Back Yard Burgers (BYBI) 10-K 2006 FY Annual report

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark One)

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

FOR THE FISCAL YEAR ENDED DECEMBER 30, 2006
or

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

Commission file number1-12104

BACK YARD BURGERS, INC.

(Name of registrant as specified in its charter)

Delaware	64-0737163
(State or other jurisdiction of	(IRS employer
incorporation or organization)	identification no.)
1657 N. Shelby Oaks Drive, Suite 105
Memphis, Tennessee	38134-7401
(Address of principal executive offices)	(Zip code)

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

Title of each class	Name of each exchange on which registered
Common Stock $.01 par value	NASDAQ Capital Market

Securities registered pursuant to Section 12(g) of the Act:None

     Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.       
Yeso      Nox

     Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act.           Yeso      Nox

     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.           Yesx      Noo

     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 information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.      x

     Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

Large accelerated filero      Accelerated filero      Non-accelerated filerx

     Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yeso      Nox

     The aggregate market value of common stock held by non-affiliates on July 1, 2006 was approximately $16,811,000.

     The number of shares outstanding of the registrant’s common stock as of March 30, 2007 was 5,125,747.

     Certain portions of Part III are incorporated by reference from the registrant’s proxy statement relating to the annual meeting of stockholders which will be filed with the Commission no later than 120 days from the fiscal year end covered by thisForm 10-K.

TABLE OF CONTENTS

Ex-10.31 Retention and Change in Control Agreement dated October 9, 2006

Ex-21 Subsidiaries of the Registrant

Ex-23.1 Consent of Independent Registered Public Accounting Firm

Ex-31.1 Section 302 Certification of the CEO

Ex-31.2 Section 302 Certification of the CFO

Ex-32.1 Section 906 Certification of the CEO

Ex-32.2 Section 906 Certification of the CFO

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 factors described under Risk Factors, including 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; road and other construction adversely impacting access and curb appeal; consumer preferences, spending patterns and demographic trends; the possibility of unforeseen events affecting the industry generally; the possibility of unforeseen events affecting the beef and poultry industries, 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.

ASSUMPTIONS USED IN THIS REPORT

Throughout this report, our fiscal years ended December 28, 2002, January 3, 2004, January 1, 2005, December 31, 2005 and December 30, 2006 are referred to as fiscal years 2002, 2003, 2004, 2005 and 2006, respectively. Our fiscal year ends on the Saturday closest to December 31 in each year. Our fiscal years typically consist of 52 weeks except for 2003 which was a 53-week year. All prior quarters consisted of 13 weeks except for 2003 which included a final quarter of 14 weeks.

PART I

ITEM 1. BUSINESS

General

     Back Yard Burgers, Inc. (referred to herein as the “Company” or in the first person as “we”, “our”, and “us”) operates and franchises quick-service restaurants in 20 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 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 December 30, 2006, our operations included 44 Company-operated restaurants in 4 states and 136 franchised restaurants in 20 states.

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 Nasdaq since that time.

     Recent Developments

     In October 2006, the Company’s senior management team initiated an informal review of the Company’s

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historical stock option grant practices and related accounting treatment. On October 12, 2006, the Company’s senior management advised the Company’s Board of Directors that the review had been commenced and the Board directed senior management to continue its review and report its findings to the Audit Committee of the Board of Directors as soon as practicable. On October 30, 2006, the Company’s senior management team reported its preliminary findings to the Board’s Audit Committee and, as part of the report, recommended that the Audit Committee oversee a formal investigation of the Company’s historical stock option grant practices. The Audit Committee undertook its investigation with the assistance of independent legal counsel to assist it in its factual investigation of the Company’s historical stock option grant practices. The Audit Committee also engaged independent accounting experts to both assist its legal counsel in their factual investigation and assist the Company in establishing the appropriate measurement date for each of the Company’s stock option grants during the period under review. The Audit Committee’s investigation covered a period of time from June 25, 1993, the date of the Company’s initial public offering, to August 12, 2005, the last date on which the Company granted stock options.

     In conducting its investigation, the Audit Committee, with the assistance of its independent advisors, reviewed minutes from the meetings of the Company’s Board of Directors and Compensation Committee relating to the issuance of stock options, the terms of the Company’s 1993 Incentive Stock Option Plan, 1995 Incentive Award Plan and 2002 Equity Incentive Plan (collectively, the “Stock Option Plans”), as well as the representative forms of option grant agreements used by the Company during those periods, the employment offer letters from the Company to employees in which the Company included the grant of stock options as part of the compensation package and the confirmation letter issued by the Company in connection with the appointment of an independent director to fill a vacancy on the Company’s Board of Directors. The Audit Committee authorized its legal counsel to engage forensic consultants to conduct a review to determine whether, and if so, to what extent, the Company’s email data contained information about the Company’s stock option grant and exercise activity during the periods covered by the Audit Committee’s investigation. In the course of that review, approximately 270,000 emails were searched and, of the emails searched, approximately 8,410 emails were reviewed. The forensic investigation was necessarily limited by the saving and deleting activities of individual users along with the Company’s email policies regarding deletion, saving and archiving. In addition, interviews were conducted with various members of the Company’s senior management team and members of the Company’s Board of Directors and Compensation Committee for the years in question.

     During the period covered by the Audit Committee’s investigation, the Company made option grants covering 1,292,695 shares of the Company’s common stock. The Company’s grants generally fell into the following four categories:

• Annual stock option grants

• Grants made to rank and file existing employees by the Company’s Chief Executive Officer

• Grants made to new hires by the Company’s Chief Executive Officer

• Grants made to the Company’s independent directors (other than as part of the Company’s annual option grants)

     In the course of its investigation, the Audit Committee did not find any evidence of fraudulent conduct on the part of members of the Company’s Board of Directors, Compensation Committee or senior management team in the granting of stock options. However, the Audit Committee concluded that the measurement dates previously used by the Company with respect to certain stock option grants made during the period under review differed from the appropriate measurement dates that should have been used with respect to such awards pursuant toAccounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (“APB No. 25”), and related interpretations. As a result, revised measurement dates were applied to the affected option grants and in the third quarter of 2006 the Company has recorded a total of $311,000 (net of a $118,000 tax benefit) of additional stock-based compensation expense relating to years prior to 2006 for the 13 years covered by the Audit Committee’s investigation.

     To correct the inaccuracies with the previously selected measurement dates, the Company, with the assistance of its accounting advisors, established the date for each affected grant on which allAPB No. 25 criteria were satisfied. According toAPB No. 25, the measurement date is the first date on which proper approval is obtained and all of the following are known: (1) the individual employee who is entitled to receive the option grant, (2) the number of options that an individual employee is entitled to receive, and (3) the option’s exercise price. In determining the correct measurement date for the affected option grants, the Company considered:

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• the report prepared by the Audit Committee’s legal counsel relating to the Company’s historical stock option granting practices;

• minutes of meetings of the Company’s Board of Directors and Compensation Committee, and any available related documentation;

• personnel files;

• payroll records;

• reports on Form 4 filed with the SEC;

• contemporaneous emails; and

• information obtained in interviews with various current and former Company employees and members of the Board of Directors and Compensation Committee.

     With respect to grants for which there was not sufficient evidence and documentation to support the original measurement date or to determine the precise date when the number of options and exercise price were finalized, in accordance with the SEC Chief Accountant’s letter dated September 19, 2006 (the letter can be found at www.sec.gov), the Company used all available relevant information to form a reasonable conclusion as to the most likely measurement date for such option grants.

     Although the Audit Committee did not find any evidence of fraudulent conduct on the part of members of the Company’s Board of Directors, Compensation Committee, or senior management team in the granting of stock options, the Audit Committee found instances of missing or incomplete minutes supporting the issuance of stock options awarded by the Compensation Committee or the Board of Directors; the issuance of stock options to rank and file employees by the Company’s Chief Executive Officer without clear delegation of authority in certain instances; stock options with favorable exercise prices in certain periods compared to stock prices before or after grant date; and the issuance of stock options that did not strictly adhere to the terms of the particular Stock Option Plan under which they were granted. The Audit Committee concluded that the errors in measurement dates resulted from a combination of unintentional errors, lack of attention to timely administration and paperwork, and insufficient internal control over the administration and accounting for aspects of the stock option plans.

     Certain of the errors found by the Audit Committee require the Company to make adjustments to its financial statements. The following paragraphs provide additional information regarding the various types of errors identified in conjunction with the Audit Committee investigation that required financial statement adjustments, resulting in the net $311,000 cumulative adjustment described above:

Stock options issued with favorable exercise prices in certain periods compared to stock prices before or after grant date

     Rather than making stock option grants to various employees several times per year, the Company’s policy has generally been to make stock option grants to existing employees once per year. Although the specific date on which the Company made its annual stock option grants has varied during the thirteen year period covered by the Audit Committee’s investigation, the Company’s policy at the time of the 2001 and 2002 annual stock option grants was for the grants to be made January 1st of each respective year.

     In conducting its investigation, the Audit Committee determined, with respect to the 2001 annual stock option grants, that the members of the Compensation Committee initially reviewed the grants in early January, but that the actual approval of the grants did not occur until March 5, 2001. In keeping with the Company’s policy at the time, the measurement date used by the Company for the 2001 annual stock option grants was January 1, 2001. The Audit Committee did note that on January 2, 2001, the Company issued a press release announcing that its Board of Directors had authorized the repurchase of up to 500,000 shares of the Company’s outstanding common stock. The difference in per share closing sale price of the common stock as reported by Nasdaq on December 29, 2000 ($0.66), the last trading day before January 1, 2001 and the per share closing price on March 5, 2001 ($1.12) represents a difference of $0.46 per share. The Company awarded a total of 130,000 stock options as part of the 2001 annual stock option grants, of which 100,000 stock options were issued to individuals who, at the time, were serving as officers of the Company. No recipient of any of the 2001 annual stock option grants served on the Compensation Committee, which approved the grant awards.

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     With respect to the 2002 annual stock option grants, the actual approval of the grants did not occur until January 25, 2002. In keeping with the Company’s policy at the time, the measurement date used by the Company for the 2002 annual stock option grant was January 1, 2002. The Company executed a co-branding agreement with Yum! Brands, Inc. (formerly Tricon Global Restaurants, Inc.) to establish a pilot program to offer the Company’s fast food products in conjunction with the Yum! Brands products, such as Taco Bell, Pizza Hut and KFC operations, in up to 10 restaurant locations, with an option in favor of Yum! Brands to expand that relationship to up to 500 restaurants. The difference in the per share closing sale price of the common stock as reported by Nasdaq on December 31, 2001 ($3.98), the last trading day before January 1, 2002, and the per share closing sale price on January 25, 2002 ($7.65) represents a difference of $3.67 per share. The Company awarded a total of 111,000 stock options as part of the 2002 annual stock option grants, of which 89,000 stock options were issued to individuals who, at the time, were serving as officers of the Company. No recipient of any of the 2002 annual stock option grants served on the Compensation Committee, which approved the grant awards.

     The cumulative impact of adjustments applied to the 2001 and 2002 annual stock grants were approximately $30,000 (net of a $17,000 tax benefit) and $236,000 (net of a $92,000 tax benefit), respectively. With respect to the 2001 adjustment, $21,000 related to stock option grants to the Company’s officers and the remaining $9,000 related to stock option grants to other key employees. With respect to the 2002 adjustments, $210,000 related to stock option grants to the Company’s officers and the remaining $26,000 related to stock option grants to other key employees. The Company also recorded approximately $26,000 in additional payroll tax expense relating to 2001 and 2002 annual stock grants that have been exercised to date due to the fact that these options were originally treated as incentive stock options but should have been treated as non-qualified stock options, for which payroll tax withholdings are required upon exercise.

Inaccurate measurement date for 2002 automatic grants to three independent directors

     The Company’s 1995 Incentive Award Plan contained a provision for the automatic grant of stock options to independent directors on the tenth day after the Company’s annual stockholders meeting. It was noted during the investigation that in 2002, the Company’s 2002 annual stockholders meeting was held on May 16, 2002. The automatic grants for that year were granted with an exercise price equal to the closing price of the Company’s common stock on May 28, 2002 (the 10^th day the meeting was Sunday, May 26, 2002, and the following Monday, May 27, 2002, was Memorial Day, on which the stock markets were closed). After further review, it was determined that the grants should have been made on May 24, 2002, the last business day before the tenth day after the Company’s annual stockholders meeting. The closing price of the Company’s common stock on May 28, 2002 was $10.13 and the closing price of the Company’s common stock on May 24, 2002 was $10.93, resulting in an $0.80 difference in the exercise price and the measurement date price. This resulted in an approximate $8,000 (net of a $4,000 tax benefit) adjustment related to the 15,000 shares issued under the May 28, 2002 grant.

Inaccurate measurement dates for two new hires and one independent director

     In the course of its investigation, the Audit Committee identified grants made by the Company’s Chief Executive Officer to two employees in connection with their hiring in 1999 and 2005, respectively, for which the grant date for their respective stock options was prior to their respective start dates with the Company (although the grant dates were subsequent to the employees having accepted their respective offers of employment with the Company). The Audit Committee determined that the appropriate measurement dates with respect to these grants should have been the first day of service with the Company. These two grants were made for a total of 28,000 stock options. The cumulative impact of adjusting the measurement dates of these two stock option grants to the respective dates on which the respective employees commenced employment with the Company is $1,000.

     In addition, the Audit Committee determined that in late 1999 the Company incorrectly accounted for one stock option grant made to a new independent director. In this case, the director was elected to fill a vacancy resulting from the resignation of another director. The director was elected to the Board of Directors on December 2, 1999 and in connection with his election, it was agreed that the director was to be granted a stock option to purchase 60,000 shares of the Company’s common stock at the fair market value on the date of grant. However, due to administrative errors and lack of attention to timely paperwork, the stock option instrument was not issued by the Company until March 1, 2000, and it bore a grant date of March 1, 2000. The Audit Committee determined that the measurement date and grant dates should have been established as the first day of the director’s service with the Company (December 2, 1999), and the fair market value of the Company’s common stock as of the adjusted

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measurement date in this instance was higher than the fair market value of the stock on the recited grant date. The cumulative impact of correcting the measurement date of this grant to December 2, 1999 is $10,000 (net of a $5,000 tax benefit).

Additional Inconsistencies Not Requiring Financial Statement Adjustments

     In addition to the above described errors requiring adjustments to the financial statements, the Audit Committee determined that certain grants of stock options in 1998 did not conform to the Company’s policy at the time but for the reasons noted below, the Company did not make any adjustment to the financial statements in respect of such grant.

     The stock options issued as part of the 1998 annual stock option grant were approved for issuance at a meeting of the Company’s Compensation Committee on January 15, 1998. The minutes of that meeting did not specify a grant date for the options. Prior to the implementation of The Sarbanes-Oxley Act of 2002, the Compensation Committee did not customarily specify a grant date when approving the annual option grants but rather delegated that decision to the Company’s senior management, with the expectation that the Company’s senior management would issue the options at a time and in a manner that was consistent with the then current Company policy. At the time, it was the Company’s policy that its annual option grants would be issued on the first business day of the second fiscal quarter. In the case of the 1998 annual stock option grants, this date would have been April 5, 1998. The Audit Committee determined that the Company issued the award agreements reflecting the 1998 annual stock option grants on February 27, 1998 and February 28, 1998 and used those dates for accounting purposes as the appropriate measurement dates. Based on historical closing prices for the Company’s common stock on the NASDAQ Capital Market, February 27, 1998 represented the lowest closing price for the Company’s common stock during the period between January 15, 1998, the date the Compensation Committee approved the grants, and April 5, 1998, the first business day of the Company’s second fiscal quarter. Based on the information obtained by the Audit Committee in the course of its review, the Audit Committee concluded that the Company did in fact execute the award agreements reflecting the 1998 annual stock option grant on February 27, 1998 and February 28, 1998. As no explicit grant date was approved by the Compensation Committee and there are no findings to suggest that the Company’s management acted inappropriately in the issuing the options on February 27, 1998 and February 28, 1998, the Company has not made any adjustments to its financial statements associated with the 1998 annual stock option grant.

New Board Policy for Stock Options and other Equity Awards

     The Audit Committee also recommended, and the Board of Directors has adopted a formal policy (the “Policy”) with respect to the granting of options or other equity incentive awards (“Equity Awards”) in the future. The Policy states that the Board of Directors recognizes that the granting of Equity Awards presents specific legal, tax and accounting issues and that the Policy shall be followed in connection with all issuances of Equity Awards by the Company.

     Under the Policy, the Board of Directors has determined that the Compensation Committee of the Board remains best suited to review and approve Equity Awards. Accordingly, any Equity Awards shall be approved by the Compensation Committee or the full Board of Directors. To avoid the timing issues inherent in the Board or the Compensation Committee acting by unanimous written consent, the Policy requires all Equity Awards to be approved at a meeting (including telephonic meeting) of the Board of Directors or Compensation Committee, as the case may be, and not by written consent.

     The Policy expressly provides that the grant date of any Equity Award shall be the date of the meeting at which the award was approved and the exercise price shall be the closing price of the Company’s common stock on such date on the Nasdaq Stock Market, or any successor to such market on which the Company’s common stock is listed for trading.

     The Policy permits the Company to continue its practice of making grants to existing employees once per year. In the event of an Equity Award being granted to a new employee of the Company (“new hire”), the Policy allows the new hire to be notified that management will recommend to the Board or the Compensation Committee, as the case may be, an Equity Award, but that the Equity Award will not be approved, nor be deemed awarded, unless and until appropriate granting action is taken at a subsequent Board or Compensation Committee meeting

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following the commencement of employment of the new hire and such Equity Award shall be dated (and the exercise price will be determined as of) the date of the Board or Compensation Committee meeting at which it was approved.

     The Policy requires that the details of every Equity Award shall be reflected in the minutes of the requisite Board or Compensation Committee meeting, which minutes shall be maintained in the respective minute books. These details will include, at a minimum, the following information:

• Name of grantee;

• Number of shares of common stock covered by any options or other Equity Awards being granted to the grantee;

• Statement that the grant date is the date of the meeting at which the options are approved;

• Statement that the exercise price of the option or other Equity Award shall be the closing price of the Company’s common stock on the NASDAQ Capital Market (or applicable successor market) on such date.

     Neither the Board of Directors nor Compensation Committee will be authorized to grant an unallocated “pool” of options to a group of individuals or otherwise delegate the authority to grant any options or other Equity Awards to any other person.

     Under the Policy, all Equity Awards shall be promptly communicated to the necessary accounting and legal personnel to assure proper reporting and accounting of the awards. Grant award packages shall be promptly distributed to each grantee, and in no event shall such communication be later than 20 days from the approval date.

Stock Option Amendment Agreements with Certain Executive Officers

     On March 29, 2007, the Company and Mr. Lattimore M. Michael, its Chairman and Chief Executive Officer, agreed to amend the stock option award agreements entered into between the Company and Mr. Michael to increase the exercise price for the stock options granted to Mr. Michael as part of the 2001 annual stock option grant and 2002 annual stock option grant. Under the amendments, the exercise price for the options granted to Mr. Michael pursuant to the 2001 annual stock option grant was increased from $.722 per share (110% of the fair market value of the common stock on the recited date of grant in the original award agreement) to $1.232 per share (110% of the fair market value of the common stock on the adjusted measurement date for such award), as a result of the stock option investigation described elsewhere in this report. In addition, the exercise price for the options granted to Mr. Michael pursuant to the 2002 annual stock option grant was increased from $4.38 per share (110% of the fair market value of the common stock on the recited date of grant in the original award agreement) to $8.42 per share (110% of the fair market value of the common stock on the adjusted measurement date for such award). These exercise prices, being equal to 110% of the fair market value of the Company’s common stock on the adjusted measurement dates, are required by the stock option plans under which the options were granted since Mr. Michael holds in excess of 10% of the outstanding capital stock of the Company. The amendments to these options were made voluntarily by Mr. Michael.

     On March 29, 2007, the Company and Mr. Michael G. Webb, its Executive Vice President and Chief Financial Officer, agreed to amend the stock option award agreement entered into between the Company and Mr. Webb to increase the exercise price for the stock options granted to Mr. Webb as part of the 2002 annual stock option grant. Under the amendment, the exercise price for the options granted to Mr. Webb pursuant to the 2002 annual stock option grant was increased from $3.98 per share, the fair market value of the common stock on the recited date of grant in the original award agreement, to $7.65 per share, the fair market value of the common stock on the adjusted measurement date for such award, as a result of the stock option investigation described elsewhere in this report. This amendment was made voluntarily by Mr. Webb.

