of $2,344 and $2,459 at December 31, 1995 and
  December 29, 1996, respectively                                                                      5,262          4,769
Other assets, less accumulated amortization of $1,638 and $1,101 at December 31, 1995 and
  December 29, 1996, respectively                                                                      3,890          3,147
                                                                                                   -------------  --------------
         Total assets                                                                              $ 137,392      $ 112,258
                                                                                                   =============  ==============

LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities:
   Accounts payable                                                                                $    8,773         4,884
   Accrued liabilities                                                                                15,959         13,600
   Current maturities of long-term debt and obligations under capital leases                          17,544          1,484
                                                                                                   -------------  --------------
         Total current liabilities                                                                    42,276         19,968

Senior notes, less current maturities, net of discount of $768 and $429 at December 31, 1995
   and December 29, 1996, respectively                                                                69,034         57,897
Long-term debt, less current maturities                                                                5,749          4,775
Obligations under capital leases, less current maturities                                              5,631          5,408
Other liabilities                                                                                      8,030          4,845
                                                                                                   -------------  --------------
         Total liabilities                                                                           130,720         92,893
                                                                                                   -------------  --------------

Commitments and contingencies (Note 12)

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 20,788,000 shares
   issued at December 31, 1995 and December 29, 1996, respectively                                     1,593          2,079
Additional paid-in capital                                                                            60,804         71,023
Less:  Treasury shares, 273,000 at December 31, 1995 and December 29, 1996                            (2,108)        (2,108)
Retained deficit                                                                                     (53,617)       (51,629)
                                                                                                   -------------  --------------
         Total shareholders' equity                                                                    6,672         19,365
                                                                                                   =============  ==============
         Total liabilities and shareholders' equity                                                $ 137,392      $ 112,258
                                                                                                   =============  ==============

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

                                       2
<PAGE>

<TABLE>
<CAPTION>

                    RALLY'S HAMBURGERS, INC. AND SUBSIDIARIES
                      CONSOLIDATED STATEMENTS OF OPERATIONS
  FOR THE YEARS ENDED JANUARY 1, 1995, DECEMBER 31, 1995, AND DECEMBER 29, 1996
                    (In thousands, except per share amounts)

                                                                                          Fiscal Years Ended
                                                                             ----------------------------------------------
<S>                                                                          <C>            <C>              <C>
                                                                             January 1,     December 31,     December 29,
                                                                                1995            1995             1996
                                                                             ------------  ---------------  ---------------

REVENUES:
   Restaurant sales                                                           $  178,476   $      181,778   $     156,445
   Franchise revenues and fees                                                     7,842           7,081            5,867
   Owner fee income                                                                    -               -              440
                                                                             ------------  ---------------  ---------------
         Total revenues                                                          186,318         188,859          162,752
                                                                             ------------  ---------------  ---------------

COSTS AND EXPENSES:
   Restaurant costs of sales                                                      62,518          64,813           53,712
   Restaurant operating expenses exclusive of depreciation and
     amortization and advertising and promotion expenses                          78,072          84,305           71,155
   General and administrative expenses                                            18,068          18,972           15,426
   Advertising and promotion expenses                                             10,898          13,188            7,767
   Depreciation and amortization                                                  14,139          13,006            9,838
   Owner expense                                                                       -               -              744
   Provision for restaurant closures and other                                    17,259          31,045               20
                                                                             ------------  ---------------  ---------------
         Total costs and expenses                                                200,954         225,329          158,662
                                                                             ------------  ---------------  ---------------

Income (loss) from operations                                                    (14,636)        (36,470)           4,090
                                                                             ------------  ---------------  ---------------

OTHER INCOME (EXPENSE):
   Interest expense                                                               (9,742)        (10,682)          (8,622)
   Interest income                                                                   477             538              614
   Other                                                                            (354)            234              (49)
                                                                             ------------  ---------------  ---------------
         Total other (expense)                                                    (9,619)         (9,910)          (8,057)
                                                                             ------------  ---------------  ---------------

Loss before income taxes and extraordinary items                                 (24,255)        (46,380)          (3,967)

PROVISION (BENEFIT) FOR INCOME TAXES                                              (4,982)            539             (675)
                                                                             ------------  ---------------  ---------------

Loss before extraordinary items                                                  (19,273)        (46,919)          (3,292)

EXTRAORDINARY ITEMS (net of tax expense of $1,350)                                     -               -            5,280
                                                                             ------------  ---------------  ---------------
Net income (loss)                                                            $   (19,273)  $     (46,919)   $       1,988       
                                                                             ============  ===============  ===============

Earnings (loss) per common share:
   Earnings (loss) before extraordinary item                                 $             $                $
                                                                                   (1.42)          (3.00)            (.19)
   Extraordinary item                                                                  -               -              .31
                                                                             ============  ===============  ===============

Earnings (loss) per common share                                             $             $                $
                                                                                   (1.42)          (3.00)             .12
                                                                             ============  ===============  ===============

Weighted average shares outstanding                                               13,564          15,620           17,007
                                                                             ============  ===============  ===============


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

</TABLE>

                                       3
<PAGE>
<TABLE>
<CAPTION>


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

                                 (In thousands)


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

Balances at January 2,1994   25,000   13,268  $1,327      -         -    $   -    (239)  $(2,009)     50,634    $ 12,575   $ 62,527

Issuance of common stock       -       2,569     257      -         -        -      -       -          9,976       -         10,233
Net loss                       -        -        -        -         -        -      -       -           -       (19,273)    (19,273)
                          ---------- -------- ------- ---------- ------- ------- ------ ----------   ---------- ----------  --------
Balances at January 1,       25,000   15,837   1,584      -         -        -    (239)   (2,009)     60,610     (6,698)     53,487
   1995

Amendment to the             25,000      -        -       -         -        -      -       -           -          -
   Charter (A)
Issuance of common stock       -          90        9     -         -        -      -       -            194       -            203
Treasury stock acquired        -         -        -       -         -        -     (34)      (99)       -          -            (99)
Net loss                       -         -        -       -         -        -      -       -           -       (46,919)    (46,919)
                          ---------- -------- ------- ---------- ------- ------- ------ ----------   ---------- ----------  --------
Balances at
  December 31, 1995          50,000   15,927   1,593      -         -        -    (273)   (2,108)     60,804    (53,617)      6,672

Issuance of common stock       -          35       3      -         -        -      -       -             74       -             77
Authorization of
   preferred stock (B)         -         -        -    5,000,000    -        -      -       -          -           -
Shareholders Rights Offering   -       4,826     483      -         -        -      -       -          9,975       -         10,458

Issuance of
   compensatory stock
   options and warrants        -         -        -      -          -        -      -       -            170       -            170
Net income                     -         -        -      -          -        -      -       -          -          1,988       1,988
                          ========== ======== ======= ========== ======= ======= ====== ==========   ========== ==========  ========
Balances at December
   29, 1996                  50,000   20,788  $2,079   5,000,000    -     $  -    (273)  $(2,108)    $71,023   $(51,629)   $ 19,365
                          ========== ======== ======= ========== ======= ======= ====== ==========   ========== ==========  ========


(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 ratified the authorization of
     5,000,000 shares of Preferred Stock at a par value of $.10.

















