<PAGE>

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                                    UNITED STATES
                          SECURITIES AND EXCHANGE COMMISSION

                               Washington, D.C.  20549


                                      FORM 10-Q



                  Quarterly report pursuant to Section 13 or 15(d)
                       of the Securities Exchange Act of 1934
                                          
                                          
                    For the quarterly period ended June 30, 1998


                          Commission File Number:  0-27008

                                          
                                 SCHLOTZSKY'S, INC.
               (Exact name of registrant as specified in its charter)
                                          
            Texas                                         74-2654208
(State or other jurisdiction of                         (IRS Employer
incorporation or organization)                      Identification Number)

                                203 Colorado Street
                                Austin, Texas  78701
                      (address of principal executive offices)
                                          
                                 (512) 236-3600
                         (Registrant's telephone number)
                                          
                                          
                                          
     Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days:

                         YES  /X/          NO    / /


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

             Class                    Shares Outstanding at August 1, 1998
   Common Stock, no par value                      7,399,342

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<PAGE>

                                        INDEX

<TABLE>
PART I.   FINANCIAL INFORMATION                                          Page No.
                                                                         --------
<S>                                                                      <C>
Item 1.   Consolidated Financial Statements

              Condensed Consolidated Balance Sheets --
              June 30, 1998 and December 31, 1997                           2
          
              Condensed Consolidated Statements of 
              Income -- Three and Six Months Ended 
              June 30, 1998 and June 30, 1997                               3
          
              Condensed Consolidated Statements of 
              Stockholders' Equity -- Six Months Ended 
              June 30, 1998 and the year ended December 31, 1997            4
          
              Condensed Consolidated Statements of 
              Cash Flows -- Six Months Ended 
              June 30, 1998 and June 30, 1997                               5
          
              Notes to Condensed Consolidated 
              Financial Statements                                          6

Item 2.   Management's Discussion and Analysis of 
          Financial Condition and Results of Operations                     9

PART II.  OTHER INFORMATION

Item 1.   Legal Proceedings                                                15
     
Item 2.   Changes in Securities                                            15

Item 3.   Defaults Upon Senior Securities                                  15

Item 4.   Submission of Matters to a Vote of Security Holders              15

Item 5.   Other Information                                                16

Item 6.   Exhibits and Reports on Form 8-K                                 16
</TABLE>
<PAGE>

PART I.   FINANCIAL INFORMATION
Item 1.   Financial Statements

                      SCHLOTZSKY'S, INC. AND SUBSIDIARIES
                     CONDENSED CONSOLIDATED BALANCE SHEETS
                                 (UNAUDITED)
<TABLE>
<CAPTION>
                                                                           JUNE 30,      DECEMBER 31,
                                                                             1998            1997
                                                                          -----------    -----------
<S>                                                                       <C>            <C>
Assets
Current assets:
  Cash and cash equivalents                                               $13,720,818    $31,254,048
  Temporary cash investments                                                1,435,906         18,000
  Receivable from sales of Turnkey Program development                      1,849,074      6,054,337
  Royalties receivable                                                      1,246,268        809,125
  Other receivables                                                         2,674,302      2,005,760
  Prepaid expenses and other assets                                           760,092        584,510
  Turnkey Program development                                              17,384,854      6,950,595
  Notes receivable, current portion                                         2,291,679      2,574,588
  Notes receivable from related parties, current portion                      185,808         50,000
                                                                          -----------    -----------
     Total current assets                                                  41,548,801     50,300,963

  Property, equipment and leasehold improvements, net                      11,741,897      9,998,630
  Real estate held for sale                                                   848,981      1,063,592
  Notes receivable, less current portion                                    8,496,628      1,972,470
  Notes receivable from related parties, less current portion               2,411,557      2,565,399
  Investments and advances                                                  1,431,027      1,456,790
  Deferred federal income tax asset                                           590,376        580,460
  Intangible assets, net                                                   11,218,140     11,113,213
  Other noncurrent assets                                                     469,069        469,069
                                                                          -----------    -----------
     Total assets                                                         $78,756,476    $79,520,586
                                                                          -----------    -----------
                                                                          -----------    -----------
Liabilities and Stockholder's Equity
Current liabilities:
  Current maturities of long-term debt                                    $   226,740    $   250,625
  Accounts payable                                                          2,010,754      6,002,920
  Accrued liabilities                                                       1,530,540      1,484,715
                                                                          -----------    -----------
     Total current liabilities                                              3,768,034      7,738,260
  Deferred revenue, net                                                     2,624,259      2,855,380
  Long-term debt, less current maturities                                   1,936,387      1,936,387
                                                                          -----------    -----------
     Total liabilities                                                      8,328,680     12,530,027
Commitments and contingencies
Stockholders' equity:
  Preferred stock:
  Class C--no par value; authorized--1,000,000 shares; issued--none
  Common stock, no par value, 30,000,000 shares authorized, 
    7,334,416 and 7,391,727 issued and outstanding at December 31, 1997 
    and June 30, 1998, respectively                                            62,775         62,202
  Additional paid-in capital                                               57,188,134     56,664,104
  Retained earnings                                                        13,176,887     10,264,253
                                                                          -----------    -----------
     Total stockholders' equity                                            70,427,796     66,990,559
                                                                          -----------    -----------
     Total liabilities and stockholders' equity                           $78,756,476    $79,520,586
                                                                          -----------    -----------
                                                                          -----------    -----------
</TABLE>
                                        