Regulatory Matters

     The Company has advised the SEC of the Audit Committee’s investigation of its stock option grant practices and the Company intends to cooperate with the SEC in any investigation into this matter. As of the date of this Form 10-K, the Company has not been notified of any commencement by the SEC or other governmental

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agencies of any investigation into the Company’s stock option granting practices.

     On November 14, 2006, the Company notified the SEC that because its Audit Committee’s investigation of the Company’s historical stock option grant practices was ongoing, the Company would not be able to timely file its Form 10-Q for the period ended September 30, 2006. On November 20, 2006, the Company received a Nasdaq Staff Determination notice stating that due to its failure to timely file its Form 10-Q for the quarter ended September 30, 2006, the Company’s common stock would be delisted from the NASDAQ Capital Market at the opening of business on November 29, 2006 unless the Company requested a hearing before a Nasdaq Listing Qualifications Panel (the “Panel”). On November 21, 2006, the Company submitted a request for a hearing before the Panel, which stayed the delisting pending the hearing. The hearing occurred on February 1, 2007. At the hearing, the Company requested that the Panel grant it an extension until March 19, 2007 to file its Form 10-Q for the period ended September 30, 2006. On March 19, 2007, the Company requested an extension until April 17, 2007, and on March 20, 2007, the Panel granted the request for such extension. The Company filed its Quarterly Report on Form 10-Q for the period ended September 30, 2007, on March 27, 2007. On April 2, 2007, the Company received notice from the Panel that it was in compliance with all Nasdaq Marketplace Rules and that the Panel had determined to continue the listing of the Company’s common stock on The NASDAQ Capital Market.

     The Company determined the impact of recording the charges for stock-based compensation was not material to fiscal years 2005 and 2004, and recording the cumulative out-of period charges in fiscal year 2006 would not be material to that period, and accordingly recorded the adjustments relating to stock option practices in the Quarterly Report on Form 10-Q for the quarter ended September 30, 2006, This conclusion was reached based on an analysis of the adjustments under both Staff Accounting Bulletin 99 and 108. Management concluded that none of the adjustments were material to any of the financial statements presented in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005 and there were no qualitative issues identified during the investigation that would require restatement under Staff Accounting Bulletin 99 or 108.

     See Note 3 to the consolidated financial statements for a detail of the adjustments.

Costs of Investigation and Legal Activities

     The Company has incurred substantial expenses for legal, accounting, tax and other professional services in connection with the Audit Committee’s investigation, the preparation of its financial statements and related regulatory matters. The Company has expenses of approximately $350,000 related to these matters, and these costs have been recorded as general and administrative costs in the quarter ended December 30, 2006.

Operating Strategy

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

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

• 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;

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

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

• actively training, supervising and supporting franchised and Company-operated restaurants.

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Growth Strategy

     During 2007, we will continue to focus on opening new franchised restaurants and increasing same-store sales. Our growth strategy is to continue to:

• set our restaurants apart from fast-food competition by serving premium fast food, enhancing the interiors of our dine-in facilities and re-imaging existing franchise 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;

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

• 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;

• test new and improved operational technology systems that should enable the Company and our franchisees to increase sales, control operating costs and build customer loyalty through innovative technology solutions including: new state of the art biometric point-of-sale systems, self-serve kiosks, interactive customer ordering, back office software, enterprise reporting, loyalty programs, point-of-sale hardware and support;

• analyze results of two new Company-operated restaurants with playgrounds and determine if future store facilities will include playgrounds (each playground centerpiece is a tree house, which the company feels will further enhance our back yard theme and increase restaurant traffic);

• develop additional franchised restaurants, primarily within existing markets, with a committed and experienced group of franchisees (we expect that 14 to 18 franchised restaurants will open in 2007); and

• continue to develop and improve sales of our breakfast menu with targeted system-wide availability by the end of 2007 (currently, breakfast is being served at 21 of our locations, thirteen of which are Company-operated and eight franchised).

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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 December 30, 2006.

Company-operated:			Franchised:
	Number of			Number of
Core Markets	Restaurants		Core Markets	Restaurants
Memphis, TN Area		27	Kansas City, MO Area		12
Little Rock, AR Area		7	Atlanta, GA Area		10
Nashville, TN Area		6	Springfield, MO Area		6
Gulf Coast, FL Area		4	Charlotte, NC Area		5
Total		44	Birmingham, AL Area		4
			Jackson, MS Area		4
			Orlando, FL Area		4
			Hickory, NC Area		3
			Knoxville, TN Area		3
			Memphis, TN Area		3
			Tulsa, OK Area		3
			Waco, TX Area		3
			Asheville, NC Area		2
			Baton Rouge, LA Area		2
			Chattanooga, TN Area		2
			Huntsville, AL Area		2
			Lexington, KY Area		2
			Little Rock, AR Area		2
			Montgomery, AL Area		2
			Oklahoma City, OK Area		2
			Paducah, KY Area		2
			State College, PA Area		2
			Tupelo, MS Area		2
			Other Markets(1)
			Georgia		9
			Mississippi		8
			Kentucky		6
			Louisiana		4
			Alabama		3
			South Carolina		3
			North Carolina		3
			Tennessee		3
			Florida		2
			Indiana		2
			Missouri		2
			Virginia		2
			Arkansas		1
			Illinois		1
			Kansas		1
			Nebraska		1
			Ohio		1
			Pennsylvania		1
			Texas		1
			Total		136

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

	Year Ended
	December 30,			December 31,			January 1,			January 3,
	2006			2005			2005			2004
Restaurants
Company-operated
Open at beginning of period		44			42			42			42
Opened during period		2			1			2			1
Converted to Company		0			4			0			0
Converted to Franchise		(1	)		0			(1	)		0
Closed during period		(1	)		(3	)		(1	)		(1	)
Open at end of period		44			44			42			42
Franchised(a)
Open at beginning of period		127			114			90			77
Opened during period		17			32			31			19
Converted to Company		0			(4	)		0			0
Converted to Franchise		1			0			1			0
Closed during period		(9	)		(15	)(b)		(8	)		(6	)
Open at end of period		136			127			114			90
Total Restaurants		180			171			156			132

^(a) As of March 30, 2007, two franchised restaurants have opened since December 30, 2006, one in Florence, AL and one in Branson, MO, and two franchised restaurants closed, one in Alpharetta, GA and one in Springfield, MO.

^(b) Includes the closing of 9 co-branded restaurants with Taco Bell. The co-branding relationship between the Company and YUM! Brands, Inc. was terminated during 2005.

     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.

     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 (double drive-through) 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 December 30, 2006, the number of restaurants with indoor dining was 36 Company-operated facilities and 127 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

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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 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 four to nine restaurants. Each district manager reports directly to the 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 five 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%, approximately 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 approximately 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, 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, 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.

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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. The Company will continue to promote the development of franchised restaurants in existing markets enabling franchisees to increase overall spending on advertising to drive guest traffic and minimize distribution costs.

     Franchisee Support Services.The Company maintains a staff of six well-trained and experienced franchised field consultants 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.

     Each franchise field consultant 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 Company 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 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 residential, commercial and industrial characteristics of the area, geographic factors, population of the area and the

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previous experience of the franchisee. The franchisee’s development schedule for the restaurants is set forth in the area development agreement. As of December 30, 2006, 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 238 restaurants by the end of August 31, 2013. Of the 136 franchised restaurants open as of December 30, 2006, 76 were being operated under area development agreements by multiple unit franchisees and 60 were being operated under single franchise agreements by single unit franchisees. The Company may revoke an area development agreement of any franchisee that is unsuccessful in meeting its projected development schedule. No area development agreements were terminated during 2004 or 2005; however, during 2006 the Company terminated four of these agreements which related to the development of up to 44 stores and total deferred fees (net of sales commissions) of $99,100 due to lack of required development under the agreements. The Company does anticipate the termination of at least eleven additional agreements in 2007, which relate to the development of up to 54 stores. The total deferred fees associated with these agreements (net of sales commissions) are approximately $258,000, of which the Company will recognize a portion or all upon termination of these agreements. 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 the upfront area development fee will by $20,000, and the franchise fee will be $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.

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., Wendy’s International, Inc. and Chik-Fil-A. 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

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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 upscale and 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.

     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 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.

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Employees

     As of March 1, 2006, the Company employed approximately 1,000 persons in its restaurant operations, 37 of whom are corporate personnel, 138 of whom are restaurant management and supervisory personnel and the remainder of whom are hourly restaurant personnel.

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 links to 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.

ITEM 1A. RISK FACTORS

We face the possibility of additional actions relating to our past stock option granting practices.

     As a result of our Audit Committee’s review of our historical stock option granting practices, our Audit Committee has concluded that incorrect measurement dates were used for financial accounting purposes for stock option grants made in certain prior periods. As a result, we have recorded additional compensation expense, and related tax effects, with regard to certain past stock option grants. All of these adjustments were recorded in the financial statements included in our Quarterly Report on Form 10-Q for the quarter ended September 30, 2006. Our Audit Committee’s review and related activities have required us to incur substantial expenses for legal, accounting, tax and other professional services, have diverted management’s attention from our business, and could in the future harm our business, financial condition, results of operations and cash flows. While we believe that we have made appropriate judgments in determining the correct measurement dates for our stock option grants, the SEC may disagree with the manner in which we have accounted for and reported the financial impact. Accordingly, there is a risk that we may have to restate our prior financial statements, amend prior filings with the SEC or take other actions not currently contemplated. In addition, we may be exposed to greater risks associated with possible future government actions and shareholder lawsuits relating to our past stock option granting practices and we can provide no assurance regarding the initiation or outcomes of such actions or lawsuits. For a description of the Audit Committee’s review and findings, see Item 1 — Business under “Recent Developments”.

Our ability to open and operate new restaurants is subject to factors beyond our control.

     Our growth strategy depends in large part on our ability and the ability of our franchisees to timely and efficiently open new restaurants and to operate these restaurants on a profitable basis. Delays or failures in opening new restaurants could materially and adversely affect our planned growth. The success of our planned expansion will depend upon numerous factors, many of which are beyond our control, including the following:

• our ability to identify, and secure an adequate supply of, available and suitable restaurant sites;

• availability and retention of qualified operating personnel;

• increases in minimum wage and other operating costs cost;

• shortages in raw food products and volatility of commodity prices;

• consumer preferences, spending patterns and demographic trends;

• securing required governmental approvals and permits;

• competition in our markets and competitive discounting;

• availability of capital; and

• the possibility of unforeseen events affecting our industry generally and in the Southeastern region of the United States in particular.

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The locations of our Company-owned and franchised restaurants are critical to our success.

     Our success is dependent on our ability to identify and secure suitable locations for our Company-owned and franchised restaurants. Factors we typically review in considering any potential restaurant locations include traffic count, speed of traffic, convenient access, size and configuration, demographics and density of population, visibility and cost, as well as potential competition and sales and traffic counts of national and regional chain restaurants operating in the area. The sales performance and guest counts for our restaurants may be adversely affected in the event one or more of our competitors opens new restaurants in close proximity to our locations.

Our business is dependent on the availability and retention of qualified operating personnel.

     Our success depends in part upon our ability to attract, motivate and retain a sufficient number of qualified managerial and other employees. Qualified individuals needed to fill these positions are in short supply in some areas. The inability to recruit and retain these individuals may delay the planned openings of new restaurants or result in high employee turnover in existing restaurants, which could harm our business. Additionally, competition for qualified employees could require us to pay higher wages to attract sufficient employees, which could result in higher labor costs. Most of our employees are paid on an hourly basis. These employees are paid in accordance with applicable minimum wage regulations. Accordingly, any increase in the minimum wage, whether state or federal, could have a material adverse impact on our business.

Our operations are susceptible to the cost of and changes in food availability.

     Our profitability depends in part on our ability to anticipate and react to changes in food costs. Various factors beyond our control, including adverse weather conditions, governmental regulation, production, availability, recalls of food products and seasonality may affect our food costs or cause a disruption in our supply chain. Beef and chicken represent a significant portion of our food purchases. Changes in the price or availability of chicken or beef could materially adversely affect our profitability. We cannot predict whether we will be able to anticipate and react to changing food costs by adjusting our purchasing practices and menu prices, and a failure to do so could adversely affect our operating results.

Changes in consumer preferences could negatively impact our results of operations.

     Our menu features made-to-order gourmet Black Angus hamburgers and chicken sandwiches, fresh salads, chili and other special entrees as well as hand-dipped milkshakes, fresh-made lemonade and fresh-baked cobbler. Our continued success depends, in part, upon the popularity of these foods in the quick serve restaurant market. 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 upscale and are, or are perceived to be, healthful, nutritious, low in calories and low in fat content. Our success will depend in part on our ability to anticipate and respond to changing consumer preferences, tastes and eating and purchasing habits, as well as other factors affecting the food service industry, including new market entrants and demographic changes.

Health concerns relating to the consumption of beef or chicken could negatively impact our results of operations.

     Like other restaurant chains, consumer preferences could be affected by health concerns about the avian influenza, also known as bird flu, or the consumption of beef, or negative publicity concerning food quality, illness and injury generally, such as negative publicity concerning E. coli, “mad cow” or “foot-and-mouth” disease or the publication of government or industry findings concerning food products served by us. This negative publicity may adversely affect demand for our food and could result in a decrease in guest traffic to our restaurants.

We are subject to government regulation that may adversely hinder or impact the growth of our business.

     We are 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 the rule. State laws that regulate the offer and sale of franchises and the franchisor — franchisee relationship presently exist in a substantial number of states.

17

     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 also subject to federal and state environmental regulations. 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.

     State and federal labor laws that govern the relationship with employees of our Company-owned and franchised restaurants, such as minimum wage requirements, overtime and working conditions and citizenship requirements. Significant numbers of the food service and preparation personnel at our restaurants are paid at rates governed by the federal minimum wage. Accordingly, further increases in the minimum wage would increase our labor costs and may have an adverse effect on the Company’s operating margins.

Our success depends on our ability to compete effectively in the quick service restaurant industry.

     The restaurant industry, particularly the fast food segment, is highly competitive with respect to price, service, food quality and location. We compete with numerous well-established competitors possessing substantial financial, marketing, personnel and other resources. In addition, we compete with national, regional and local fast food chains, many of which specialize in or offer quick serve hamburger and chicken products. We also expect 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.

     We compete primarily based on the quality of our food and guest service, rather than price. We implemented a menu price increase of approximately 3% effective in October 2006 in order to partially offset increased costs of beef and other operating expenses. Although we have not experienced significant consumer resistance to our past price increases, we cannot provide assurance that these or other future price increases will not deter guests from visiting our restaurants in favor of lower-price competitors.

If our franchisees cannot develop new restaurants, our growth and success may be impeded.

     Our ability to grow is dependent on the development of franchised restaurants 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. Under our current form of area development agreement, franchisees must develop a predetermined number of restaurants in their area according to a schedule that lasts for the term of their development agreement. The Company may revoke an area development agreement of any franchisee that is unsuccessful in meeting its projected development schedule. The Company anticipates the termination of at least eleven area development agreements, which relate to the development of up to 54 stores, during 2007 due to lack of required development under the agreements.

Our expansion into new markets may present increased risks due to our unfamiliarity with the area.

     Some of our new restaurants will be located in areas where we have little or no meaningful experience and where there is the lack of market awareness of the Back Yard Burgers^® brand. Those markets may have competitive conditions, consumer tastes and discretionary spending patterns that are different from our existing markets, which may cause our new restaurants to be less successful than restaurants in our existing markets.

The acquisition of existing restaurants from our franchisees may have an adverse impact on our operating results or financial condition.

     We may seek to selectively acquire existing restaurants from our franchisees who are seeking an exit strategy. To do so, we would need to identify suitable acquisition candidates, negotiate acceptable acquisition terms and obtain appropriate financing. Future acquisitions of existing restaurants from our franchisees could result in the incurrence of contingent liabilities and impairment charges related to goodwill and other intangible assets, any of which could harm our business, results of operations and financial condition.

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Our restaurants are located primarily in the Southeast region of the United States and, as a result, we are sensitive to economic and other trends and developments in this region.

     As of December 30, 2006, our operations included 44 Company-operated restaurants and 136 franchised restaurants in the Southeast region of the United States, primarily in the states of Alabama, Arkansas, Florida, Georgia, Mississippi, Missouri and Tennessee. As a result, we are particularly susceptible to adverse trends and economic conditions in this region, including its labor market. In addition, given our geographic concentration, negative publicity regarding any of our restaurants in the Southeastern United States could have a material adverse effect on our business and operations, as could other regional occurrences such as local strikes, energy shortages or increases in energy prices, droughts, earthquakes, fires or other natural disasters.

Our franchisees could take actions that could harm our business.

     Franchisees are independent contractors and are not our employees. We provide training and support to franchisees; however, franchisees operate their restaurants as independent businesses. Consequently, the quality of franchised restaurant operations may be diminished by any number of factors beyond our control. Moreover, franchisees may not successfully operate restaurants in a manner consistent with our standards and requirements, or may not hire and train qualified managers and other restaurant personnel. Our image and reputation, and the image and reputation of other franchisees, may suffer materially and system-wide sales could significantly decline if our franchisees do not operate successfully.

If we are not able to transition the role of CEO to a qualified person, our business could suffer.

     Our growth in the past has depended on the services and performance of Lattimore M. Michael, our Chairman and Chief Executive Officer. On February 27, 2006, we announced that we would separate the roles of Chairman and CEO and that, upon retaining an individual to serve as President and CEO of the Company, Mr. Michael would resign from his position as CEO. Our future performance will depend on our ability to recruit and retain an individual to serve as President and CEO of the Company. Competition for qualified executives is intense. The inability to attract additional qualified personnel as needed could materially harm our business.

Compliance with changing regulation of corporate governance and public disclosure may result in additional expense.

     Keeping abreast of, and in compliance with, changing laws, regulations and standards relating to corporate governance and public disclosure, including the Sarbanes-Oxley Act of 2002, new SEC regulations and Nasdaq Stock Market rules, has required an increased amount of management attention and external resources. We remain committed to maintaining high standards of corporate governance and public disclosure. As a result, we intend to invest all reasonably necessary resources to comply with evolving standards, and this investment may result in increased general and administrative expenses and a diversion of management time and attention from revenue generating activities to compliance-related activities.

Our future success depends on our ability to protect our proprietary information.

     Our business prospects will depend in part on our ability to develop favorable consumer recognition of the Back Yard Burgers^® name and logo. Although Back Yard Burgers^® and the kettle and flame logo are federally registered trademarks with the United States Patent and Trademark Office; our trademarks could be infringed in ways that leave us without redress.

A significant increase in litigation could have a material adverse effect on our results of operations, financial condition and business prospects.

     As a member of the restaurant industry, we are sometimes the subject of complaints or litigation from guests alleging illness, injury or other food quality, health or operational concerns. Adverse publicity resulting from these allegations could harm our restaurants, regardless of whether the allegations are valid or whether we are liable. We are subject to the same risks of adverse publicity resulting from these sorts of allegations even if the claim involves one of our franchisees.

ITEM 1B. UNRESOLVED STAFF COMMENTS

     None

19

ITEM 2. PROPERTIES

     Of the 44 Company-operated restaurants as of December 30, 2006, the Company has entered into leases, as lessee, for 30 restaurants. The Company owns the real property for 14 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 13 Company-operated restaurants occupied under a ground lease is approximately $3,700 per month. For the 17 restaurants where the Company leases the building as well as the site, the average monthly cost is approximately $6,000 per month. Of the 30 restaurant leases, 23 are operating leases and 7 are capital leases.

     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 August 31, 2007 and provides for an average monthly rent of approximately $6,700. The Company also has a National Training Center located in approximately 2,500 square feet of lease space at 7780 Stage Road, Bartlett, Tennessee, 38135. This lease expires July 31, 2014 and provides for an average monthly rent of approximately $3,500. BYB Properties, Inc., a wholly-owned subsidiary of the Company, rents nominal office space at 103 Faulk Road, Suite 200, Wilmington, Delaware 19803. The average monthly rent for this space is approximately $400.

ITEM 3. LEGAL PROCEEDINGS

     The Company is subject to legal proceedings, claims and liabilities, such as sexual harassment, slip and fall cases, etc., which arise in the ordinary course of business and are generally covered by insurance. In the opinion of management, the amount of the ultimate liability with respect to those actions will not have a materially adverse impact on our financial position or results of operations and cash flows.

