Back to GetFilings.com

Table of Contents

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

For the quarterly period ended September 27, 2003

For the transition period from                           to                          

Commission file number 1-12104

BACK YARD BURGERS, INC.

1657 Shelby Oaks Dr. N. Ste. 105, Memphis, Tennessee 38134
(Address of principal executive offices)

(901) 367-0888
(Registrant’s telephone number)

Check whether the registrant (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes [X] No [  ]

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes [  ] No [X]

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

Class - Common stock, par value $.01 per share

Outstanding at October 31, 2003 – 4,739,316

Table of Contents

BACK YARD BURGERS, INC.

INDEX

2

Table of Contents

Back Yard Burgers, Inc.
Consolidated Balance Sheets (Unaudited)
(in thousands, except for share and per share amounts)

See accompanying notes to unaudited financial statements

3

Table of Contents

Back Yard Burgers, Inc.
Consolidated Statements of Income (Unaudited)
(in thousands, except per share amounts)

See accompanying notes to unaudited financial statements

4

Table of Contents

Back Yard Burgers, Inc.
Consolidated Statements of Cash Flows (Unaudited)
(in thousands)

See accompanying notes to unaudited financial statements

5

Table of Contents

BACK YARD BURGERS, INC.
NOTES TO UNAUDITED FINANCIAL STATEMENTS

NOTE 1 - BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Back Yard Burgers, Inc. owns and operates quick-service and fast-casual restaurants and is engaged in the sale of franchises and the collection of royalties based upon related franchise sales. The company grants franchise rights for the use of “Back Yard Burgers,” “BYB” or “BY Burgers” trade names and other associated trademarks, signs, emblems, logos, slogans and service marks which have been or may be developed.

     The accompanying unaudited financial statements have been prepared in accordance with the instructions to Form 10-Q and therefore do not include all information and notes necessary for a fair presentation of financial position, results of operations and cash flows in conformity with generally accepted accounting principles. The statements do reflect all adjustments (consisting of only normal recurring adjustments) which are, in the opinion of management, necessary to present fairly the financial position and results of operations and cash flows in conformity with generally accepted accounting principles. The statements should be read in conjunction with the Notes to Financial Statements for the year ended December 28, 2002 included in the company’s 2002 Annual Report.

     The financial statements include the accounts of Back Yard Burgers, Inc. and its wholly-owned subsidiaries, Little Rock Back Yard Burgers, Inc., Atlanta Burgers BYB Corporation and BYB Properties, Inc., as well as the Back Yard Burgers National Advertising Fund. All significant intercompany transactions have been eliminated.

     The results of operations for the current thirteen and thirty-nine week periods are not necessarily indicative of the results to be expected for the full year.

     The company maintains its financial records on a 52-53 week fiscal year ending on the Saturday closest to December 31.

     Other Revenue. Other revenue is primarily comprised of sales of proprietary food products to franchisees, volume based incentive receipts under long-term contracts with vendors entered into before December 29, 2002 and contributions to the National Advertising Fund by certain of our vendors based upon purchasing volumes of the Company and our franchisees. Revenue from sales of proprietary food products is recognized when the products are shipped. Volume based revenue and contributions from our vendors are recognized systematically throughout the accounting period based on the estimated annual volume to be achieved under the agreements.

     Preopening costs. The company expenses preopening costs as incurred. Preopening costs expensed for the thirty-nine weeks ended September 27, 2003, and September 28, 2002, were approximately $63,000 and $50,000, respectively.

NOTE 2 - STOCK-BASED EMPLOYEE COMPENSATION

     The company applies Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations in accounting for its plans. Accordingly, no compensation expense has been recognized for its stock-based compensation. Had compensation cost for the company’s stock option plan been determined based on the fair value at the grant date for awards in the quarters ended September 27, 2003, and September 28, 2002, under the plan consistent with the fair value method prescribed by SFAS No. 123, Accounting for Stock-Based Compensation, the company’s operating results for the quarters ended September 27, 2003, and September 28, 2002 would have been reduced to the pro forma amounts indicated below (in thousands, except per share data):

6

Table of Contents

     The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model.

NOTE 3 - RECENTLY ISSUED ACCOUNTING STANDARDS

     Statement of Financial Accounting Standards (“SFAS”) No. 143, “Accounting for Asset Retirement Obligations,” was issued in June 2001. SFAS No. 143 addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. The company adopted SFAS No. 143 on December 29, 2002, with no material impact on the company’s consolidated financial position or results of operations.