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

                                       4
<PAGE>
<TABLE>
<CAPTION>

                    RALLY'S HAMBURGERS, INC. AND SUBSIDIARIES
                      CONSOLIDATED STATEMENTS OF CASH FLOW
                                 (In thousands)

                                                                                         Fiscal Years Ended
                                                                             --------------------------------------------
<S>                                                                          <C>           <C>             <C>
                                                                             January 1,    December 31,    December 29,
                                                                                1995           1995            1996
                                                                             ------------  -------------- ---------------
CASH FLOWS PROVIDED FROM OPERATING ACTIVITIES:
Net income (loss)                                                              $ (19,273)    $ (46,919)    $    1,988
Adjustments to reconcile net income (loss) to net cash provided by
   operating activities:
     Depreciation and amortization                                                14,139        13,006         10,482
     Extraordinary items, before tax expense of $1,350                                 -             -         (6,630)
     Provision for restaurant closures and other                                  17,259        31,045             20
     Provision for losses on receivables                                             377         1,507            968
     Other                                                                           568         2,276          1,265
     Changes  in  assets  and   liabilities   net  of  effects   from   business
       combinations:
       (Increase) decrease in assets:
         Receivables                                                              (1,810)          775           (306)
         Inventory                                                                   (14)          (63)           262
         Prepaid expenses and other current assets                                   752           185            161
         Other assets                                                             (2,563)          292           (121)
       Increase (decrease) in liabilities:
         Accounts payable and accrued liabilities                                    187         7,815         (6,011)
         Deferred income taxes                                                    (1,524)         -                 -
         Other liabilities                                                        (1,824)       (1,424)        (1,535)
                                                                             ------------  -------------- ---------------
           Net cash provided by operating activities                               6,274         8,495            543
                                                                             ------------  -------------- ---------------

CASH FLOWS PROVIDED FROM (USED IN) INVESTING ACTIVITIES:
   (Increase) decrease in investments                                              9,022          (848)         2,975
   Notes receivable                                                                  429           154            312
   Pre-opening costs                                                                (832)          (45)          (156)
   Capital expenditures                                                          (19,808)       (3,405)        (2,306)
   Proceeds from the sale of property and equipment                                2,525         4,266          4,392
   (Increase) decrease in intangible assets                                       (1,436)         (111)           (39)
   Acquisition of businesses, net of cash acquired                                (1,836)       (1,931)             -
   Proceeds from the sale of a business                                             -            2,730              -
                                                                             ------------  -------------- ---------------
           Net cash provided by (used in) investing activities                   (11,936)          810          5,178
                                                                             ------------  -------------- ---------------

CASH FLOWS PROVIDED FROM (USED IN) FINANCING ACTIVITIES:
   (Increase) in restricted cash                                                    -             (683)          (966)
   Payment of organization and development costs                                      (4)           (3)             -
   Principal payments of debt                                                     (5,538)       (2,114)        (1,696)
   Senior Notes retirement                                                          -             -           (19,612)
   Issuance of common stock, net of costs of issuance                             10,233           203         10,535
   Principal payments on capital lease obligations                                  (393)         (604)          (508)
                                                                             ------------  -------------- ---------------
           Net cash provided from (used in) financing activities                   4,298        (3,201)       (12,247)
                                                                             ------------  -------------- ---------------
           Net increase (decrease) in cash                                        (1,364)        6,104         (6,526)

CASH AND CASH EQUIVALENTS, beginning of period                                     4,071         2,707          8,811
                                                                             ============  ============== ===============
CASH AND CASH EQUIVALENTS, end of period                                     $     2,707   $     8,811      $   2,285
                                                                             ============  ============== ===============




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

                                       5
<PAGE>


                    RALLY'S HAMBURGERS, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
            (tabular dollars in thousands, except per share amounts)



1.    SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

     a)   Financial Statement Presentation and Organization

          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  December  29,  1996,  the  Rally's  system
          included 467  restaurants  in 19 states,  primarily in the Midwest and
          the  Sunbelt,   comprised  of  209  Company-owned  and  operated,  231
          franchised and 27  Company-owned  restaurants in Western markets which
          are operated as Rally's restaurants by CKE Restaurants,  Inc. ("CKE"),
          a significant shareholder of the Company, under an operating agreement
          which began July, 1996. One additional  Company-owned store covered by
          the operating  agreement  has been  converted to the Carl's Jr. format
          and  is  not  included  in  the  above  store  count.   The  Company's
          restaurants  offer high  quality  fast food.  The  Company  serves the
          drive-thru  and  take-out  segments  of the  quick-service  restaurant
          industry.  The Company opened its first restaurant in January 1985 and
          began offering franchises in November 1986.

          Rally's  Hamburgers,  Inc.,  Rally's of Ohio, Inc., Self Service Drive
          Thru,  Inc.  and Hampton  Roads Foods,  Inc.  own and operate  Rally's
          restaurants in various states. Additionally,  Rally's Hamburgers, Inc.
          operates as franchisor of the Rally's brand. Rally's Management,  Inc.
          provides  overall  corporate  management of the Company's  businesses.
          Rally's Finance, Inc. was organized for the purpose of making loans to
          Rally's franchisees to finance the acquisition of restaurant equipment
          and modular  buildings.  RAR,  Inc. was  organized  for the purpose of
          acquiring  and  operating  a  corporate   airplane  and  is  currently
          inactive. The Company's wholly-owned subsidiary, ZDT Corporation,  was
          formed  to  own  the  Zipps  brand  and  franchise  system.  MAC 1 was
          organized  for the  purpose of  acquiring  a  manufacturer  of modular
          buildings.  The  manufacturing  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 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.

      b) Revenue Recognition

          The  Company  recognizes  franchise  fees  as  income  on  the  date a
          restaurant  is opened,  at which time the  Company has  performed  its
          obligations relating to such fees. Area development fees are generated
          from the  awarding of  exclusive  rights to  develop,  own and operate
          Rally's restaurants in certain

                                       6
<PAGE>

          geographic areas pursuant to an Area Development Agreement.  Such fees
          are  recognized as income on a pro rata basis as the  restaurants  are
          opened or upon the  cancellation or expiration of an Area  Development
          Agreement.   Both  franchise  fees  and  area   development  fees  are
          non-refundable.   The  Company   also   receives   royalty  fees  from
          franchisees in the amount of 4% of each franchised  restaurant's gross
          revenues,  as defined in the  Franchise  Agreement.  Royalty  fees are
          recognized as earned.

     c)  Property and Equipment

          Property and equipment are depreciated using the straight-line  method
          for financial  reporting  purposes and accelerated  methods for income
          tax  purposes.  The  estimated  useful lives for  financial  reporting
          purposes are the shorter of 20 years or the lease life plus  available
          renewal  options for buildings and property held under capital leases,
          eight years for furniture and  equipment,  five years for software and
          computer systems and the life of the lease for leasehold improvements.
          Expenditures for major renewals and betterments are capitalized  while
          expenditures for maintenance and repairs are expensed as incurred.

     d)  Interest Costs

          Interest costs incurred  during the  construction  of restaurants  are
          capitalized  as a  component  of the cost of the  restaurants  and are
          amortized on a straight-line  basis over the estimated useful lives of
          the  restaurants.  The amounts  capitalized for the fiscal years ended
          January  1,  1995,  December  31,  1995 and  December  29,  1996  were
          approximately $490,000, $30,000 and $7,000, respectively.

     e)  Inventory

          Inventory  is valued at latest  invoice  cost which  approximates  the
          lower of first-in, first-out cost or market.

     f)  Supplemental Disclosures of Cash Flow Information

                                                   Fiscal Years Ended
                                          --------------------------------------
                                           January 1,  December 31, December 29,
                                              1995        1995         1996
                                          ------------ ------------ ------------

Interest paid (net of amount capitalized)    $ 9,760    $ 10,679       $ 8,639
Income taxes paid                                163         212           983
Capital lease obligations incurred               -         1,616           111

              The purchase of HRF described in Note 2 was recorded as follows:

                                                                      Fiscal
                                                                   Year Ended
                                                                 ---------------
                                                                   December 31,
                                                                       1995
                                                                 ---------------

                              Fair value of assets acquired            $ 9,133
                              Cash paid                                 (2,125)
                                                                 ===============
                              Liabilities assumed                      $ 7,008
                                                                 ===============

          As a result of the sale of  Beaman  discussed  in Note 2, the  Company
          recorded  the net  present  value of a  non-interest  bearing  note of
          approximately  $347,000.  The Company  recorded in 1996  approximately
          $547,000 in notes  receivable  primarily  as the result of the sale of
          five  of  its  restaurants  in  Montgomery,  Alabama.  These  non-cash
          transactions  have been  excluded from the  consolidated  statement of
          cash flows.

