UNITED STATES SECURITIES AND EXCHANGE COMMISSION

FORM 10-K

(Mark One)

[X]	Annual report under Section 13 or 15(d) of the Securities Exchange Act of 1934

FOR THE FISCAL YEAR ENDED JANUARY 3, 2004
or

[   ]	Transition report under Section 13 or 15(d) of the Securities Exchange Act of 1934

Commission file number 1-12104

BACK YARD BURGERS, INC.

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

Securities registered pursuant to Section 12(b) of the Securities Exchange Act of 1934:

Securities registered pursuant to Section 12(g) of the Securities Exchange Act of 1934:

     Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [ü] No [  ].

     Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or in information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ü]

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

     The aggregate market value of common stock held by non-affiliates on March 16, 2004 was approximately $24,970,000.

     The number of shares outstanding of the registrant’s common stock as of March 16, 2004 was 4,766,881.

     Certain portions of Part II are incorporated by reference from the registrant’s annual report to stockholders for the year ended January 3, 2004 and certain portions of Part III are incorporated by reference from the registrant’s proxy statement relating to the annual meeting of stockholders to be held on May 20, 2004.

FORWARD-LOOKING STATEMENTS: This Form 10-K, the documents that we incorporate by reference, and other written reports and oral statements made from time to time by us and our representatives contain “forward-looking statements” within the meaning of the federal securities laws. These statements, which are not statements of historical fact, may contain estimates, assumptions, projections and/or expectations regarding our financial position, results of operations, growth strategy and plans for future expansion, product development, economic conditions, and other similar forecasts and statements of expectation. We generally indicate these statements by words or phrases such as “anticipate,” “estimate,” “plan,” “expect,” “believe,” “intend,” “foresee,” and similar words or phrases. Forward-looking statements 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. The factors that could cause our actual results to differ materially, many of which are beyond our control, include, but are not limited to, the following: delays in opening new stores or outlets because of weather, local permitting, and the availability and cost of land and construction; increases in competition and competitive discounting; increases in minimum wage and other operating costs; shortages in raw food products; volatility of commodity prices; consumer preferences, spending patterns and demographic trends; the possibility of unforeseen events affecting the industry generally, and other risks described from time to time in our periodic reports filed with the Securities and Exchange Commission. Back Yard Burgers, Inc. disclaims any obligation to update or revise any forward-looking statement based on the occurrence of future events, the receipt of new information, or otherwise.

PART I

ITEM 1. BUSINESS

General

     Back Yard Burgers operates and franchises quick-service restaurants in 17 states, primarily in markets throughout the Southeast region of the United States. Our restaurants specialize in charbroiled, freshly prepared, great tasting food. As our name implies, we strive to offer the same high-quality ingredients and special care typified by outdoor grilling in your own back yard. Our menu features made-to-order gourmet 100% Black Angus hamburgers and chicken sandwiches - charbroiled over an open flame, fresh salads, chili and other special entrees as well as hand-dipped milkshakes, fresh-made lemonade and fresh-baked cobblers. As of January 3, 2004, our operations included 42 company-operated restaurants and 90 franchised restaurants.

Corporate History

     The company was incorporated in December, 1986 as Back Yard Burgers, Inc., a Mississippi corporation, and opened its first restaurant in Cleveland, Mississippi in March 1987. The company was reorganized under the laws of the State of Delaware in January 1991. The company consummated its initial public offering on July 2, 1993 and its common stock has traded on the Nasdaq SmallCap Market since that time.

Operating Strategy

     Our restaurants are designed to project a back yard theme that emphasizes charbroiled, freshly prepared, great tasting food, including gourmet 100% Black Angus hamburgers, chicken sandwiches and other gourmet items as customers would prepare in their own back yard. Our operating strategy includes:

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serving premium quality, great tasting food comparable to that of the best full-service casual dining restaurants;

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utilizing restaurant designs featuring a single drive-thru concept integrated with an inviting indoor dining area, which projects a uniform image and creates pleasing curb appeal;

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providing fast and friendly service with emphasis on a positive customer experience;

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offering a diverse menu of freshly prepared food items that are competitive with the everyday prices of the three largest hamburger chains; and

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actively training, supervising and supporting franchised and company-operated restaurants.

Growth Strategy

     During 2004, we will continue to focus on opening new company-operated and franchised restaurants and increasing same-store sales. Our growth strategy is to continue to:

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set our restaurants apart from fast-food competition by serving premium fast food, enhancing our dine-in facilities and re-imaging existing facilities with the company’s new logo and color schemes so that the design and feel of our restaurants will match the standards set by the quality of the food;

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improve the work flow of existing units to improve productivity and throughput;

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develop additional company-operated restaurants in existing markets and fund such development with cash flow from operations and additional debt or equity financing where warranted. We expect to open approximately three company-operated restaurants in 2004;

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develop additional franchised restaurants with a committed and experienced group of franchisees. We expect that approximately 30 franchised restaurants will open in 2004; and

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develop additional franchised restaurants by seeking to expand our relationship with YUM! Brands, Inc.

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Restaurant Operations

     Restaurant Locations. The following tables set forth the number of restaurants located in each market of the company’s system at January 3, 2004.

     ⁽¹⁾ The “Other Markets” portion of the table reflects the total number of restaurants located in such markets by state. Other markets for the restaurants range from small towns to large cities where franchisees have only one restaurant.

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     The following table sets forth information as to the sales of both company-operated and franchised restaurants in operation for the periods indicated (in thousands). Because the company’s fiscal year ends on the Saturday closest to December 31, the fiscal year ended January 3, 2004 contains 53 weeks, while the fiscal year ended December 28, 2002 contains 52 weeks.

     Restaurant Openings and Closings. The following table presents an activity summary of the company-operated and franchised restaurants during the periods presented.