     In April 2002, the FASB issued SFAS No. 145, “Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections” (“SFAS 145”). SFAS 145 rescinds SFAS No. 4, “Reporting Gains and Losses from Extinguishment of Debt,” requiring that gains and losses from the extinguishment of debt be classified as extraordinary items only if certain criteria are met. SFAS 145 also amends SFAS No. 13, “Accounting for Leases,” and the required accounting for sale-leaseback transactions and certain lease modifications that have economic effects that are similar to sale-leaseback transactions. The company adopted SFAS 145 on December 29, 2002, with no material impact on the company’s consolidated financial position or results of operations.

     In July 2002, the FASB issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities” (“SFAS 146”). SFAS 146 requires that a liability for a cost associated with an exit or disposal activity be recognized initially at fair value when the liability is incurred. The company adopted SFAS 146 on December 29, 2002, with no material impact on the company’s consolidated financial position or results of operations.

     SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure, an Amendment of FASB Statement No. 123,” was issued in December 2002. The Statement amends FASB No. 123, “Accounting for Stock-Based Compensation,” to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, this Statement amends the disclosure requirements of Statement No. 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The company has adopted FASB No. 148, however, implementation did not have a material effect on its results of operations or financial position.

7

Table of Contents

     FASB Interpretation No. 45 (“FIN 45”), “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others,” was issued in November 2002. This Interpretation elaborates on the disclosures to be made by a guarantor in its interim and annual financial statements about its obligations under certain guarantees that it has issued. It also clarifies that a guarantor is required to recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee. The initial recognition and initial measurement provisions of this Interpretation are applicable on a prospective basis to guarantees issued or modified after December 31, 2002. The Company adopted FIN 45 on December 31, 2002 and such adoption did not have a material effect on its results of operations or financial position.

     In January 2003, the Financial Accounting Standards Board issued Interpretation No. 46 (“FIN 46”), “Consolidation of Variable Interest Entities (“VIEs”), an interpretation of Accounting Research Bulletin No. 51, “Consolidated Financial Statements,” to improve financial reporting of special purpose and other entities. In accordance with the interpretation, business enterprises that represent the primary beneficiary of another entity by retaining a controlling financial interest in that entity’s assets, liabilities, and results of operating activities must consolidate the entity in their financial statements. Prior to the issuance of FIN 46, consolidation generally occurred when an enterprise controlled another entity through voting interests. Certain VIEs that are qualifying special purpose entities (“QSPEs”) subject to the reporting requirements of SFAS 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities,” will not be required to be consolidated under the provisions of FIN 46. The consolidation provisions of FIN 46 apply to VIEs created or entered into after January 31, 2003, and for pre-existing VIEs in the first reporting period ending after December 15, 2003. If applicable, transition rules allow the restatement of financial statements or prospective application with a cumulative effect adjustment. In addition, FIN 46 expands the disclosure requirements for the beneficiary of a significant or a majority of the variable interests to provide information regarding the nature, purpose and financial characteristics of the entities. Management has not completed their analysis of the adoption of FIN 46 and its impact on the company’s financial statements as of the date of this filing.

     The Company adopted EITF 02-16 Accounting by a Customer (Including a Reseller) for Certain Consideration Received from a Vendor effective December 29, 2002. EITF 02-16 concluded that cash consideration received by a customer from a vendor is presumed to be a reduction of the prices of the vendor’s products or services and should, therefore, be characterized as a reduction of cost of sales when recognized in the customer’s income statement. The Company previously recorded volume-based incentives as other revenues. The Company will record volume-based incentives related to company operated stores as a reduction of cost of restaurant sales for all contracts or agreements entered into after December 28, 2002. Volume-based incentives reclassified from other revenues into cost of sales for the quarters ended September 27, 2003 and September 28, 2002, were not material to the consolidated statements of operations and had no impact on net income.

8

Table of Contents

NOTE 4 - NET INCOME PER SHARE

The company calculates earnings per share in accordance with Statement of Financial Accounting Standards No. 128, Earnings per Share, which requires the presentation of basic and diluted earnings per share. Basic earnings per share excludes dilution and is computed by dividing income available to common stockholders by the weighted-average number of common shares outstanding for the period. Diluted earnings per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the entity.

COMPUTATION OF INCOME PER SHARE
(in thousands, except per share amounts)
(unaudited)

The calculation of diluted income per share for the thirteen weeks ended September 27, 2003, and September 28, 2002 excluded 31,056 and 20,000 stock options, respectively, as their effect would be anti-dilutive. The calculation of diluted income per share for the thirty-nine weeks ended September 27, 2003 and September 28, 2002 excluded 51,730 and 13,055 stock options, respectively, as their effect would be anti-dilutive.