                                       7
<PAGE>

          During fiscal 1995 and 1996, the Company accepted notes due within two
          to five years,  bearing interest at rates previously  specified in the
          underlying   franchise   agreements,   for  certain  receivables  from
          franchises in the aggregate amount of approximately  $542,000 for 1995
          and approximately $340,000 for 1996. There were no such notes in 1994.

          For purposes of the consolidated  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.  Cash  equivalents  at December 31, 1995 and December 29,
          1996 were approximately $6.8 million and $976,000, respectively.

     g)  Earnings (Loss) Per Common Share

          Earnings (loss) per common share is calculated based upon the weighted
          average shares and common  equivalent  shares  outstanding  during the
          periods.

     h)   Goodwill,  Reacquired  Franchise  Rights,  Other Intangibles and Other
          Assets

          Goodwill, reacquired franchise and territory rights, other intangibles
          and other assets are being  amortized using the  straight-line  method
          over the following periods:

                                                                  Amortization
                                                                     Period
                                                                 --------------

                      Goodwill                                    5, 20-25 years
                      Reacquired franchise and territory rights      15-20 years
                      Other intangibles                               3-25 years
                      Other assets                                    5-25 years

          Subsequent  to the  intangibles'  acquisition,  the Company  evaluates
          whether later events and circumstances have occurred that indicate the
          remaining  estimated useful life of goodwill and other intangibles may
          warrant  revision or that the remaining  balance of goodwill and other
          intangibles  may  not  be  recoverable.  When  factors  indicate  that
          goodwill  or  other  intangibles  should  be  evaluated  for  possible
          impairment,  the Company uses an estimate of the related  undiscounted
          cash  flows  over  the  remaining  life  of  the  goodwill  and  other
          intangibles  in measuring  whether the goodwill and other  intangibles
          are  recoverable.  The amount of any such  impairment is determined as
          the  difference  between  carrying  value and fair  value  based  upon
          discounted  cash flows.  No such impairment was recorded in any period
          presented except as disclosed in Note 16.

     i)  Owner Fee Income and Expense

          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.

     j)  Advertising Costs

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

     k)  Reclassification

          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 fiscal year ended  December  29,
          1996. Such  reclassifications had no effect on previously reported net
          income.

                                       8
<PAGE>

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 and 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   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  non-compete  (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 to be paid  pursuant to a  non-interest  bearing,
     unsecured promissory note.

3.   RESTAURANT CLOSURES AND OTHER

     Certain  charges in  fiscals1994,  1995 and 1996 have been  aggregated  and
     segregated into the caption  "Provision for Restaurant  Closures and Other"
     in  the  accompanying  Statements  of  Operations.  These  items  represent
     estimates  of the impact of  management  decisions  which have been made at
     various  points in time in  response  to the  Company's  sales  and  profit
     performance  and the  then-current  revenue  building and profit  enhancing
     strategies.

     In summary and chronologically, the decisions that had been reached in 1994
     were to abandon  additional  real estate  development  projects and certain
     investment in  infrastructure  (approximately  $5.3 million) and to abandon
     additional  projects and franchise or otherwise dispose of up to 60 Company
     restaurants   (approximately  $12.0  million).  During  1995,  the  Company
     concluded  that much of its 1994 plan of disposal  would not be executable.
     As a result,  the Company  decided to (i) close up to 16 of the original 60
     restaurants  included  in the 1994  disposal  plan,  (ii)  close  nine poor
     performing  restaurants  in its  core  markets,  (iii)  writeoff  estimated
     exposure resulting from the default of a  subleasee/franchisee  in a former
     Company  market,  (iv) record  additional  writedowns  of modular  building
     value,  (v)  record  writedowns  to sales  price  less  cost to sell of all
     properties  auctioned in fourth quarter,  1995 (vi) record asset writedowns
     and occupancy  exposure  related to the default of a tenant for five of the
     units  closed  under  the 1994  plan and  (vii)  record  other  changes  in
     estimates related to the Company's surplus properties.  The charges for the
     above 1995 items totaled  approximately  $17.3  million.  Also reflected in
     this caption for fiscal 1995 is an approximate $13.7 million charge related
     to the Company's  adoption of Statement of Financial  Accounting  Standards
     No. 121 ("SFAS 121) further discussed in Note 16.

     Included  in this  caption  for fiscal  1996 are  charges of  approximately
     $679,000   related  to  the   writedown   and  sale  of  assets  offset  by
     approximately  $659,000  resulting  from a  reduction  in surplus  property
     reserves related to Management's decision to re-open three units previously
     closed and to continue  to operate a fourth  unit that had been  designated
     for closure.  See also  "Management's  Discussion and Analysis of Financial
     Condition and Results of Operations--"Restaurants Closures and Other."

                                       9
<PAGE>

4.   RELATED PARTY TRANSACTIONS

     a)   Issuance of Warrants

          On December 20, 1996, the Company issued warrants (the  "Warrants") to
          purchase an  aggregate of  1,500,000  restricted  shares of its Common
          Stock to CKE and Fidelity National  Financial,  Inc. The Warrants were
          granted as an incentive to CKE and Fidelity to continue to participate
          in the  identification  and exploitation of synergistic  opportunities
          with the  Company.  The Warrants  have a  three-year  term and are not
          exercisable  until December 20, 1997. The exercise price is $4.375 per
          share, the closing price of the Common Stock on December 20, 1996. The
          underlying  shares of Common Stock have not been  registered  with the
          Securities  and Exchange  Commission  and,  therefore,  are not freely
          tradable. Upon exercise, the Warrants would provide approximately $6.6
          million in additional  capital to the Company.  The Company obtained a
          valuation  analysis  from  an  investment  banking  firm  of  national
          standing.  Such  analysis  estimated  the value of the  Warrants to be
          approximately $960,000. Approximately $24,000 has been expensed during
          1996 within General and Administrative  expenses.  The remaining value
          will be  expensed  in fiscal  1997 over the  remainder  of the vesting
          period of the underlying Warrants.

     b)   West Coast Operating Agreement

          On July  1,  1996,  the  Company  entered  into a  ten-year  Operating
          Agreement  with Carl Karcher  Enterprises,  Inc., a subsidiary  of CKE
          Restaurants,  Inc.  (collectively  referred  to as "CKE").  CKE is the
          operator  of  the  Carl's  Jr.  restaurant  chain.   Pursuant  to  the
          agreement,  28 Rally's owned  restaurants  located in  California  and
          Arizona are being operated by CKE. Such agreement is cancelable  after
          an initial  five-year  period,  at the discretion of CKE. A portion of
          these restaurants,  at the discretion of CKE, will be converted to the
          Carl's Jr. format.  To date, one  restaurant has been  converted.  The
          agreement was approved by a majority of the  independent  Directors of
          the  Company.  Prior  to  the  agreement,  the  Company's  independent
          Directors had received an opinion as to the fairness of the agreement,
          from a financial  point of view,  from an  investment  banking firm of
          national standing.