                  THE ACCOMPANYING NOTES ARE AN INTEGRAL PART 
                  OF THE CONSOLIDATED FINANCIAL STATEMENTS.
                                          
                                      2
<PAGE>
                         SCHLOTZSKY'S, INC. AND SUBSIDIARIES
                    CONDENSED CONSOLIDATED STATEMENTS OF INCOME 
                                    (UNAUDITED)
                                          
<TABLE>
<CAPTION>
                                                               THREE MONTHS ENDED             SIX MONTHS ENDED
                                                            -------------------------     -------------------------
                                                             JUNE 30,       JUNE 30,       JUNE 30,       JUNE 30,
                                                              1998            1997           1998           1997
                                                            ----------     ----------     ----------     ----------
<S>                                                         <C>            <C>            <C>            <C>
Revenues
  Royalties                                                 $4,719,538     $3,605,747     $8,978,556     $6,883,307
  Franchise fees                                               380,000        240,000        720,000        592,500
  Developer fees                                                   - -        125,000            - -        125,000
  Restaurant sales                                           1,884,651      1,438,639      3,500,908      2,762,290
  Brand contribution                                         1,005,571        807,177      1,865,887      1,341,823
  Turnkey development                                        1,732,462        762,278      2,857,479      1,447,768
  Other fees and revenue                                       590,803        361,674        844,487        522,379
                                                           -----------     ----------    -----------    -----------
        Total revenues                                      10,313,025      7,340,515     18,767,317     13,675,067

Expenses
  Service Costs:
     Royalties                                               1,799,891      1,305,235      3,420,513      2,507,957
     Franchise fees                                            203,250        132,500        374,500        312,500
  Restaurant Operations:
     Cost of sales                                             600,974        443,146      1,135,326        840,875
     Labor cost                                                761,532        558,814      1,516,418      1,088,381
     Operating expenses                                        542,963        451,815      1,042,786        850,543
  General and administrative                                 3,860,312      2,419,146      6,776,013      4,429,352
  Depreciation and amortization                                447,573        264,200        763,389        513,940
                                                           -----------     ----------    -----------    -----------
     Total expenses                                          8,216,495      5,574,856     15,028,945     10,543,548
                                                           -----------     ----------    -----------    -----------
Income from operations                                       2,096,530      1,765,659      3,738,372      3,131,519

Other
  Interest income, net                                         417,237        137,118        921,518        195,517
                                                           -----------     ----------    -----------    -----------
  Income before income taxes                                 2,513,767      1,902,777      4,659,890      3,327,036

  Provision for federal and state income taxes                 943,246        740,963      1,747,256      1,276,646
                                                           -----------     ----------    -----------    -----------
  Net Income                                               $ 1,570,521     $1,161,814    $ 2,912,634    $ 2,050,390
                                                           -----------     ----------    -----------    -----------
                                                           -----------     ----------    -----------    -----------
Income per common share - basic:
  Income per common share                                         $.21           $.21           $.40           $.37
                                                           -----------     ----------    -----------    -----------
                                                           -----------     ----------    -----------    -----------
  Weighted average shares outstanding                        7,389,977      5,548,264      7,358,065      5,544,547
                                                           -----------     ----------    -----------    -----------
Income per common share - diluted:
  Income per common share                                         $.21           $.20           $.38           $.36
                                                           -----------     ----------    -----------    -----------
                                                           -----------     ----------    -----------    -----------
  Weighted average shares outstanding                        7,605,953      5,720,652      7,602,320      5,695,591
                                                           -----------     ----------    -----------    -----------
                                                           -----------     ----------    -----------    -----------
</TABLE>
                                         
                    THE ACCOMPANYING NOTES ARE AN INTEGRAL PART 
                      OF THE CONSOLIDATED FINANCIAL STATEMENTS. 

                                          3
<PAGE>

                        SCHLOTZSKY'S, INC. AND SUBSIDIARIES
              CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
                                    (UNAUDITED)
                                          
                                          

<TABLE>
<CAPTION>

                                              Common Stock
                                        -------------------------
                                                          Stated      Additional                          Total
                                          Shares          Capital      Paid-In         Retained        Stockholders'
                                        Outstanding       Amount       Capital         Earnings           Equity 
                                        -----------       ------       -------         --------           ------
<S>                                      <C>              <C>        <C>             <C>                <C>
Balance, January 1, 1997                 5,539,922        $44,257    $26,493,165     $  5,774,599       $32,312,021
Public sale of stock                     1,731,825         17,318     29,615,201               --        29,632,519
Options exercised                           57,201            572        485,802           40,239           526,613
Warrants exercised                           5,468             55         69,936              - -            69,991
Net income                                     - -            - -            - -        4,449,415         4,449,415
                                         ---------        -------    -----------      -----------       -----------
Balance, December 31, 1997               7,334,416         62,202     56,664,104       10,264,253        66,990,559
Options exercised                           33,874            339        299,269              - -           299,608
Warrants exercised                          23,437            234        224,761              - -           224,995
Net income                                     - -            - -            - -        2,912,634         2,912,634
                                         ---------        -------    -----------      -----------       -----------
Balance, June 30, 1998                   7,391,727        $62,775    $57,188,134      $13,176,887       $70,427,796
                                         ---------        -------    -----------      -----------       -----------
                                         ---------        -------    -----------      -----------       -----------
</TABLE>

                                          
                        THE ACCOMPANYING NOTES ARE AN INTEGRAL PART
                          OF THE CONSOLIDATED FINANCIAL STATEMENTS. 