NOTE 5 - DEFERRED FRANCHISE AND AREA DEVELOPMENT FEES

Amounts received for certain franchise and area development rights, net of commissions paid, have been deferred. Revenues on individual franchise fees are recognized when substantially all of the initial services required of the company have been performed, which generally coincides with the opening of the franchises. Under the terms of the franchise agreements, these fees are non-refundable, and may be recognized as income should the franchisee fail to perform as agreed. Area development fees are recognized on a pro-rata basis as each unit opens. At September 27, 2003, deferred fees include franchise and area development rights sold during the following years:

NOTE 6 - COMMITMENTS AND CONTINGENCIES

The company is party to several pending legal proceedings and claims. Although the outcome of the proceedings and claims cannot be determined with certainty, management of the company is of the opinion that it is unlikely that these proceedings and claims will have a material adverse effect on the financial condition or results of operations of the company.

9

Table of Contents

Forward-Looking Information

          Certain information included herein may contain statements that are forward-looking, such as statements related to financial items and results, plans for future expansion and other business development activities, capital spending or financing sources, capital structure and the effects of regulation and competition, as well as statements identified by words such as “may,” “will,” “expect,” “anticipate,” “believe,” “plan” and other similar terminology. Forward-looking statements made by the company are based upon estimates, projections, beliefs and assumptions of management at the time of such statements and should not be viewed as guarantees of future performance. Such forward-looking information involves important risks and uncertainties that could significantly impact anticipated results in the future and, accordingly, such results may differ materially from those expressed in any forward-looking statements by or on behalf of the company. These risks and uncertainties include, but are not limited to, increased competition and competitive discounting, the availability of qualified labor and desirable locations, increased costs for beef, chicken or other food products, the ongoing financial viability of our franchisees, our ability to secure distribution of products and equipment to restaurants on favorable economic terms and the effectiveness of promotional efforts and management decisions related to restaurant growth, financing, franchising and new product development, as well as items described under “Management’s Discussion and Analysis of Financial Condition and Results of Operations” below. The company undertakes no obligation to publicly update or revise any forward looking statements, whether as a result of new information, future events or otherwise.

          Item 2 Management’s Discussion and Analysis of Financial Condition and Results of Operations

Introduction

          As of September 27, 2003, the Back Yard Burgers system included 129 restaurants, of which 42 were company-operated and 87 were franchised. The company’s revenues are derived primarily from company-operated restaurant sales, franchise and area development fees and royalty fees. Certain expenses (cost of restaurant sales, restaurant operating expenses, depreciation and amortization and advertising) relate directly to company-operated restaurants, while general and administrative expenses relate to both company-operated restaurants and franchise operations. The company’s revenues and expenses are affected by the number and timing of the opening of additional restaurants. Sales for new restaurants in the period immediately following their opening tend to be high because of trial by public and promotional activities. As a result, the timing of openings can affect the average volume and other period-to-period comparisons.

Results of Operations

The following table sets forth the percentage relationship to total revenue, unless otherwise indicated, of certain items included in the company’s historical operations and operating data for the periods indicated.

10

Table of Contents

(1)		As a percentage of restaurant sales.
(2)		As a percentage of income before taxes.
(3)		Includes sales for restaurants open for entire trailing twelve-month period. Restaurants are included in the calculation after the completion of eighteen months of operation as sales during the six-month period immediately after the opening tend to be higher due to promotions and trial by public.

11

Table of Contents

Comparison of the Company’s Results for the Thirteen Weeks Ended September 27, 2003 and September 28, 2002.

     Restaurant sales increased 11.7% to $8,739,000 during the thirteen weeks ended September 27, 2003, from $7,823,000 for the year-earlier period. This increase is primarily the result of a net increase in company-operated restaurants of two stores, as well as an increase of 5.0% in same-store sales at restaurants open for more than one year.

     Franchise and area development fees decreased to $20,000 for the thirteen weeks ended September 27, 2003, from $81,000 in the year-earlier period. Two new franchise stores opened during the thirteen weeks ended September 27, 2003 compared with five franchised restaurant openings in the year-earlier period.

     Royalty fees increased 22.7% to $664,000 during the thirteen week period ended September 27, 2003, compared with $541,000 during the third quarter of 2002. The change is due to a net increase of fifteen franchised stores since September 28, 2002 resulting in increased franchised sales on which royalty fees are based. This increase was partially offset by a 3.8% decrease in same-store sales at franchised restaurants compared with the year-earlier period.

     Advertising fees increased 14.1% to $162,000 during the thirteen week period ended September 27, 2003, from $142,000 during the third quarter of 2002. The change is due to an increase in franchised restaurant sales, upon which a portion of the fees are based.