(a)

As of March 16, 2004, four franchised restaurants opened since January 3, 2004, one each in Alabama, Florida, Indiana and Oklahoma and two franchised restaurants closed, one each in Mississippi and Texas.

     Site Selection. The company believes that the location of a restaurant is critical to its success. Management inspects each potential restaurant site prior to final selection of the site. In evaluating particular sites, the company considers various criteria including traffic count, speed of traffic, convenient access, size and configuration, demographics and density of population, visibility and cost. The company also reviews potential competition and the sales and traffic counts of national and regional chain restaurants operating in the area. A majority of both company-operated and franchised restaurants are located on leased land.

     Restaurant Design and Service. Restaurants with a single drive-thru and indoor dining are built to company-approved specifications. There are some existing double drive-thru restaurants without indoor dining; however, the additional development of this facility type has been discontinued.

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     In some circumstances, restaurants may be constructed via the conversion of buildings used previously by other concepts, including other restaurants. The restaurants range in size from 820 square feet to 4,000 square feet. The restaurants also include company-approved interior and exterior decor, equipment, fixtures, furnishings, signs, parking and site improvements. The restaurants have a highly visible, distinctive and uniform look that is intended to appeal to customers of all ages.

     Prior to 1994, the company operated and franchised predominately double drive-thru restaurants without indoor dining. Since that time, the company has added a number of indoor dining facilities to its operations, including the retrofitting of many existing double drive-thru restaurants to include indoor dining. At January 3, 2004, the number of restaurants with indoor dining was 33 company-operated facilities and 80 franchised facilities.

     It is the company’s objective to serve customers within 60 seconds of their arrival at the drive-thru window. Each restaurant has a computerized point-of-sale system which displays each individual item ordered on a monitor in front of the food and drink preparers. This enables the preparers to begin filling an order before the order is completed and totaled, and thereby increases the speed of service to the customer and the number of sales per hour. The restaurants are generally open from 12 to 15 hours per day, seven days a week, for lunch, dinner and late-night snacks and meals.

     Supplies. The company and its franchisees purchase their food, beverages and supplies from company-approved suppliers. All products must meet standards and specifications set by the company. Management constantly monitors the quality of the food, beverages and supplies provided to the restaurants. The company has been successful in negotiating price concessions from suppliers for bulk purchases of food and paper supplies used by the restaurants. The company believes that these arrangements have achieved cost savings, improved food quality and consistency and helped decrease volatility of food and supply costs for the restaurants. All essential food and beverage products are available or, upon short notice, could be made available from alternate qualified suppliers.

     Management and Employees. Each company-operated restaurant employs an average of approximately 25 employees, many of whom work part-time. The management staff of a typical restaurant operated by the company consists of a general manager and two assistant managers. Each company-operated restaurant unit supervisor reports directly to a district manager. The district managers are able to provide close, hands-on management of each company-operated restaurant since they have responsibility for only five to eight restaurants. Each district manager reports directly to a director of operations.

     Supervision and Training. The company believes that training and personnel development are crucial to its success. The company’s training program is an intensive four-week program consisting of both in-store and classroom training. The in-store training stresses food quality, fast, friendly customer service, restaurant cleanliness, and proper management operations of a quick service restaurant. The classroom training consists of such topics as food safety and sanitation, employment laws and regulations, interviewing and hiring of employees, and systems to control both food and labor costs. Prior to opening, each restaurant must have a minimum of three trained and certified managers that have successfully completed the company training program.

     Advertising and Promotion. Marketing promotions are planned by the company’s national marketing committee made up of company employees and selected franchisee representatives from the Back Yard Burgers, Inc. franchisee association’s board of directors. The four franchisees are elected to two-year terms by the franchise association. These franchisees also serve as officers of the franchise association for the two-year term as well. Production of some marketing materials is paid for through a national advertising fund, which collects 1% of taxable sales from each franchisee and company-operated restaurant. Of that 1%, 50% goes toward the creation of marketing tools such as advertising copy for use on local radio and television, ad slicks, four-color art, design and other collateral pieces and marketing expenses and 50% goes toward testing new products and systems, market research, improvements in operating methods and techniques or for other such purposes that the company deems to be in the interest of improving operations and earnings of restaurants.

     Restaurant Reporting. Each restaurant has a computerized point-of-sale system monitored by the management of the restaurant. With this system, managers are able to monitor sales, labor and food costs, customer counts and other pertinent information every 30 minutes that the restaurant is open. This information allows a manager to better control labor utilization, inventories and operating costs. For company-operated restaurants,

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management monitors sales, food and labor costs, product mix, inventories and customer counts on a weekly basis and profit and loss statements and balance sheets on a monthly basis.

Franchise Operations

     Strategy. In addition to the development of company-operated restaurants, the company will continue to emphasize the development of additional franchised restaurants expected to be opened pursuant to existing area development agreements and franchise agreements as well as the pursuit of additional franchised restaurants pursuant to new area development agreements and franchise agreements. The company believes that it has attracted a committed and enthusiastic group of franchisees as a result of the strength of its concepts and operating strategies.

     Franchisee Support Services. The company maintains a staff of four well-trained and experienced restaurant operations personnel whose only responsibilities are to help train and assist franchisees in opening new restaurants and to monitor the operations of existing restaurants. These services are provided as part of the company’s franchise program. Upon the opening of a new franchised restaurant, the company sends an opening team to the restaurant to assist the franchisee during the first several days that the restaurant is open. This management team works in the restaurant to monitor compliance with the company’s standards as to quality of product and service.