                                           4
<PAGE>

                           SCHLOTZSKY'S, INC. AND SUBSIDIARIES
                    CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
                                    (UNAUDITED)

<TABLE>
<CAPTION>
                                                                           SIX MONTHS ENDED
                                                                    -----------------------------
                                                                       JUNE 30,         JUNE 30,
                                                                         1998             1997
                                                                    -------------     -----------
<S>                                                                 <C>               <C>
Cash flows provided by/(used for) operating activities              $ (7,254,739)     $ 6,641,204

Cash flows from investing activities:
  Issuance of notes receivable (less payments)                        (6,783,293)        (342,853)
  Acquisition of intangibles                                            (185,934)      (2,173,570)
  Purchase of property, equipment and leasehold improvements          (2,218,664)      (2,275,200)
  Purchase of temporary investments                                   (1,417,906)             - -
  Other                                                                 (173,412)        (224,354)
                                                                    ------------      -----------
Net cash used for investing activities                               (10,779,209)      (5,015,977)

Cash flows from financing activities:
  Proceeds from issuance of long term debt                                   - -          679,361
  Principal payments on long term debt                                   (23,885)        (452,196)
  Proceeds from exercises of options and warrants                        524,603          110,238
                                                                    ------------      -----------
Net cash provided by financing activities                                500,718          337,403
                                                                    ------------      -----------
Net increase/(decrease) in cash and cash equivalents                 (17,533,230)       1,962,630

Cash and cash equivalents at beginning of period                      31,254,048        5,638,958
                                                                    ------------      -----------
Cash and cash equivalents at end of period                          $ 13,720,818      $ 7,601,588
                                                                    ------------      -----------
                                                                    ------------      -----------
</TABLE>
 
                       THE ACCOMPANYING NOTES ARE AN INTEGRAL PART 
                        OF THE CONSOLIDATED FINANCIAL STATEMENTS. 

                                              5
<PAGE>

                            SCHLOTZSKY'S, INC. AND SUBSIDIARIES
                  NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                        (Unaudited)


June 30, 1998

NOTE 1. -- BASIS OF PRESENTATION

     The accompanying unaudited consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q and Article 10 of
Regulation S-X.  Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements.  In the opinion of management, all adjustments, consisting
of normal recurring accruals, considered necessary for a fair presentation have
been included.  Operating results for the six months ended June 30, 1998, are
not necessarily indicative of the results that may be expected for the year
ended December 31, 1998.  This information should be read in connection with the
consolidated financial statements and footnotes thereto incorporated by
reference in the Schlotzsky's, Inc. Annual Report on Form 10-K/A for the year
ended December 31, 1997.


NOTE 2. -- SIGNIFICANT ACCOUNTING POLICIES

TURNKEY PROGRAM DEVELOPMENT

   Under the Turnkey Program, the Company works independently or with an area
developer to identify superior store sites within a territory.  The Company may
purchase or lease a selected site, design and construct a Schlotzsky's Deli
restaurant on the site and sell, lease or  sublease the completed store to a
franchisee.  Where the Company does not sell the property to a franchisee, the
Company sells the improved property, or, in the case of a leased property,
assigns the lease and any sublease, to an investor. Additionally, the Company
may sell the site or assign its earnest money contract and lease with its
franchisee to a third party investor who then assumes responsibility for
developing the store. The Company typically provides a credit enhancement on the
franchisee's lease on leased locations.  Upon sale of the site or assignment of
its earnest money contract, the Company realizes revenue based on the excess of
the sales price over its cost of securing or developing the property, if it has
provided no credit enhancement on the lease. When a guaranty exists, the Company
defers revenue and related costs of the site to a date when the guaranty is
terminated or the Company's exposure to loss under the guaranty has passed. The
third-party investor may contract with the Company in a separate agreement to
manage construction of the Schlotzsky's Deli restaurant on the site. The Company
typically charges a construction management fee, plus interim interest on the
Company's monies outstanding during construction. The cost of construction,
interim interest and the management fee are collected upon completion of the
restaurant. The Company believes the Turnkey Program enhances the Company's
ability to recruit qualified franchisees by securing and developing high profile
sites and achieving critical mass for advertising purposes more quickly in
selected markets.

   Turnkey Program development is stated at the lower of cost or estimated net
realizable value. Land, site development, building and equipment costs,
including capitalized carrying costs (primarily interest incurred and property
taxes), are accumulated and accounted for on a site specific basis. Construction
costs incurred in connection with the development of properties are capitalized
and accounted for with respect to each project. Generally, interest incurred and
property taxes are capitalized until the related properties are ready for sale.
Thereafter, such costs are charged to expense as they are incurred.
           