     Other revenues increased by $41,000 to $230,000 during the thirteen week period ended September 27, 2003, from $189,000 during the third quarter of 2002. The increase in other revenues is due to higher volume rebates from vendors, sales of proprietary spices to franchisees, and other miscellaneous revenues.

     Cost of restaurant sales, consisting of food and paper costs, totaled $2,912,000 for the thirteen weeks ended September 27, 2003, and $2,390,000 during the same period in 2002, increasing as a percentage of restaurant sales to 33.3% from 30.6%. The increase in costs as a percentage of sales is primarily due to an 18% increase in the cost of beef over the prior year, as well as additional costs associated with implementing new menu items and promotions offering certain sandwich items at a discounted price in efforts to increase guest traffic and sales at company-operated restaurants.

     Restaurant operating expenses, consisting of labor, supplies, utilities, maintenance, rent and certain other unit level operating expenses, increased to $4,300,000 for the thirteen weeks ended September 27, 2003, from $3,730,000 in the same prior year period, increasing as a percentage of restaurant sales to 49.2%, from 47.7% for the year-earlier period. Labor costs increased by 0.8% primarily due to the implementation of a late-night operations program, requiring an additional investment in labor at the stores. Labor benefit costs have also risen due to increases in health insurance costs. The remainder of the increase is due to higher spending for repairs and maintenance, utilities, insurance and property taxes.

     General and administrative costs which increased $49,000 to $1,096,000 for the thirteen weeks ended September 27, 2003 from $1,047,000 in the year-earlier period, decreased as a percentage of total revenue for the thirteen weeks ended September 27, 2003, to 11.2% from 11.9% in the year-earlier period. The increase was primarily due to a $42,000 increase in pre-opening costs from the year-earlier period. Other areas of increased spending included personnel costs, travel and franchise recruiting. These increases were offset by a reduction in spending for new product testing and development.

     Advertising expense which increased to $604,000 for the thirteen weeks ended September 27, 2003, from $499,000 in the same period in 2002, increased as a percentage of total revenues to 6.2% from 5.7% in the year-earlier period.

     Depreciation and amortization expense increased 23.4% to $448,000 for the thirteen weeks ended September 27, 2003, from $363,000 in the same period in 2002 due primarily to the addition of approximately $4.2 million in fixed assets since September 28, 2002.

12

Table of Contents

     Interest expense decreased 6.8% to $124,000 for the thirteen weeks ended September 27, 2003, from $133,000 in the year-earlier period. Since September 28, 2002, debt decreased by $518,000, or 8.5%, to $5,567,000 as of September 27, 2003.

     Other, net expense was $21,000 for the thirteen weeks ended September 27, 2003, compared with a net expense of $15,000 in the prior year. The change is primarily due to a $5,000 increase in franchise and excise taxes over the year-earlier period. Also included in this category is other miscellaneous income and expenses, and these income and expense categories were relatively consistent during the thirteen weeks ended September 27, 2003, and the year-earlier period.

13

Table of Contents

Comparison of the Company’s Results for the Thirty-Nine Weeks Ended September 27, 2003 and September 28, 2002.

     Restaurant sales increased 7.6% to $25,186,000 during the thirty-nine weeks ended September 27, 2003, from $23,413,000 for the year-earlier period. This increase is primarily the result of a net increase in company-operated restaurants of two stores.

     Franchise and area development fees increased to $185,000 for the thirty-nine weeks ended September 27, 2003, from $125,000 in the year-earlier period. Fourteen new franchise stores opened during the thirty-nine weeks ended September 27, 2003 compared with ten openings in the year-earlier period.

     Royalty fees increased 17.9% to $1,914,000 during the thirty-nine week period ended September 27, 2003 from $1,623,000 during the year-earlier period. The change is due to a net increase of fifteen franchised stores since September 28, 2002 resulting in increased franchised sales on which royalty fees are based. This increase was partially offset by a 5.6% decrease in same-store sales at franchised restaurants compared with the year-earlier period.

     Advertising fees increased 16.5% to $474,000 during the thirty-nine week period ended September 27, 2003, from $407,000 during the year-earlier period. The change is due to an increase in franchised restaurant sales, upon which a portion of the fees are based.

     Other revenues increased by $235,000 to $818,000 during the thirty-nine week period ended September 27, 2003, from $583,000 in the same period of 2002. The increase in other revenues is due to higher volume rebates from vendors, sales of proprietary spices to franchisees, and other miscellaneous revenues.