     The company employs four franchise field consultants, each of whom supervises franchised restaurants in defined geographic areas. Presently, the company has one franchise field consultant for each 23 restaurants. That ratio will increase as existing franchisees develop new stores within existing territories. Each franchise field consultant has been fully trained by the company to assist franchisees in implementing the operating procedures and policies of the company once a restaurant is open. As part of these services, the franchise service representative rates the restaurant’s hospitality, food quality, speed of service and cleanliness and maintenance of facilities. The franchisees receive a written report of the findings and, if any deficiencies are noted, recommended procedures to be followed to correct such deficiencies. In addition, the consultant assists in developing business and marketing plans, as well as assisting in the training and development of the franchisee’s staff.

     The company also provides construction support services to its franchisees. All site plans must be approved by the company before construction or site improvements begin. These plans include information detailing building location, internal traffic patterns and curb cuts, location of utilities, walkways, driveways, signs and parking lots and a complete landscape plan. The company also approves all plans and specifications for the restaurant building to ensure uniformity of design of the building and the site improvements. The company’s personnel also visit the site during construction, to meet with the franchisees and verify that all standards are met.

     Advertising and Promotion. Franchisees are required to participate in seasonal promotions, which are supported by television, radio, newspaper, banners, point-of-purchase materials and other local store marketing activities. The company’s marketing manual outlines advertising and public relations promotions as well as new store opening information, grand opening information, trade area surveys and describes how to write a marketing plan and budget for the franchisee’s area. Marketing is supported by a staff consisting of two field marketing managers who coordinate plans and implementation with a national advertising agency. Approved suppliers are set up to facilitate such things as uniforms and collateral materials.

     Area Development and Franchise Agreements. In addition to offering single unit franchise agreements, the company also promotes franchisees to enter into area development agreements. The area development agreement grants to the franchisee the exclusive right to develop and open a specified number of restaurants within a limited period of time and in a defined geographic territory and thereafter to operate each restaurant in accordance with the terms and conditions of the franchise agreement. The franchise agreement grants an exclusive license at a specified location to operate a restaurant in accordance with the Back Yard Burgers system and to utilize the company’s trademarks, service marks and other rights of the company relating to the sale of its menu items. The term of a franchise agreement is 10 years, renewable for successive five year periods, if certain conditions pertaining to such renewal are met, including the payment of a $1,000 renewal fee.

     Each area development agreement establishes the number of restaurants the franchisee is to construct and open in the territory during the term of the area development agreement after considering many factors, including the

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residential, commercial and industrial characteristics of the area, geographic factors, population of the area and the previous experience of the franchisee. The franchisee’s development schedule for the restaurants is set forth in the area development agreement. As of January 3, 2004, the company had entered into franchise agreements and area development agreements with certain franchisees that require them to open or have under construction a minimum of 208 restaurants by the end of August 31, 2013. Of the 90 franchised restaurants open as of January 3, 2004, 71 were being operated under area development agreements by multiple unit franchisees and 19 were being operated under single franchise agreements by single unit franchisees. The company may revoke an area development agreement of any franchisee who is unsuccessful in meeting its projected development schedule. During the past three years, the company has exercised its right to terminate eleven area development agreements, which related to the development of up to 28 stores, for lack of performance by multiple unit franchisees with respect to their projected development schedules. Eight of these agreements were terminated during 2003, which related to the development of up to 19 stores. Additionally, during the past three years, two franchise agreements were terminated because of a lack of performance by single unit franchisees with respect to certain franchise agreement requirements, both of which were during 2001. The company believes that its overall experience with franchisees who commit to develop restaurants under franchise agreements and area development agreements has been favorable, although there can be no assurance that future performance by franchisees under these agreements will be successful.

     The franchise agreement and area development agreement require that the franchisee submit information regarding proposed restaurant sites to the company for its review. The company does not arrange or make any provisions for financing the development of restaurants by its franchisees. Each franchisee is required to purchase all fixtures, equipment, inventory, products, ingredients, materials and other supplies used in the operation of its restaurants from approved suppliers, all in accordance with the company’s specifications. The company provides a training program for management personnel of its franchisees. Under the terms of the franchise agreement, the company has adopted standards of quality, service and food preparation for franchised restaurants. Each franchisee is required to comply with all of the standards for restaurant operations as published from time to time in the company’s operations manual.

     The company may terminate a franchise agreement for several reasons, including among others, the franchisee’s bankruptcy or insolvency, default in the payment of royalties or advertising fees to the company, failure to maintain standards set forth in the franchise agreement or operations manual, material violation of any law, ordinance or governmental rule or regulation or cessation of business. In such event, the company may also elect to terminate a multiple unit franchisee’s area development agreement.

     Franchise Fees and Royalties. Under the current franchise agreement, each franchisee is generally required to pay a franchise fee of $25,000. If a franchisee purchases franchise development rights in an area pursuant to an area development agreement, the franchisee must pay $25,000 for the first restaurant and agree to pay a franchise fee of $22,000 for each additional restaurant covered under the agreement. With respect to the area development agreement, the amount of the fee varies depending upon the number of restaurants the company estimates can be developed within the territory. Upon signing the area development agreement, the franchisee will pay to the company a franchise fee of $25,000 for the first restaurant, plus a $5,000 (per restaurant) area development fee (to be credited toward the subsequent $22,000 franchise fees(s)) for subsequent restaurants covered under the area development agreement. For example, for a franchisee whose area development agreement requires the development of five restaurants, the franchise fee will be $25,000 for the first restaurant, and $17,000 ($22,000 less $5,000) for each of the next four restaurants for an aggregate total of $113,000. Each franchisee is also generally required to pay the company a weekly royalty of 4% of the restaurant’s taxable sales and to pay 1% of the restaurant’s weekly taxable sales to the company’s national advertising fund. Each restaurant is required to spend not less than 2% of the restaurant’s taxable sales on local store marketing.