                                            6
<PAGE>

     Turnkey development revenue consisted of the following:

<TABLE>
                                                         SIX MONTHS ENDED
                                                    --------------------------
                                                     JUNE 30,       JUNE 30, 
                                                       1998           1997
                                                    -----------   ------------
<S>                                                 <C>           <C>
Sales to investors and franchisees                  $ 8,880,614   $ 12,105,851
Development and construction management fees            130,000        100,000
                                                    -----------   ------------
          Gross Turnkey Program                       9,010,614     12,205,851
Turnkey Program costs                                (6,260,683)   (11,011,509)
                                                    -----------   ------------
          Net revenue from Turnkey Program 
           projects                                   2,749,931      1,194,342
Rental income                                            43,600        253,426
Interim construction interest                            88,217            - -
Plus:  Recognized deferred revenue                      550,396            - -
Less:  Deferred revenue, net                           (574,665)           - -
                                                    -----------   ------------
          Total Turnkey Program revenue             $ 2,857,479   $  1,447,768
                                                    -----------   ------------
                                                    -----------   ------------
</TABLE>

     The following table reflects system performance of the Turnkey Program for
     the year ended December 31, 1997 and the six months ended June 30, 1998:

<TABLE>
                                                  NUMBER OF UNITS
                                                ----------------------
                                                JUNE 30,  DECEMBER 31,
                                                  1998       1997
                                                --------  ------------
<S>                                              <C>        <C>
Sites in process at beginning of period             78        30
Sites beginning development during the period       28        90
Sites completed as Company-owned stores            - -        (1)
Sites sold - revenue recognized                    (20)       (7)
Sites sold - revenue deferred                       (6)      (33)
Other                                              - -        (1)
                                                  ----      ----
Sites in process at end of period                   80        78
                                                  ----      ----
                                                  ----      ----
                                                                        INVESTED AT
                                                                       JUNE 30, 1998
                                                                       -------------
Opened (receiving rent & royalties)                  2         2        $ 1,725,000
Investment Sites (under construction)               12         3         14,060,000
Predevelopment Site (prequalification)              66        73          1,600,000
                                                  ----      ----        -----------
                                                    80        78        $17,385,000
                                                  ----      ----        -----------
                                                  ----      ----        -----------
</TABLE>
     
   Turnkey Program sites in process at the end of a period are classified as 
current assets as management expects to complete and sell such sites within 
the next year.

EARNINGS PER SHARE 

   In March 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings Per
Share." SFAS No. 128 supersedes Accounting Principles Board ("APB") Opinion No.
15, "Earnings Per Share", and changes the computation of earnings per share
("EPS") by replacing the "primary" EPS requirements of APB 15 with a "basic" EPS
computation based upon weighted average shares outstanding. It also requires
dual representation of basic and diluted EPS on the face of the income statement
for all entities with complex capital structures.  SFAS No. 128 is effective for
financial statements issued for periods ending after December 15, 1997, thus the
Company has adopted SFAS No. 128 for the year ended December 31, 1997.
Previously reported EPS have been restated to conform to SFAS No. 128. 

                                      7
<PAGE>

   Basic and diluted EPS computations for the three and six months ended 
June 30, 1998 and 1997 are as follows:

<TABLE>
<CAPTION>

                                                          THREE MONTHS ENDED                 SIX MONTHS ENDED
                                                       -------------------------       ----------------------------
                                                        JUNE 30,       JUNE 30,         JUNE 30,          JUNE 30,
                                                          1998           1997             1998              1997
                                                       ----------     ----------       ----------        ----------
<S>                                                    <C>            <C>              <C>               <C>
Basic EPS
----------
Net income available to common stockholders            $1,570,521     $1,161,814       $2,912,634        $2,050,390
                                                       ----------     ----------       ----------        ----------
                                                       ----------     ----------       ----------        ----------
Weighted average common shares outstanding              7,389,977      5,548,264        7,358,065         5,544,547
                                                       ----------     ----------       ----------        ----------
                                                       ----------     ----------       ----------        ----------
Basic EPS                                                    $.21           $.21             $.40              $.37
                                                       ----------     ----------       ----------        ----------
                                                       ----------     ----------       ----------        ----------
Diluted EPS
-----------
Net income available to common stockholders            $1,570,521     $1,161,814       $2,912,634        $2,050,390
                                                       ----------     ----------       ----------        ----------
                                                       ----------     ----------       ----------        ----------
Weighted average common shares outstanding              7,389,977      5,548,264        7,358,065         5,544,547

Assumed conversion of common shares issuable
 under stock option plan and exercise of warrants         215,976        172,388          244,255           151,044
                                                       ----------     ----------       ----------        ----------
Weighted average common and common 
 equivalent shares outstanding                          7,605,953      5,720,652        7,602,320         5,695,591
                                                       ----------     ----------       ----------        ----------
                                                       ----------     ----------       ----------        ----------
Diluted EPS                                                  $.21           $.20             $.38              $.36
                                                       ----------     ----------       ----------        ----------
                                                       ----------     ----------       ----------        ----------
</TABLE>
 

USE OF ESTIMATES

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

RECENT PRONOUNCEMENTS

In June 1998, the Financial Accounting Standards Board ("FASB") issued SFAS No.
133, "Accounting for Derivative Instruments and Hedging Activities", which is
effective for all fiscal quarters of fiscal years beginning after June 15, 1999.
Management does not believe the implementation of this recent accounting
pronouncement will have a material effect on its consolidated financial
statements. 

                                         8
<PAGE>

      ITEM 2.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
      RESULTS OF OPERATIONS.

RESULTS OF OPERATIONS

THREE MONTHS ENDED JUNE 30, 1998, COMPARED TO THREE MONTHS ENDED JUNE 30, 1997

     REVENUES.  Total revenues increased 40.5% from $7,341,000 to $10,314,000.

     Royalties increased 30.9% from $3,606,000 to $4,720,000.  This increase was
due to the opening of 131 restaurants during the period from July 1, 1997 to
June 30, 1998.  Also driving the increase was the growing influence of larger
freestanding units, particularly the prototype units, which are the focus of the
new unit development.  Furthermore, average weekly sales increased 13.1% and
same store sales increased 3.9% during the second quarter of 1998.