     Cost of restaurant sales, consisting of food and paper costs, totaled $8,269,000 for the thirty-nine weeks ended September 27, 2003, and $7,269,000 during the same period in 2002, increasing as a percentage of restaurant sales to 32.8% from 31.0%. The increase in costs as a percentage of sales is primarily due to a 6% increase in the cost of beef over the prior year, as well as additional costs associated with implementing new menu items and promotions offering certain sandwich items at a discounted price in efforts to increase guest traffic and sales at company-operated restaurants.

     Restaurant operating expenses, consisting of labor, supplies, utilities, maintenance, rent and certain other unit level operating expenses, increased to $12,131,000 for the thirty-nine weeks ended September 27, 2003, from $10,946,000 in the same prior year period, increasing as a percentage of restaurant sales to 48.2%, from 46.8% for the year-earlier period. Labor costs increased by 0.4% primarily due to the implementation of a late-night operations program during the second quarter of 2003, requiring an additional investment in labor at the stores. Labor benefit costs have also risen due to increases in health insurance costs. The remainder of the increase resulted from increased spending for repairs and maintenance, utilities, insurance and property taxes.

     General and administrative costs which increased $226,000 to $3,379,000 for the thirty-nine weeks ended September 27, 2003 from $3,153,000 in the year-earlier period, decreased as a percentage of total revenue for the thirty-nine weeks ended September 27, 2003, to 11.8% from 12.1% in the same period in 2002. The increase was primarily due to a $182,000 increase in personnel costs, including increased spending on recruiting, training and benefit costs. Other areas of increased spending included pre-opening costs, professional services, travel for franchisee support and recruiting, operations training, insurance and other miscellaneous costs.

     Advertising expense which increased to $1,680,000 for the thirty-nine weeks ended September 27, 2003, from $1,484,000 in the same period in 2002, increased as a percentage of total revenues to 5.9% from 5.7% in the year-earlier period.

14

Table of Contents

     Depreciation and amortization expense increased 29.0% to $1,333,000 for the thirty-nine weeks ended September 27, 2003, from $1,033,000 in the same period in 2002 due primarily to the addition of approximately $4.2 million in fixed assets since September 28, 2002.

     Interest expense decreased 1.6% to $376,000 for the thirty-nine weeks ended September 27, 2003, from $382,000 in the year-earlier period. Since September 28, 2002, debt decreased by $518,000, or 8.5%, to $5,567,000 as of September 27, 2003.

     Other, net expense decreased to $49,000 for the thirty-nine weeks ended September 27, 2003, from $80,000 in the year-earlier period. The company recorded a $17,000 loss on the disposal of assets and $23,000 in deferred loan costs during 2002 for which there were no comparable costs during 2003. Franchise tax expense increased by $12,000 for the thirty-nine weeks ended September 27, 2003 over the year-earlier period. Also included in this category is other miscellaneous income and expenses and these income and expense categories were relatively consistent during thirty-nine weeks ended September 27, 2003, and the year-earlier period.

Impairment of Long-Lived Assets

     The company adopted Statement of Financial Accounting Standard (“SFAS”) No. 144, Accounting for the Impairment and Disposal of Long-Lived Assets, at the beginning of 2002. At each balance sheet date, the company assesses whether there has been impairment in the value of all long-lived assets by determining whether projected undiscounted future cash flows from operations for each restaurant, as defined in SFAS No. 144, exceed its net book value as of the assessment date. A new cost basis is established for impaired assets based on the fair value of these assets as of the date the assets are determined to be impaired.

     No impairment charges were recorded during the thirty-nine weeks ended September 27, 2003, or the thirty-nine weeks ended September 28, 2002; however, in the past, the company incurred non-cash charges for the effect of company-operated restaurant closings and impaired assets at company-operated restaurants. Also, related accruals for future lease payments of closed stores, net of estimated sub-lease income, were previously recorded.

     During the thirty-nine weeks ended September 27, 2003, $26,000 of lease obligation payments were incurred for closed stores and charged against this reserve. As of September 27, 2003, the company’s remaining accrual for all future lease obligations discussed above was $35,000 for the remaining lease payments due, net of estimated sub-lease income.

Liquidity and Capital Resources

     Capital expenditures totaled $2,712,000 for the thirty-nine weeks ended September 27, 2003 and $3,334,000 for the year-earlier period. Generally, the company constructs its restaurant buildings on leased properties for company-operated restaurants. The average monthly lease cost for the 14 company-operated restaurants on leased sites at September 27, 2003 is approximately $3,380 per month. For the 18 restaurants where the company leases the building as well as the site, the average monthly lease cost is approximately $5,300.

     Cash from operations for the company is primarily affected by net earnings adjusted for deferred franchise fees and non-cash expenses which consist primarily of depreciation and amortization. Depreciation and amortization totaled $1,333,000 for the thirty-nine weeks ended September 27, 2003 and $1,033,000 for the year-earlier period.