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

     None.

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 Capital Market, Inc. 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 Capital Market. Such price information contains inter-dealer prices, without retail mark-up, mark-down or commissions paid, and may not necessarily reflect actual transactions.

Quarter Ended	High		Low
April 2, 2005	$	7.53	$	5.76
July 2, 2005	$	6.04	$	5.13
October 1, 2005	$	5.80	$	4.70
December 31, 2005	$	5.55	$	4.75
March 31, 2006	$	5.07	$	4.32
June 30, 2006	$	5.80	$	4.60
September 29, 2006	$	6.05	$	5.00
December 30, 2006	$	6.11	$	5.08

     At March 30, 2007, the common stock of record was held by approximately 500 record stockholders. On March 30, 2007, the last sale price for the common stock as reported by NASDAQ Capital Market was $5.41 per share.

20

     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.

PERFORMANCE GRAPH

     The graph below shows a comparison for the past five years of the cumulative total stockholder returns, assuming reinvestment of dividends (the Company paid no dividends during this period), for the Company’s common stock, the S&P SmallCap 600 Index, and the S&P SmallCap 600 Restaurants Index, assuming a $100 investment as of the beginning of the period.

			INDEXED RETURNS
	Base		Years Ending
	Period
Company/Index	2001		2002		2003		2004		2005		2006
Back Yard Burgers, Inc.		100		97.99		156.76		188.44		124.87		131.91
S&P Smallcap 600 Index*		100		84.55		117.69		144.11		155.18		178.64
S&P SmallCap 600 Restaurants*		100		93.25		126.15		153.37		157.11		174.75

* Source — Standard & Poor’s Investment Services Division

21

ITEM 6. SELECTED FINANCIAL DATA

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

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

     The information required by Items 6, 7, 7A and 8 is incorporated herein by reference from the Financial Supplement.

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

     On May 18, 2006 Back Yard Burgers, Inc., (the “Company”) dismissed PricewaterhouseCoopers, LLP as the Company’s independent registered public accounting firm, as described in the Company’s Current Report on Form 8-K previously filed with the Securities and Exchange Commission on May 24, 2006.

     On August 11, 2006 the Company engaged the firm of BDO Seidman, LLP as its new Independent Registered Public Accounting Firm, as described in the Company’s Quarterly Report on Form 10-Q for the period ended July 1, 2006 and filed with the Securities and Exchange Commission on August 15, 2006. The engagement of BDO Seidman, LLP was approved by the Company’s Board of Directors. During the fiscal years 2004 and 2005, the Company did not consult with BDO Seidman, LLP on any matters of accounting principles or practices, financial statement disclosure, or auditing scope or procedure. The Company has authorized PricewaterhouseCoopers, LLP, its previous Independent Registered Public Accounting Firm, to respond fully to all inquiries from BDO Seidman, LLP.

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 amended, the “Exchange Act”) as of the end of the period covered by the report. The evaluation was 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”).

     Based on this evaluation, which included the findings of the Company’s Audit Committee as part of its review of the Company’s historical stock option granting practices and the adjustments to our consolidated financial statements resulting from that review, our CEO and CFO concluded that our disclosure controls and procedures constituted a material weakness in our internal control over financial reporting as of December 30, 2006. In making this determination, we concluded that our controls over the application of accounting policies related to the determination of the measurement date of stock options were ineffective to ensure that these policies complied with accounting principles generally accepted in the United States of America. Specifically, the deficiency in our controls over the application of our stock option accounting policies failed to identify errors in our financial statements, which resulted in adjustments to the Company’s consolidated financial statements. A detailed discussion of the correction of these errors and the impact of the adjustment to our consolidated financial statements is included in Part I, Item 1 under Recent Developments in this Form 10-K.

     We have since corrected these deficiencies in our controls and procedures by implementing a formal policy (the “Policy”) with respect to the granting of options or other equity incentive awards (“Equity Awards”) which includes additional review procedures over the approval and issuance of Equity Awards, including without limitation, stock option grants, and the application of appropriate assumptions and factors affecting our stock option accounting.

     The Policy states that the Board of Directors recognizes that the granting of Equity Awards presents specific legal, tax and accounting issues and that the Policy shall be followed in connection with all issuances of Equity Awards by the Company.

     Under the Policy, the Board of Directors has determined that the Compensation Committee of the Board remains best suited to review and approve Equity Awards. Accordingly, any Equity Awards shall be approved by the

22

Compensation Committee or the full Board of Directors. To avoid the timing issues inherent in the Board or the Compensation Committee acting by unanimous written consent, the Policy requires all Equity Awards to be approved at a meeting (including telephonic meeting) of the Board of Directors or Compensation Committee, as the case may be, and not by written consent.

     The Policy expressly provides that the grant date of any Equity Award shall be the date of the meeting at which the award was approved and the exercise price shall be the closing price of the Company’s common stock on such date on the NASDAQ Capital Market, or any successor to such market on which the Company’s common stock is listed for trading.

     The Policy permits the Company to continue its practice of making grants to existing employees once per year. In the event of an Equity Award being granted to a new employee of the Company (“new hire”), the Policy allows the new hire to be notified that management will recommend to the Board or the Compensation Committee, as the case may be, an Equity Award, but that the Equity Award will not be approved, nor be deemed awarded, unless and until appropriate granting action is taken at a subsequent Board or Compensation Committee meeting following the commencement of employment of the new hire and such Equity Award shall be dated (and the exercise price shall be determined as of) the date of the Board or Compensation Committee meeting at which it is approved.

     The Policy requires that the details of every Equity Award shall be reflected in the minutes of the requisite Board or Compensation Committee meeting, which minutes shall be maintained in the respective minute books. These details will include, at a minimum, the following information:

• Name of grantee;

• Number of shares of common stock covered by any options or other Equity Awards being granted to the grantee;

• Statement that the grant date is the date of the meeting at which the options are approved;

• Statement that the exercise price of the option or other Equity Award shall be the closing price of the Company’s common stock on the Nasdaq Stock Market (or applicable successor market) on such date.

     Neither the Board of Directors nor Compensation Committee will be authorized to grant an unallocated “pool” of options to a group of individuals or otherwise delegate the authority to grant any options or other Equity Awards to any other person.

     Under the Policy, all Equity Awards shall be promptly communicated to the necessary accounting and legal personnel to assure proper reporting and accounting of the awards. Grant award packages shall be promptly distributed to each grantee, and in no event shall such communication be later than 20 days from the approval date.

     Management believes these changes will formalize and improve the internal practices for timely approving, documenting, recording and reporting stock options grants.

     There were no changes in our internal control during the quarter ended December 30, 2006, that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. However, as described above, we have subsequently changed our accounting policies regarding the review, analysis and recording of stock option grants, including the selection and monitoring of appropriate assumptions and guidelines to be applied during the review and analysis of all stock option grants.

ITEM 9B. OTHER INFORMATION

     None.

23

PART III

ITEM 10. DIRECTORS, EXECUTIVE AND CORPORATE GOVERNANCE

ITEM 11. EXECUTIVE COMPENSATION

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

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE

ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES

     The information required by Items 10, 11, 12, 13 and 14 is incorporated herein by reference from the Company’s definitive proxy statement which will be filed with the SEC within 120 days after the close of our fiscal year.

PART IV

ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

(a)(1) Consolidated Financial Statements

     The following consolidated financial statements, notes related thereto and report of independent registered public accounting firm 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 December 30, 2006 and December 31, 2005

• Consolidated Statements of Operations for the years ended December 30, 2006 and December 31, 2005 and January 1, 2005

• Consolidated Statements of Changes in Stockholders’ Equity for the years ended December 30, 2006 and December 31, 2005 and January 1, 2005

• Consolidated Statements of Cash Flows for the years ended December 30, 2006 and December 31, 2005 and January 1, 2005

• Notes to Consolidated Financial Statements

• Reports of Independent Registered Public Accounting Firms

(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.

24

(a)(3) Exhibits

Exhibit
Number		Description
	3.1	Restated Certificate of Incorporation. (4)
	3.2	Amended and Restated By-Laws. (2)
	4.1	Specimen Common Stock Certificate. (2)
	10.1	Employment Agreement, dated April 15, 1993, between the Registrant and Lattimore M. Michael.(1)
	10.2	Form of Incentive Stock Option Plan of 1993. (1)
	10.3	Lease, dated February 1, 1990, between Trezevant Properties and the Registrant.(1)
	10.4	Joint Venture Agreement of Lester’s Back Yard Burgers Joint Venture I by and among William L. Lester, Pattie F. Lester, Patricia B. Litow, Elizabeth B. Fox and Back Yard Burgers, Inc., dated November 15, 1994. (3)
	10.5	Joint Venture Agreement of Lester’s Back Yard Burgers Joint Venture II by and among William L. Lester, Pattie F. Lester, Patricia B. Litow, Elizabeth B. Fox, Charles B. Fox, David P. Fox and Back Yard Burgers, Inc., dated November 15, 1994. (3)
	10.6	1995 Employee Stock Purchase Plan of Back Yard Burgers, Inc. (4)
	10.7	The 1995 Incentive Award Plan of Back Yard Burgers, Inc. (4)
	10.8	Joint Venture Agreement of Lester’s Back Yard Burgers Joint Venture III by and among Pattie F. Lester, Patricia B. Litow, Elizabeth B. Fox, Charles B. Fox, David P. Fox, Alexandra B. Litow, Andrew R. Litow and Back Yard Burgers, Inc., dated September 12, 1995. (4)
	10.9	Capital Contribution Agreement between Back Yard Burgers, Inc. and BYB Properties, Inc. dated October 10, 1997. (5)
	10.10	Trademark Assignment by Back Yard Burgers, Inc. to BYB Properties, Inc. dated October 10, 1997.(5)
	10.11	Trademark License Agreement between BYB Properties, Inc. and Back Yard Burgers, Inc. dated October 10, 1997.(5)
	10.12	Revolving Loan Agreement regarding Uncommitted Line of Credit Agreement from BYB Properties, Inc. to Back Yard Burgers, Inc. dated October 10, 1997.(5)
	10.13	Promissory Note by and between BYB Properties, Inc. and Back Yard Burgers, Inc. dated October 10, 1997.(5)

25

Exhibit
Number		Description
	10.14	Tax Sharing Agreement between BYB Properties, Inc. and Back Yard Burgers, Inc. dated October 10, 1997.(5)
	10.15	Form of Joint Venture Agreement of Lester’s Back Yard Burgers Joint Venture IV by and among William L. Lester, Pattie F. Lester, Alexandra B. Litow, Andrew R. Litow and Back Yard Burgers, Inc., dated August 28, 1998. (6)
	10.16	Lease agreement by and between Belz Devco, L.P. and Back Yard Burgers, Inc. dated November 12, 1999.(7)
	10.17	2002 Equity Incentive Plan of Back Yard Burgers, Inc.(8)
	10.18	Loan agreement by and between First Tennessee Bank and Back Yard Burgers, Inc. dated February 11, 2003.(9)
	10.19	Lease agreement by and between Batesville Back Yard Properties, LLC and Back Yard Burgers, Inc. dated May 1, 2002.(10)
	10.20	Severance Agreement, dated October 11, 2004, between the Registrant and Lattimore M. Michael.(11)
	10.21	Separation Agreement by and between Back Yard Burgers, Inc. and William N. Griffith dated January 7, 2005.(12)
	10.22	Consulting Services Agreement by and between Back Yard Burgers, Inc. and William N. Griffith dated January 7, 2005.(12)
	10.23	Amendment to Stock Option Plans and Agreement by and between Back Yard Burgers, Inc. and William N. Griffith dated January 7, 2005.(12)
	10.24	Franchise Agreement by and between Back Yard Burgers, Inc. and William N. Griffith dated January 7, 2005.(12)
	10.25	Area Development Agreement by and between Back Yard Burgers, Inc. and William N. Griffith dated January 7, 2005.(12)
	10.26	Agreement for Purchase and Sale of Assets dated as of the 18th day of October, 2005 by and among Back Yard Burgers, Inc., Charles L. Rodgers, Tennessee, Southern Restaurant Development, LLC, and CLR Management, LLC. (13)
	10.27	Loan Agreement dated November 17, 2005 by and among First Tennessee Bank National Association and Back Yard Burgers, Inc. and its subsidiaries. (14)
	10.28	Form of Secured Promissory Note dated November 17, 2005 in the principal amount of $6,200,000 payable by Back Yard Burgers, Inc. to First Tennessee Bank National Association.(14)
	10.29	Separation Agreement and General Release dated February 27, 2006 by and between Michael W. Myers and Back Yard Burgers, Inc. (15)
	10.30	Employment Agreement dated April 4, 2006 by and between Lattimore M. Michael and Back Yard Burgers, Inc. (16)
	10.31*	Retention and Change in Control Agreement dated October 9, 2006 by and between Michael G. Webb and Back Yard Burgers, Inc.
	21*	Subsidiaries of the Registrant.
	23.1*	Consents of Independent Registered Public Accounting Firms

26

Exhibit
Number		Description
	31.1*	Certification by the Chief Executive Officer.
	31.2*	Certification by the Chief Financial Officer.
	32.1*	Certification by the Chief Executive Officer.
	32.2*	Certification by the Chief Financial Officer.

*	Filed herewith.
(1)	Previously filed with the Securities and Exchange Commission (the “Commission”) as an Exhibit to the Registrant’s Form SB-2 on April 20, 1993 (File No. 33-61356).
(2)	Previously filed with the Commission as an Exhibit to the Registrant’s Amendment No. 2 to Form SB-2 on June 25, 1993 (File No. 33-61356).
(3)	Previously filed with the Commission as an Exhibit to the Registrant’s Form 10-K, dated December 31, 1994 and filed on March 31, 1995.
(4)	Previously filed with the Commission as an Exhibit to the Registrant’s Form 10-QSB, dated September 30, 1995 and filed on November 14, 1995.
(5)	Previously filed with the Commission as an Exhibit to the Registrant’s Form 10-K, dated January 3, 1998 and filed on April 3, 1998.
(6)	Previously filed with the Commission as an Exhibit to the Registrant’s Form 10-QSB dated October 3, 1998 and filed on November 17, 1998.
(7)	Previously filed with the Commission as an Exhibit to the Registrant’s Form 10-K dated January 1, 2000 and filed on March 31, 2000.
(8)	Previously filed with the Commission as an Exhibit to the Registrant’s Form 10-K dated December 29, 2001 and filed on March 28, 2002.
(9)	Previously filed with the Commission as an Exhibit to the Registrant’s Form 10-Q dated March 29, 2003 and filed on May 13, 2003.
(10)	Previously filed with the Commission as an Exhibit to the Registrant’s Form 10-K dated January 3, 2004 and filed on April 2, 2004.
(11)	Previously filed with the Commission as an Exhibit to the Registrant’s Form 10-Q dated October 2, 2004 and filed on November 16, 2004.
(12)	Previously filed with the Commission as an Exhibit to the Registrant’s Form 10-K dated January 1, 2005 and filed on April 18, 2005.
(13)	Previously filed with the Commission as an Exhibit to the Registrant’s Form 8-K filed on October 24, 2005.
(14)	Previously filed with the Commission as an Exhibit to the Registrant’s Form 8-K filed on November 18, 2005.
(15)	Previously filed with the Commission as an Exhibit to the Registrant’s Form 8-K filed on February 28, 2006.
(16)	Previously filed with the Commission as an Exhibit to the Registrant’s Form 8-K filed on April 4, 2006.

27

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.

BACK YARD BURGERS, INC.
By:	/s/ Lattimore M. Michael
	Lattimore M. Michael, Chairman
	and Chief Executive Officer

Date:April 16, 2007

     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.

Signature	Title	Date
/s/ Lattimore M. MichaelLattimore M. Michael	Chairman of the Board and Chief Executive Officer	April 16, 2007
/s/ Joseph L. WeissJoseph L. Weiss	Chief Operating Officer and Director	April 16, 2007
/s/ Michael G. WebbMichael G. Webb	Chief Financial Officer	April 16, 2007
/s/ W. Kurt HenkeW. Kurt Henke	Director	April 16, 2007
/s/ Jim L. PetersonJim Peterson	Director	April 16, 2007
/s/ William B. Raiford, IIIWilliam B. Raiford, III	Director	April 16, 2007
/s/ Gina A. BalducciGina A. Balducci	Director	April 16, 2007
/s/ Dane C. AndreeffDane C. Andreeff	Director	April 16, 2007

28

INDEX TO FINANCIAL SUPPLEMENT
TO ANNUAL REPORT ON FORM 10-K
FOR THE YEAR ENDED DECEMBER 30, 2006

	Page
Selected Consolidated Financial Data		F-1
Management’s Discussion And Analysis of Financial Condition And Results Of Operations		F-4
Consolidated Balance Sheets as of December 30, 2006 and December 31, 2005		F-16
Consolidated Statements of Operations for the years ended December 30, 2006 and December 31, 2005 and January 1, 2005		F-17
Consolidated Statements of Changes in Stockholders’ Equity for the years ended December 30, 2006 and December 31, 2005 and January 1, 2005		F-18
Consolidated Statements of Cash Flows for the years ended December 30, 2006 and December 31, 2005 and January 1, 2005		F-19
Notes to the Consolidated Financial Statements		F-20
Reports of Independent Registered Public Accounting Firms		F-38

Selected Consolidated Financial Data

(in thousands, except per share data)

     The selected consolidated financial data presented below for each of the years in the five-year period ended December 30, 2006 was derived from the Company’s audited consolidated financial statements. Fiscal years 2002 and 2003 were restated in the Company’s fiscal year 2004 Annual Report on Form 10-K to reflect the correction of errors in lease accounting (see the Company’s Annual Report on Form 10-K for the year ended January 1, 2005 for a detailed description of this issue and related adjustments). The restatement to correct errors in lease accounting resulted in after-tax charges of 84,000 and $80,000 in 2003 and 2002, respectively. The cumulative effect of the correction of errors in lease accounting on retained earnings as of December 29, 2001 was a reduction of $445,000.

	December 30,			December 31,			January 1,		January 3,			December 28,
	2006			2005			2005		2004(1)			2002
									(restated)			(restated)
OPERATIONS
Restaurant Sales	$	37,423		$	34,479		$	34,912	$	34,279		$	30,951
Total revenues		44,710			41,001			40,183		38,647			34,464
Total royalties(2)		4,792			4,143			3,108		2,621			2,172
Income(loss) before income taxes		1,384			(117	)		1,789		1,772			2,082
Net income		876	(4)		(44	)		1,264		1,225			1,397
FINANCIAL POSITION
Total assets	$	33,410		$	31,641		$	24,269	$	24,769		$	22,405
Property and equipment, net		23,393			23,035			17,746		18,672			17,307
Debt		9,952			10,965			4,900		5,676			6,250
Shareholders’ equity		17,305			15,302			14,476		13,078			11,759
PER SHARE DATA
Net (loss) income — basic	$	0.17		$	(0.01	)	$	0.26	$	0.26		$	0.30
Net (loss) income — diluted		0.17			(0.01	)		0.25		0.24			0.28
Dividends		0.00			0.00			0.00		0.00			0.00
Market price at year end		5.25			4.97			7.50		6.52			4.00
OTHER DATA
Capital expenditures		2,806	(3)		8,614	(3)		2,178		2,702	(3)		4,861

⁽¹⁾ 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 30, 2006, December 31 2005, January 1, 2005 and December 28, 2002 contain 52 weeks.

⁽²⁾ Total royalties are derived from sales at franchised restaurants of $121.6 million in 2006, $104.3 million in 2005, $78.3 million in 2004, $66.2 million in 2003 and $54.0 million in 2002.

⁽³⁾ Expenditures exclude non-cash transactions of $305,000 in 2006, $646,000 in 2005 and $627,000 in 2003.

⁽⁴⁾ As described in Note 3 of the Notes to the Consoldiated Financial Statements, the Company recorded $311,000 (net of a $118,000 tax benefit) in compensation expense as a result of its review of the Company’s historical stock option practices.