     Development Agreement with YUM Brands, Inc. Under the terms of a Development Agreement entered into in January 2002 with YUM! Brands, Inc., the company granted YUM the right to use Back Yard Burgers’ trademarks in connection with the establishment and operation of up to ten Back Yard Burgers outlets as part of multi-brand units with Taco Bell, Pizza Hut and/or KFC operations. The Development Agreement also granted YUM! an option to co-brand up to 500 additional Back Yard Burgers restaurants within certain geographic areas if certain conditions were satisfied. YUM did not exercise its option, but has entered into a non-binding term sheet which contemplates that the Development Agreement would be amended to provide YUM with the right to license and sublicense the Back Yard Burgers concept and trademarks in connection with the establishment and operation of

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up to 500 stand alone and multi-brand outlets. While no binding agreement has been reached with YUM to amend the terms of the Development Agreement to provide for the operation of more than ten co-branded stores, the company is currently holding discussions with YUM! with respect to the terms and conditions under which such a license and sublicense would be granted. Such terms and conditions may be different from the provisions described above.

Competition

     Restaurant Operations. The restaurant industry, particularly the fast food segment, is highly competitive with respect to price, service, food quality and location and there are numerous well-established competitors possessing substantially greater financial, marketing, personnel and other resources than the company. The company believes that its primary direct competitors consist of McDonald’s Corp., Burger King Corp. and Wendy’s International, Inc. In addition, there are other national, regional and local fast food chains, many of which specialize in or offer quick serve hamburger and chicken products. The company can also be expected to face competition from a broad range of other restaurants and food service establishments. Many of the company’s competitors have achieved significant national, regional and local brand name and product recognition and engage in extensive advertising and promotional programs, both generally and in response to efforts by additional competitors to enter new markets or introduce new products. In addition, the fast food industry is characterized by the frequent introduction of new products, accompanied by substantial promotional campaigns. In recent years, numerous companies in the fast food industry have introduced products positioned to capitalize on growing consumer preference for food products which are, or are perceived to be, healthful, nutritious, low in calories and low in fat content. It can be expected that the company will be subject to competition from companies whose products or marketing strategies address these consumer preferences. In addition, the market for suitable restaurant locations is highly competitive in that fast food companies, major restaurant companies and non-food companies compete for prime real estate sites.

     Certain Factors Affecting the Fast Food Restaurant Industry. The company constantly responds to various factors affecting the restaurant industry, including changes in consumer preferences, tastes and eating habits, demographic trends and traffic patterns, increases in food and labor costs and national, regional and local economic conditions. A number of fast food restaurant companies have recently been experiencing flattening growth rates and declines in average sales per restaurant, in response to which certain of such companies have adopted competitive discounting or “value pricing” strategies. As the company’s principal method of competition is based on quality and service, rather than price, such strategies could have the effect of drawing customers away from the company.

     Franchise Operations. In addition to its restaurant operations, the company competes with fast food chains, major restaurant chains and other franchisors for franchisees. Many franchisors, including those in the restaurant industry, have greater market recognition and greater financial, marketing and human resources.

Trademarks and Service Marks

     The company believes its trademarks and service marks have significant value and are important to its marketing efforts. The company has registered the name “Back Yard Burgers” and the kettle and flame design as service marks with the United States Patent and Trademark Office. The company’s policy is to pursue registration of its marks whenever possible and to oppose vigorously any infringement of its marks.

Government Regulations

     The company is subject to Federal Trade Commission regulation and several state laws which regulate the offer and sale of franchises. The company is also subject to state laws that regulate substantive aspects of the franchisor - - franchisee relationship. The FTC’s Trade Regulation Rule on Franchising requires the company to furnish to prospective franchisees a franchise offering circular containing information prescribed by this rule.

     State laws that regulate the offer and sale of franchises and the franchisor - franchisee relationship presently exist in a substantial number of states. Such laws generally require registration of the franchise offering with state authorities and regulate the franchise relationship by, for example, requiring the franchisor to deal with its franchisees in good faith, prohibiting interference with the right of free association among franchisees, limiting the

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imposition of standards of performance on a franchisee and regulating discrimination against franchisees in charges, royalties or fees. Although such laws may restrict a franchisor in the termination of a franchise agreement by, for example, requiring “good cause” to exist as a basis for the termination, advance notice to the franchisee of the termination, an opportunity to cure a default and a repurchase of inventory or other compensation, these provisions have not had a significant effect on the company’s franchise operations. The company is not aware of any pending franchise legislation which in its view is likely to affect significantly the operations of the company. The company believes that its operations comply in all material respects with rules and the applicable state franchise laws.

     Each company-operated and franchised restaurant is subject to licensing and regulation by a number of governmental authorities, which may include health, sanitation, safety, fire, building and other agencies in the state or municipality in which the restaurant is located. Difficulties in obtaining or failure to obtain the required licenses or approvals could delay or prevent the development of a new restaurant in a particular area. The company is subject to federal and state environmental regulations, but these regulations have not had a material effect on the company’s operations. More stringent and varied requirements of local governmental bodies with respect to zoning, land use and environmental factors could delay or prevent the development of a new restaurant in a particular area.

     The company is also subject to state and federal labor laws that govern its relationship with its employees, such as minimum wage requirements, overtime and working conditions and citizenship requirements. Significant numbers of the company’s food service and preparation personnel are paid at rates governed by the federal minimum wage. Accordingly, further increases in the minimum wage would increase the company’s labor costs and may have an adverse effect on the company’s operating margins.

Employees

     As of March 16, 2004, the company employed approximately 1,000 persons in its restaurant operations, 31 of whom are corporate personnel, 115 of whom are restaurant management and supervisory personnel and the remainder of whom are hourly restaurant personnel. Of the 31 corporate employees, 13 are in management positions and 18 are administrative or office employees.

Available Information

     The Company maintains an internet website at www.backyardburgers.com. The Company makes available free of charge under the section “Investor Relations” of its website its annual reports on Form 10-K, quarterly reports on Form 10-Q, and current reports on Form 8-K, and all amendments to any of those reports, as soon as reasonably practicable after providing such reports to the Securities and Exchange Commission.