          Under the terms of the Operating  Agreement,  CKE is  responsible  for
          conversion costs  associated with  transforming the restaurants to the
          Carl's  Jr.  format,  as well  as the  operating  expenses  of all the
          restaurants.  Rally's  retains  ownership of all 28 restaurants and is
          entitled to receive a percentage of gross  revenues  generated by each
          restaurant.  Subsequent to the agreement,  the Company's revenues have
          been,  and  will  continue  to  be,  reduced  by  the  absence  of the
          restaurants' sales,  somewhat offset by the fee paid to the Company by
          CKE.  For the first six months of the current  year,  the  restaurants
          covered by this Operating  Agreement had sales of approximately  $10.5
          million.  The Company  anticipates that the agreement will continue to
          positively  impact  both net income and cash flow.  While the  overall
          impact  of  the  agreement  is  not  expected  to be  material  to the
          financial  statements,  it will allow  management to  concentrate  its
          efforts in more fully developed  Rally's  markets.  The agreement will
          also  allow the  Company  to take  advantage  of any  improvements  in
          restaurant   operations   attained  by  CKE  by   implementing   these
          improvements in Company  stores.  In the event of a sale by Rally's of
          any of the 28 restaurants, Rally's and CKE would share in the proceeds
          based upon the relative value of their respective capital  investments
          in such restaurant.

     c)   Option Grants to Non-employees

          During  1996,  the  Company   granted   150,000   options  to  certain
          individuals  not  employed  by  the  Company  for  services  provided.
          Approximately  $84,000 has been  expensed  for these grants in General
          and   Administrative   Expenses  in  the  accompanying   Statement  of
          Operations.  Such  options  were  granted at the market  values on the
          dates of grant, were immediately exercisable and expire in five years.

                                       10
<PAGE>

     d)   Other Transactions

          The Company has had transactions with certain companies or individuals
          which are related parties by virtue of having  stockholders in common,
          by  being   officers/directors  or  because  they  are  controlled  by
          significant  stockholders or  officers/directors  of the Company. Such
          transactions  which  impacted  the  Company's  consolidated  financial
          statements are summarized  below.  Information with respect to related
          party rent is  disclosed  in Note 12. The Company and its  franchisees
          each pay 1/2% of sales to the Rally's  National  Advertising Fund (the
          "Fund"),  established  for  the  purpose  of  creating  and  producing
          advertising   for  the  chain.   The  Fund  is  not  included  in  the
          consolidated    financial    statements,    although   the   Company's
          contributions  to  the  Fund  are  included  in  the  Advertising  and
          Promotion  Expenses  in  the  Company's  consolidated   Statements  of
          Operations.

                                            December 31,     December 29,
                                               1995              1996
                                        ------------------  ----------------
          Balance Sheet Amounts
          Royalties receivable                $ 483           $    -
          Accounts receivable                    23               565
          Notes receivable                      175               127
          Accounts payable                      307                95
          Accrued liabilities                   -                  60

                                                     Fiscal Years Ended
                                  ----------------------------------------------
                                    January 1,   December 31,     December 29,
                                       1995          1995             1996
                                  ------------- -------------    ---------------
Revenue and Transaction Amounts
Repurchase of Senior Notes (gross)  $   -          $    -          $   6,339
Royalty fees                          2,129          2,407             -
Owner fee income                        -               -                440
Rental income                           195            262             -
Interest income                          93             16                49
                                    ==========     ==========      =============
                                    $ 2,417        $ 2,685         $   6,828
                                    ==========     ==========      =============

Expense Amounts
Legal                               $   923        $   777         $   1,024
Owner expense                           -               -                744
Interest expense                        -               -                180
Compensatory stock options and
   warrants                             -               -                170
Other                                    14             -                -
                                    ==========     ==========      =============
                                    $   937        $    777        $   2,118
                                    ==========     ==========      =============

5.   RESTRICTED CASH

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

6.   INVESTMENTS

     Excess  funds are being  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

                                       11
<PAGE>

     losses considered to be other than temporary,  are reported as a net amount
     in a separate  component of shareholders'  equity. No net unrealized losses
     were reported for any period  presented.  Provisions for declines in market
     value are made for losses  considered to be other than  temporary.  No such
     provision was necessary for the years ended  December 31, 1995 and December
     29,  1996.   The   provision  for  the  year  ended  January  1,  1995  was
     approximately  $95,000.  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.

     The carrying  value is equal to the market value of investments at December
     31, 1995 and December 29, 1996 and consist of the following:

          December 31, 1995
          United States government and its agencies   $  4,933
          Corporate debt instruments                      -
                                                     ==========
          Total                                       $  4,933
                                                     ==========

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

     The contractual  maturities of these  investments at December 29, 1996 were
     as follows:

                                  1997      $    500
                                  2002           248
                                  2012           299
                                  2013           597
                                  2017           314
                                            =========
                                               1,958
                                            =========

     The  proceeds  from the sale of  investments  and  related  gross gains and
     losses for the twelve months ended  January 1, 1995,  December 31, 1995 and
     December 29, 1996 were as follows:

                                                    Fiscal Years Ended
                                        ----------------------------------------
                                        January 1,   December 31,   December 29,
                                           1995          1995           1996
                                        ---------- --------------   ------------

          Proceeds from the sale of     $  17,798    $   15,653     $  10,531
            investments
          Gross gains realized               137             56          -
          Gross losses realized             (364)         -                (4)


                                       12
<PAGE>


7.   NET PROPERTY AND EQUIPMENT

     Property and equipment consists of the following:

                                                December 31,      December 29,
                                                    1995              1996
                                               ----------------  ---------------

     Land                                      $       14,310    $       14,074
     Buildings and leasehold improvements              46,520            47,463
     Equipment, furniture and fixtures                 45,036            41,312
                                               ----------------  ---------------
                                                      105,866           102,849
     Less accumulated depreciation                    (32,049)          (37,518)
                                               ----------------  ---------------
                                                       73,817            65,331
                                               ----------------  ---------------
     Property held under capital lease                  6,208             6,145
     Less accumulated amortization                     (1,342)           (1,670)
                                               ----------------  ---------------
                                                        4,866             4,475
                                               ================  ===============
     Net property and equipment                $       78,683    $       69,806
                                               ================  ===============

8.   ACCRUED LIABILITIES

     Accrued liabilities consist of the following:

                                           December 31,    December 29,
                                               1995            1996
                                          --------------- ---------------

     Payroll and payroll taxes            $        3,013   $        2,245
     Closed store reserve                          2,767            1,964
     Workers compensation                          2,102            2,367
     Advertising                                   1,819              316
     Other                                         6,258            6,708
                                          =============== ===============
                                          $       15,959   $       13,600
                                          =============== ===============

9.   OTHER LIABILITIES

     Other liabilities consist of the following:

                                      December 31,    December 29,
                                          1995            1996
                                     --------------- ---------------

     Closed store reserve            $        6,908    $       3,881
     Unfavorable lease loss                     890              748
     Other                                      232              216
                                     =============== ===============
                                     $        8,030    $       4,845
                                     =============== ===============

10.  SENIOR NOTES

     On March 9, 1993,  the  Company  sold  approximately  $85 million of 9 7/8%
     Senior,  Notes due 2000 (the  "Notes").  The  Company is required to make a
     mandatory  sinking  fund  payment  on June 15,  1999 to  retire  33 1/3% in
     aggregate  principal amount of the Notes issued.  The Notes are carried net
     of the  related  discount,  which is being  amortized  over the life of the
     Notes.  Interest  is payable  June 15 and  December  15. The Notes  include
     certain restrictive  covenants which, among other  restrictions,  limit the
     Company's ability to obtain  additional  borrowings and to pay dividends as
     well as impose certain change of control provisions, as defined.