F-1

The selected consolidated financial data presented below is a summary of the unaudited quarterly results of operations for the year ended December 30, 2006:

	Year Ended December 30, 2006
	First			Second			Third			Fourth
	Quarter			Quarter			Quarter			Quarter
Income Statement Data:
Revenues:
Restaurant sales	$	8,932		$	9,686		$	9,444		$	9,361
Franchise and area development fees		86			204			39			98
Royalty fees		1,135			1,245			1,207			1,205
Advertising fees		297			314			303			302
Other		191			246			212			203
Total Revenues		10,641			11,695			11,205			11,169
Expenses:
Cost of restaurant sales		2,997			3,120			2,987			2,902
Restaurant operating expenses		4,290			4,646			4,580			4,669
General and administrative		1,748			1,634			2,045	(1)		2,042	(2)
Advertising		685			668			737			754
Depreciation		551			543			548			550
Other operating income		(162	)		—			—			—
Total expenses		10,109			10,611			10,897			10,917
Operating income (loss)		532			1,084			308			252
Interest income		7			16			36			31
Interest expense		(189	)		(198	)		(207	)		(208	)
Other, net		(23	)		(24	)		(28	)		(5	)
Income (loss) before income taxes		327			878			109			70
Income tax expense (benefit)		110			302			71			25
Net income (loss)	$	217		$	576		$	38		$	45
Income per share:
Basic	$	0.04		$	0.11		$	0.01		$	0.01
Diluted	$	0.04		$	0.11		$	0.01		$	0.01
Weighted average number of common shares and common equivalent shares outstanding:
Basic		4,943			5,022			5,105			5,123
Diluted		5,105			5,151			5,105			5,200

⁽¹⁾ The Company recorded $429,000 in stock compensation expense as general and administrative expenses in the third quarter of 2006 in conjunction with its review of historical stock option practices as described in Note 3 of the Notes to the Consolidated Financial Statements.

⁽²⁾ The Company incurred $350,000 in fees in the fourth quarter of 2006 associated with its review of historical stock option practices as described in Note 3 of the Notes to the Consolidated Financial Statements.

F-2

The selected consolidated financial data presented below is a summary of the unaudited quarterly results of operations for the year ended December 31 2005:

	Year Ended December 31, 2005
	First									Fourth
	Quarter			Second			Third			Quarter
	(a)			Quarter			Quarter			(b)
Income Statement Data:
Revenues:
Restaurant sales	$	8,208		$	9,072		$	8,450		$	8,749
Franchise and area development fees		165			146			209			109
Royalty fees		931			1,038			1,059			1,115
Advertising fees		244			271			267			279
Other		129			210			144			206
Total Revenues		9,677			10,737			10,129			10,458
Expenses:
Cost of restaurant sales		2,639			2,951			2,749			2,786
Restaurant operating expenses		3,995			4,275			4,089			4,539
General and administrative		2,054			1,579			1,531			1,659
Advertising		554			713			598			682
Depreciation		563			515			523			605
Other operating income		—			—			—			(5	)
Impairment of long-lived assets		—			—			—			986
Total expenses		9,805			10,033			9,490			11,252
Operating income		(128	)		704			639			(794	)
Interest income		6			7			7			7
Interest expense		(108	)		(104	)		(100	)		(140	)
Other, net		(21	)		(23	)		(26	)		(43	)
Income before income taxes		(251	)		584			520			(970	)
Income tax (benefit) expense		(88	)		180			166			(331	)
Net Income	$	(163	)	$	404		$	354		$	(639	)
Income per share:
Basic	$	(0.03	)	$	0.08		$	0.07		$	(0.13	)
Diluted	$	(0.03	)	$	0.08		$	0.07		$	(0.13	)
Weighted average number of common shares and common equivalent shares outstanding:
Basic		4,791			4,806			4,834			4,900
Diluted		4,791			5,107			5,072			4,900

(a)	The Company recorded a non-cash charge of approximately $358,000 (net of a tax benefit of $153,000) relating to the extension of the exercise date of certain stock options upon the resignation of an officer/director on January 7, 2005 during the first quarter of 2005.
(b)	The Company recorded a non-cash charge of approximately $600,000 (net of a tax benefit of $386,000) under FAS No. 144 relating to three Company-operated stores during the fourth quarter of 2005.

F-3

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

Introduction

     The following discussion and analysis should be read in conjunction with the Back Yard Burgers’ (the “Company”) consolidated financial statements and notes thereto, included elsewhere in this annual report.

     As of December 30, 2006, the Back Yard Burgers system included 180 restaurants, of which 44 were Company-operated and 136 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 and depreciation) relate directly to Company-operated restaurants, while general and administrative and advertising 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 the public and promotional activities.

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.

	For the Years Ended
	December 30,			December 31,			January 1,
	2006			2005			2005
Revenues
Restaurant sales		83.7	%		84.1	%		86.9	%
Franchise and area development fees		1.0			1.5			1.5
Royalty fees		10.7			10.1			7.7
Advertising fees		2.7			2.6			2.2
Other operating revenue		1.9			1.7			1.7
Total revenue		100.0	%		100.0	%		100.0	%
Costs and Expenses
Cost of restaurant sales(1)		32.1	%		32.3	%		31.7	%
Restaurant operating expenses(1)		48.6			49.0			47.9
General and administrative		16.7			16.6			13.3
Advertising		6.4			6.2			6.6
Depreciation		4.9			5.4			5.2
Other operating income		(0.4	)		(0.0	)		(0.2	)
Impairment of long-lived assets		0.0			2.4			0.0
Operating income		4.9			1.0			5.9
Interest income		0.2			0.1			0.0
Interest expense		(1.8	)		(1.1	)		(1.2	)
Other, net		(0.2	)		(0.3	)		(0.2	)
Income (loss) before taxes		3.1			(0.3	)		4.5
Income tax expense(2)		36.7			62.4			29.3
Net (loss) income		2.0			(0.1	)		3.1

⁽¹⁾ As a percentage of restaurant sales.

⁽²⁾ As a percentage of income before taxes.

F-4

	For the Years Ended
	December 30,		December 31,		January 1,
	2006		2005		2005
Average annual sales per restaurant open for a full year(1)
Company-operated	$	871,000	$	835,000	$	828,000
Franchised		892,000		823,000		808,000
Combined		885,000		827,000		815,000
Number of restaurants(2)
Company-operated		44		44		42
Franchised		136		127		114
Total		180		171		156

⁽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 30, 2006, two franchised restaurants have opened since December 30, 2006, one in Florence, AL and one in Branson, MO, and two franchised restaurants closed, one in Alpharetta, GA and one in Springfield, MO.

COMPARISON OF FISCAL YEAR 2006 TO FISCAL YEAR 2005

     Restaurant salesat Company-operated restaurants increased $2,944,000, or 8.5%, to $37,423,000 during 2006 from $34,479,000 during 2005. Same-store sales at Company-operated restaurants open for more than eighteen months increased by 2.5% during 2006, resulting in an increase of sales of approximately $829,000. The remaining increase is related to the sales volume differences in the seven units opened, either through acquisition or new construction, in 2005 and 2006, collectively, and the five units divested during the two years.

     Franchise and area development feeswere $427,000 during 2006, compared with $629,000 in 2005. In 2006, the Company recognized approximately $99,000 in fees related to the cancellation of four previously entered area development agreements compared with no cancellation fees in 2005. Net of these fees, the Company recognized $328,000 in 2006 related to franchise and area development fees compared with $629,000 in 2005. Seventeen new franchised restaurants were opened in 2006, for which the Company recognized $328,000, compared with thirty- two new franchised units opened in 2005, for which the Company recognized $629,000. Franchise and area development 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.

     Royalty feesincreased 15.7% to $4,792,000 during 2006 from $4,143,000 during 2005. The increase is the result of an increase in franchised sales upon which the fees are based. Franchise restaurant sales increased to approximately $121.6 million in 2006 from approximately $104.3 million in 2005. The increase in franchised restaurant sales was due to a net unit growth of nine franchised stores in addition to a full year of operations for units opened in 2005.

     Advertising feesincreased 14.6% to $1,216,000 for 2006 from $1,061,000 during 2005. The increase is primarily due to the increase in franchised restaurant sales, upon which a portion of the fees is based. The portion of these fees that are based on sales is a 1% of sales National Advertising Fund fee. As part of the standard franchise agreement, each operating unit contributes 1% of its sales to a National Advertising Fund. Franchise restaurant sales increased to approximately $121.6 million in 2006 from approximately $104.3 million in 2005. The increase in franchised restaurant sales was due to a net unit growth of nine franchised stores in addition to a full year of operations for units opened in 2005. Also included in advertising fees are monies collected from franchisees for direct mail advertising in addition to the 1% National Advertising Fee. In 2006, the Company did not recognize any revenue associated with direct mail advertising funds, whereas in 2005, the Company recognized approximately $23,000.

     Otherrevenues is primarily comprised of sales of proprietary food products to franchisees and payments by certain vendors of the Company primarily as contributions to the National Advertising Fund based upon purchasing volumes of our franchisees. These purchases by franchisees from vendors have no specific incremental impact to costs of the Company. Revenue from sales of proprietary food products is recognized when the products are shipped. Volume based revenue and contributions from our vendors are recognized throughout the accounting period based on the purchase volumes by our franchisees from these vendors. The Company also includes other miscellaneous revenues in other revenue. Other revenue increased 23.7% to $852,000 in 2006 from $689,000 in 2005. The increase in other revenues is primarily due to an increase in funds earned from vendors based on franchisee purchase volumes.

F-5

     Cost of restaurant sales, consisting of food, beverage and paper costs, totaled $12,006,000 during 2006 compared to $11,125,000 during 2005, declined to 32.1% as a percentage of restaurant sales during 2006 from 32.3% for 2005. The primary reasons for the decline in the cost of restaurant sales as a percentage of restaurant sales were attributable to the facts that beef costs decreased approximately 8% during 2006 and the Company implemented a 3.5% menu price increase at Company-operated restaurants effective October 2006.

     Restaurant operating expenses,consisting of labor, supplies, utilities, rent, insurance and certain other unit level operating expenses, increased to $18,185,000 for 2006 from $16,898,000 during 2005. These expenses decreased as a percentage of restaurant sales to 48.6% in 2006 from 49.0% in 2005. Rent decreased as a percentage of sales by a total of 0.6% of sales due to the acquisition of the real property of four existing Company-operated restaurants in the fourth quarter of 2005 that was previously leased. Labor costs increased as a percentage of restaurant sales by 0.3%. Other operating costs, including utilities, insurance, property taxes, credit card discount fees, repairs and maintenance and other unit level operating expenses, decreased as a percentage of sales by a net additional 0.1%.

     General and administrativecosts increased $646,000, or 9.5%, to $7,469,000 during 2006 from $6,823,000 in 2005, increasing as a percentage of total revenue to 16.7% from 16.6% during 2005. As described in Note 3 of the Notes to the Consolidated Financial Statements, during the thirteen weeks ended September 30, 2006, the Company recorded approximately $429,000 in charges relating to the re-determination of measurement dates of certain prior stock option grants as well as $350,000 in fees incurred associated with the Company’s review of its historical stock option granting and pricing practices. Other corporate personnel related costs, including benefit costs, increased by approximately $393,000, but was offset from previous year costs by a decrease of $511,000, which was related to a pre-tax non-cash stock compensation charge relating to the extension of the maturity date of certain stock options upon the resignation of an officer/director on January 7, 2005. Pre-opening costs for new Company-operated restaurants increased by $78,000 over the year-earlier period as the Company had two restaurants under construction for a portion of the fifty-two weeks ended December 30, 2006 compared with one restaurant under construction in the year-earlier period. These increases in general and administrative costs were offset by decreases in other miscellaneous general and administrative costs incurred by the Company during 2006.

     Advertisingexpense, which increased to $2,844,000 for 2006 from $2,547,000 during 2005, increased as a percentage of total revenues to 6.4% in 2006 compared with 6.2% in 2005. The Company spent approximately 5% of net restaurant sales at Company-operated stores on local store advertising, including media and print advertising in the four markets in which the Company-operated restaurants are located during both FY 2006 and FY 2005. In addition, all stores (both Company and franchised stores) contribute 1% of each stores net restaurant sales as advertising fees to the Company’s National Advertising Fund ((see Note 13 of Notes to the Consolidated Financial Statements). Of these advertising fees, the Company spends at least 50% of these funds on the creation of marketing tools; however, in some years, the Company spends more than 50% of these fees on advertising related costs. Fluctuations in the advertising spending as a percentage of total revenues are related to the timing of promotions and exact percentage of the advertising fees earned by the Company’s National Advertising Fund that is spent on the creation of marketing tools.

     Depreciationexpense was $2,192,000 during 2006 compared with $2,206,000 during 2005. Since December 31, 2005, the Company has spent approximately $3.1 million for fixed assets additions; however, the additional depreciation associated with the addition of these assets was offset by other assets, primarily furniture, fixtures and equipment, becoming fully depreciated since December 31, 2005 as well as the disposal of the assets related to three company-operated locations and sale of one company-operated location since the year-earlier period.

     Other operating incomewas $162,000 during 2006 compared with $5,000 during 2005. This income is related to gains on sales of assets in both years. The income recorded in both years is primarily related to the gain associated with the sale of the assets of one Company-operated store in each respective year.

     Impairment of Long-Lived Assetsexpense was $986,000 during 2005. The Company had no impairment charges recorded during 2006. The Company recorded a non-cash impairment charge in the quarter ending December 31, 2005 in the amount of $986,000. The charge consists primarily of the write down of asset values for three Company-operated restaurants. The Company determined that an impairment charge would be required underSFAS No. 144 “Accounting for the Impairment or Disposal of Long-Lived Assets.” The impairment charge results from internal analysis which indicated that the investment for the impacted restaurants will not be fully recovered by anticipated cash flows (see Note 1 of Notes to the Consolidated Financial Statements).

     Interest expenseincreased by $350,000 to $802,000 for the year ended December 30, 2006 from $452,000 in the prior year. Debt outstanding as of December 30, 2006 was $9,952,000, compared with $10,965,000 the year-earlier period. The increase in interest expense was due to an additional borrowing in November 2005 of $6.2

F-6

million to acquire four restaurants in Florida and to purchase the real property of four additional restaurants, previously leased by the Company, of which approximately $6.0 million remained outstanding as of December 30, 2006. While this debt bears interest at a rate of one-month LIBOR + 2%, the Company entered into a swap agreement (see Note 9) in May 2006 which made the effective rate fixed at 7.75%.

     Other, netexpense was $80,000 in 2006 compared with $113,000 in expense for 2005. This decrease was primarily due to a decrease in franchise tax expense of $34,000 for the fifty-two weeks ended December 30, 2006, 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 expensewas $508,000 in 2006 compared with an income tax benefit of $73,000 in 2005. The 2006 expense was related to a pre-tax income of $1,384,000 recognized by the Company in 2006 compared with the benefit recorded for the pre-tax loss of $117,000 in 2005.

COMPARISON OF FISCAL YEAR 2005 TO FISCAL YEAR 2004

     Restaurant salesat Company-operated restaurants decreased $433,000, or 1.2%, to $34,479,000 during 2005 from $34,912,000 during 2004. Same-store sales at Company-operated restaurants open for more than eighteen months decreased by 1.8% during 2005, resulting in a reduction of sales of approximately $606,000. This decrease was offset by $173,000 in additional restaurant sales from the net addition of two new Company-operated restaurants since the prior year.

     Franchise and area development feeswere $629,000 during 2005, compared to $620,000 in 2004. Thirty-two new franchised restaurants were opened in 2005, compared with thirty-one new franchised units opened in 2004. Franchise and area development 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.

     Royalty feesincreased 33.3% to $4,143,000 during 2005 from $3,108,000 during 2004. The increase is the result of an increase in franchised sales upon which the fees are based. Franchise restaurant sales increased to approximately $104.3 million in 2005 from approximately $78.3 million in 2004. The increase in franchised restaurant sales was due to a net unit growth of thirteen franchised stores in addition to a full year of operations for units opened in 2004.

     Advertising feesincreased 22.5% to $1,061,000 for 2005 from $866,000 during 2004. The increase is primarily due to the increase in franchised restaurant sales, upon which a portion of the fees is based. The portion of these fees that are based on sales is a 1% of sales National Advertising Fund fee. As part of the standard franchise agreement, each operating unit contributes 1% of its sales to a National Advertising Fund. Franchise restaurant sales increased to approximately $104.3 million in 2005 from approximately $78.3 million in 2004. The increase in franchised restaurant sales was due to a net unit growth of thirteen franchised stores in addition to a full year of operations for units opened in 2004. Also included in advertising fees are monies collected from franchisees for direct mail advertising in addition to the 1% National Advertising Fee. In 2005, the Company recognized approximately $23,000 in revenue associated with direct mail advertising funds, and in 2004, the Company recognized approximately $84,000.

     Otherrevenues is primarily comprised of sales of proprietary food products to franchisees and payments by certain vendors of the Company primarily as contributions to the National Advertising Fund based upon purchasing volumes of our franchisees. These purchases by franchisees from vendors have no specific incremental impact to costs of the Company. Revenue from sales of proprietary food products is recognized when the products are shipped. Volume based revenue and contributions from our vendors are recognized throughout the accounting period based on the purchase volumes by our franchisees from these vendors. The Company also includes other miscellaneous revenues in other revenue. Other revenue remained relatively flat at $689,000 for 2005 and $677,000 for 2004. The increase in other revenues is primarily due to an increase in the sales of proprietary food products to franchisees.

     Cost of restaurant sales, consisting of food, beverage and paper costs, totaled $11,125,000 during 2005 compared to $11,066,000 during 2004, increasing to 32.3% as a percentage of restaurant sales during 2005 from 31.7% for 2004. The cost of beef increased by 5.6% over the prior year, and the Company also incurred increases in other food costs driven primarily by higher fuel costs over the year-earlier period.

     Restaurant operating expenses,consisting of labor, supplies, utilities, rent, insurance and certain other unit level operating expenses, increased to $16,898,000 for 2005 from $16,726,000 during 2004. These expenses

F-7

increased as a percentage of restaurant sales to 49.0% in 2005 from 47.9% in 2004. Operating costs, including utilities, insurance, property taxes, credit card discount fees, repairs and maintenance and other unit level operating expenses increased as a percentage of sales by 1.5%. Labor costs as a percentage of restaurant sales decreased by 0.4%, offsetting a portion of these increases.

     General and administrativecosts increased $1,474,000, or 27.6%, to $6,823,000 during 2005 from $5,349,000 in 2004, increasing as a percentage of total revenue to 16.6% from 13.3% during 2004. Corporate personnel related costs, including benefit costs, increased by approximately $778,000, $511,000 of which was a pre-tax non-cash stock compensation charge relating to the extension of the maturity date of certain stock options upon the resignation of an officer/director on January 7, 2005. The Company also incurred an additional $395,000 for professional services during 2005. Approximately $102,000 of the increase was related to higher spending for customer feedback surveys. The remainder of the increase is due to increased spending in travel expenses for franchisee support and openings and other miscellaneous general and administrative costs incurred by the Company during 2005.

     Advertisingexpense, which decreased to $2,547,000 for 2005 from $2,652,000 during 2004, decreased as a percentage of total revenues to 6.2% in 2005 compared with 6.6% in 2004. The Company spent approximately 5% of net restaurant sales at Company-operated stores on local store advertising, including media and print advertising in the four markets in which the Company-operated restaurants are located during both FY 2005 and FY 2004. In addition, all stores (both Company and franchised stores) contribute 1% of each stores net restaurant sales as advertising fees to the Company’s National Advertising Fund ((see Note 13 of Notes to the Consolidated Financial Statements). Of these advertising fees, the Company spends at least 50% of these funds on the creation of marketing tools; however, in some years, the Company spends more than 50% of these fees on advertising related costs. Fluctuations in the advertising spending as a percentage of total revenues are related to the timing of promotions and exact percentage of the advertising fees earned by the Company’s National Advertising Fund that is spent on the creation of marketing tools.

     Depreciationexpense was $2,206,000 during 2005 compared with $2,096,000 during 2004. This increase was primarily related to approximately $9.3 million in fixed assets additions during 2005, the majority of which were added during the fourth quarter of 2005.

     Other operating (income)was $5,000 during 2005 compared with $69,000 during 2004. This income is related to gains on sales of assets in both years. The income recorded in both years is primarily related to the gain associated with the sale of the assets of one Company-operated store in each respective year.

     Impairment of Long-Lived Assetsexpense was $986,000 during 2005. The Company had no impairment charges recorded during 2004. The Company recorded a non-cash impairment charge in the quarter ending December 31, 2005 in the amount of $986,000. The charge consists primarily of the write down of asset values for three Company-operated restaurants. The Company determined that an impairment charge would be required underSFAS No. 144 “Accounting for the Impairment or Disposal of Long-Lived Assets.” The impairment charge results from internal analysis which indicated that the investment for the impacted restaurants will not be fully recovered by anticipated cash flows (see Note 1 of Notes to the Consolidated Financial Statements).