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ITEM 2. PROPERTIES

     Of the 42 company-operated restaurants as of January 3, 2004, the company has entered into ground leases, as lessee, for 33 restaurants. The company owns the real property for 9 restaurants. The company’s leases are generally written for a term of five to 15 years with one or more five-year renewal options. The company’s average monthly lease cost for the 14 company-operated restaurants located on leased sites is approximately $3,300 per month. For the 19 restaurants where the company leases the building as well as the site, the average monthly cost is approximately $5,300 per month. Most leases are operating leases. Leasehold improvements made by the company generally become the property of the landlord upon expiration or earlier termination of the lease; however, in most instances, if the company is not in default under the lease, modular buildings remain the property of the company and can be removed from the site upon expiration of the ground lease. With respect to the buildings and equipment relating to the 42 company-operated restaurants, management believes that its commercial insurance coverage is adequate. Also see “Business-Restaurant Operations.”

     The company’s executive offices are located in approximately 7,500 square feet of leased space at 1657 N. Shelby Oaks Drive, Suite 105, Memphis, Tennessee 38134. The company’s lease expires February 28, 2007 and provides for a minimum annual rent of $80,040. Also, BYB Properties, Inc., a wholly-owned subsidiary of the company, leases nominal office space at 103 Faulk Road, Suite 200, Wilmington, Delaware 19803. This lease expires on December 31, 2004, and provides for annual rent of $4,870.

ITEM 3. LITIGATION

     The company is involved in certain litigation matters 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 of the company.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS

     No items are reportable hereunder.

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PART II

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

     The company’s common stock is traded and quoted on The Nasdaq SmallCap Market under the symbol “BYBI.” The following table sets forth, for all periods indicated, the high and low closing bid prices for the common stock as reported by Nasdaq. Such price information contains inter-dealer prices, without retail mark-up, mark-down or commissions paid, and may not necessarily reflect actual transactions.

     At March 16, 2004, the common stock was held of record by approximately 530 record stockholders. On March 16, 2004, the last sale price for the common stock as reported by NASDAQ was $7.68 per share.

     The company has not paid or declared cash distributions or dividends and does not intend to pay cash dividends on the common stock or its preferred stock in the foreseeable future. Future cash dividends, if any, will be determined by the board of directors based on the company’s earnings, financial condition, capital requirements and other relevant factors. The company has a loan agreement in place which requires the prior written consent of the lending institution for any dividends paid by the company, which according to the loan agreement shall not be unreasonably withheld.

ITEM 6. SELECTED FINANCIAL DATA

     Incorporated herein by reference from the Financial Supplement.

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

     Incorporated herein by reference from the Financial Supplement.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

     Incorporated herein by reference from the Financial Supplement.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

     Incorporated herein by reference from the Financial Supplement.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

     No items are reportable hereunder.

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ITEM 9A. CONTROLS AND PROCEDURES

The company has evaluated the effectiveness of the design and operation of its disclosure controls and procedures pursuant to Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 as of the end of the period covered by the report. Based on the evaluation, performed under the supervision and with the participation of the Company’s management, including the Chief Executive Officer (the “CEO”) and Chief Financial Officer (the “CFO”), the company’s management, including the CEO and CFO, concluded that the Company’s disclosure controls and procedures were effective as of the end of the period covered by the report.

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

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PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

     Information regarding Section 16(a) compliance, the Audit Committee and the Audit Committee financial expert, the Company’s code of ethics and background of the directors are incorporated herein by reference from the company’s definitive proxy statement for the annual meeting of stockholders to be held May 20, 2004, to be filed pursuant to Regulation 14A.

     Set forth below is certain information regarding the company’s directors and executive officers.

     Mr. Michael has been chairman and chief executive officer of the company since 1993. From 1987 to 1992, he was the company’s president and chief executive officer. He has been a director since 1987.

     Mr. Myers has been chief operating officer since August 1999 and was named president in April, 2001. From 1995 to 1999, he was a regional vice president for Whataburger, Inc.

     Mr. Griffith has been executive vice president and secretary/treasurer of the company since 1993. From 1989 to 1992, he was the company’s senior vice president of operations. He has been a director since 1989.

     Mr. Webb has been chief financial officer since March 1999. From 1995 to 1999, he was the controller for Shepherd Tissue, Inc. From 1993 to 1995, he was a senior financial analyst for The Promus Companies. Prior to 1993, Mr. Webb was an auditor for KPMG Peat Marwick.

     Mr. Henke has been a director since 1993. He has been an attorney with Henke-Bufkin since 1992.

     Mr. Peterson is the chairman and CEO of J. P. Family Restaurants Holding Company. He is also the chairman emeritus for Bojangles’ Restaurants, Inc., and past chairman of Apigent Solutions. From 1994 to 1999, he was chairman, president and chief executive officer of Bojangles’ Restaurants, Inc. Prior to joining Bojangles, he was president and chief executive officer for Whataburger, Inc. for 20 years.

     Mr. Raiford has been a director since 1993. He has been an attorney with Merkel & Cocke, P.A. since 1989.

     Mr. Weiss is currently president of A. Weiss Company, a franchisee of the company. He was president and chief operating officer of the company from 1993 to 1999. He has been a director since 1989.

ITEM 11. EXECUTIVE COMPENSATION

     Incorporated herein by reference from the company’s definitive proxy statement for the annual meeting of stockholders to be held May 20, 2004, to be filed pursuant to Regulation 14A.

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ITEM 12.	SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

     Incorporated herein by reference from the company’s definitive proxy statement for the annual meeting of stockholders to be held May 20, 2004, to be filed pursuant to Regulation 14A.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

     Incorporated herein by reference from the company’s definitive proxy statement for the annual meeting of stockholders to be held May 20, 2004, to be filed pursuant to Regulation 14A.

ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES

     Incorporated herein by reference from the company’s definitive proxy statement for the annual meeting of stockholders to be held May 20, 2004, to be filed pursuant to Regulation 14A.

PART IV

ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K

(a)(1) Consolidated Financial Statements

     The following consolidated financial statements, notes related thereto and report of independent auditors are referenced in Item 8 of this Form 10-K and are incorporated herein by reference from the Financial Supplement:

•

Consolidated Balance Sheets as of January 3, 2004 and December 28, 2002

•

Consolidated Statements of Operations for the years ended January 3, 2004 and December 28, 2002 and December 29, 2001

•

Consolidated Statements of Changes in Stockholders’ Equity for the years ended January 3, 2004 and December 28, 2002 and December 29, 2001

•

Consolidated Statements of Cash Flows for the years ended January 3, 2004 and December 28, 2002 and December 29, 2001

•

Notes to Consolidated Financial Statements

•

Report of Independent Auditors

(a)(2) Consolidated Financial Statement Schedules:

     All schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are not required under the related instructions or are not applicable and therefore have been omitted.

15

(a)(3) Exhibits

16

(b)		Reports on Form 8-K
		Fourth quarter and fiscal year 2003 earnings release dated February 17, 2004.
(c)		Exhibits
		The exhibits to this report are listed in Item 14(a) (3) above.
(d)		Financial Statement Schedule
		Not applicable

17

18

SIGNATURES

     Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

     Pursuant to the requirements of the Securities Exchange Act, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.

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INDEX TO FINANCIAL SUPPLEMENT
TO ANNUAL REPORT ON FORM 10-K
FOR THE YEAR ENDED JANUARY 3, 2004

Selected Consolidated Financial Data

     The selected consolidated financial data presented below for each of the years in the five-year period ended January 3, 2004 was derived from the company’s audited Consolidated Financial Statements. The selected consolidated financial data should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations and the Consolidated Financial Statements and Notes thereto included elsewhere herein.

⁽¹⁾ The company incurred a non-cash charge for impairment of long-lived assets of $78,000 during the year ended January 3, 2004.

⁽²⁾ The company incurred a non-cash charge for impairment of long-lived assets of $1,362,000 during the year ended January 1, 2000.

⁽³⁾ Because the company’s fiscal year ends on the Saturday closest to December 31, the fiscal year ended January 3, 2004 contains 53 weeks, while the fiscal years ended December 28, 2002, December 29, 2001, December 30, 2000 and January 1, 2000 contain 52 weeks.

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The selected consolidated financial data presented below is a summary of the unaudited quarterly results of operations for the year ended January 3, 2004:

F-2

The selected consolidated financial data presented below is a summary of the unaudited quarterly results of operations for the year ended December 28, 2002:

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MANAGEMENT’S DISCUSSION AND ANALYSIS

Introduction

     The following discussion and analysis should be read in conjunction with the company’s consolidated financial statements and notes thereto, included elsewhere in this annual report. Because Back Yard Burgers’ fiscal year ends on the Saturday closest to December 31, fiscal 2003 contains 53 weeks versus 52 weeks for 2002 and 2001. As a result, operating results for fiscal 2003 are not directly comparable with those of the prior 52-week periods.

     As of January 3, 2004, the Back Yard Burgers system included 132 restaurants, of which 42 were company-operated and 90 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, 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 revenues, unless otherwise indicated, of certain items included in the company’s historical operations and operating data for the periods indicated.

⁽¹⁾ As a percentage of restaurant sales.

⁽²⁾ As a percentage of income before taxes.

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⁽¹⁾ Includes sales for restaurants open for entire trailing twelve-month period. Restaurants are included in the calculation after the completion of six months of operations, as sales during the period immediately after opening tend to be higher due to promotions and trial by public.

⁽²⁾ As of March 16, 2004, four franchised restaurants have opened and two franchised restaurants have closed since January 3, 2004.

COMPARISON OF FISCAL YEAR 2003
TO FISCAL YEAR 2002

Back Yard Burgers’ fiscal year ends on the Saturday closest to December 31. As a result, fiscal 2003 contains 53 weeks versus 52 weeks for the prior year. Therefore, all references to fiscal 2003 are for the 53-week period ended January 3, 2004 and all references to fiscal 2002 are for the 52-week period ended December 28, 2002.

     Restaurant sales at company-operated restaurants increased 10.8% to $34,279,000 during 2003 from $30,951,000 during 2002. In addition to the fact that fiscal year 2003 contained 53 weeks compared with 52 weeks in fiscal year 2002, the increase is partially the result of a 2.6% increase in same-store sales at restaurants open for more than one year. While the company ended 2002 with 42 restaurants, two of those restaurants opened in late 2002, which also contributed to the increase in restaurant sales.

     Franchise and area development fees were $378,000 during 2003, an increase of 66.5% from $227,000 in 2002. Nineteen new franchised restaurants were opened in 2003, compared to fifteen new franchised units opened in 2002. A portion of the increase in fees is also attributable to the company recording $86,000 in fees for the cancellation of franchise and area development agreements in 2003 compared with $18,000 in 2002.

     Royalty fees increased 20.7% to $2,621,000 during 2003 from $2,172,000 during 2002. The increase is the result of an increase in franchised sales upon which the fees are based. In addition to the fact that fiscal year 2003 contained 53 weeks compared with 52 weeks in fiscal year 2002, the increase in franchised restaurant sales was due to a net unit growth of thirteen franchised stores. The increase is partially offset by a decrease of 4.2% in same-store sales for franchised units during 2003.

     Advertising fees increased 20.6% to $661,000 for 2003 from $548,000 during 2002. The increase is primarily due to the increase in franchised restaurant sales, upon which the fees are based.