     Cash provided by operations for the thirty-nine week period ended September 27, 2003, was $2,741,000 compared with $2,607,000 in the year-earlier period. In recent history, cash from operations and debt have been used for the addition of new restaurants and equipment as well as the re-imaging of existing restaurants to reflect the company’s new logo and related color scheme.

15

Table of Contents

     As of September 27, 2003, the company had total long-term debt of $5,567,000 and unused lines of credit and loan commitments of potential additional borrowings of $3,376,000. On February 11, 2003, the company entered a loan agreement with a financial institution in the amount of $5,000,000. The loan agreement comprised the following three components: (1) a $2,500,000 five-year loan with a fixed rate of 5.2%. The funds from the five-year term loan were used to refinance approximately $2.3 million of existing term loans with an average interest rate of 6.8% and maturity dates ranging from one to two years, (2) a $2.0 million draw down line for future expansion with a variable rate of interest equal to the one month LIBOR rate plus a spread not to exceed 3% that is calculated based on certain financial covenants and (3) a $500,000 revolver line with a variable rate of interest equal to the one month LIBOR rate plus a spread not to exceed 3% that is calculated based on certain financial covenants. This revolver line replaced the $750,000 line of credit that was in place as of December 28, 2002. No additional long-term debt commitments were made by the company during the thirty-nine weeks ended September 27, 2003.

     On January 2, 2001, the company’s board of directors adopted a stock repurchase plan that allows the company to repurchase up to 500,000 shares of its outstanding common stock. As of September 27, 2003, the company had repurchased 25,000 shares of common stock under the plan. No further purchases are anticipated in the near term.

     The company has budgeted capital expenditures of approximately $3.5 million in fiscal year 2003, excluding potential acquisitions and share repurchases. These capital expenditures primarily relate to the development of additional company-operated restaurants, the re-imaging of existing restaurants to reflect the company’s new logo and related color scheme, store equipment upgrades, and enhancements to existing financial and operating information systems. As of September 27, 2003, the company had spent $2,712,000 of these budgeted capital expenditures. The company expects to fund these capital expenditures through cash flow from operations and borrowings under the new loan agreement entered in February of 2003.

Seasonality and Inflation

     While the company does not believe that seasonality affects its operations in a materially adverse manner, first quarter results are generally lower than other quarters due to seasonal climate conditions in the locations of many of its restaurants. Although results were negatively impacted during the third quarter of 2003 due to an 18% increase in the cost of beef, management does not believe that inflation has had a material effect on income during the thirty-nine weeks ended September 27, 2003. Increases in food, labor or other operating costs could adversely affect the company’s operations. In the past, however, the company generally has been able to increase menu prices or modify its operating procedures to substantially offset increases in its operating costs.

Conversion of Preferred Stock

     In accordance with the provisions of the company’s Certificate of Incorporation regarding preferred stock, as a result of the company’s having attained after tax net income in excess of $600,000 during 1994, each share of preferred stock is convertible into one share of common stock, at the option of the holder. The company notified preferred stockholders of their right to convert preferred stock to common stock, and anticipates that all shares of preferred stock will eventually be converted. Such conversion began on April 5, 1995, at which time there were 1,199,979 shares of preferred stock outstanding. As of September 27, 2003, only 19,617 shares have yet to be converted.

Recently Issued Accounting Standards

     Note 3 of the Notes to Unaudited Financial Statements discusses new accounting policies adopted by the Company during 2003 and the expected impact of accounting policies recently issued or proposed but not yet required to be adopted. To the extent the adoption of new accounting standards affects the Company’s financial condition, results of operations or liquidity, the impacts are discussed in the applicable section(s) of the Management’s Discussion and Analysis and the Notes to Unaudited Financial Statements.

16

Table of Contents

Known Trends and Uncertainties

     Labor will continue to be a critical factor for the company in the foreseeable future. In most areas where the company operates restaurants, there is a shortage of suitable labor. This, in itself, could result in higher wages as the competition for employees intensifies, not only in the restaurant industry, but in practically all retail and service industries. It is crucial for the company to develop and maintain programs to attract and retain quality employees.

     During the thirteen weeks ended September 27, 2003, the cost of beef increased approximately 18.0% over the prior year while the cost of chicken was relatively stable. In light of what appears to be a sustained period of increased beef costs, the company implemented menu price increases of approximately 2% effective October 12, 2003 in order to partially offset these increased costs. It will be difficult to raise menu prices to fully cover these or any future cost increases. Additional margin improvements will have to be made through operational improvements, equipment advances and increased volumes to help offset these increases, due to the competitive state of the quick-service restaurant industry.