     Franchise fees increased 58.3% from $240,000 to $380,000.  This increase
was principally a result of a greater number of stores and a higher average
franchise fee per unit opened during the three-month period ended June 30, 1998.
A higher number of primary restaurants, which have a higher franchise fee, were
opened during the second quarter of 1998 than during the corresponding period in
1997.

     Developer fees decreased from $125,000 to $0.  Substantially, all
development rights to domestic territories have been sold and only limited
sales, as a result of re-marketing a territory, are anticipated in the future.

     Restaurant sales increased 31.0% from $1,439,000 to $1,885,000.  This 
increase was attributable to the relocation and upgrade of two Company-owned 
units in the Austin, Texas market, which were temporarily closed or 
under-performing, during the second quarter of 1997.

     Brand contributions, or private label licensing fees, increased 24.7% from
$807,000 to $1,006,000.  The increase was principally the result of the
increasing volume of system-wide sales, which generated more purchases of
private label products, and greater franchisee participation in the Company's
purchasing programs.

   Turnkey development revenue increased 127.3% from $762,000 to $1,732,000. 
The release of guaranties on five sites sold in 1997 resulted in approximately
$550,000 of revenue in the current quarter. Revenues from the sales of eleven
sites developed under the Turnkey Program comprise the balance of Turnkey
development revenue generated during this period.  None of these sites included
any credit enhancement from the Company.

     Other fees and revenues increased 63.3% from $362,000 to $591,000.  This
change was primarily due to the increased level of supplier contributions to the
Company's annual convention held in July 1998 and revenue associated with
completion of certain contractual obligations performed for franchisees. 

                                      9
<PAGE>

     The following table reflects the growth of the franchise system for the
three months ended June 30, 1998 and 1997, which has been principally
responsible for the increased revenue as discussed above.

<TABLE>
<CAPTION>
SYSTEM PERFORMANCE                               THREE MONTHS ENDED
                                                ---------------------
                                                JUNE 30,     JUNE 30,
                                                  1998         1997
                                                --------     --------
<S>                                             <C>          <C>
Units Opened
   Domestic
      Freestanding                                   25           14
      End Cap                                         2            3
      Other                                           3            2
                                                -------      -------
          Total Domestic Openings                    30           19
    International                                     1            2
                                                -------      -------
          Total Openings                             31           21
Units Closed                                         (7)          (3)
                                                -------      -------
          Net Unit Growth                            24           18
                                                -------      -------
                                                -------      -------
System-wide Sales (in thousands)                $86,737      $66,951

Average Weekly Sales                            $ 9,900      $ 8,756

Increase in Average Weekly Sales                   13.1%        9.8%

Stores in Operation                                 722         612

Increase in Same Store Sales                        3.9%        3.5%
</TABLE>

     COSTS AND EXPENSES.  Royalty service costs increased 37.9% from $1,305,000
to $1,800,000.  This increase was a result of the increase in royalty revenue
for the three months ended June 30, 1998, as compared to the same period in the
prior year.  Royalty service costs as a percentage of royalties grew from 36.2%
to 38.1%.  This increase reflected the growing percentage of stores serviced by
the area developer system. Area developers receive approximately 42% of the
royalties from stores in their territories.

     Restaurant cost of sales, which consists of food, beverage and paper 
costs, increased 35.7% from $443,000 to $601,000, and as a percentage of 
restaurant sales increased from 30.8% to 31.9%.  Likewise, restaurant labor 
costs increased 36.3% from $559,000 to $762,000, and as a percentage of 
restaurant sales increased from 38.8% to 40.4% for the same quarter in 1997.  
Restaurant operating expenses increased 20.1% from $452,000 to $543,000, but 
as a percentage of restaurant sales decreased from 31.4% to 28.8% for the 
three months ended June 30, 1998, as compared to the corresponding period in 
1997. The percentage increases in restaurant cost of sales and restaurant 
labor cost were primarily attributable to operating inefficiencies related to 
the relocation and reopening of two Company-owned restaurants during the six 
months ended June 30, 1998.  The percentage decrease in restaurant operating 
expenses was attributable to the improving sales outpacing the increase in 
operating costs, particularly at the two reopened stores.

     General and administrative expenses grew 59.6% from $2,419,000 to
$3,860,000 and as a percentage of total revenues increased from 33.0% to 37.4%. 
Costs associated with certain Turnkey Program sites no longer being considered
for development were expensed in the current quarter.  The release of Company
guaranties on five sites sold in 1997 resulted in deferred costs associated with
those sites being recognized during the second quarter of 1998.  Also, the
Company continued to add personnel at the corporate office to support the
growing franchise system, incurring certain one-time expenses related to the
hiring and relocation of new employees.  These items, together with expenses
associated with the completion of certain contractual obligations performed for
franchisees, were the principal reasons for the increases over the corresponding
period in 1997.

     Depreciation and amortization increased 69.7% from $264,000 to $448,000,
and as a percentage of total revenues increased from 3.6% to 4.3%.  The increase
was principally due to the amortization of goodwill and other intangibles
acquired in late 1997 and depreciation related to the additional Company-owned
stores.

     OTHER.  Net interest income increased from $137,000 to $417,000. This 
increase was a result of the higher level of funds invested during the more 
recent period.