                                       13
<PAGE>

     On January 29, 1996, the Company  repurchased,  in two  transactions,  at a
     price of approximately  $678.75 per $1,000 principal amount,  approximately
     $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  approximately  $16 million face value of the
     Notes for  approximately  $11.1  million in cash.  The  second  transaction
     involved  the purchase of  approximately  $6 million face value of Notes in
     exchange for a short-term note of approximately $4.1 million,  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  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.  Due to the  repurchases  in January 1996,  the
     redemption price of approximately  $15.2 million has been classified in the
     caption "Current Maturities of Long-Term Debt and Obligations Under Capital
     Leases" in the accompanying consolidated balance sheet for fiscal 1995.

     Additionally, in four separate transactions during the fourth quarter 1996,
     the Company repurchased  approximately $4.7 million face value of the Notes
     from various other bondholders for approximately $4.5 million in cash.

     These  purchases  resulted  in  extraordinary  gains  in  1996  net of tax,
     totaling approximately $5.3 million or $.31 per share. As a result of these
     debt  repurchases,  the annualized  ongoing interest payments on the Senior
     Notes  have  been  reduced  by  approximately  $2.6  million  per  year  to
     approximately $5.8 million. In addition, these repurchases have reduced the
     sinking fund requirement discussed above to approximately $1.6 million from
     approximately $28 million.

     The  remaining  outstanding  Notes are publicly  traded and at December 29,
     1996 had a market value of approximately  $54.5 million based on the quoted
     market price for such notes.

     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.


                                       14
<PAGE>


11.  LONG-TERM DEBT

     Long-term debt consists of the following:
<TABLE>
<CAPTION>
                                                                                      December 31,      December 29,
                                                                                          1995             1996
                                                                                      --------------   --------------
     <S>                                                                              <C>              <C>
     Notes payable to banks, maturing at various dates through February 10, 2000,
          secured by property and/or  equipment,  bearing  interest ranging from
          1/2% above prime to 9.25%. The notes are payable in monthly  principal
          and  interest  installments  ranging  from  $848 to $41,033.                    $ 1,883        $  1,006


     Note payable  to  finance  company  due  October  1998,  secured by certain
          equipment, bearing interest at a rate of 7.3%. The note is payable in
          monthly principal and interest installments of $6,762.                              384             133

     Note payable to Company  for  acquisition  of certain  markets,  secured by
          certain property and equipment,  maturing  November 30, 1998,  bearing
          interest of 8.3%. The note is payable in monthly principal and
          interest installments of $11,494.                                                   205             79

     Secured notes payable to a bank used to finance  equipment  and/or  modular
          buildings for franchisees (the Franchisee Loans),  maturing at various
          dates through July 15, 2000,  bearing interest at prime plus 1/2%. The
          notes are payable in monthly principal installments of $4,875.
          Interest is payable monthly.                                                        261             195

     Notespayable to former owners for acquisition of market,  secured by common
          stock  of  Hampton  Roads  Foods,   maturing  March  13,  2001,   with
          outstanding balances due after last monthly payments, bearing interest
          of 9.0%. The notes are payable in monthly principal and interest
          installments ranging from $4,742 to $50,211.                                      4,814           4,461


                                                                                      --------------  --------------
                                                                                            7,547           5,874
     Less - Current portion                                                                (1,798)         (1,099)
                                                                                             -                -
                                                                                      ==============  ==============
                                                                                      $     5,749      $    4,775
                                                                                      ==============  ==============
</TABLE>
     At December 29, 1996,  the prime rate was 8.25%.  There were no  short-term
     borrowings in the year ended December 31, 1995.

     The  following are the  maturities  of long-term  debt for each of the next
     five years and thereafter:

                                    Year
                              -------------------

                                     1997              $     1,099
                                     1998                      722
                                     1999                      727
                                     2000                      590
                                  Thereafter                 2,736
                                                       ============
                                                       $     5,874
                                                       ============

     The  Company is subject to  certain  restrictive  covenants  under its debt
     agreements.

     The market value of the Company's long-term debt approximated book value at
     December 29, 1996.  Debt related to the  acquisition of Hampton Roads Foods
     was entered  into in 1995 and bears  interest  at rates  which  approximate
     current  rates for debt with similar  terms.  The majority of the remaining
     long-term debt has  contractual  rates which vary based on  fluctuations in
     market rates.


                                       15
<PAGE>


12.  COMMITMENTS AND CONTINGENCIES

     (a)  Lease Commitments

          The  Company  leases  certain  land  and  buildings   generally  under
          agreements  with terms of or renewable to 15 to 20 years.  Some of the
          leases contain  contingent  rental  provisions based on percentages of
          gross sales. The leases generally obligate the Company for the cost of
          property taxes, insurance and maintenance.  Following is a schedule by
          year of future minimum lease  commitments under all leases at December
          29, 1996:

                                                     Capital           Operating
                    Year                              Leases             Leases
---------------------------------------------       -----------       ----------

1997                                                $    1,087             8,475
1998                                                     1,010             7,870
1999                                                       973             7,216
2000                                                       906             6,413
Thereafter                                               6,772            33,052
                                                    ----------        ==========
Total minimum lease commitments                         10,748        $   63,026
                                                                      ==========
Less amounts representing interest,
   discounted at rates ranging from 10% to 12%          (4,955)
                                                    -----------
Present value of minimum lease payments                  5,793
Current portion of capital lease obligations              (385)
                                                    ===========
Long-Term lease obligations                         $    5,408
                                                    ===========

          The  discount  rates  applicable  to  the  Company's   capital  leases
          approximate  currently available market rates. Minimum operating lease
          payments  have not been  reduced by minimum  sublease  rentals of $2.7
          million due in the future under noncancellable subleases.

          Rent expense consists of:

                                                Fiscal Years Ended
                                      ----------------------------------------
                                      January 1,     December      December
                                         1995        31, 1995      29, 1996
                                      -----------  ------------- -------------

     Minimum rentals - related parties   $   261      $     292     $    470
     Minimum rentals - others              6,514          6,641        4,681
     Contingent rentals - others             136            173          122
                                      ===========  ============= ============
                                         $ 6,911      $   7,106     $  5,273
                                      ===========  ============= ============

     (b)  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,
          certifying  a class  from July 20,  1992 to  September  29,  1993.  In
          October 1995, the plaintiffs filed a motion to disqualify Christensen,
          Miller,  Fink,  Jacobs,  Glaser,  Weil & Shapiro,  LLP  ("Christensen,
          Miller") as counsel for  defendants  based on a purported  conflict of
          interest   allegedly  arising  from  the  representation  of  multiple
          defendants as well as Ms. Glaser's  position as both a former director
          of Rally's and a partner in Christensen,  Miller.  Defendants filed an
          opposition to the motion,  and the motion to  disqualify  Christensen,
          Miller 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.  The Court
          denied  the  motion  in the fall of 1996  and  refused  to  disqualify
          Christensen, Miller. Fact

                                       16
<PAGE>

          discovery  is set to  close  in April  1997.  No  trial  date has been
          scheduled  yet.  Management  is unable to predict  the outcome of this
          matter  at the  present  time  or  whether  or not  certain  available
          insurance coverages will apply. 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.  An estimate of defense costs reimbursable under
          the Company's directors' and officers' insurance is included in "Other
          Assets" in the accompanying consolidated financial statements.