     Interest expensedecreased 5.6% to $452,000 for the year ended December 31, 2005 from $479,000 in the prior year. Debt outstanding as of December 31, 2005 was $10,965,000, compared with $4,900,000 the year-earlier period. The decrease in interest expense was due to reductions of existing debt throughout the first three quarters of 2005; however, on November 17, 2005, the Company borrowed $6.2 million to acquire four restaurants in Florida and to purchase the real property of four additional restaurants, previously leased by the Company. This debt bears interest at a rate of one-month LIBOR + 2%. Interest expense for the fourth quarter of 2005 was $140,000 compared with $113,000 for the fourth quarter of 2004.

     Other, netexpense was $113,000 in 2005 compared with $100,000 in expense for 2004. This increase was primarily due to an increase in franchise tax expense of $17,000 for the fifty-two weeks ended December 31, 2005, 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 benefitwas $73,000 in 2005 compared with an income tax expense of $525,000 in 2004. The 2005 benefit was related to a pre-tax loss of $117,000 recognized by the Company in 2005 compared with pre-tax income of $1,789,000 in 2004.

F-8

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. We assess the potential impairment of long-lived assets whenever events or changes in circumstances indicate that the carrying value may not be recoverable. 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 by the Company during fiscal years 2004 or 2006; however, in 2005, the Company incurred a non-cash charge for the effect of three underperforming Company-operated restaurants. The Company recorded a non-cash impairment charge in the quarter ending December 31, 2005 in the amount of $600,000 (net of a tax benefit of $386,000). The charge consists primarily of the write down of asset values for three Company-operated restaurants. The Company determined that an impairment charge would be required under SFAS No. 144 “Accounting for the Impairment or Disposal of Long-Lived Assets.” The impairment charge results from internal analysis which indicated that the investment for the impacted restaurants will not be fully recovered by anticipated future cash flows. One of the restaurants closed in December 2005 and one in March 2006. The Company is currently seeking to sublease and/or sell its interest in the third restaurant, which leases the land and building.

     The taking of these impairment charges did not precipitate additional cash expenditure by the Company, nor does the Company anticipate the future recognition of a material gain or loss on the disposal of the assets on these respective properties.

     During 2005, the Company recorded a $15,000 lease reserve related to a closed store as noted above, and as of December 31, 2005, the accrual for future lease obligations for closed stores remained $15,000. The Company paid these reserve amounts in 2006 and the balance as of December 30, 2006 is zero.

Liquidity and Capital Resources

     Capital expenditures totaled $2,806,000 in 2006, $8,614,000 in 2005 and $2,178,000 in 2004. Generally, the Company constructs its restaurant buildings on leased properties for its Company-operated restaurants. The Company owns the land and building at 14 Company-operated restaurants. The average monthly lease cost for the 13 Company-operated restaurants occupied under a ground lease at December 30, 2006 is approximately $3,700 per month. For the 17 restaurants where the Company leases the building as well as the site, the average monthly lease cost is approximately $6,000.

     Cash provided by operations for the Company is primarily affected by net earnings adjusted for non-cash expenses which consist primarily of depreciation. Depreciation totaled $2,192,000 in 2006, $2,206,000 in 2005 and $2,096,000 in 2004.

     Cash provided by operations in 2006 was $4,055,000 compared with $3,334,000 in 2005. $427,000 of the $721,000 increase is related to an increase in income adjusted for non-cash items including depreciation, impairment charges and stock compensation related expenses. Additionally, in 2006, accounts payable and accrued expenses increased $820,000 compared with an increase of $595,000 in 2005, contributing an additional $225,000 increase in cash. Cash provided by operations in 2005 was $3,334,000 compared with $1,765,000 in 2004. The $1,569,000 increase in cash provided by operations was primarily related to the fluctuation in total accounts payable and accrued expenses. In 2005, the Company’s accounts payable and accrued expenses increased by $595,000 compared with a $1,038,000 reduction in 2004.

     Cash used in financing activities was $365,000 in 2006 compared with net cash provided by financing activities of $5,778,000 in 2005. The Company incurred no long-term debt financing in 2006, but in 2005, the Company borrowed $6,200,000 to acquire four restaurants in Florida and to purchase the real property of four additional restaurants, previously leased by the Company. In 2006, the Company made $1,013,000 in principal payments on existing debt compared with $781,000 in 2005. Net cash used by financing activities was $642,000 in 2004. The Company incurred no long-term debt financing during 2004 and made $776,000 in principal payments on existing debt.

F-9

     During 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.

     As of December 30, 2006, the Company had total long-term debt of $9,952,000 and unused lines of credit and loan commitments of potential additional borrowings of $2.5 million, as described above. As of December 31, 2005, the Company had total long-term debt of $10,965,000 and unused lines of credit and loan commitments of potential additional borrowings of $2.5 million.

     Cash used for capital expenditures was $2,806,000 in 2006 compared with $8,614,000 in 2005. Capital expenditures in 2006 was primarily used for the construction of two new Company-operated restaurants as well as capital expenditures for existing restaurants; whereas in 2005 the Company purchased four restaurants in Florida and the real property of four additional restaurants, previously leased by the Company. Net cash used in investing activities for both 2006 and 2005 are comprised of capital expenditures offset by proceeds on the sale of certain property and equipment. Proceeds on the sale of property and equipment of $958,000 in 2006, primarily relating to the sale of two Company-operated restaurants and $784,000 in 2005 primarily related to the sale of one Company-operated restaurant. In 2004, the Company spent $2,178,000 on capital expenditures and received proceeds on the sale of property and equipment of $1,076,000 primarily related to the sale of one Company-operated restaurant.

     The Company is budgeting capital expenditures of approximately $3.0 to $3.5 million in fiscal year 2007, excluding potential acquisitions and share repurchases. These capital expenditures primarily relate to the development of two additional Company-operated restaurants, store equipment upgrades and store interior remodels, and enhancements to existing financial and operating information systems. The Company expects to fund fiscal year 2007 capital expenditures with cash flow from operations and with funds under the loan agreement entered in February of 2003, if needed, in order to fund these budgeted capital expenditures. The Company believes that existing cash and funds generated from internal operations, as well as borrowings under the credit facility will meet the Company’s needs for the foreseeable future.

     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 December 30, 2006, the Company had repurchased 25,000 shares of common stock under the plan. No purchases were made during fiscal years 2006, 2005 or, 2004 and no further purchases are anticipated in the near term.

Contractual Commitments

     The Company has contractual obligations and commercial commitments including long-term debt, lease obligations and future purchase obligations. The table below presents our future contractual obligations (in thousands):

			Less than						More than
	Total		1 Year		1-3 Years		3-5 Years		5 years
Long-term debt	$	6,608	$	802	$	658	$	655	$	4,493
Interest payments		2,271		392		692		615		572
Capital leases		4,877		1,115		834		558		2,370
Operating leases(1)		4,575		1,119		1,626		1,068		762
Purchase obligations		3,337		1,127		1,555		655		—
Total contractual obligations	$	21,668	$	4,555	$	5,365	$	3,551	$	8,197

⁽¹⁾ Represents aggregate minimum lease payments. Some of the leases also require contingent rent in addition to the minimum rent based on a percentage of sales.

F-10

Qualitative and Quantitative Disclosure about Market Risk

Interest Rate Risk

     The Company is exposed to certain financial market risks, the most predominant being fluctuations in interest rates. 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.

     As of December 30, 2006, the Company had $6.0 million in borrowings bearing interest at a rate equal to the one-month LIBOR plus 2%, adjusted monthly; however, in May 2006, the Company executed a cash flow hedging instrument (interest rate swap) to minimize interest rate fluctuation risk to convert all of the interest associated with this debt to a fixed rate of 7.75% through the maturity of the note payable. One-month LIBOR plus 2% was approximately 7.08% on the date the swap was executed and was approximately 7.33% as of December 30, 2006. The Company records the excess or reduction in interest expense related to the swap rate in relation to the fixed rate in the period incurred. As of December 30, 2006, approximately $6.0 million in principal was outstanding under this note payable. If the fixed rate swap was not in place, a ten percent increase in current interest rates would result in approximately $44,000 of additional expense for the Company. The remainder of the Company’s long-term debt portfolio is financed with fixed rate debt, primarily in the form of capital leases.

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. The Company receives contract pricing for chicken on a monthly basis; 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. A ten percent increase in the cost of beef would result in approximately $500,000 of additional food costs for the Company annually.

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. Management does not believe that inflation has had a material effect on income during the fifty-two weeks ended December 30, 2006. 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 be converted. Such conversion began on April 5, 1995, at which time there were 1,199,979 shares of preferred stock outstanding. As of December 30, 2006, only 1,836 shares have yet to be converted.

Recent Accounting Pronouncements

     Note 2 of the Notes to the Consolidated Financial Statements discusses new accounting policies adopted by the Company during 2006 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 the Consolidated Financial Statements.

F-11

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 ongoing 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 also earns income from certain vendors based on purchases made by our franchisees from those vendors. The Company records this income as other revenues in its statement of operations as the Company has no cost associated with these purchases.

Long-Lived Assets:

     The restaurant industry is capital intensive. The Company has approximately 70% 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.

F-12

     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. We assess the potential impairment of long-lived assets whenever events or changes in circumstances indicate that the carrying value may not be recoverable. 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 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 $1.5 million of goodwill on our balance sheet resulting from the acquisition of businesses. 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.

     The Company has approximately $73,000 (net of a $17,000 allowance) related to a long-term note receivable taken by the Company related to the sale of a Company-operated restaurant and related equipment to a franchisee in 1999. Depending on certain factors, including the franchisee’s financial condition and profitability to the store, the Company may determine it is necessary to take an additional allowance against this receivable in the future. No payments were made on the note receivable and no adjustments to the allowance were made during the fifty-two weeks ended December 30, 2006. Due to the fact that payments on this note are currently past due, the Company does not recognize interest income associated with this note until the related payment is received.

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 $781,000 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.

Leases:

     When determining the lease term for purposes of recording depreciation and rent or for evaluating whether a lease is capital or operating, the Company includes option periods for which failure to renew the lease imposes an economic penalty on the Company of such an amount that a renewal appears, at the inception of the lease, to be reasonably assured.

     For operating leases, minimum lease payments, including minimum scheduled rent increases, are recognized as rent expense on a straight line basis over the lease term as that term is defined in SFAS No. 13, as amended, including any option periods considered in the lease term and any periods during which the Company has use of the property but is not charged rent by a landlord (“rent holiday”). Contingent rentals are generally based on either a percentage of restaurant sales or as a percentage of restaurant sales in excess of stipulated amounts, and thus are not included in minimum lease payments but are included in rent expense when incurred. The Company has received no leasehold improvement incentives from a landlord. No individual lease is material to the Company.

Stock-Based Compensation:

     SFAS No. 123, “Accounting for Stock-Based Compensation,” encourages but does not require a fair value based method of accounting for employee stock options or similar equity instruments. SFAS No. 123 allows an

F-13

entity to continue to measure compensation costs under Accounting Principles Board Opinion (“APB”) No. 25, “Accounting for Stock Issued to Employees,” but requires pro forma disclosure of net earnings as if the fair value based method of accounting had been applied. The Company previously elected to follow APB No. 25 and related interpretations in accounting for our employee stock options.

     We had generally not recorded compensation expense for options granted to employees because all prior options granted under our stock option plans were initially considered to have an exercise price equal to the market value of the underlying common stock on the date of grant. However, as described in Note 3 of the Notes to the Consolidated Financial Statements, we found inaccuracies in the determination of measurement dates for certain stock option grants. In those instances where the fair market value of our common stock at the originally stated grant date was lower than the fair market value on the actual re-determined measurement date, in accordance with APB No. 25 and related interpretations. The cumulative error was not material and we recorded net stock-based compensation expense of $311,000 during the third quarter of 2006.

     In December 2004, the FASB issued SFAS 123 (Revised), “Share-Based Payment”, a revision of SFAS 123, “Accounting for Stock-Based Compensation.” SFAS 123R requires the fair value measurement of all stock-based payments to employees, including grants of employee stock options, and recognition of those expenses in the statement of operations. SFAS 123R is effective for annual reporting periods beginning after December 15, 2005. The Company adopted SFAS 123R on January 1, 2006 (See Note 1 of the Notes to the Consolidated Financial Statements). The impact of the adoption of SFAS 123R for fiscal year 2006, relating to prior grants only, was approximately $76,000.

     In March 2005, the Securities and Exchange Commission (“SEC”) issued Staff Accounting Bulletin No. 107 (“SAB 107”) regarding the Staff’s interpretation of SFAS 123(R). This interpretation expresses the views of the Staff regarding the interaction between SFAS 123(R) and certain SEC rules and regulations and provides the Staff’s views regarding the valuation of share-based payment arrangements by public companies. In particular, this SAB provides guidance related to share-based payment transactions with non-employees, the transition from nonpublic to public entity status, valuation methods, the accounting for certain redeemable financial instruments issued under share-based payment arrangements, the classification of compensation expense, non-GAAP financial measures, first time adoption of SFAS 123(R) in an interim period, capitalization of compensation cost related to share-based payment arrangements, the accounting for income tax effects of share-based payment arrangements upon adoption of SFAS 123(R), the modification of employee share options prior to adoption of SFAS 123(R) and disclosures in Management’s Discussion and Analysis subsequent to adoption of SFAS 123(R). The Company adopted SAB 107 in connection with its adoption of SFAS 123(R) with no impact to its financial condition or results of operations.

Off-Balance Sheet Arrangements

     At December 30, 2006, 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 December 31, 2005, was approximately $470,000. The term of the guarantee is through August 13, 2023, the maturity date of the loan. If the franchisee ceases to make note payments, the Company may be required to make note payments until the collateral is liquidated. The guarantee provides for no limitation to the maximum potential future payments under the guarantee; however, the estimated maximum potential future payments are approximately $470,000, which represents the principal balance of the note payable as of the end of our fiscal year 2006. The Company currently has no liability recorded in its financial statements for the guarantor’s obligations under the guarantee. There are no recourse provisions in the guaranty agreement; however, the Company’s potential loss contingencies are minimal since the loan is collateralized with assets whose estimated fair value is greater than the amount of debt outstanding and based on current cash flows of the restaurant, if acquired through default, would be adequate to cover the debt payments.

Known Trends and Uncertainties

     Beef costs increased by approximately 11% and 6% in 2004 and 2005, respectively. Beef costs decreased by approximately 8% in 2006; however, this decrease was offset by increases in other food and operating costs, primarily related rising fuel and energy costs. The Company implemented a menu price increase of approximately 3.5% effective in October 2006 in order to partially offset these prior cost increases. It may be difficult to raise menu prices to fully cover any future cost increases, but to the extent permitted by competition, we may implement additional menu price increases if deemed necessary. Additional margin improvements may have to be made through operational improvements, equipment advances and increased volumes to help offset these cost increases, due to the competitive state of the quick-service restaurant industry.

F-14

     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.

     If the Fair Minimum Wage Act of 2007 is approved by Congress, the federal minimum wage rate will increase from the current level of $5.15 to (1) $5.85 an hour, beginning on the 60th day after enactment of this Act; (2) $6.55 an hour, beginning 12 months after that 60th day; and (3) $7.25 an hour, beginning 24 months after that 60th day. The Company has estimated the annual impact on its labor costs for an increase of minimum wage to (1) $5.85 an hour would be approximately $9,000, (2) $6.55 an hour would be approximately $119,000, and (3) $7.25 an hour would be approximately $400,000. Additional, certain states current minimum wage rates in which the Company operates is higher than the current federal rate of $5.15; therefore, if federal minimum wage rate increases are implemented, certain states may adopt additional state minimum wage rate increases to adjust to the cost of living and to meet the needs of citizens of each respective state. This could have an additional adverse impact on labor costs paid by the Company in the future.

     The Company has incurred increases in energy prices, including fuel and utilities, in recent history, as have most retail businesses. Continued increases in the cost of fuel and energy may be difficult to offset with additional menu price increases and could have an adverse effect on our business and operations.

     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.

     The cost of construction has also increased in recent history, in part due to the hurricanes that impacted the Southeastern United States during 2005. The Company may not be able to achieve higher restaurant sales volumes or margin improvements to offset these or addition construction cost increases, which may in turn have an adverse effect on our business and operations, particularly for new restaurant development.

     Company-operated same-store sales increased 2.5% during 2006 and franchised same-store sales increased 1.4% during 2006. Average per-store annual unit sales volumes (“Average Unit Volumes”) were $871,000 at Company-operated stores and $892,000 at franchised stores during 2006. The Company will continue with its marketing strategy of enhancing the Company’s points of differentiation and further positioning the Company as a premium fast-food provider. Management intends to continue testing new, bold-flavored premium product offerings and modifying existing menu offerings in order to drive positive trends for same-store sales and average unit volumes, both of which are key performance indicators in our industry. The Company will also continue to explore potentially extending operational hours at both Company-operated and franchised stores to accomplish these goals as well. By continuing to improve in these areas, it will also help to offset some of the potential negative financial impacts of the other trends and uncertainties listed above.

F-15

BACK YARD BURGERS, INC.
Consolidated Balance Sheets
(in thousands, except for share and per share amounts)

	December 30,			December 31,
	2006			2005
ASSETS
Cash and cash equivalents	$	5,444		$	3,602
Receivables, less allowance for doubtful accounts of $218 and $153		739			786
Inventories		257			281
Income taxes receivable		265			268
Current deferred tax asset		226			193
Prepaid expenses		153			186
Total current assets		7,084			5,316
Property and equipment, at depreciated cost		23,393			23,035
Goodwill		1,506			1,751
Noncurrent deferred tax asset		763			871
Notes receivable, less allowance of $17		73			73
Other assets		591			595
Total assets	$	33,410		$	31,641
LIABILITIES AND STOCKHOLDERS’ EQUITY
Accounts payable	$	1,452		$	1,295
Accrued expenses		2,692			1,734
Reserve for closed stores		—			15
Current installments of long-term debt		1,645			966
Total current liabilities		5,789			4,010
Long-term debt, less current installments		8,307			9,999
Deferred franchise and area development fees		1,227			1,441
Other deferred income		250			276
Other deferred liabilities		532			613
Total liabilities		16,105			16,339
Commitments and contingencies (Note 9 and Note 17)
Stockholders’ equity
Preferred stock, $.01 par value; 2,000,000 shares authorized; 1,836 and 19,269 shares issued and outstanding		—			—
Common stock, $.01 par value; 12,000,000 shares authorized; 5,124,861 and 4,940,151 shares issued and outstanding		51			49
Paid-in capital		12,632			11,507
Treasury stock, at cost, 25,000 shares		(28	)		(28	)
Retained earnings		4,650			3,774
Total stockholders’ equity		17,305			15,302
Total liabilities and stockholders’ equity	$	33,410		$	31,641

See accompanying notes to consolidated financial statements.

F-16

BACK YARD BURGERS, INC.
Consolidated Statements of Operations
(in thousands, except per share amounts)

	Years Ended
	December 30,			December 31,			January 1,
	2006			2005			2005
Revenues:
Restaurant sales	$	37,423		$	34,479		$	34,912
Franchise and area development fees		427			629			620
Royalty fees		4,792			4,143			3,108
Advertising fees		1,216			1,061			866
Other		852			689			677
Total revenues		44,710			41,001			40,183
Expenses:
Cost of restaurant sales		12,006			11,125			11,066
Restaurant operating expenses		18,185			16,898			16,726
General and administrative		7,469			6,823			5,349
Advertising		2,844			2,547			2,652
Depreciation		2,192			2,206			2,096
Other operating income		(162	)		(5	)		(69	)
Impairment of long-lived assets		—			986			—
Total expenses		42,534			40,580			37,820
Operating income		2,176			421			2,363
Interest income		90			27			5
Interest expense		(802	)		(452	)		(479	)
Other, net		(80	)		(113	)		(100	)
Income (loss) before income taxes		1,384			(117	)		1,789
Income tax expense (benefit)		508			(73	)		525
Net income (loss)	$	876		$	(44	)	$	1,264
Income (loss) per share:
Basic	$	0.17		$	(0.01	)	$	0.26
Diluted	$	0.17		$	(0.01	)	$	0.25
Weighted average number of common shares and common equivalent shares outstanding:
Basic		5,084			4,833			4,774
Diluted		5,206			4,833			5,096

See accompanying notes to consolidated financial statements.