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     Other revenues increased 12.8% to $890,000 for 2003 from $789,000 during 2002. The increase in other revenues is due to higher volume rebates from vendors, sales of proprietary spices and other miscellaneous revenues.

     Cost of restaurant sales, consisting of food, beverage and paper costs, totaled $11,117,000 during 2003 compared to $9,558,000 during 2002, increasing to 32.4% as a percentage of restaurant sales during 2003 from 30.9% for 2002. The increase is primarily due to an 11% 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, rent, insurance and certain other unit level operating expenses, increased to $16,457,000 for 2003 from $14,536,000 during 2002, increasing as a percentage of restaurant sales to 48.0% from 47.0% in 2002. Labor costs as a percentage of restaurant sales increased by 0.4% 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 increased $98,000 to $4,533,000 during 2003 from $4,435,000 in 2002, decreasing as a percentage of total revenue to 11.7% from 12.8% during 2002. Personnel related costs, including recruiting, training and benefit costs, increased by approximately $200,000 over the prior year. The increase is partially offset by a decrease of $88,000 in store preopening costs to $63,000 in 2003 from $151,000 in 2002.

     Advertising expense, which increased to $2,349,000 for 2003 from $1,985,000 during 2002, remained relatively flat as a percentage of total revenues at 6.0% in 2003 compared with 5.7% in 2002.

     Depreciation expense was $1,840,000 during 2003 compared with $1,379,000 during 2002. This increase was primarily related to $3.3 million in fixed asset additions during 2003 as well as $4.9 million in fixed asset additions in 2002, primarily related to restaurant growth.

     Interest expense decreased 4.8% to $495,000 for the year ended January 3, 2004 from $520,000 in the prior year. This decrease primarily results from lower average debt outstanding during 2003. Debt outstanding as of January 3, 2004 was $5,350,000, a decrease of $575,000 or 9.7% from the year-earlier period.

     Other, net expense was $67,000 in 2003 compared with $88,000 in expense for 2002. The company recorded a $19,000 loss on the disposal of assets during 2002 compared with a $1,000 gain during 2003. The company also wrote off $23,000 in deferred loan costs during 2002 for which there were no comparable costs during 2003. These decreases in expense were partially offset by the fact that franchise tax expense increased by $27,000 for the fifty three weeks ended January 3, 2004, 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 between the two years.

     Income tax expense, which decreased by $136,000 to $590,000 from $726,000 in 2002, decreased as a percentage of pre-tax income at 31.1% in 2003 compared with 33.0% in 2002. The decrease in income tax expense as a percentage of pre-tax income is primarily a result of a $62,000 work opportunity tax credit earned by the company during 2003.

COMPARISON OF FISCAL YEAR 2002
TO FISCAL YEAR 2001

     Restaurant sales at company-operated restaurants increased 12.4% to $30,951,000 during 2002 from $27,541,000 during 2001. This increase is primarily the result of a net increase in company-operated restaurants of five stores since December 29, 2001, and a 4% price increase taken by the company in December 2001, offset by the impact of competitive discounting occurring in the last half of 2002.

     Franchise and area development fees were $227,000 during 2002, a decrease of 29.1% from $320,000 in 2001. Fifteen new franchised restaurants were opened in 2002, compared to thirteen new franchised units opened in 2001. A portion of the decline in fees is attributable to the company recording $65,000 in fees for the cancellation

F-6

of franchise and area development agreements in 2001 compared with $18,000 in 2002. The remaining decline is due to the fact that five of the openings in 2002 were co-branded franchised stores under the company’s Multi-Brand Development Agreement with YUM! Brands, Inc., and the fees for these units are lower than traditional stand-alone franchised restaurants.

     Royalty fees increased 9.5% to $2,172,000 during 2002 compared with $1,984,000 during 2001. The increase is the result of an increase in franchised sales upon which the fees are based. The increase in franchised restaurant sales was due to a net unit growth of ten franchised stores. The increase is partially offset by a decrease of 1.8% in same-store sales for franchised units during 2002.

     Advertising fees increased 9.2% to $548,000 for 2002 compared with $502,000 during 2001. The increase is primarily due to the increase in franchised restaurant sales, upon which the fees are based.

     Cost of restaurant sales, consisting of food, beverage and paper costs, totaled $9,558,000 during 2002 compared to $8,797,000 during 2001, decreasing to 30.9% as a percentage of restaurant sales during 2002 from 31.9% for 2001. Product costs remained relatively flat throughout 2002. The decrease in cost of restaurant sales as a percentage of sales is attributable to a 4% menu price increase taken by the company in December of 2001.

     Restaurant operating expenses, consisting of labor, supplies, utilities, rent, insurance and certain other unit level operating expenses, increased to $14,536,000 for 2002 from $13,027,000 during 2001, decreasing as a percentage of restaurant sales to 47.0% from 47.3% in 2001. Labor costs as a percentage of restaurant sales decreased by 0.8%; however this decrease was partially offset by increased spending for insurance, utilities and property taxes.

     General and administrative costs increased $498,000 to $4,435,000 during 2002 from $3,935,000 in 2001, increasing as a percentage of total revenue to 12.8% from 12.6% during 2001. Approximately $187,000 of the increase was personnel related, including increased spending on recruiting, training and benefit costs. Preopening expenses also increased by $62,000 due to the expenditures related to the opening of five company-operated restaurants during 2002. The remaining cost increases were related to general increases in spending in the areas of marketing, operations training, information technology and franchisee recruiting during 2002.

     Advertising expense, which increased to $1,985,000 for 2002 from $1,824,000 during 2001, remained relatively flat as a percentage of total revenues at 5.7% in 2002 compared with 5.9% in 2001.