          In 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
          approximately  $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  November,  1996,  Red Line  filed a First
          Amended  Disclosure  Statement and First Amended  Liquidating  Plan of
          Reorganization  (the "Plan") which  disputed Red Line's  obligation to
          pay the Company any of the foregoing monies. By Bankruptcy Court Order
          entered February 28, 1997 (the  "Confirmation  Order"),  the Company's
          general  unsecured  claims were allowed in the amount of approximately
          $615,000.  The  Confirmation  Order also  approved the Plan.  The Plan
          provides for,  among other things,  mutual  releases among the Company
          and  Red  Line  (such  releases  do not  affect  the  allowed  general
          unsecured  claims  described above) and the sale of Red Line's assets.
          Cash from those sales will be  insufficient to pay all secured claims,
          taxes and administrative claims. Some of the Red Line assets are to be
          acquired by New Red Line, Inc., an entity  involving  certain insiders
          and/or  affiliates  of Red  Line.  Unsecured  creditors  of  Red  Line
          (including  the Company) will receive under the Plan a minority  stock
          interest  in New Red  Line,  Inc.  At this  time,  the  likelihood  of
          realizing  any value on account of such  minority  stock  interest  is
          considered  extremely  speculative.  The receivable balances have been
          fully reserved.

          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
          Court. Harbor named Rally's as a nominal defendant. Harbor claims that
          the  directors  and  officers of both  Rally's  and GIANT,  along with
          GIANT,  breached their fiduciary duties to the public  shareholders of
          Rally's by causing  Rally's to repurchase  from GIANT certain  Rally's
          Senior Notes at an inflated  price.  Harbor seeks "millions of dollars
          in damages",  along with rescission of the repurchase transaction.  In
          the fall of 1996,  all  defendants  moved to dismiss the  action.  The
          Chancery  Court  conducted a hearing on November 26, 1996, but has not
          yet ruled on the pending  motions.  The Company  denies all wrongdoing
          and intends to  vigorously  defend the action.  It is not  possible to
          predict the outcome of this action at this time.

          Rally's filed a lawsuit on August 12, 1996 against Arkansas Investment
          Group, Inc. ("AIGI"), a franchisee that currently operates ten Rally's
          restaurants  located  in  Arkansas.   The  lawsuit  seeks  to  recover
          royalties and  contributions to the Rally's National  Advertising Fund
          owed by AIGI pursuant to the applicable  franchise  agreements,  which
          total approximately  $500,000 with accrued interest as of December 29,
          1996.  After falling in arrears on its royalties and advertising  fund
          contributions,  Rally's and AIGI  negotiated  a written  agreement  to
          allow AIGI to make payments  under a revised  payment  schedule.  AIGI
          also defaulted on that written

                                       17
<PAGE>

          obligation.  AIGI has filed an  Answer  and  Counterclaim  in which it
          alleges it does not owe the  royalties and  advertising  contributions
          due  to  its  alleged  disagreement  with  operational  and  marketing
          decisions  of Rally's  and  Rally's  alleged  failure  to rebate  sums
          obtained from suppliers. AIGI has asserted causes of action for breach
          of contract, violation of the Arkansas Franchise Practices Act, unjust
          enrichment  and fraud.  The  Counterclaim  alleges  that AIGI has been
          damaged in excess of approximately $75,000 (the minimum jurisdictional
          amount  for  federal  court),  but no  specific  amount of  damages is
          identified in the Counterclaim.  Rally's denies AIGI's allegations and
          intends to vigorously defend the Counterclaim.  Because the litigation
          is in a preliminary  stage, the Company is unable to determine whether
          a resolution adverse to the Company will have a material effect on its
          results  of  operations  or  financial  condition.   Accordingly,   no
          provisions for any liabilities that may result upon  adjudication have
          been made in the accompanying financial statements.

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

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

     (c)  Other Commitments

          The  Company  is  contingently  liable  on  certain  franchisee  lease
          commitments totaling approximately  $366,000. 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.

13.  INCOME TAXES

     The asset and  liability  method  contemplated  by  Statement  of Financial
     Accounting  Standards No. 109 requires  recognition  of deferred tax assets
     and liabilities for the expected future tax  consequences of  substantially
     all temporary  differences  between the tax bases and  financial  reporting
     bases of assets and liabilities (excluding goodwill).


                                       18
<PAGE>


     The major  components of the Company's  computation  of deferred tax assets
     and liabilities at December 31, 1995 and December 29, 1996 are as follows:
<TABLE>
<CAPTION>

                                                                            December 31,    December 29,
                                                                                1995           1996
                                                                            --------------  ------------
     <S>                                                                    <C>             <C>
     Excess of tax depreciation over book depreciation                      $   11,390      $   8,430
     Acquired intangibles with no tax basis                                      2,199          2,070
     Other                                                                           8             30
                                                                            ==============  ============
       Gross deferred tax liabilities                                       $   13,597      $  10,530
                                                                            ==============  ============

     Net operating loss carryforwards                                       $   13,070      $  12,824
     Amounts accrued for financial reporting purposes not yet                   17,122         12,885
        deductible for tax purposes
     Alternative minimum tax and targeted jobs tax credit carryforwards            937            937
     Other                                                                       1,267          1,514
                                                                            ------------    ------------
     Gross deferred tax assets                                                  32,396         28,160
     Less valuation allowance                                                   18,799         17,630
                                                                            ==============  ============
       Net deferred tax asset                                               $   13,597      $  10,530
                                                                            ==============  ============
</TABLE>
     The primary  changes from December 31, 1995 in the  components of the above
     assets  and  liabilities  relate  to the  Company's  changes  and  business
     strategies,  restructuring,  other  restaurant  closings  (See  Note 3) and
     impact of SFAS 121 (See Note 16) offset by current year tax depreciation in
     excess  of  book   depreciation.   The   alternative   minimum  tax  credit
     carryforward has no expiration.  The net operating loss  carryforwards will
     expire approximately $641,000 in 2008,  approximately $20.2 million in 2009
     and approximately  $17.5 million in 2010 and approximately  $1.6 million in
     2011. The targeted jobs tax carryforward expires approximately  $118,000 in
     2006,  approximately $184,000 in 2007 and approximately $200,000 in 2008. A
     valuation allowance of approximately $17.6 million has been established due
     to the  uncertainty  of  realizing  the  benefit  associated  with  the net
     operating loss carryforwards generated in the current and previous years.

     Income tax expense consists of the following:

                                           Fiscal Years Ended
                                 ----------------------------------------
                                 January 1,     December      December
                                    1995        31, 1995      29, 1996
                                 ------------  ------------  ------------

     Current                      $ (3,458)     $    539      $   (675)
     Deferred                       (1,524)         -                -
                                 ============  ============  ============
     Total tax (benefit) expense  $ (4,982)     $    539      $   (675)
                                 ============  ============  ============

     Income tax expense for year ended  December 29, 1996  consists of a benefit
     of  $1,350,000  related  to the  extraordinary  gain  recognized  from  the
     purchase  of bonds,  $575,000 in state  income tax expense and  $100,000 in
     expense  related to a reduction in a receivable from the IRS resulting from
     a NOL carryback to the years 1987, 1988 and 1989.