F-17

BACK YARD BURGERS, INC.
Consolidated Statements of Changes in Stockholders’ Equity
(in thousands, except for number of shares)

	Preferred Stock					Common Stock				Treasury Stock
															Paid-in		Retained
	Shares			Amount		Shares		Amount		Shares		Amount			Capital		Earnings			Total
Balance at year ended January 3, 2004		19,617		$	—		4,748,948	$	48		25,000	$	(28	)	$	10,504	$	2,554		$	13,078
Conversion of preferred stock		(348	)		—		348		—												—
Employee stock purchases							6,038		—							31					31
Exercise of stock options							35,140		—							103					103
Net income																		1,264			1,264
Balance at year ended January 1, 2005		19,269			—		4,790,474		48		25,000		(28	)		10,638		3,818			14,476
Employee stock purchases							4,877		—							24					24
Exercise of stock options							144,800		1							334					335
Stock option Modification																511					511
Net loss																		(44	)		(44	)
Balance at year ended December 31, 2005		19,269			—		4,940,151		49		25,000		(28	)		11,507		3,774			15,302
Conversion of preferred stock		(17,433	)		—		17,433		—												—
Exercise of stock options							162,250		2							624					626
Stock-based compensation							—		—							479					479
Employee stock purchases							5,027		—							22					22
Net income																		876			876
Balance at year ended December 30, 2006		1,836		$	—		5,124,861	$	51		25,000	$	(28	)	$	12,632	$	4,650		$	17,305

See accompanying notes to consolidated financial statements.

F-18

BACK YARD BURGERS, INC.
Consolidated Statements of Cash Flows
(in thousands)

	Years Ended
	December 30,			December 31,			January 1,
	2006			2005			2005
Cash flows from operating activities:
Net income	$	876		$	(44	)	$	1,264
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation of property and equipment		2,192			2,206			2,096
Impairment of long-lived assets		—			986			—
Tax benefit of impairment of long-lived assets		—			(386	)		—
Deferred income taxes		75			80			(123	)
Modification of stock plan		—			511			—
Tax benefit of modification of stock plan		—			(153	)		—
Stock based compensation		479			—			—
Provision for losses on receivables		65			93			35
(Gain) on sale of assets		(162	)		(5	)		(68	)
Changes in assets and liabilities:
Receivables		(18	)		(118	)		10
Inventories		24			(22	)		(8	)
Prepaid expenses and other current assets		33			19			(147	)
Other assets		4			(46	)		(172	)
Accounts payable and accrued expenses		820			595			(1,038	)
Reserve for closed stores		(15	)		15			(81	)
Income taxes payable/receivable		3			(280	)		(129	)
Other deferred income		(26	)		(103	)		(141	)
Other deferred liabilities		(81	)		2			10
Deferred franchise and area development fees		(214	)		(16	)		257
Net cash provided by operating activities		4,055			3,334			1,765
Cash flows from investing activities:
Additions to property and equipment		(2,806	)		(8,614	)		(2,178	)
Proceeds from sale of property and equipment		958			784			1,076
Proceeds on notes receivable		—			—			7
Net cash used in investing activities		(1,848	)		(7,830	)		(1,095	)
Cash flows from financing activities:
Issuance of stock		648			359			134
Principal payments on short-term debt		—			(1,950	)		—
Proceeds from issuance of short-term debt		—			1,950			—
Principal payments on long-term debt		(1,013	)		(781	)		(776	)
Proceeds from issuance of long-term debt		—			6,200			—
Net cash (used in) provided by financing activities		(365	)		5,778			(642	)
Net increase in cash and cash equivalents		1,842			1,282			28
Cash and cash equivalents:
Beginning of year		3,602			2,320			2,292
End of year	$	5,444		$	3,602		$	2,320
Noncash operating and investing activities
Accrued property and equipment additions	$	305		$	—		$	—
Property acquired with a capital lease	$	—		$	646		$	—
Stock option plan (Note 1)	$	—		$	358		$	—
Supplemental disclosure of cash flow information:
Income taxes paid	$	165		$	666		$	777
Interest paid	$	790		$	444		$	481

See accompanying notes to consolidated financial statements.

F-19

NOTE 1 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Business Activity.Back Yard Burgers, Inc. (the “Company”) owns and operates quick-service and fast-casual restaurants and is engaged in the sale of franchises in Back Yard Burgers and the collection of royalties based upon related franchise sales. The Company grants franchise rights for the use of the “Back Yard Burgers” trade name and other associated trademarks, signs, emblems, logos, slogans and service marks which have been or may be developed. At December 30, 2006, the Company operated 44 restaurants in four states (Mississippi, Arkansas, Tennessee and Florida) and franchised 136 restaurants in 20 states.

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

Fiscal Year.The Company maintains its financial records on a 52-53 week fiscal year ending on the Saturday closest to December 31. The years ended January 1, 2005, December 31, 2005 and December 30, 2006 were 52 week years.

Use of Estimates.The preparation of financial statements in accordance with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Cash and Cash Equivalents.The Company considers cash on hand, deposits in banks and short-term investments with an original maturity of less than three months when purchased as cash and cash equivalents.

Inventories.Inventories primarily consist of food and beverage products and are valued at the lower of cost or market; cost is determined by the first-in, first-out (“FIFO”) method.

Property and Equipment.Property and equipment is stated at cost, net of accumulated depreciation. At the time property and equipment are retired, or otherwise disposed of, the asset and accumulated depreciation are removed from the accounts and any resulting gain or loss is included in earnings. Improvements to leased properties are depreciated over the shorter of their useful life or the lease term, which includes renewal option periods where failure to exercise such options would result in an economic penalty of an amount that such renewal options are reasonably assured at the inception of the lease. Depreciation is computed on the straight-line method over the following estimated useful lives: buildings and building improvements — 15 to 25 years; leasehold improvements — 7 to 20 years (coincides with the initial lease term); furniture, fixtures and equipment — 5 to 7 years; and transportation vehicles — 5 years.

Goodwill.As of January 1, 2002, the Company accounts for goodwill under Statement of Financial Accounting Standards (SFAS) 142,Goodwill and Other Intangible Assets. Under SFAS 142, goodwill is no longer amortized but is tested for impairment using a fair value approach, at the “reporting unit” level. A reporting unit is the operating segment, or a business one level below that operating segment (the “component” level) if discrete financial information is prepared and regularly reviewed by management at the component level. The Company has determined that it operates as one segment and one reporting unit because the operations of the restaurants are homogeneous and discrete financial information of different segments or reporting units is not prepared and regularly reviewed by management.

     SFAS 142 requires a two-step process for testing impairment. First, the fair value the Company is compared to its carrying value to determine whether an indication of impairment exists. Market capitalization is used to determine the fair value of the Company. If an impairment is indicated, then the fair value of the goodwill is determined by allocation of the Company’s fair value to its assets and liabilities (including any unrecognized intangible assets) as if the Company had been acquired in a business combination. The amount of impairment for goodwill and other intangible assets is measured as the excess of its carrying value over its fair value. As required by SFAS No. 142, the Company completed a transitional impairment test for goodwill as of January 1, 2002, and also an impairment test for each fiscal year thereafter.

     At each balance sheet date, the Company also assesses whether there has been impairment in the value of goodwill at the reporting unit level by determining whether projected undiscounted future cash flows from operations for each restaurant exceed its net book value, including goodwill, 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.

     Based on the results of these tests, the Company did not record any impairment of our goodwill.

     The $245,000 reduction in goodwill during 2006 was related to the sale of a company-operated restaurant during the first quarter of 2006.

Other Deferred Income.The Company accounts for deferred income under EITF 02-16Accounting by a Customer (Including a Reseller) for Certain Consideration Received from a Vendor. EITF 02-16 concluded that cash consideration

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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 has recorded 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.

     During 2003 and 2004, the Company received 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 a reduction in cost of sales in a proportionate manner with respective future purchases. Under the terms of the 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. The Company recognized approximately $284,000, $316,000 and $282,000 as a reduction in cost of sales in 2006, 2005 and 2004, respectively pursuant to these arrangements.

     The Company also earns income from certain vendors based on purchases made by our franchisees from those vendors, of which a portion of this income was collected in advance and recorded as deferred income. The Company records this income as other revenues in its statement of operations as the Company has no cost associated with these purchases.

Income Taxes.Deferred income taxes are provided for the tax effects of temporary differences between the financial reporting basis and the income tax basis of the Company’s assets and liabilities.

Franchise and Area Development Fee Income.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.

Restaurant Sales.Revenue recognition at Company-operated restaurants is recognized as customers pay for products at the time of sale. The earnings reporting process is covered by the Company’s internal controls and generally does not require significant management judgments and estimates.

Royalty and Advertising Fee Income.As part of its franchise agreements, the Company earns a percentage of each unit’s gross sales (generally 4%) and records these fees as royalties. The franchise agreements also provide that franchisees are required to pay an additional 1% of gross sales to the National Advertising Fund (see Note 13 of Notes to the Consolidated Financial Statements). These fees are recorded as earned by the Company.

Allowance for Doubtful Accounts.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.

Other Revenue.Other revenue is primarily comprised of sales of proprietary food products to franchisees and payments by certain vendors of the Company primarily as contributions to the National Advertising Fund based upon purchasing volumes of our franchisees. These purchases by franchisees from vendors have no specific incremental impact to costs of the Company. Revenue from sales of proprietary food products is recognized when the products are shipped. Volume based revenue and contributions from our vendors are recognized throughout the accounting period based on the purchase volumes by our franchisees from these vendors. The Company also includes other miscellaneous revenues in other revenue.

Restaurant Operating Expenses.Restaurant operating expenses include all costs associated with the operation of the restaurant except corporate overhead, advertising, depreciation and amortization.

Preopening costs.The Company expenses preopening costs as incurred. Preopening costs expensed for fiscal years 2006, 2005 and 2004 were approximately $117,000, $39,000 and $85,000, respectively. Preopening costs are included in the general and administrative expenses of the Company’s statements of operations.

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Advertising Costs.Advertising costs, including production costs, are charged to expense as incurred on the first date of the advertising period. Advertising costs expensed for fiscal years 2006, 2005 and 2004 were approximately $2,844,000, $2,547,000 and $2,652,000, respectively.

Impairment of Long-Lived Assets.The Company accounts for the impairment of long-lived assets under Statement of Financial Accounting Standard (“SFAS”) No. 144,Accounting for the Impairment and Disposal of Long-Lived Asset. We assess the potential impairment of long-lived assets whenever events or changes in circumstances indicate that the carrying value may not be recoverable. 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 by the Company during fiscal years 2004 or 2006; however, in 2005, the Company incurred a non-cash charge for the effect of three underperforming Company-operated restaurants. The Company recorded a non-cash impairment charge in the quarter ending December 31, 2005 in the amount of $600,000 (net of a tax benefit of $386,000). The charge consists primarily of the write down of asset values for three Company-operated restaurants. The Company determined that an impairment charge would be required under SFAS No. 144 “Accounting for the Impairment or Disposal of Long-Lived Assets.” The impairment charge results from internal analysis which indicated that the investment for the impacted restaurants will not be fully recovered by anticipated future cash flows. One of the restaurants closed in December 2005 and one in March 2006. The Company is currently seeking to sublease and/or sell its interest in the third restaurant, which leases the land and building.

     The taking of these impairment charges did not precipitate additional cash expenditure by the Company, nor does the Company anticipate the future recognition of a material gain or loss on the disposal of the assets on these respective properties.

     During 2005, the Company recorded a $15,000 lease reserve related to a closed store as noted above, and as of December 31, 2005, the accrual for future lease obligations for closed stores remained $15,000. The Company paid these reserve amounts in 2006 and the balance as of December 30, 2006 is zero.

Leases.When determining the lease term for purposes of recording depreciation and rent or for evaluating whether a lease is capital or operating, the Company includes option periods for which failure to renew the lease imposes an economic penalty on the Company of such an amount that a renewal appears, at the inception of the lease, to be reasonably assured.

     For operating leases, minimum lease payments, including minimum scheduled rent increases, are recognized as rent expense on a straight line basis over the lease term as that term is defined in SFAS No. 13, as amended, including any option periods considered in the lease term and any periods during which the Company has use of the property but is not charged rent by a landlord (“rent holiday”). Contingent rentals are generally based on either a percentage of restaurant sales or as a percentage of restaurant sales in excess of stipulated amounts, and thus are not included in minimum lease payments but are included in rent expense when incurred. The Company has received no leasehold improvement incentives by a landlord. No individual lease is material to the Company.

Preferred Stock.In accordance with the provisions of the Company’s Restated Certificate of Incorporation regarding preferred stock, each share of preferred stock is convertible into one share of common stock, at the option of the holder. As of December 30, 2006, all but 1,836 shares of preferred stock had been converted to common stock.

Treasury Stock.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 the end of fiscal years 2006 and 2005, the Company had repurchased 25,000 shares of common stock under the plan being held as treasury stock with a value of approximately $28,000. No purchases were made during fiscal years 2006, 2005 or 2004 and no further purchases are anticipated in the near term.

Earnings 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 using the treasury stock method for stock options (Note 15).

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Stock-Based Employee Compensation.In December 2004, the FASB issued SFAS 123 (Revised), “Share-Based Payment”, a revision of SFAS 123, “Accounting for Stock-Based Compensation.” SFAS 123R requires the fair value measurement of all stock-based payments to employees, including grants of employee stock options, and recognition of those expenses in the statement of operations. SFAS 123R is effective for annual reporting periods beginning after December 15, 2005. The impact of the adoption of SFAS 123R and SAB 107 for fiscal year 2006, relating to prior grants only, was approximately $66,000, net of tax.

     Prior to fiscal year 2006, 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 was normally recognized for its stock-based compensation; however, in January 2005, the Company recorded a non-cash charge of approximately $358,000 (net of a tax benefit of $153,000) relating to the extension of the exercise date of certain stock options upon the resignation of an officer/director in 2005.

     Had compensation cost for the Company’s stock option plan been determined based on the fair value at the grant date for awards in 2005 and 2004 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 2005 and 2004 would have been adjusted to the pro forma amounts indicated below (in thousands, except per share data):

	2005			2004
Net income (loss), as reported	$	(44	)	$	1,264
Add: Expense recognized, net of tax		358			—
Deduct: Total stock-based employee compensation expense determined under fair value based methods for all rewards, net of related taxes		(101	)		(263	)
Pro forma		213			1,001
Basic (loss) earnings per share:
As reported		(0.01	)		0.26
Pro forma		0.04			0.21
Diluted (loss) earnings per share:
As reported		(0.01	)		0.25
Pro forma		0.04			0.20

     The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions using grants in 2005 and 2004, respectively:

	2005			2004
Average expected life (years)		5.0			5.0
Average expected volatility		53.5	%		63.4	%
Risk-free interest rates		4.1	%		3.7	%
Dividend yield		0.0	%		0.0	%

     The pro forma results reported above will not be representative of the effect on operating results for future years because we may make greater or less use of stock-based compensation in future periods.

Fair Value of Financial Instruments.At December 31, 2005, the Company had $6.2 million in borrowings bearing interest at a rate equal to the one-month LIBOR plus 2%, adjusted monthly; therefore, the Company was exposed to market risk from changes in the one-month LIBOR rate during the first quarter of 2006. However, on May 5, 2006, the Company executed a cash flow hedging instrument (interest rate swap) to minimize interest rate fluctuation risk to convert all of the interest associated with this debt to a fixed rate of 7.75% through the maturity of the note payable. One-month LIBOR plus 2% was approximately 7.08% on the date the swap was executed and was approximately 7.33% as of December 30, 2006. As of December 30, 2006, approximately $6.0 million in principal was outstanding under this note payable. The remainder of the Company’s long-term debt portfolio is financed with fixed rate debt, primarily in the form of capital leases. The fair value of the Company’s entire long-term debt portfolio was approximately $10.2 million and $11.6 million as of December 30, 2006 and December 31, 2005, respectively .

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NOTE 2 — RECENTLY ISSUED ACCOUNTING STANDARDS

     In September 2006, the SEC issued Staff Accounting Bulletin No. 108,Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements (SAB 108), to address diversity in practice in quantifying financial statement misstatements. SAB 108 requires that we quantify misstatements based on their impact on each of our financial statements and related disclosures. On December 30, 2006, we adopted SAB 108. Our adoption of SAB 108 did not impact our financial statements.

     In July 2006, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No. 48,Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109(FIN 48),which clarifies the accounting for uncertainty in tax positions. FIN 48 requires that we recognize in our financial statements, the impact of a tax position, if that position is more likely than not of being sustained on audit, based on the technical merits of the position. The provisions of FIN 48 are effective as of the beginning of our 2007 fiscal year, with the cumulative effect of the change in accounting principle recorded as an adjustment to opening retained earnings. We are currently evaluating the impact of adopting FIN 48 on our financial statements.

NOTE 3 — HISTORICAL STOCK OPTION PRACTICE REVIEW

     In October 2006, our senior management team initiated an informal review of the Company’s historical stock option grant practices and related accounting treatment. On October 12, 2006, the Company’s senior management advised the Company’s Board of Directors that the review had been commenced and the Board directed senior management to continue its review and report its findings to the Audit Committee of the Board of Directors as soon as practicable. On October 30, 2006, the Company’s senior management team reported its preliminary findings to the Board’s Audit Committee and, as part of the report, recommended that the Audit Committee oversee a formal investigation of the Company’s historical stock option grant practices. The Audit Committee undertook its investigation with the assistance of independent legal counsel to assist it in its factual investigation of the Company’s historical stock option grant practices. The Audit Committee also engaged independent accounting experts to both assist its legal counsel in their factual investigation and assist the Company in establishing the appropriate measurement date for each of the Company’s stock option grants during the period under review. The Audit Committee’s investigation covered a period of time from June 25, 1993, the date of the Company’s initial public offering, to August 12, 2005, the last date on which the Company granted stock options.

     In conducting its investigation, the Audit Committee, with the assistance of its independent advisors, reviewed minutes from the meetings of the Company’s Board of Directors and Compensation Committee relating to the issuance of stock options, the terms of the Company’s 1993 Incentive Stock Option Plan, 1995 Incentive Award Plan and 2002 Equity Incentive Plan (collectively, the “Stock Option Plans”), as well as the representative forms of option grant agreements used by the Company during those periods, the employment offer letters from the Company to employees in which the Company included the grant of stock options as part of the compensation package and the confirmation letter issued by the Company in connection with the appointment of an independent director to fill a vacancy on the Company’s Board of Directors. The Audit Committee authorized its legal counsel to engage forensic consultants to conduct a review to determine whether, and if so, to what extent, the Company’s email data contained information about the Company’s stock option grant and exercise activity during the periods covered by the Audit Committee’s investigation. In the course of that review, approximately 270,000 emails were searched and, of the emails searched, approximately 8,410 emails were reviewed. The forensic investigation was necessarily limited by the saving and deleting activities of individual users along with the Company’s email policies regarding deletion, saving and archiving. In addition, interviews were conducted with various members of the Company’s senior management team and members of the Company’s Board of Directors and Compensation Committee for the years in question.

     During the period covered by the Audit Committee’s investigation, the Company made option grants covering 1,292,695 shares of the Company’s common stock. The Company’s grants generally fell into the following four categories:

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• Annual stock option grants

• Grants made to rank and file existing employees by the Company’s Chief Executive Officer

• Grants made to new hires by the Company’s Chief Executive Officer

• Grants made to the Company’s independent directors (other than as part of the Company’s annual option grants)

     In the course of its investigation, the Audit Committee did not find any evidence of fraudulent conduct on the part of members of the Company’s Board of Directors, Compensation Committee or senior management team in the granting of stock options. However, the Audit Committee concluded that the measurement dates previously used by the Company with respect to certain stock option grants made during the period under review differed from the appropriate measurement dates that should have been used with respect to such awards pursuant to Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (“APB No. 25”), and related interpretations. As a result, revised measurement dates were applied to the affected option grants and in the third quarter of 2006 the Company has recorded a total of $311,000 (net of a $118,000 tax benefit) of additional stock-based compensation expense relating to years prior to 2006 for the 13 years covered by the Audit Committee’s investigation.