     Depreciation expense was $1,379,000 during 2002 compared with $1,383,000 during 2001. The company recorded $158,000 in goodwill amortization in 2001 compared with zero amortization in 2002 due to the adoption of the Statement of Financial Accounting Standards No. 142, Goodwill and other Intangible Assets effective January 1, 2002. This decrease in amortization expense was offset by additional depreciation expense recorded during 2002 for the purchase of additional property and equipment since the prior year.

     Interest expense decreased 7.8% to $520,000 for the year ended December 28, 2002 from $564,000 in the year-earlier period. While debt outstanding as of December 28, 2002 was $5,925,000, an increase of $153,000 on the balance outstanding as of December 29, 2001, the company was able to renegotiate interest rates downward by 1.7% to 2.4% on approximately 45% of its outstanding debt during the fourth quarter of 2001 resulting in the decrease in interest expense for the company in 2002.

     Other, net expense was $88,000 in 2002 compared with $49,000 in expense for the year ended December 29, 2001. The increase is due to a write-off of $23,000 of deferred loan costs incurred by the company as well as a net loss on the disposal of assets of $19,000 compared with a net loss of $1,000 recognized in the year-earlier period. Also included in this category is other miscellaneous income and expenses, including franchise tax expense and these income and expense categories were relatively consistent during fiscal year 2002 and 2001.

     Income tax expense, which increased by $174,000 to $726,000 from $552,000 in 2001, decreased as a percentage of pre-tax income at 33.0% in 2002 compared with 35.0% in 2001. The decrease in income tax expense as a percentage of pre-tax income is primarily a result of the decrease in taxable income.

F-7

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.

     The company incurred non-cash impairment charges of $78,000 in the 53 weeks ended January 3, 2004, for the effect of company-operated restaurant closings and impaired assets at company-operated restaurants, of which $59,000 was related to future lease payments of closed stores, net of estimated sub-lease income and $19,000 was related to impairments of property and equipment at closed stores.

     The company had $61,000 in reserves for closed properties at the end of fiscal year 2002 of which $22,000 was charged against the reserve for lease payments. Lease payments of $39,000 in 2003 were incurred and charged against this additional reserve. As of January 3, 2004, the company’s remaining accrual for all future lease obligations discussed above was $81,000, which is net of estimated sub-lease income.

Liquidity and Capital Resources

     Capital expenditures totaled $3,329,000 in 2003 and $4,861,000 in 2002. Generally, the company constructs its restaurant buildings on leased properties for its company-operated restaurants. The average monthly lease cost for the 14 company-operated restaurants on leased sites at January 3, 2004 is approximately $3,300 per month. For the 19 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 $1,840,000 in 2003 and $1,379,000 in 2002.

     Cash provided by operations in 2003 was $4,816,000 compared with $3,842,000 in 2002. 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.

     As of January 3, 2004, the company had total long-term debt of $5,350,000 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 fifty-three weeks ended January 3, 2004.

     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 January 3, 2004, the company had repurchased 25,000 shares of common stock under the plan. No further purchases are anticipated in the near term.

F-8

     The company is budgeting capital expenditures of approximately $4.0 million in fiscal year 2004, 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.

     The company expects to fund fiscal year 2004 capital expenditures with cash flow from operations and borrowings under the new loan agreement entered in February of 2003. The company believes that existing cash and funds generated from internal operations, as well as borrowings under the new credit facility will meet the company’s needs for the foreseeable future.

     The company has contractual obligations and commercial commitments including long-term debt, land lease obligations for company-operated restaurants and office space for corporate operations. The table below presents our future contractual obligations (in thousands):

Qualitative and Quantitative Disclosure about Market 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 on 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.

     Approximately 10% of the company’s debt portfolio as of January 3, 2004, 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 $1,500 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 program has been deemed necessary for the company at this time.

Seasonality and Inflation

     While the company does not believe that seasonality affects its operations in a materially adverse manner, first quarter results will generally be lower than other quarters due to seasonal climate conditions in the locations of many of its restaurants. Although results were negatively impacted during 2003 due to an 11% increase in the cost of beef, management does not believe that inflation has had a material effect on income during the fifty-three weeks ended January 3, 2004. 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 Restated 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 has notified preferred stockholders of their right to convert preferred stock to common stock and anticipates that all shares of preferred stock will

F-9

be converted. Such conversion began on April 5, 1995, at which time there were 1,199,979 shares of preferred stock outstanding. As of January 3, 2004, only 19,617 shares have yet to be converted.

Recent Accounting Pronouncements

     Note 2 of the Notes to Consolidated 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 Consolidated Financial Statements.

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.

     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.

     The company has also 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, the 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 76% of its total assets invested in property and equipment. The company capitalizes only those costs that meet the definition of capital

F-10

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.

     The company has approximately $1.8 million of goodwill on our 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 $394,000 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.

Off-Balance Sheet Arrangements

     At January 3, 2004, the company had a guarantee of a franchisee loan relating to the acquisition of a parcel of land and the construction of a building that is currently being operated as a Back Yard Burgers franchised location. The original loan balance was $655,000 and the balance as of January 3, 2004, was approximately $500,000.

Known Trends and Uncertainties

     Labor will continue to be a critical factor 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.

F-11

     During 2003, the cost of beef increased approximately 11% over the prior year while the cost of chicken was relatively stable. In light of what appeared 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 may be difficult to raise menu prices to fully cover 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.

     Company-operated same-store sales increased 2.6% during 2003 compared with a 0.1% increase in 2002. Franchised same-store sales decreased 4.2% during 2003 compared with a 1.8% decrease in 2002. Management attributes the decline in same-store sales for franchised locations to competitive discounting. The impact of competitive discounting on company-operated same-store sales was 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.

     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 the ability to positively address these issues.

F-12

BACK YARD BURGERS, INC.

See accompanying notes to consolidated financial statements.

F-13

BACK YARD BURGERS, INC.

See accompanying notes to consolidated financial statements.

F-14

BACK YARD BURGERS, INC.