     INCOME TAX EXPENSE.  Income tax expense reflected a combined federal and
state effective tax rate of 37.5% for the three months ended June 30, 1998,
which was slightly lower than the effective combined tax rate of 38.9% for 

                                     10
<PAGE>

the comparable period in 1997.  Based on projections of taxable income, the 
Company anticipates that its effective combined rate for federal and state 
taxes will be approximately 37.5% for 1998.

RESULTS OF OPERATIONS

SIX MONTHS ENDED JUNE 30, 1998, COMPARED TO SIX MONTHS ENDED JUNE 30, 1997

     REVENUES.  Total revenues increased 37.2% from $13,675,000 to $18,767,000.

     Royalties increased 30.5% from $6,883,000 to $8,979,000.  This increase was
due to the opening of 131 restaurants opened during the period from July 1, 1997
to June 30, 1998.  Also driving the increase was the growing influence of larger
freestanding units, particularly the prototype units, which are the focus of the
new unit development.  Furthermore, average weekly sales increased 12.7% and
same store sales increased 5.2% during the six months ended June 30, 1998.

     Franchise fees increased 21.4% from $593,000 to $720,000.  This increase
was attributable to the opening of 11 more stores during the six months ended
June 30, 1998, as compared to the same period in 1997.

   Developer fees decreased from $125,000 to $0. Substantially, all development
rights to domestic territories have been sold and only limited sales, as a
result of re-marketing a territory, are anticipated in the future.

     Restaurant sales increased 26.8% from $2,762,000 to $3,501,000.  This
increase was attributable to the relocation and upgrade of two units in the
Austin, Texas market, which were temporarily closed or under-performing, during
the six months ended June 30, 1997.

     Brand contributions, or private label licensing fees, increased 39.1% from
$1,342,000 to $1,866,000.  The increase was principally the result of the
increasing volume of system-wide sales, which generated more purchases of
private label products, and greater franchisee participation in the Company's
purchasing programs.

   Turnkey development revenue increased 97.3% from $1,448,000 to $2,857,000. 
The release of guaranties on five sites sold in 1997 resulted in approximately
$550,000 of revenue in the current quarter.  Revenues from the sales of twenty
sites developed under the Turnkey Program, which had no credit enhancement from
the Company associated with the transactions, comprise the balance of Turnkey
development revenue generated during this period.  Six additional sites sold
during the period included guaranties by the Company, and the revenue from these
transactions was deferred.

     Other fees and revenues increased 61.7% from $522,000 to $844,000.  This
change was primarily due to the increased level of supplier contributions to the
Company's annual convention held in July 1998 and revenue associated with
completion of certain contractual obligations performed for franchisees. 

                                       11
<PAGE>

     The following table reflects the growth of the franchise system for the six
months ended June 30, 1998 and 1997, which has been principally responsible for
the increased revenue as discussed above.

<TABLE>
<CAPTION>
SYSTEM PERFORMANCE                               SIX MONTHS ENDED
                                               --------------------
                                               JUNE 30,    JUNE 30,
                                                 1998        1997
                                               --------    --------
<S>                                            <C>         <C>
Units Opened
   Domestic
      Freestanding                                   44          36
      End Cap                                        10           7
      Other                                           4           4
                                               --------    --------
          Total Domestic Openings                    58          47
   International                                      3           3
                                               --------    --------
          Total Openings                             61          50
Units Closed                                        (12)        (11)
                                               --------    --------
          Net Unit Growth                            49          39
                                               --------    --------
                                               --------    --------
System-wide Sales (in thousands)               $164,781    $127,955

Average Weekly Sales                           $  9,568    $  8,487

Increase in Average Weekly Sales                   12.7%       10.6%

Stores in Operation                                 722         612

Increase in Same Store Sales                        5.2%        2.8%
</TABLE>

     COSTS AND EXPENSES.  Royalty service costs increased 36.4% from $2,508,000
to $3,421,000.  This increase was a result of the increase in royalty revenue
for the six months ended June 30, 1998, as compared to the same period in the
prior year.  Royalty service costs as a percentage of royalties grew from 36.4%
to 38.1%.  This increase reflected the growing percentage of restaurants
serviced by the area developer system. Area developers receive approximately 42%
of the royalties from stores in their territories.

     Restaurant cost of sales, which consists of food, beverage and paper costs,
increased 35.0% from $841,000 to $1,135,000, and as a percentage of restaurant
sales increased from 30.4% to 32.4%.  Likewise, restaurant labor costs increased
39.3% from $1,088,000 to $1,516,000, and as a percentage of restaurant sales
increased from 39.4% to 43.3% for the same quarter in 1997.  Restaurant
operating expenses have increased 22.6% from $851,000 to $1,043,000, but as a
percentage of restaurant sales decreased from 30.8% to 29.8% for the six months
ended June 30, 1998, as compared to the corresponding period in 1997. These
percentage increases in restaurant cost of sales and restaurant labor cost were
primarily attributable to pre-opening costs and operating inefficiencies related
to the relocation and reopening of two Company-owned restaurants during the six
months ended June 30, 1998.  Operating expenses increased principally because of
the reopening of these restaurants.