     To correct the inaccuracies with the previously selected measurement dates, the Company, with the assistance of its accounting advisors, established the date for each affected grant on which all APB No. 25 criteria were satisfied. According to APB No. 25, the measurement date is the first date on which proper approval is obtained and all of the following are known: (1) the individual employee who is entitled to receive the option grant, (2) the number of options that an individual employee is entitled to receive, and (3) the option’s exercise price. In determining the correct measurement date for the affected option grants, the Company considered:

• the report prepared by the Audit Committee’s legal counsel relating to the Company’s historical stock option granting practices;

• minutes of meetings of the Company’s Board of Directors and Compensation Committee, and any available related documentation;

• personnel files;

• payroll records;

• reports on Form 4 filed with the SEC;

• contemporaneous emails; and

• information obtained in interviews with various current and former Company employees and members of the Board of Directors and Compensation Committee.

     With respect to grants for which there was not sufficient evidence and documentation to support the original measurement date or to determine the precise date when the number of options and exercise price were finalized, in accordance with the SEC Chief Accountant’s letter dated September 19, 2006 (the letter can be found at www.sec.gov), the Company used all available relevant information to form a reasonable conclusion as to the most likely measurement date for such option grants.

     Although the Audit Committee did not find any evidence of fraudulent conduct on the part of members of the Company’s Board of Directors, Compensation Committee, or senior management team in the granting of stock options, the Audit Committee found instances of missing or incomplete minutes supporting the issuance of stock options awarded by the Compensation Committee or the Board of Directors; the issuance of stock options to rank and file employees by the Company’s Chief Executive Officer without clear delegation of authority in certain instances; stock options with favorable exercise prices in certain periods compared to stock prices before or after grant date; and the issuance of stock options that did not strictly adhere to the terms of the particular Stock Option Plan under which they were granted. The Audit Committee concluded that the errors in measurement dates resulted from a combination of unintentional errors, lack of attention to timely administration and paperwork, and insufficient internal control over the administration and accounting for aspects of the stock option plans.

     Certain of the errors found by the Audit Committee require the Company to make adjustments to its financial statements. The following paragraphs provide additional information regarding the various types of errors identified in conjunction with the Audit Committee investigation that required financial statement adjustments, resulting in the net $311,000 cumulative adjustment described above:

Stock options with favorable exercise prices in certain periods compared to stock prices before or after grant date

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     Rather than making stock option grants to various employees several times per year, the Company’s policy has generally been to make stock option grants to existing employees once per year. Although the specific date on which the Company made its annual stock option grants has varied during the thirteen year period covered by the Audit Committee’s investigation, the Company’s policy at the time of the 2001 and 2002 annual stock option grants was for the grants to be made January 1st of each respective year.

     In conducting its investigation, the Audit Committee determined, with respect to the 2001 annual stock option grants, that the members of the Compensation Committee initially reviewed the grants in early January, but that the actual approval of the grants did not occur until March 5, 2001. In keeping with the Company’s policy at the time, the measurement date used by the Company for the 2001 annual stock option grants was January 1, 2001. The Audit Committee did note that on January 2, 2001, the Company issued a press release announcing that its Board of Directors had authorized the repurchase of up to 500,000 shares of the Company’s outstanding common stock. The difference in per share closing sale price of the common stock as reported by NASDAQ Capital Market on December 29, 2000 ($0.66), the last trading day before January 1, 2001 and the per share closing price on March 5, 2001 ($1.12) represents a difference of $0.46 per share. The Company awarded a total of 130,000 stock options as part of the 2001 annual stock option grants, of which 100,000 stock options were issued to individuals who, at the time, were serving as officers of the Company. No recipient of any of the 2001 annual stock option grants served on the Compensation Committee, which approved the grant awards.

     With respect to the 2002 annual stock option grants, the actual approval of the grants did not occur until January 25, 2002. In keeping with the Company’s policy at the time, the measurement date used by the Company for the 2002 annual stock option grant was January 1, 2002. The Audit Committee did note that on January 2, 2002, the Company executed a co-branding agreement with Yum! Brands, Inc. (formerly Tricon Global Restaurants, Inc.) to establish a pilot program to offer the Company’s fast food products in conjunction with the Yum! Brands products, such as Taco Bell, Pizza Hut and KFC operations, in up to 10 restaurant locations, with an option in favor of Yum! Brands to expand that relationship to up to 500 restaurants. The difference in the per share closing sale price of the common stock as reported by NASDAQ Capital Market on December 31, 2001 ($3.98), the last trading day before January 1, 2002, and the per share closing sale price on January 25, 2002 ($7.65) represents a difference of $3.67 per share. The Company awarded a total of 111,000 stock options as part of the 2002 annual stock option grants, of which 89,000 stock options were issued to individuals who, at the time, were serving as officers of the Company. No recipient of any of the 2002 annual stock option grants served on the Compensation Committee, which approved the grant awards.

     The cumulative impact of adjustments applied to the 2001 and 2002 annual stock grants were approximately $30,000 (net of a $17,000 tax benefit) and $236,000 (net of a $92,000 tax benefit), respectively. With respect to the 2001 adjustment, $21,000 related to stock option grants to the Company’s officers and the remaining $9,000 related to stock option grants to other key employees. With respect to the 2002 adjustments, $210,000 related to stock option grants to the Company’s officers and the remaining $26,000 related to stock option grants to other key employees. The Company also recorded approximately $26,000 in additional payroll tax expense relating to 2001 and 2002 annual stock grants that have been exercised to date due to the fact that these options were originally treated as incentive stock options but should have been treated as non-qualified stock options, for which payroll tax withholdings are required upon exercise.

Inaccurate measurement date for 2002 automatic grants to three independent directors

     The Company’s 1995 Incentive Award Plan contained a provision for the automatic grant of stock options to independent directors on the tenth day after the Company’s annual stockholders meeting. It was noted during the investigation that in 2002, the Company’s 2002 annual stockholders meeting was held on May 16, 2002. The automatic grants for that year were granted with an exercise price equal to the closing price of the Company’s common stock on May 28, 2002 (the 10^th day the meeting was Sunday, May 26, 2002, and the following Monday, May 27, 2002, was Memorial Day, on which the stock markets were closed). After further review, it was determined that the grants should have been made on May 24, 2002, the last business day before the tenth day after the Company’s annual stockholders meeting. The closing price of the Company’s common stock on May 28, 2002 was $10.13 and the closing price of the Company’s common stock on May 24, 2002 was $10.93, resulting in an $0.80 difference in the exercise price and the measurement date price. This resulted in an approximate $8,000 (net of a $4,000 tax benefit) adjustment related to the 15,000 shares issued under the May 28, 2002 grant.

Inaccurate measurement dates for two new hires and one independent director

     In the course of its investigation, the Audit Committee identified grants made by the Company’s Chief Executive Officer to two employees in connection with their hiring in 1999 and 2005, respectively, for which the

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grant date for their respective stock options was prior to their respective start dates with the Company (although the grant dates were subsequent to the employees having accepted their respective offers of employment with the Company). The Audit Committee determined that the appropriate measurement dates with respect to these grants should have been the first day of service with the Company. These two grants were made for a total of 28,000 stock options. The cumulative impact of adjusting the measurement dates of these two stock option grants to the respective dates on which the respective employees commenced employment with the Company is $1,000.

     In addition, the Audit Committee determined that in late 1999 the Company incorrectly accounted for one stock option grant made to a new independent director. In this case, the director was elected to fill a vacancy resulting from the resignation of another director. The director was elected to the Board of Directors on December 2, 1999 and in connection with his election, it was agreed that the director was to be granted a stock option to purchase 60,000 shares of the Company’s common stock at the fair market value on the date of grant. However, due to administrative errors and lack of attention to timely paperwork, the stock option instrument was not issued by the Company until March 1, 2000, and it bore a grant date of March 1, 2000. The Audit Committee determined that the measurement date and grant dates should have been established as the first day of the director’s service with the Company (December 2, 1999), and the fair market value of the Company’s common stock as of the adjusted measurement date in this instance was higher than the fair market value of the stock on the recited grant date. The cumulative impact of correcting the measurement date of this grant to December 2, 1999 is $10,000 (net of a $5,000 tax benefit).

Additional Inconsistencies Not Requiring Financial Statement Adjustments

     In addition to the above described errors requiring adjustments to the financial statements, the Audit Committee determined that certain grants of stock options in 1998 did not conform to the Company’s policy at the time but for the reasons noted below, the Company did not make any adjustment to the financial statements in respect of such grant.

     The stock options issued as part of the 1998 annual stock option grant were approved for issuance at a meeting of the Company’s Compensation Committee on January 15, 1998. The minutes of that meeting did not specify a grant date for the options. Prior to the implementation of The Sarbanes-Oxley Act of 2002, the Compensation Committee did not customarily specify a grant date when approving the annual option grants but rather delegated that decision to the Company’s senior management, with the expectation that the Company’s senior management would issue the options at a time and in a manner that was consistent with the then current Company policy. At the time, it was the Company’s policy that its annual option grants would be issued on the first business day of the second fiscal quarter. In the case of the 1998 annual stock option grants, this date would have been April 5, 1998. The Audit Committee determined that the Company issued the award agreements reflecting the 1998 annual stock option grants on February 27, 1998 and February 28, 1998 and used those dates for accounting purposes as the appropriate measurement dates. Based on historical closing prices for the Company’s common stock on the NASDAQ Capital Market, February 27, 1998 represented the lowest closing price for the Company’s common stock during the period between January 15, 1998, the date the Compensation Committee approved the grants, and April 5, 1998, the first business day of the Company’s second fiscal quarter. Based on the information obtained by the Audit Committee in the course of its review, the Audit Committee concluded that the Company did in fact execute the award agreements reflecting the 1998 annual stock option grant on February 27, 1998 and February 28, 1998. As no explicit grant date was approved by the Compensation Committee and there are no findings to suggest that the Company’s management acted inappropriately in the issuing the options on February 27, 1998 and February 28, 1998, the Company has not made any adjustments to its financial statements associated with the 1998 annual stock option grant.

New Board Policy for Stock Options and other Equity Awards

     The Audit Committee also recommended, and the Board of Directors has adopted a formal policy (the “Policy”) with respect to the granting of options or other equity incentive awards (“Equity Awards”) in the future. The Policy states that the Board of Directors recognizes that the granting of Equity Awards presents specific legal, tax and accounting issues and that the Policy shall be followed in connection with all issuances of Equity Awards by the Company.

     Under the Policy, the Board of Directors has determined that the Compensation Committee of the Board remains best suited to review and approve Equity Awards. Accordingly, any Equity Awards shall be approved by the Compensation Committee or the full Board of Directors. To avoid the timing issues inherent in the Board or the Compensation Committee acting by unanimous written consent, the Policy requires all Equity Awards to be

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approved at a meeting (including telephonic meeting) of the Board of Directors or Compensation Committee, as the case may be, and not by written consent.

     The Policy expressly provides that the grant date of any Equity Award shall be the date of the meeting at which the award was approved and the exercise price shall be the closing price of the Company’s common stock on such date on the NASDAQ Capital Market, or any successor to such market on which the Company’s common stock is listed for trading.

     The Policy permits the Company to continue its practice of making grants to existing employees once per year. In the event of an Equity Award being granted to a new employee of the Company (“new hire”), the Policy allows the new hire to be notified that management will recommend to the Board or the Compensation Committee, as the case may be, an Equity Award, but that the Equity Award will not be approved, nor be deemed awarded, unless and until appropriate granting action is taken at a subsequent Board or Compensation Committee meeting following the commencement of employment of the new hire and such Equity Award shall be dated (and the exercise price will be determined as of) the date of the Board or Compensation Committee meeting at which it was approved.

     The Policy requires that the details of every Equity Award shall be reflected in the minutes of the requisite Board or Compensation Committee meeting, which minutes shall be maintained in the respective minute books. These details will include, at a minimum, the following information:

• Name of grantee;

• Number of shares of common stock covered by any options or other Equity Awards being granted to the grantee;

• Statement that the grant date is the date of the meeting at which the options are approved;

• Statement that the exercise price of the option or other Equity Award shall be the closing price of the Company’s common stock on the NASDAQ Capital Market (or applicable successor market) on such date.

     Neither the Board of Directors nor Compensation Committee will be authorized to grant an unallocated “pool” of options to a group of individuals or otherwise delegate the authority to grant any options or other Equity Awards to any other person.

     Under the Policy, all Equity Awards shall be promptly communicated to the necessary accounting and legal personnel to assure proper reporting and accounting of the awards. Grant award packages shall be promptly distributed to each grantee, and in no event shall such communication be later than 20 days from the approval date.

Stock Option Amendment Agreements with Certain Executive Officers

     On March 29, 2007, the Company and Mr. Lattimore M. Michael, its Chairman and Chief Executive Officer, agreed to amend the stock option award agreements entered into between the Company and Mr. Michael to increase the exercise price for the stock options granted to Mr. Michael as part of the 2001 annual stock option grant and 2002 annual stock option grant. Under the amendments, the exercise price for the options granted to Mr. Michael pursuant to the 2001 annual stock option grant was increased from $.722 per share (110% of the fair market value of the common stock on the recited date of grant in the original award agreement) to $1.232 per share (110% of the fair market value of the common stock on the adjusted measurement date for such award), as a result of the stock option investigation described elsewhere in this report. In addition, the exercise price for the options granted to Mr. Michael pursuant to the 2002 annual stock option grant was increased from $4.38 per share (110% of the fair market value of the common stock on the recited date of grant in the original award agreement) to $8.42 per share (110% of the fair market value of the common stock on the adjusted measurement date for such award). These exercise prices, being equal to 110% of the fair market value of the Company’s common stock on the adjusted measurement dates, are required by the stock option plans under which the options were granted since Mr. Michael holds in excess of 10% of the outstanding capital stock of the Company. The amendments to these options were made voluntarily by Mr. Michael.

     On March 29, 2007, the Company and Mr. Michael G. Webb, its Executive Vice President and Chief Financial Officer, agreed to amend the stock option award agreement entered into between the Company and Mr. Webb to increase the exercise price for the stock options granted to Mr. Webb as part of the 2002 annual stock option grant. Under the amendment, the exercise price for the options granted to Mr. Webb pursuant to the 2002 annual stock option grant was increased from $3.98 per share, the fair market value of the common stock on the

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recited date of grant in the original award agreement, to $7.65 per share, the fair market value of the common stock on the adjusted measurement date for such award, as a result of the stock option investigation described elsewhere in this report. This amendment was made voluntarily by Mr. Webb.

Regulatory Matters

     The Company has advised the SEC of the Audit Committee’s investigation of its stock option grant practices and the Company intends to cooperate with the SEC in any investigation into this matter. As of the date of this Form 10-K, the Company has not been notified of any commencement by the SEC or other governmental agencies of any investigation into the Company’s stock option granting practices.

     On November 14, 2006, the Company notified the SEC that because its Audit Committee’s investigation of the Company’s historical stock option grant practices was ongoing, the Company would not be able to timely file its Form 10-Q for the period ended September 30, 2006. On November 20, 2006, the Company received a Nasdaq Staff Determination notice stating that due to its failure to timely file its Form 10-Q for the quarter ended September 30, 2006, the Company’s common stock would be delisted from the NASDAQ Capital Market at the opening of business on November 29, 2006 unless the Company requested a hearing before a Nasdaq Listing Qualifications Panel (the “Panel”). On November 21, 2006, the Company submitted a request for a hearing before the Panel, which stayed the delisting pending the hearing. The hearing occurred on February 1, 2007. At the hearing, the Company requested that the Panel grant it an extension until March 19, 2007 to file its Form 10-Q for the period ended September 30, 2006. On March 19, 2007, the Company requested an extension until April 17, 2007, and on March 20, 2007, the Panel granted the request for such extension. The Company filed its Quarterly Report on Form 10-Q for the period ended September 30, 2007, on March 27, 2007. On April 2, 2007, the Company received notice from the Panel that it was in compliance with all Nasdaq Marketplace Rules and that the Panel had determined to continue the listing of the Company’s common stock on the NASDAQ Capital Market.

     The Company determined the impact of recording the charges for stock-based compensation was not material to fiscal years 2005 and 2004, and recording the cumulative out-of period charges in fiscal year 2006 would not be material to that period, and accordingly recorded the adjustments relating to stock option practices in the Quarterly Report on Form 10-Q for the quarter ended September 30, 2006, This conclusion was reached based on an analysis of the adjustments under both Staff Accounting Bulletin 99 and 108. Management concluded that none of the adjustments were material to any of the financial statements presented in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005 and there were no qualitative issues identified during the investigation that would require restatement under Staff Accounting Bulletin 99 or 108.

Costs of Investigation and Legal Activities

     The Company has incurred substantial expenses for legal, accounting, tax and other professional services in connection with the Audit Committee’s investigation, the preparation of its financial statements and related regulatory matters. The Company has expenses of approximately $350,000 related to these matters, and these costs have been recorded as general and administrative costs in the quarter ended December 30, 2006.

Adjustment Summary

     Following is a summary (in thousands, except per share data) of the effects of these corrections on the Company’s consolidated financial statements:

	Consolidated Balance Sheet
	Unadjusted		Adjustments			Adjusted
December 30, 2006
Income taxes receivable	$	202		63			265
Total current assets		7,021		63			7,084
Non-current deferred tax asset		655		108			763
Total assets		33,239		171			33,410
Accrued expenses		2,666		26			2,692
Total current liabilities		5,763		26			5,789
Total liabilities		16,079		26			16,105
Paid-in capital		12,176		456			12,632
Retained earnings		4,961		(311	)		4,650
Total shareholders’ equity		17,160		145			17,305
Total liabilities and shareholders’ equity		33,239		171			33,410

F-29

	Consolidated Statements of Operations
	Unadjusted		Adjustments			Adjusted
Fifty-two weeks ended December 30, 2006
General and administrative		7,040		429			7,469
Total expenses		42,105		429			42,534
Operating income		2,605		(429	)		2,176
Income before income taxes		1,813		(429	)		1,384
Income tax expense		626		(118	)		508
Net income		1,187		(311	)		876
Net income per common shares — basic		0.23		(0.06	)		0.17
Net income per common shares — diluted		0.23		(0.06	)		0.17

	Consolidated Statement of Cash Flows
	Unadjusted			Adjustments			Adjusted
Fifty-two weeks ended December 30, 2006
Net cash provided by operating activities		4,307			(53	)		4,360
Net cash provided by financing activities		(418	)		53			(365	)

NOTE 4 — ACCOUNTS RECEIVABLE

     Corporate receivables and National Advertising Fund receivables represent amounts due from franchisees for contractual obligations and for product purchases. A summary of accounts receivable follows (in thousands):

	December 30,			December 30,
	2006			2005
Corporate receivables	$	558		$	442
National Advertising Fund receivables		116			113
Credit card receivables		96			162
Rebate receivables		117			123
Other		70			99
		957			939
Allowance for doubtful accounts		(218	)		(153	)
	$	739		$	786

NOTE 5 — PROPERTY AND EQUIPMENT

     Summaries of property and equipment follow (in thousands):

	December 30,			December 31,
	2006			2005
Land	$	7,444		$	7,560
Buildings		14,573			13,052
Building and site improvements		2,931			2,965
Fixtures and equipment		13,130			13,182
Transportation vehicles		266			224
		38,344			36,983
Accumulated depreciation and amortization		(14,951	)		(13,948	)
	$	23,393		$	23,035

     Approximately $7.5 million and $6.9 million of the total fixed assets above relate to assets, primarily buildings, under capital leases and held by the Company as of December 30, 2006 and December 31, 2005, respectively. Related accumulated depreciation for these assets was approximately $2.6 million and $2.5 million for fiscal years 2006 and 2005, respectively.

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NOTE 6 — INVESTMENT IN JOINT VENTURES

      As of December 28, 2002, the Company had invested a total of $200,000 for 23%-25% interests in four joint ventures for the purpose of operating Back Yard Burgers restaurants. The Company accounts for these joint ventures using the equity method of accounting. The Company leases the real property from the joint ventures. Three of these leases are capital leases (see Note 9 of Notes to the Consolidated Financial Statements) and one of the leases is an operating lease.