     A  reconciliation  of the  provisions  for income  taxes  with the  federal
     statutory rate is as follows:

                                                   Fiscal Years Ended
                                        ----------------------------------------
                                        January 1,   December 31,     December
                                           1995          1995         29, 1996
                                        -----------  -------------- ------------

Provision (benefit) computed at          $  (8,247)      $ (15,770)   $  (1,349)
   statutory rate
State and local income taxes, net of
   federal income tax benefit                  162             736          380
Valuation allowance                          3,446          15,352          182
Other                                         (343)            221          112
                                        ===========  ============== ============
                                         $  (4,982)      $     539    $    (675)
                                        ===========  ============== ============

                                       19
<PAGE>

14.  STOCK-BASED COMPENSATION PLANS

     The Company  currently  has three stock  option  plans in effect,  the 1990
     Stock Option Plan (the "Employees'  Plan"),  the 1990 Stock Option Plan for
     Non-Employee  Directors (the "1990  Directors'  Plan"),  and the 1995 Stock
     Option  Plan for  Non-Employee  Directors  (the  "1995  Directors'  Plan").
     Additionally,  the Company has an employee  stock  purchase plan (the "1993
     Purchase Plan").  Although there are existing options outstanding under the
     1990  Directors'  Plan, no additional  grants will be made pursuant to this
     plan. The Company  accounts for these plans under APB Opinion No. 25, under
     which  approximately  $66,000 of  compensation  cost has been recognized in
     fiscal 1996 related to 157,000  options granted to directors under the 1995
     Directors Plan.  Such  compensation  represents the difference  between the
     market  values  on the dates of grant and the  measurement  date,  July 10,
     1996, the date when the grants were ultimately approved by the shareholders
     at the annual  meeting.  No  compensation  cost was recognized in any other
     period presented.

     During 1996, a total of 350,000  additional options were granted to five of
     the current directors. These options were not granted pursuant to an option
     plan. The options were granted at a price equal to the stock's market price
     on the date of grant. The options were  immediately  exercisable and expire
     after five years.

     Had compensation cost for all option grants to employees and directors been
     determined consistent with FASB Statement No. 123, the Company's net income
     and earnings per share would have been reduced to the  following  pro forma
     amounts:

                                                          1995          1996
                                                          ----          ----

         Net Income (Loss):      As Reported          $ (46,919)     $  1,988
                                 Pro Forma              (47,154)         (699)
         Earnings (Loss) Per
            Common Share:        As Reported          $  (3.00)      $   .12
                                 Pro Forma               (3.02)         (.04)

     Because the  Statement  123 method of  accounting  has not been  applied to
     options  granted  prior  to  January  2,  1995,  the  resulting  pro  forma
     compensation  cost  may not be  representative  of that to be  expected  in
     future years.  Additionally,  the pro forma amounts  include  approximately
     $16,000 and $12,000 in 1995 and 1996, respectively, related to the purchase
     discount offered under the 1993 Purchase Plan.

     The Company may sell up to 500,000  shares of stock to its employees  under
     the 1993 Purchase Plan. The Company has sold  approximately  36,000 shares,
     51,000 shares, and 25,000 shares in 1994, 1995, and 1996, respectively, and
     has sold  approximately  126,000 shares through December 29, 1996 since the
     inception  of this plan in 1993.  The  Company  sells  shares at 85% of the
     stock's market price at date of purchase.  The weighted  average fair value
     of  shares  sold in 1995  and  1996  was  approximately  $2.06  and  $3.03,
     respectively.

     Options to purchase an  aggregate  of 5.5 million  shares of the  Company's
     Common Stock may be granted  under the stock option  plans,  at a price not
     less than the market  value on the date of grant.  The  Company has granted
     options on  approximately  2.4 million shares under the stock option plans.
     Outstanding options expire ten years after grant under the Employees' Plan,
     except with regard to shares  granted to the Company's  President and Chief
     Executive  Officer  pursuant to his employment  agreement  which expires in
     five years.  Options outstanding under the two directors' plans expire five
     years after grant.  Options are  exercisable  over various  periods ranging
     from immediate to three years after grant  depending upon their grant dates
     and the plan under which the options were granted.

     On August 26, 1994,  the Board of Directors  authorized an option  exchange
     program,  subject to  shareholder  approval,  pursuant to which  options to
     purchase 1,042,000 common shares at prices ranging from $8.00 to $21.50 per
     share were terminated.  These options were reissued, subject to shareholder
     approval, at $4.125 per share, which was the closing price of the Company's
     Common Stock on August 26, 1994. The option  exchange  program was approved
     by the shareholders at the annual meeting held on May 13, 1995.

                                       20
<PAGE>

     A summary of the status of all options  granted to employees and directors,
     as well as those options granted to non-employees  (see Note 4), at January
     1, 1995,  December 31, 1995,  and December 29, 1996, and changes during the
     years then ended is presented in the table and narrative below:
<TABLE>
<CAPTION>
                                                December 31, 1995        December 29, 1996
                                              ----------------------  ----------------------
                                                          Wtd. Avg.              Wtd. Avg.
                                               Shares     Ex. Price    Shares    Ex. Price
                                              ---------  ----------   --------  ------------
       <S>                                    <C>        <C>          <C>       <C>
       Outstanding at beginning of year          2,225    $  4.74       2,219     $ 4.24
       Granted at price equal to market            676       2.88       2,154       2.63
       Granted at price greater than market        ---        ---         350       1.75
       Exercised                                   ---        ---          (9)      3.05
       Forfeited                                 (412)       3.93        (201)      3.34
       Expired                                   (270)       5.38        (667)      5.62
                                              =========               ========
       Outstanding at end of  year               2,219       4.24       3,846       2.92
                                              =========               ========
       Exercisable at end of  year               1,048       5.09       2,359       3.21
       Weighted average of fair value of
       options granted                           $1.76                  $1.31
</TABLE>

     The Company had approximately  1,910,000 options  outstanding as of January
     2, 1994 at  prices  ranging  form  $2.67 to  $21.50.  During  fiscal  1994,
     approximately  1,925,000 options were granted at prices ranging from $2.875
     to $11.25;  approximately  34,000  options were exercised at prices ranging
     form $2.66 to $6.92; and  approximately  1,576,000  options were terminated
     with prices ranging from $4.125 to $21.50.  These transactions  resulted in
     approximately  2,225,000  options  outstanding as of January 1, 1995,  with
     prices  ranging  form  $2.67 to $9.333.  At January 1, 1995,  approximately
     756,000 options were exercisable at prices ranging from $2.67 to $6.50.

     The following table summarizes  information about stock options outstanding
     at December 29, 1996:
<TABLE>
<CAPTION>
                                 Options Outstanding                                      Options Exercisable
       ------------------------------------------------------------------------     --------------------------------
                                                 Wtd. Avg.
          Range of           Outstanding         Remaining         Wtd. Avg.         Exercisable        Wtd. Avg.
       Exercise Prices          as of           Contractual         Exercise            as of            Exercise
                            Dec. 29, 1996           Life             Price          Dec. 29, 1996         Price
       ----------------    ----------------    ---------------    -------------     ---------------    -------------
        <S>                <C>                 <C>                <C>               <C>                <C>
        $1.25 to 2.50              982              6.9 years         $1.88                 80             $2.36
         2.50 to 3.75            2,047              5.1                2.93              1,679              2.92
         3.75 to 5.00              817              5.1                4.16                599              4.16
                           ================                                         ===============

        $1.25 to 5.00            3,846              5.6                2.92              2,358              3.21
                           ================                                         ===============
</TABLE>
     The fair value of each option grant is estimated on the date of grant using
     the Black-Scholes option pricing model with the following  weighted-average
     assumptions used for grants in fiscal 1995 and 1996, respectively: expected
     volatility of 45.0 percent and 45.7 percent;  risk-free  interest  rates of
     6.75  percent and 6.82 percent for options  granted to  employees  and 6.54
     percent and 6.59  percent for options  granted to  directors;  and expected
     lives for  fiscal  1995 and 1996 of eight  years  for  options  granted  to
     employees  and five years for  options  granted to  directors.  An expected
     dividend yield of 0 percent per share was used for all periods based on the
     Company's history of no dividend payments.