     General and administrative expenses grew 53.0% from $4,429,000 to
$6,776,000 and as a percentage of total revenues increased from 32.4% to 36.1%. 
Costs associated with certain Turnkey Program sites no longer being considered
for development were expensed in the current quarter.  The release of Company
guaranties on five sites sold in 1997 resulted in deferred costs associated with
those sites being recognized during the second quarter of 1998.  Also, the
Company continued to add personnel at the corporate office to support the
growing franchise system, incurring certain one-time expenses related to the
hiring and relocation of new employees.  These items, together with expenses
associated with the completion of certain contractual obligations performed for
franchisees, were the principal reasons for the increases over the corresponding
period in 1997.

     Depreciation and amortization increased 48.4% from $514,000 to $763,000,
and as a percentage of total revenues decreased from 3.8% to 4.1%.  These
increases were principally due to the amortization of goodwill and other
intangibles acquired in late 1997 and depreciation related to the additional
Company-owned restaurants.

     OTHER.  Net interest income increased from $196,000 to $922,000. This 
increase was a result of the higher level of funds invested during the more 
recent period because of the secondary offering.

     INCOME TAX EXPENSE.  Income tax expense reflected a combined federal and
state effective tax rate of 37.5% for the six months ended June 30, 1998, which
was slightly lower than the effective combined tax rate of 38.4% for the
comparable period in 1997.  Based on projections of taxable income, the Company
anticipates that its effective combined rate for federal and state taxes will be
approximately 37.5% for 1998.

                                        12
<PAGE>

LIQUIDITY AND CAPITAL RESOURCES

   Net cash used by operating activities was $7,255,000 for the first six 
months of 1998.  The use of cash resulted from the fact that purchases and 
development costs of Turnkey Program properties far exceeded the proceeds 
generated from the sale of Turnkey Program properties.  Activity during the 
first six months of 1998 reflected a transition in the Turnkey Program from a 
focus on leases with franchisees combined with a sale of the real estate to 
third party investors, to the sale of Turnkey Program properties directly to 
franchisees through the origination of a mortgage or interim construction 
loan.  The mortgage program is intended to allow franchisees the opportunity 
to own the land and building rather than lease it at approximately the same 
monthly cost.  The Company anticipates that it will originate a mortgage for 
qualified franchisees and subsequently sell the mortgage, a financial 
instrument, to one of several financial institutions.  Net cash of 
$10,779,000 was used in investing activities primarily consisting of 
expenditures of $2,219,000 on the completion of the relocation of two 
Company-owned stores and the use of $6,783,000 to fund certain Turnkey 
Development costs associated with mortgage financing or making interim 
construction loans to franchisees.  During the balance of 1998, it is 
anticipated that the cash needed to fund the development of Turnkey Program 
properties will exceed the proceeds from the sale of the mortgages to the 
financial institutions.
   
   During the first half of 1998, financing activities provided net cash of
approximately $501,000 due primarily to the exercise of stock options and
warrants.
   
   At June 30, 1998, the Company had approximately $2,163,000 of debt
outstanding.  As discussed in the "Notes to Financial Statements," the Company
guaranties certain real estate leases, equipment leases and other obligations of
franchisees. At June 30, 1998, these contingent liabilities totaled
approximately $28,491,000. Included in this amount is a construction loan for a
limited partnership in which the Company and its subsidiary, Schlotzsky's Real
Estate, Inc., own a combined 40% interest in capital and profits. The loan, for
which the Company is liable for the full amount, had a balance of $1,105,000 at
June 30, 1998, bears interest at prime plus 1.25% and matures April 2001.
Monthly payments are being made by the limited partnership.
   
   The Company continues to expand and refine its Turnkey Program and expects
that it will have 50 to 100 sites under contract or at various stages of
development at any given time. The Company has used the net proceeds from its
public offerings and the proceeds from sites sold and earnest money contracts
assigned to finance the activity of the Turnkey Program. With the anticipated
growth in the Turnkey Program, particularly the introduction of the mortgage
program described above, the capital required to finance the Turnkey Program
will increase significantly.  Eighty properties were under contract or in
various stages of development at June 30, 1998. The tables below provide a
summary of the Turnkey Program activity for the six months ended June 30, 1997
and 1998.
     
     Turnkey Program revenue consisted of the following:

<TABLE>
<CAPTION>
                                                         SIX MONTHS ENDED
                                                    --------------------------
                                                      JUNE 30,      JUNE 30, 
                                                        1998          1997
                                                    -----------   ------------
<S>                                                 <C>           <C>
Sales to investors and franchisees                  $ 8,880,614   $ 12,105,851
Development and construction management fees            130,000        100,000
                                                    -----------   ------------
    Gross Turnkey Program revenue                     9,010,614     12,205,851
Turnkey Program development costs                    (6,260,683)   (11,011,508)
                                                    -----------   ------------
    Net revenue from Turnkey Program projects         2,749,931      1,194,343
Rental income                                            43,600        253,426
Interim construction interest                            88,217            - -
Plus:  deferred revenue recognized                      550,396            - -
Less:  deferred revenue, net                           (574,665)           - -
                                                    -----------   ------------
    Total Turnkey Program revenue                   $ 2,857,479   $  1,447,768
                                                    -----------   ------------
                                                    -----------   ------------
</TABLE>



                                      13
<PAGE>
      
     The following table reflects system performance of the Turnkey Program for
     the year ended December 31, 1997 and the six months ended June 30, 1998:

<TABLE>
<CAPTION>
                                                          NUMBER OF UNITS
                                                     --------------------------
                                                     JUNE 30,      DECEMBER 31,
                                                       1998            1997
                                                     --------      ------------
<S>                                                     <C>            <C>
Sites in process at beginning of period                  78             30
Sites beginning development during the period            28             90
Sites completed as Company-owned stores                  --             (1)
Sites sold - revenue recognized                         (20)            (7)
Sites sold - revenue deferred                            (6)           (33)
Other                                                    --             (1)
                                                       ----            ----
Sites in process at end of period                        80             78
                                                       ----            ----
                                                       ----            ----
                                                                                   INVESTED AT
                                                                                  JUNE 30, 1998
                                                                                  -------------
Opened (receiving rent & royalties)                       2               2        $ 1,725,000
Investment Sites (under construction)                    12               3         14,060,000
Predevelopment Site (prequalification)                   66              73          1,600,000
                                                       ----            ----        -----------
                                                         80              78        $17,385,000
                                                       ----            ----        -----------
                                                       ----            ----        -----------
</TABLE>

     The Company currently has a line of credit available from a financial
institution which may be used to finance Turnkey Program capital requirements.
The line of credit can be drawn upon to fund up to $12,000,000, bears interest
at the bank's prime lending rate and expires April 2000. As of June 30, 1998,
the Company had not drawn upon this line of credit.  However, the Company has
provided certain guaranties on notes to franchisees and area developers which
reduced the available balance of this line of credit to $6,883,000.

   The Company believes that cash flow from operations, together with the
proceeds of the Turnkey Program, collections from notes receivable and
borrowings under existing credit facilities described above and the proceeds
from its secondary public offering of common stock, will be sufficient to meet
the Company's anticipated cash needs for the foreseeable future. To the extent
that the net proceeds from the Turnkey Program, credit facilities, cash flow
from operations and the proceeds from its secondary offering are insufficient to
finance the Company's future expansion plans, the Company intends to seek
additional funds for this purpose from future borrowings or additional offerings
of equity securities.  However, there can be no assurance of the availability of
such funds on acceptable terms in the future.
   
   
FORWARD LOOKING STATEMENTS

     This report contains forward looking statements within the meaning of
Section 27A of the Securities Act of 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934, as amended, that are not historical facts. 
Such statements may include, but not be limited to, projections of revenues,
income, capital expenditures, plans for future operations, financing needs or
plans, and plans relating to products or services of the Company, as well as
assumptions relating to the foregoing.  These statements involve management
assumptions and are subject to risks and uncertainties, along with factors set
forth in the Company's Annual Report on Form 10-K/A in "Business," pages 1-15. 

                                    14
<PAGE>

PART II.  OTHER INFORMATION

ITEM 1.  LEGAL PROCEEDINGS.

None


ITEM 2.  CHANGES IN SECURITIES.

None


ITEM 3.  DEFAULTS UPON SENIOR SECURITIES

None


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

   The Annual Meeting of the Shareholders of the Company was held on May 29,
1998.  At the meeting, the following items were voted on:


1)   Election of directors, whose terms expired at the meeting.

<TABLE>
<CAPTION>
                                 FOR         WITHHELD
                              ---------      --------
<S>                           <C>            <C>
     John C. Wooley           5,886,580      19,401
     
     Azie Taylor Morton       5,884,735      21,246
     
     Jeffrey J. Wooley        5,886,580      19,401
</TABLE>

     The following directors' terms of office were not expired and continued
after the meeting:

                         John L. Hill, Jr.
                         Floor Mouthaan
                         John M. Rosillo
                         Raymond A. Rodriguez

2)   Proposal to approve amendments to the Third Amended and Restated 1993 Stock
     Option Plan.

<TABLE>
<CAPTION>
           FOR                AGAINST           ABSTAIN
        ---------             -------           -------
<S>                           <C>               <C>
        5,228,589             612,713           64,679
</TABLE>

        Of the amount voted "for," 1,914,219 were broker non-votes voted in
     accordance with the terms of the proxy.

3)   Proposal to approve the Schlotzsky's, Inc. Employee Stock Purchase Pan.

<TABLE>
<CAPTION>
           FOR                AGAINST           ABSTAIN
        ---------             -------           -------
<S>                           <C>               <C>
        5,858,491             30,335            17,155
</TABLE>

        Of the amount voted "for," 1,914,450 were broker non-votes voted in
     accordance with the terms of the proxy. 

                                      15
<PAGE>

ITEM 5.  OTHER INFORMATION

None


ITEM 6.  EXHIBITS AND REPORTS ON FORM 8-K.

     a.  Exhibits:

<TABLE>
<CAPTION>
        Exhibit
          No.  
        -------
<S>                <C>
          27       Financial Data Schedule.
</TABLE>

     b.  Current Reports on Form 8-K:        

         1)   The Registrant filed a report on Form 8-K on May 7, 1998 related
              to the resignation of the Company's independent accountant under
              Item 4. Changes in Registrant's Certifying Accountant.

         2)   The Registrant filed a report on Form 8-K on June 9, 1998 related
              to the appointment of the Company's independent accountant under 
              Item 4. Changes in Registrant's Certifying Accountant.

                                           16
<PAGE>

                                     SIGNATURE

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

                                          
                          SCHLOTZSKY'S, INC.



                                   By:  /s/ John C. Wooley
                                        ---------------------------------
                                        John C. Wooley, President
                                        and Chief Executive Officer




                                   By:  /s/ Monica Gill
                                        ---------------------------------
                                        Monica Gill
                                        Chief Financial Officer


Austin, Texas
August 13, 1998


                                    17