NOTE 7 — ACCRUED EXPENSES

     A summary of accrued expenses follows (in thousands):

	December 30,		December 31,
	2006		2005
Payroll related	$	909	$	652
Sales taxes		316		295
Property taxes		230		184
Interest		86		45
Utilities		101		109
Professional fees		383		47
Construction in progress		305		—
Other miscellaneous accruals		362		402
	$	2,692	$	1,734

NOTE 8 — DEFERRED FRANCHISE AND AREA DEVELOPMENT FEES

     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. At December 30, 2006 deferred fees received for certain franchise and area development rights, net of commissions paid, include amounts sold during the following years (in thousands):

2006	$	101
2005		208
Previous years		918
	$	1,227

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NOTE 9 — INDEBTEDNESS

     Long-term debt is collateralized by property and equipment with a net book value aggregating $13,435,000. The balances consist of the following (in thousands):

	December 30,			December 31,
	2006			2005
Notes payable, payable in monthly installments ranging from $47 to $52, including interest ranging from 5.2% to 7.75%	$	6,608		$	7,364
Capital lease obligations for leased buildings, payable in monthly installments of approximately $5, and effective interest rates ranging from 8.7% to 10.7%		3,246			3,353
Equipment-related capital lease obligation, payable in monthly installment of approximately $5, and effective interest rate of 7.9%		46			106
Capital lease obligations to Lester’s Back Yard Burgers Joint Venture I, II and IV (See Note 6), payable in monthly installments ranging from $4 to $7 and effective interest rates ranging from 12.0% to 12.5%		1,585			1,846
		11,485			12,669
Less interest payments for capital leases		(1,533	)		(1,704	)
Less current installments		(1,645	)		(966	)
Total	$	8,307		$	9,999

     The principal maturities of all long-term debt outstanding as of December 30, 2006, are as follows: $1,645,000 in 2007, $534,000 in 2008, $474,000 in 2009, $455,000 in 2010, $496,000 in 2011 and $6,348,000 thereafter. These principal maturities include principal maturities for capital leases as follows: $843,000 in 2007, $169,000 in 2008, $181,000 in 2009, $139,000 in 2010, $156,000 in 2011 and $1,856,000 thereafter.

     Scheduled interest payments on capital leases as of December 30, 2006 are as follows: $272,000 in 2007, $255,000 in 2008, $229,000 in 2009, $144,000 in 2010, $119,000 in 2011 and $514,000 thereafter.

     On November 17, 2005 the Company borrowed $6,200,000, all of which was outstanding as of December 31, 2005, pursuant to the terms of a Loan Agreement dated November 17, 2005 by and among the Company and its subsidiaries and First Tennessee Bank National Association and a Secured Promissory Note and related collateral documents (collectively, the “Loan Agreement”). Approximately $5,965,000 was outstanding as of December 30, 2006. Under the terms of the Loan Agreement, the Company will make monthly installments of principal and interest on borrowings under the Loan Agreement commencing January 1, 2006 and continuing until December 1, 2012, at which time the entire outstanding principal balance, together with all accrued and unpaid interest, is due and payable. Amortization of the outstanding principal balance is made on a monthly basis and begins at $19,600 per month and increases over the term of the Loan Agreement to $30,200 per month. The unpaid principal balance of borrowings under the Loan Agreement bear interest at a rate equal to the one-month LIBOR plus 2%, adjusted monthly. In May 2006, the Company executed a cash flow hedging instrument (interest rate swap) to minimize interest rate fluctuation risk to convert all of the interest associated with this debt to a fixed rate of 7.75% through the maturity of the note payable. One-month LIBOR plus 2% was approximately 7.08% on the date the swap was executed and was approximately 7.33% as of December 30, 2006. The Company records in its statement of operations interest expense or income related to the fixed rate of the interest rate swap in the period incurred.

     The borrowings under the Loan Agreement were used by the Company to pay the purchase price to acquire four restaurants in Florida and to purchase the real property of four additional restaurants, previously leased by the Company. Borrowings under the Loan Agreement are guaranteed by the Company’s subsidiaries and are secured by a pledge of all real property and improvements and personal property of eight Company-operated restaurants located in Florida, Tennessee and Arkansas.

     The Loan Agreement contains customary affirmative and negative covenants, including without limitation, covenants regarding the sale, lease or franchise of the collateral; delivery of financial statements; maintenance of financial covenants; maintenance of books and records; payment of taxes; maintenance of existence; compliance with law and other agreements; mergers, acquisitions, sales and grants of security interest in assets; changes in management or ownership; dividends; incurrence of loans and guarantees; and conduct of business. The financial covenants relate to the Company’s tangible stockholders’ equity, ratio of total liabilities to stockholders’ equity, and debt coverage ratio; the most restrictive requiring the Company to maintain a debt coverage ratio of at least 1.5 to 1.0. As of December 30, 2006, the Company’s debt coverage ratio was 2.2 to 1.0.

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     On February 11, 2003, the Company entered a loan agreement with First Tennessee Bank National Association 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 notes payable to financial institutions 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, the most restrictive requiring the Company to maintain a debt coverage ratio of at least 1.5 to 1.0. As of December 30, 2006, the Company’s debt coverage ratio was 2.2 to 1.0. The effective rate of interest for the draw down line and revolver line was LIBOR plus 3%, or approximately 8.33%, as of December 30, 2006; however, no borrowings were outstanding at the end of 2005 and 2006 for the draw down line or the revolver line. The principal balance outstanding under the five-year loan was approximately $643,000 as of December 30, 2006, and $1,164,000 as of December 31, 2005. This loan matures in March of 2008.

     As of December 31, 2005, the Company had three capital lease obligations relating to three buildings in which the Company operates restaurants. Two of these obligations were entered during fiscal year 2001 and the third entered during fiscal year 2002. The principal balance outstanding under these leases was approximately $1,484,000 as of December 30, 2006, and approximately $1,551,000 as of December 31, 2005. All three of these leases have an initial term of 15 years with a minimum of four 5-year renewal options at the discretion of the Company. During fiscal year 2005, the Company entered into another capital lease with a principal balance of $646,000, all of which was outstanding as of December 30, 2006. The effective interest rate of this lease was approximately 10.5% and the lease has an initial term of 30 years with a minimum of two 5-year renewal options at the discretion of the Company.

     The Company also had a capital lease obligation relating to the acquisition of certain restaurant equipment as of December 31, 2005. The lease was entered in October of 2002, bearing interest of approximately 7.9% and maturing in September of 2007. The principal balance of this lease was approximately $44,000 as of December 30, 2006, and approximately $99,000 as of December 31, 2005.

     At December 31, 2005, 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 December 31, 2005, was approximately $470,000. The term of the guarantee is through August 13, 2023, the maturity date of the loan. If the franchisee ceases to make note payments, the Company may be required to make note payments until the collateral is liquidated. The guarantee provides for no limitation to the maximum potential future payments under the guarantee; however, the estimated maximum potential future payments are approximately $470,000, which represents the principal balance of the note payable as of the end of our fiscal year 2006. The Company currently has no liability recorded in its financial statements for the guarantor’s obligations under the guarantee. There are no recourse provisions in the guaranty agreement; however, the Company potential loss contingencies are minimal since the loan is collateralized with assets whose estimated fair value is greater than the amount of debt outstanding and based on current cash flows of the restaurant, if acquired through default, would be adequate to cover the debt payments.

NOTE 10 — OPERATING LEASES

     Operating leases relate to leased land sites for Company-operated restaurants and office space for corporate operations. All leases contain renewal options. The future minimum rental payments under operating lease agreements as of December 30, 2006 are as follows (in thousands):

2007	$	1,119
2008		929
2009		697
2010		640
2011		428
Thereafter		762
	$	4,575

The above schedule presents minimum lease payments under the Company’s operating leases. The Company has certain operating leases that also require contingent rent in addition to the minimum rent based on a percentage of sales. Rent expense was $1,263,000, $1,525,000, and $1,475,000 in 2006, 2005 and 2004, respectively.

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NOTE 11 — RELATED PARTY TRANSACTIONS

     In July of 2002, the Company entered into a financing transaction for a new restaurant site and building with certain officers and directors of the Company. The total value of the transaction was $812,500. The Company recorded $490,000 as a capital lease for the construction of the building and $322,500 as financing for the land on which the building is located. Fair market values were used as the basis for assigning these respective values to the building and land. The effective interest rate of the transaction was approximately 10.7%. The transaction was reviewed and approved by the Company’s Board of Directors. As of December 30, 2006, the remaining principle balance of the lease was approximately $745,000.

NOTE 12 — INCOME TAXES

     Income tax expense (benefit) for the following tax years is comprised of (in thousands):

	2006			2005			2004
Federal, current	$	434		$	395		$	638
State, current		—			(9	)		10
Federal, deferred		78			(504	)		(131	)
State, deferred		(4	)		45			8
	$	508		$	(73	)	$	525

     Deferred income taxes are provided in recognition of the future tax consequences attributable to the differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases.

     The deferred tax assets (liabilities) comprise the following (in thousands):

	December 30,			December 31,
	2006			2005
Current
Current deferred tax assets:
Allowance for doubtful receivable	$	85		$	60
Accrued expenses		141			133
Net current deferred tax asset	$	226		$	193
Noncurrent
Noncurrent deferred tax assets:
Franchise and area development fees	$	480		$	563
Net operating loss carryforwards		694			547
Trademark amortization		22			24
Goodwill amortization		(172	)		(105	)
Stock based compensation		75			—
Other deferred income		292			335
Impaired asset write-off		144			266
Other		57			83
Gross noncurrent deferred tax assets		1,592			1,713
Noncurrent deferred tax liabilities:
Depreciation		(48	)		(198	)
Gross noncurrent deferred tax liabilities		(48	)		(198	)
Net noncurrent deferred tax assets		1,544			1,515
Deferred tax asset valuation allowance		(781	)		(644	)
	$	763		$	871

     The ultimate realization of these assets is dependent upon the generation of future taxable income sufficient to offset the related deductions and loss carryforwards within the applicable carryforward period. The Company evaluates the need for a valuation allowance and, based on the weight of available evidence, has determined that it is more likely than not that certain deferred tax assets will eventually be realized. The valuation allowance reflected above is based on management’s conclusion that it is more likely than not that certain state tax carryforward items will expire unused.

F-34

     A reconciliation of the statutory Federal and State income tax rates to the income tax provision is as follows:

	2006						2005						2004
	Amount			%			Amount			%			Amount			%
Computed tax at 35% statutory rate	$	484			35.0		$	(41	)		35.0		$	626			35.0
State income taxes, net of federal benefit		(4	)		(0.3	)		35			(29.9	)		7			0.4
Stock option expense		26			1.9			74			(63.4	)		—			—
Work opportunity tax credit		(49	)		(3.5	)		(100	)		85.5			(100	)		(5.6	)
Valuation allowance releases		—			—			—			—			(28	)		(1.6	)
Other		51			3.6			(41	)		35.2			20			1.1
	$	508			36.7		$	(73	)		62.4		$	525			29.3

     As of December 30, 2006, the Company has net operating loss carryforwards available for state income tax reporting purposes on a consolidated basis of approximately $18 million. These net operating loss carryforwards expire between 2007 and 2021.

NOTE 13 — NATIONAL ADVERTISING FUND

     As part of the standard franchise agreement, each operating unit contributes 1% of its sales to a National Advertising Fund. Under the terms of the agreement, at least 50% of these funds must be spent on the creation of marketing tools, such as advertising copy for use on local radio and television and other collateral material for the operating units. As a general rule, the funds are not used for the purchase and placement of media advertising. The remaining funds are available for use by the Company on such items as testing and development of new products, investigating improvements in operating methods, or other purposes that the Company shall deem to be in the interest of improving operations and earnings of the Company and its franchisees.

NOTE 14 — STOCK OPTION AND BENEFIT PLANS

     In 1992, the Board of Directors of the Company and the shareholders authorized the adoption of an Incentive Stock Option Plan (“ISOP”) for the Company’s employees. As amended in 1993, an aggregate of 176,969 shares of common stock may be granted under the ISOP. Options granted under the ISOP may not be granted at a price less than the fair market value of the common stock on the date of grant (or 110% of fair market value in the case of persons holding 10% or more of the voting stock of the Company). The aggregate fair market value of shares for which options are granted to any employee during any calendar year may not exceed $100,000. The options expire ten years from the date of grant. No future grants will be made from this plan.

     In May 1995, the Board of Directors of the Company and the shareholders authorized the adoption of an Incentive Award Plan (“IAP”) for the Company’s employees. An aggregate of 450,000 shares of common stock may be granted under the IAP, as amended in May 1997. Options granted under the IAP may be designated by the Compensation Committee of the Board of Directors as Incentive Stock Options or Non-Qualified Stock Options. Non-Qualified Stock Options granted under the IAP may not be granted at a price less than par value of the common stock. Incentive Stock Options granted under the IAP may not be granted at a price less than the fair market value of the common stock on the date of grant (or 110% of fair market value in the case of persons holding 10% or more of the voting stock of the Company). The aggregate number of shares for which options are granted to any employee during any calendar year may not exceed 15,000. The term of the options shall be set by the Compensation Committee of the Board of Directors and no term shall exceed a reasonable time period. In the case of Incentive Stock Options, the term shall not be more than ten years from the date of grant. No future grants will be made from this plan.

     Under the IAP, the Compensation Committee of the Board of Directors may award Restricted Stock and/or a Performance Award to selected employees. A Performance Award shall mean cash bonus, stock bonus or other performance or incentive award that is paid in cash, stock or a combination of both. The Company has not issued any Restricted Stock or Performance Awards.

     In May 2002, the Board of Directors of the Company and the shareholders authorized the adoption of an Equity Incentive Plan (“EIP”) for the Company’s employees and directors. An aggregate of 225,000 shares of common stock may be granted under the EIP. In 2004, the plan was amended with shareholder approval to (i)

F-35

increase the number of shares of common stock that may be issued under the Plan by 400,000 shares from 225,000 shares to 625,000 shares, and (ii) provide that the Board may not materially amend the Plan without the approval of the Company’s stockholders. As of December 30, 2006, there were 373,000 options available under the EIP for future grants. Options granted under the EIP may be designated by the Compensation Committee of the Board of Directors as Incentive Stock Options or Non-Qualified Stock Options. Non-Qualified Stock Options granted under the EIP may be granted at a price less than fair market value of the common stock on the grant date. Incentive Stock Options granted under the EIP may not be granted at a price less than the fair market value of the common stock on the date of grant (or 110% of fair market value in the case of persons holding 10% or more of the voting stock of the Company). The aggregate number of shares for which Awards are granted to any employee during any calendar year may not exceed 35,000. The term of the options shall be set by the Compensation Committee of the Board of Directors and shall not be more than ten years from the date of grant.

     Additionally, under the EIP, the Compensation Committee of the Board of Directors may award Restricted Stock and/or stock appreciation rights (SARs) to selected employees. The Company has not issued any Restricted Stock or SARs.

     A summary of activity in the above option plans for the years ended December 30, 2006, December 31, 2005 and January 1, 2004 follows:

	2006					2005					2004
				Weighted					Weighted					Weighted
				Average					Average					Average
				Exercise					Exercise					Exercise
	Options			Price		Options			Price		Options			Price
Outstanding at beginning of year		559,846		$	3.77		629,576		$	3.29		659,051		$	3.24
Granted		—			—		93,500			5.00		7,000			7.90
Exercised		(162,250	)		2.22		(144,800	)		2.31		(35,140	)		2.93
Canceled		(46,220	)		5.77		(18,430	)		5.41		(1,335	)		3.07
Outstanding at end of year		351,376			4.23		559,846			3.77		629,576			3.29
Exercisable at end of year		332,896			4.19		464,036			3.51		599,216			3.13

     A summary of information about the Company’s stock options outstanding at December 30, 2006 follows:

			Weighted						Weighted
			average		Weighted				Average		Weighted
Range of			remaining		average				remaining		Average
exercise	Options		contractual		exercise		Options		contractual		Exercise
prices	Outstanding		life		price		exercisable		Life		Price
$0.50 - $1.00		25,000		4.0	$	0.72		25,000		4.0	$	0.72
$1.00 - $3.00		75,776		3.1		1.44		75,776		3.1		1.44
$3.00 - $5.00		93,600		5.5		4.05		93,600		5.5		4.05
$5.00 - $7.00		130,000		7.9		5.51		111,520		7.8		5.60
$7.00 -$12.00		27,000		5.9		9.74		27,000		5.9		9.74
$0.50 -$12.00		351,376		5.8	$	4.23		332,896		5.7	$	4.19

     In May 1995, the Board of Directors of the Company and the shareholders authorized the adoption of an Employee Stock Purchase Plan (“ESPP”) for the Company’s employees. An aggregate of 225,000 shares of common stock may be issued under the ESPP. Shares purchased under the ESPP shall be sold to participants at 85% of the reported price and the maximum number of shares that can be purchased by a participant is 1,000 shares per quarter. The ESPP shall continue in effect through May 31, 2010. During 2006, 2005 and 2004, 5,027, 4,877 and 6,038 shares were purchased, respectively, under the ESPP. As of December 30, 2006, a total of 136,712 shares have been purchased under the ESPP since its inception in May 1995.

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NOTE 15- EARNINGS PER SHARE

     A reconciliation of basic earnings per share to diluted earnings per share follows (in thousands, except per share data):

	2006						2005								2004
					Per-Share							Per-Share							Per-Share
	Income		Shares		Amount		(Loss)			Shares		Amount			Income		Shares		Amount
Basic EPS
Income available to common stockholders	$	876		5,084	$	0.17	$	(44	)		4,833	$	(0.01	)	$	1,264		4,774	$	0.26
Effect of Dilutive Securities
Convertible preferred stock				14							—							20
Stock options				108							—							302
Diluted EPS
Income available to common stockholders plus assumed conversions	$	876		5,206	$	0.17	$	(44	)		4,833	$	(0.01	)	$	1,264		5,096	$	0.25

     Approximately 137,000 and 49,000 options to purchase the Company’s common stock were not included in the above calculation for the years 2006 and 2004, respectively because the inclusion of these options would have been anti-dilutive. All convertible preferred stock and stock options are anti-dilutive and thus are not included in the calculation of diluted earnings per share for 2005. Income available to common stockholders for each year presented above has not been affected by preferred dividends because the Company has not declared any dividends on its preferred shares.

NOTE 16 — SUBSEQUENT EVENTS

     In January 2007, the Company entered a contract to sell one Company-operated restaurant to a third party. While there is no guarantee the transaction will close, the Company anticipates the transaction to close by the end of April 2007, at which time the Company would recognize a gain on the sale of the restaurant of approximately $135,000.

NOTE 17- COMMITMENTS AND CONTINGENCIES

     Concentration of Risk.Financial instruments which could subject the Company to concentration of credit risk are primarily cash and cash equivalents and receivables. The Company places its cash and cash equivalents in insured depository institutions. At December 30, 2006, the Company’s uninsured cash balance was approximately $5.5 million. The Company performs ongoing credit evaluations of its franchisees and when necessary maintains reserves for potential credit losses on receivables, which are not collateralized.

     Legal Proceedings.The Company is subject to legal proceedings, claims and liabilities, such as sexual harassment, slip and fall cases, etc., which arise in the ordinary course of business and are generally covered by insurance. In the opinion of management, the amount of the ultimate liability with respect to those actions will not have a materially adverse impact on our financial position or results of operations and cash flows.

     Employment Agreements.The Company is party to a three year Employment Agreement and a Severance Agreement with the Chairman and CEO of the Company. In connection with the Company’s previously announced plan to separate the positions of Chairman and CEO and appoint a new CEO/President, the Company entered into a new agreement with the Chairman and CEO in April 2006 under which the current Chairman and CEO will serve as a non-executive Chairman of the Company upon the hiring of a new CEO/President. The new agreement will also supersede the existing Employment Agreement and the Severance Agreement upon the hiring of a new CEO/President.

     The Company entered a Retention and Change in Control Agreement with the Chief Financial Officer in October 2006. The Company is also party to severance agreements with certain other key employees of the Company.

F-37

Report of Independent Registered Public Accounting Firm

Board of Directors and Stockholders
Back Yard Burgers, Inc.
Memphis, TN

We have audited the accompanying consolidated balance sheet of Back Yard Burgers, Inc. as of December 30, 2006 and the related consolidated statement of operations, stockholders’ equity, and cash flows for the fiscal year ended December 30, 2006. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Back Yard Burgers, Inc. at December 30, 2006, and the results of its operations and its cash flows for the fiscal year ended December 30, 2006,in conformity with accounting principles generally accepted in the United States of America.

/s/ BDO Seidman, LLP

April 16, 2007

F-38

Report of Independent Registered Public Accounting Firm

To the Board of Directors and Stockholders of Back Yard Burgers, Inc.

     In our opinion, the accompanying consolidated balance sheet and the related consolidated statements of operations, of changes in stockholders’ equity and of cash flows present fairly, in all material respects, the financial position of Back Yard Burgers, Inc. and its subsidiaries at December 31, 2005, and the results of their operations and their cash flows for the years ended December 31, 2005 and January 1, 2005, in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company’s management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States), which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

Memphis, Tennessee
March 7, 2006

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