                                       21
<PAGE>


15.  UNAUDITED QUARTERLY FINANCIAL DATA
<TABLE>
<CAPTION>
                                            First        Second       Third        Fourth
                                           Quarter      Quarter      Quarter      Quarter       Total
                                         -----------  -----------  -----------  -----------  -----------
     <S>                                 <C>          <C>          <C>          <C>          <C>
     Year Ended December 31, 1995
        Revenues                          $ 42,470     $ 49,843     $ 49,851     $ 46,695    $ 188,859
        Income (loss) from operations         (993)       1,205      (14,803)     (21,879)     (36,470)
        Net loss                            (3,509)      (1,244)     (17,316)     (24,850)     (46,919)
        Loss per common share                 (.22)        (.08)       (1.11)       (1.59)       (3.00)

     Year Ended December 29, 1996
        Revenues                          $ 41,912     $ 47,357     $ 38,781     $ 34,702    $ 162,752
        Income (loss) from operations       (3,369)       2,413        2,632        2,414        4,090
        Net income                             838          111          414          625        1,988
        Earnings (loss) per common
          share:
          Earnings (loss) before              (.24)         .01          .01          .01         (.19)
            extraordinary item
          Extraordinary item                   .29         -             .02          .02          .31
                                         ===========  ===========  ===========  ===========  ===========
        Earnings (loss) per common share       .05          .01          .03          .03          .12
                                         ===========  ===========  ===========  ===========  ===========
</TABLE>
16.  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  asset.  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. This belief is primarily based on the fact that
     it is at  individual  restaurant  level that most  investment  and  closure
     decisions  are made on an ongoing  basis.  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.

     Prior to the  issuance of SFAS 121,  the  Company  recorded  impairment  of
     long-lived  assets  deemed  to be  permanently  impaired.  Generally,  such
     assessment  of  permanent  impairment  arose  concurrent  with a management
     decision  to dispose  of such an asset at which time the asset was  written
     down to estimated net realizable value. In general, other long-lived assets
     were  reviewed  for  impairment  only if there  were  dramatic  changes  in
     operating  results  or  cash  flows  of  a  segregable  group  of  outlets,
     indicating a likelihood that a permanent impairment has occurred.

     The Company's past practices of estimating net realizable  value for assets
     to be disposed of are consistent with the Statement's requirements to write
     down such assets to fair market value less costs to sell and no  adjustment
     regarding  such assets was necessary  upon adoption of the  Statement.  The
     expected  disposal  dates for these assets are over the next 3 to 24 months
     and consist mainly of surplus land,  buildings and equipment.  The carrying
     amounts  of such  assets  to be  disposed  of are shown  separately  on the
     accompanying  balance sheets. The majority of assets held for sale resulted
     from  constriction of the Company's  development  plan and other associated
     store closings further discussed in Note 3.

                                       22
<PAGE>

     The Company's fourth quarter, 1995 review relating to assets to be held and
     used indicated that 37 of its 238 operating  restaurants  met the Company's
     criteria for  impairment  review.  All of the  indicated  restaurants  were
     deemed to be impaired based on current  estimates of their  underlying cash
     flows and a provision for  impairment  was recorded in the fourth  quarter,
     1995 of  approximately  $13.7  million  related to writedowns of the assets
     associated  with these  restaurants.  Approximately  $824,000 of associated
     intangible assets was included in this writedown. The writedown is included
     in the caption "  Restaurant  Closures  and Other." The  writedown of these
     assets resulted in reduced  depreciation  and  amortization  expense in the
     fourth quarter, 1995 of approximately $351,000.

     The  magnitude of the writedown  noted above  resulted  primarily  from two
     factors:  (1) the  review  of  assets  to be held  and  used at  individual
     restaurant  level,  a lower  level than used in the past and (2) the recent
     historical and continuing  poor  operating  performance of the  restaurants
     themselves (including the restaurant's 1995 full year performance).

     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,
     "Restaurant Closures and Other". No additional  restaurants were determined
     to be impaired  in 1996.  As  required  by the SFAS 121,  the Company  will
     continue  to   periodically   review  its  assets  for   impairment   where
     circumstances indicate that such impairment may exist.

17.  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
     approximately  $10.8  million in gross  proceeds  offset by legal and other
     issuance costs of  approximately  $437,000.  The proceeds from the Offering
     have  been  used to pay off  debt of  approximately  $4.5  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.  The net proceeds from the Offering were
     attributable  primarily  to the sale of the  Company's  common  stock.  The
     amount  attributable  to the  warrants is included in  "Additional  paid-in
     capital."

     In  addition  to the  approximately  $10.8  million  provided by the Rights
     Offering,  the Warrants issued,  if exercised,  could provide an additional
     $10.8 million in  proceeds..  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.
     As of December 29, 1996, 4,818,597 of these Warrants were outstanding.  The
     Warrants are publicly traded and at December 29, 1996 had a market value of
     approximately  $11.7  million  based on the  quoted  market  price for such
     warrants.

18.  SUBSEQUENT EVENTS

     On March 25, 1997, the Company agreed in principle to a merger  transaction
     pursuant to which the Company  would become a  wholly-owned  subsidiary  of
     Checkers Drive-In Restaurants,  Inc., a Delaware corporation  ("Checkers").
     Checkers, together with its franchisees,  operates approximately 478 double
     drive-thru  hamburger  restaurants  primarily  located in the  Southeastern
     United  States.  Under the terms of the  letter of intent  executed  by the
     Company and  Checkers,  each share of the  Company's  Common  Stock will be
     converted into three shares of Checker's common stock upon  consummation of
     the  merger.  The  transaction  is subject  to  negotiation  of  definitive
     agreements,  receipt  of  fairness  opinions  by  each  party,  receipt  of
     stockholder and other required approvals and other customary conditions.

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<PAGE>




                    Report of Independent Public Accountants




To Rally's Hamburgers, Inc.:

     We have audited the  accompanying  consolidated  balance  sheets of Rally's
Hamburgers,  Inc. (a Delaware  corporation)  and subsidiaries as of December 31,
1995  and  December  29,  1996,  and  the  related  consolidated  statements  of
operations,  shareholders'  equity and cash  flows for each of the three  fiscal
years in the period  ended  December  29,  1996.  These  consolidated  financial
statements  and the  schedule  referred to below are the  responsibility  of the
Company's  management.  Our  responsibility  is to  express  an opinion on these
consolidated financial statements and schedule based on our audits.

     We conducted  our audits in accordance  with  generally  accepted  auditing
standards.  Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement.  An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements.  An audit also includes
assessing the  accounting  principles  used and  significant  estimates  made by
management,  as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

     In our opinion,  the financial statements referred to above present fairly,
in all material respects, the financial position of Rally's Hamburgers, Inc. and
subsidiaries  as of December 31, 1995 and December 29, 1996,  and the results of
their  operations and their cash flows for each of the three fiscal years in the
period ended December 29, 1996, in conformity with generally accepted accounting
principles.

     Our audit was made for the  purpose  of  forming  an  opinion  on the basic
financial statements taken as a whole.  Schedule II is presented for purposes of
complying with the Securities and Exchange Commission's rules and is not part of
the basic financial statements. This schedule has been subjected to the auditing
procedures  applied in the audit of the basic  financial  statements and, in our
opinion,  fairly states in all material  respects the financial data required to
be set forth therein in relation to the basic  financial  statements  taken as a
whole.



                                                             ARTHUR ANDERSEN LLP

Louisville, Kentucky
February 12, 1997 (except with respect to the matter discussed in Note 18, as to
which the dates are March 25, 1997, and September 22, 1997, respectively).

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<PAGE>


                                   SIGNATURES

     Pursuant  to the  requirements  of  Section  13 or 15(d) 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:  January 22, 1998

                              By:             /s/ Joseph Stein
                                --------------------------------------
                                                  Joseph Stein
                                                  Chief Financial Officer


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