     Due to the competitive nature of the restaurant industry, site selection continues to be challenging as the number of businesses vying for locations with similar characteristics increases. This will likely result in higher occupancy costs for prime locations.

     Franchised same-store sales decreased 5.6% and company-operated same-store sales increased 0.1% during the thirty-nine weeks ended September 27, 2003. Management attributes the decline in same-store sales for franchised locations to several factors, including a weak overall economy, competitive discounting and inclement weather in key markets. The impact of these factors on company-operated same-store sales were offset by certain initiatives undertaken by management during 2003, including the re-imaging of existing company-operated restaurants to reflect the company’s new logo and related color scheme, promotional incentives intended to increase traffic and sales and the testing of a late-night operations program at company-operated restaurants.

     During the second quarter of 2003, the company began testing a late-night operations program during which operations at company-operated restaurants were extended by three business hours. Management believes the implementation of a late-night operations program had a positive impact on sales in the second and third quarters of 2003 and should continue to do so in future periods. However, due primarily to the additional investment in labor at the stores, the implementation of the program had a negative impact on profitability in the second and third quarters of 2003, and management expects this trend will continue over the short term. The implementation of such a program takes time to communicate to the general public and to generate incremental sales adequate to offset the incremental costs. The company is currently communicating its new hours of operations at its stores with point-of-purchase material and in radio and television advertisements.

     Management intends to continue with its marketing strategy of enhancing the company’s points of differentiation and further positioning the company as a premium fast-food provider.

     The future success of the company will be determined, to a great extent, by its ability to positively address these issues.

Critical Accounting Policies and Estimates

     Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities.

     On an on-going basis, management evaluates company estimates, including those related to bad debts, carrying value of investments in property and equipment, goodwill, income taxes, contingencies and litigation. Management bases company estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

     Management believes the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements.

17

Table of Contents

Revenue Recognition:

     Revenue recognition at Company-operated restaurants is straightforward as customers pay for products at the time of sale. The earnings reporting process is covered by the company’s system of internal controls and generally does not require significant management judgments and estimates. The company calculates royalty income each week based upon amounts reported by franchisees and provides for estimated losses for revenues that are not likely to be collected. The company maintains these allowances for doubtful accounts for estimated losses resulting from the inability of our franchisees and other borrowers to make required payments. If the financial conditions of our customers or other borrowers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required.

     Franchise fees are recognized as revenue when substantially all of the initial services required of the company have been performed, which generally coincides with the opening of the franchises. Such services include training and assistance with site location, equipment vendors, structural design and operating policies. Area development fees arise when franchisees are awarded the right to develop, own and operate additional Back Yard Burgers restaurants in specific geographical areas pursuant to the terms of an Area Development Agreement. Such fees are based on the number of restaurants the franchisee expects to develop. These fees are included as revenue in accordance with the franchise fee recognition policy as each additional restaurant is opened. Under the terms of the franchise and area development agreements, the fees are non-refundable and may be recognized as revenue should the franchisee fail to perform as agreed. Commission costs associated with the sales of franchise and area development rights are expensed when related revenues are recognized.

     Prior to December 29, 2002, the company collected funds from certain vendors relating to future purchases by the company. The company deferred this amount as other deferred income. These funds are recorded as income in a proportionate manner with respective future purchases. Under the terms of signed contracts, the company is required to purchase specific volumes in future years. If these purchase volumes are not met, funds related to the volume shortages will be refunded to the vendors.

Long-Lived Assets:

     The restaurant industry is capital intensive. The company has approximately 80% of its total assets invested in property and equipment. The company capitalizes only those costs that meet the definition of capital assets under generally accepted accounting principles. Accordingly, repairs and maintenance costs that do not extend the useful life of the asset are expensed as incurred.

     The depreciation of our capital assets over their estimated useful lives, and the determination of any salvage values, requires management to make judgments about future events. Because the company utilizes many of its capital assets over relatively long periods, the company periodically evaluates whether adjustments to our estimated lives or salvage values are necessary. The accuracy of these estimates affects the amount of depreciation expense recognized in a period and, ultimately, the gain or loss on the disposal of the asset. Historically, gains and losses on the disposition of assets have not been significant. However, such amounts may differ materially in the future based on restaurant performance, technological obsolescence, regulatory requirements and other factors beyond our control.

     Due to the fact that the company invests a significant amount in the construction or acquisition of new restaurants, the company has risks that these assets will not provide an acceptable return on our investment and an impairment of these assets may occur. The accounting test for whether an asset held for use is impaired involves first comparing the carrying value of the asset with its estimated future undiscounted cash flows. If these cash flows do not exceed the carrying value, the asset must be adjusted to its current fair value. The company periodically performs this test on each of our restaurants to evaluate whether impairment exists. Factors influencing our judgment include the age of the restaurant (new restaurants have significant start up costs which impede a reliable measure of cash flow), estimation of future restaurant performance and estimation of restaurant fair value. Due to the fact that the management can specifically evaluate impairment on a restaurant by restaurant basis, the company has historically been able to identify impaired restaurants and record the appropriate adjustment.

18

Table of Contents

     The company has approximately $1.8 million of goodwill on its balance sheet resulting from the acquisition of businesses. New accounting standards adopted in 2002 require that we review goodwill for impairment on an annual basis and cease all goodwill amortization. The adoption of these new rules did not result in an impairment of our recorded goodwill. The annual evaluation of goodwill impairment requires a two-step test in which the market value of the company is compared to the recorded book value. If the market value is less than the book value, goodwill impairment is recorded. Once an impairment of goodwill has been recorded, it cannot be reversed.

Deferred Income Taxes:

     The company records income tax liabilities utilizing known obligations and estimates of potential obligations. A deferred tax asset or liability is recognized whenever there are future tax effects from existing temporary differences and operating loss and tax credit carryforwards. The company records a valuation allowance to reduce deferred tax assets to the balance that is more likely than not to be realized. In evaluating the need for a valuation allowance, management must make judgments and estimates on future taxable income, feasible tax planning strategies and existing facts and circumstances. When management determines that deferred tax assets could be realized in greater or less amounts than recorded, the asset balance and income statement reflect the change in the period such determination is made. Based on management’s estimates, there is presently a $455,000 valuation allowance recorded on the company’s deferred tax assets. However, changes in facts and circumstances that affect our judgments or estimates in determining the proper deferred tax assets or liabilities could materially affect the recorded amounts.

19

Table of Contents

Item 3 Quantitative and Qualitative Disclosures About Market Risk

Interest Rate Risk

     The company is exposed to certain financial market risks, the most predominant being fluctuations in interest rates on variable rate debt and the repricing of fixed rate debt at maturity. Management monitors interest rate fluctuations as an integral part of the company’s overall risk management program, which recognizes the unpredictability of financial markets and seeks to reduce the potential adverse effect of our results. The effect of interest rate fluctuations historically has been small relative to other factors affecting operating results, such as food, labor and occupancy costs.

     Less than 25% of the company’s debt portfolio as of September 27, 2003, had variable rates or had maturity dates of less than two years. With every 25 basis point increase in interest rates, the company could be subject to additional interest expense of approximately $4,000 annually, depending on the timing of the rate changes and debt maturities.

     The company has considered the use of hedging instruments to minimize interest rate fluctuation risk, but based on the debt portfolio structure described above, no hedging tool has been deemed necessary for the company at this time.

Commodity Price Risk

     We are subject to volatility in food costs as a result of market risk associated with commodity prices. Our ability to recover increased costs through higher pricing is, at times, limited by the competitive environment in which we operate. We manage our exposure to this risk primarily through pricing agreements on certain products; however, the cost the company pays for beef fluctuates weekly based on beef commodity prices. The company does not currently manage this risk with commodity future and option contracts.

Item 4. Disclosure Controls

     We have carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer (the “CEO”) and our Chief Financial Officer (the “CFO”), of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Act”)) as of the end of the fiscal quarter covered by this report. Based upon that evaluation, our CEO and CFO concluded that our disclosure controls and procedures are effective in providing reasonable assurance that (a) the information required to be disclosed by us in the reports that we file or submit under the Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and (b) such information is accumulated and communicated to our management, including our CEO and CFO, as appropriate to allow timely decisions regarding required disclosure.

     There have been no changes in our internal control over financial reporting during the fiscal quarter covered by this report that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

20

Table of Contents

Part II                      OTHER INFORMATION

     Item 1 Legal Proceedings

     The company is involved in litigation incidental to its business, including, but not necessarily limited to, claims alleging violations of federal and state discrimination laws. Such litigation is not presently considered by management to be material to the financial condition or results of operations of the company.

     Item 2 Changes in Securities and Use of Proceeds

None

     Item 3 Defaults Upon Senior Securities

Not Applicable

     Item 4 Submission of Matters to a Vote of Security Holders

None

     Item 5 Other Information

None

     Item 6 Exhibits and Reports on Form 8-K

Exhibits

Reports on Form 8-K

Third quarter 2003 earnings release issued on October 21, 2003.

21

Table of Contents

SIGNATURES

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

BACK YARD BURGERS, INC.

22