Use these links to rapidly review the documentIndex to Form 10-Q

---

---

SECURITIES AND EXCHANGE COMMISSIONWashington, 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, 2002

Commission File Number: 0-27008

---

Schlotzsky's, Inc.(Exact name of registrant as specified in its charter)

Texas(State or other Jurisdiction of
incorporation or organization)

74-2654208(IRS Employer
Identification No.)


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 ý    No o

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 9, 2002
|-------------------------- |  | ------------------------------------
|Common Stock, no par value |  | 7,306,586                           

---

---

---

SCHLOTZSKY'S, INC.

Index to Form 10-Q
Quarter Ended June 30, 2002



|        |  |                                                                                                                           |  | Page No.
|------- |  | ------------------------------------------------------------------------------------------------------------------------- |  | --------
|Part I  |  | FINANCIAL INFORMATION                                                                                                     |  |         
|Item 1. |  | Financial Statements                                                                                                      |  |         
|        |  | Condensed Consolidated Balance Sheets
June 30, 2002 and December 31, 2001                                                |  | 1       
|        |  | Condensed Consolidated Statements of Income
Three and Six Months Ended June 30, 2002 and June 30, 2001                   |  | 2       
|        |  | Condensed Consolidated Statement of Stockholders' Equity
Six Months Ended June 30, 2002 and Year Ended December 31, 2001 |  | 3       
|        |  | Condensed Consolidated Statements of Cash Flows
Six Months Ended June 30, 2002 and June 30, 2001                         |  | 4       
|        |  | Notes to Condensed Consolidated Financial Statements                                                                      |  | 5       
|Item 2. |  | Management's Discussion and Analysis of Financial Condition And Results of Operations                                     |  | 15      
|Item 3. |  | Quantitative and Qualitative Disclosures About Market Risk                                                                |  | 23      
|Part II |  | OTHER INFORMATION                                                                                                         |  |         
|Item 1. |  | Legal Proceedings                                                                                                         |  | 24      
|Item 2. |  | Changes in Securities and Use of Proceeds                                                                                 |  | 25      
|Item 3. |  | Defaults Upon Senior Securities                                                                                           |  | 25      
|Item 4. |  | Submission of Matters to a Vote of Security Holders                                                                       |  | 25      
|Item 5. |  | Other Information                                                                                                         |  | 26      
|Item 6. |  | Exhibits and Reports on Form 8-K                                                                                          |  | 26      

---



PART I  FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

SCHLOTZSKY'S, INC. AND SUBSIDIARIES  CONDENSED CONSOLIDATED BALANCE SHEETS

|                                                                                                                                                            |                                        | June 30,
2002                              |            | December 31,
2001 |            
|----------------------------------------------------------------------------------------------------------------------------------------------------------- | -------------------------------------- | ------------------------------------------ | ---------- | ----------------- | -----------
|
|ASSETS                                                                                                                                                      |                                        |                                            |            |                  
|Current Assets:                                                                                                                                             |                                        |                                            |            |                   |            
|                                                                                                                                                            | Cash and cash equivalents              |                                            | $          | 981,735           |            
|                                                                                                                                                            | Accounts receivable, net:              |                                            |            |                   |            
|                                                                                                                                                            |                                        | Royalties                                  |            |                   | 786,779    
|                                                                                                                                                            |                                        | Brands                                     |            |                   | 1,516,207  
|                                                                                                                                                            |                                        | Other                                      |            |                   | 1,957,583  
|                                                                                                                                                            | Refundable income taxes                |                                            |            | 362,830           |            
|                                                                                                                                                            | Prepaids, inventories and other assets |                                            |            | 1,211,950         |            
|                                                                                                                                                            | Real estate available for sale         |                                            |            | 5,533,555         |            
|                                                                                                                                                            | Deferred tax asset                     |                                            |            | 1,888,074         |            
|                                                                                                                                                            | Current portion of notes receivable    |                                            |            | 446,968           |            
|                                                                                                                                                            |                                        |                                            |            |                   |            
|                                                                                                                                                            |                                        | Total current assets                       |            |                   | 14,685,681 
|Property, equipment and leasehold improvements, net                                                                                                         |                                        |                                            | 40,285,436 |                   |            
|Notes receivable, net, less current portion                                                                                                                 |                                        |                                            | 11,900,236 |                   |            
|Investments                                                                                                                                                 |                                        |                                            | 1,615,344  |                   |            
|Intangible assets, net                                                                                                                                      |                                        |                                            | 43,333,902 |                   |            
|Other noncurrent assets                                                                                                                                     |                                        |                                            | 1,047,737  |                   |            
|                                                                                                                                                            |                                        |                                            |            |                   |            
|                                                                                                                                                            |                                        | Total assets                               |            | $                 | 112,868,336
|                                                                                                                                                            |                                        |                                            |            |                   |            
|LIABILITIES AND STOCKHOLDERS' EQUITY                                                                                                                        |                                        |                                            |            |                  
|Current Liabilities:                                                                                                                                        |                                        |                                            |            |                   |            
|                                                                                                                                                            | Short-term debt                        |                                            | $          | 926,454           |            
|                                                                                                                                                            | Current maturities of long-term debt   |                                            |            | 6,065,058         |            
|                                                                                                                                                            | Accounts payable                       |                                            |            | 1,568,720         |            
|                                                                                                                                                            | Accrued liabilities                    |                                            |            | 3,506,935         |            
|                                                                                                                                                            | Deferred revenue, current portion      |                                            |            | 348,553           |            
|                                                                                                                                                            |                                        |                                            |            |                   |            
|                                                                                                                                                            |                                        | Total current liabilities                  |            |                   | 12,415,720 
|Long-term debt, less current portion                                                                                                                        |                                        |                                            | 22,975,268 |                   |            
|Deferred revenue, less current portion                                                                                                                      |                                        |                                            | 1,740,844  |                   |            
|Deferred tax liability                                                                                                                                      |                                        |                                            | 152,764    |                   |            
|                                                                                                                                                            |                                        |                                            |            |                   |            
|                                                                                                                                                            |                                        | Total liabilities                          |            |                   | 37,284,596 
|                                                                                                                                                            |                                        |                                            |            |                   |            
|Commitments and contingencies                                                                                                                               |                                        |                                            |            |                   |            
|Stockholders' Equity:                                                                                                                                       |                                        |                                            |            |                   |            
|Preferred stock, Class C, no par value, 1,000,000 shares authorized, none issued                                                                            |                                        |                                            |           |                   |            
|Common stock, no par value, 30,000,000 shares authorized, 7,483,189 shares and 7,463,990 shares issued at June 30, 2002 and December 31, 2001, respectively |                                        |                                            | 63,750     |                   |            
|Additional paid-in capital                                                                                                                                  |                                        |                                            | 58,071,485 |                   |            
|Retained earnings                                                                                                                                           |                                        |                                            | 18,291,661 |                   |            
|Treasury stock (189,525 shares and 186,300 shares at June 30, 2002 and December 31, 2001, respectively), at cost                                            |                                        |                                            | (843,156   | )                 |            
|                                                                                                                                                            |                                        |                                            |            |                   |            
|                                                                                                                                                            |                                        | Total stockholders' equity                 |            |                   | 75,583,740 
|                                                                                                                                                            |                                        |                                            |            |                   |            
|                                                                                                                                                            |                                        | Total liabilities and stockholders' equity |            | $                 | 112,868,336
|                                                                                                                                                            |                                        |                                            |            |                   |            

The accompanying notes are an integral part of the condensed consolidated financial statements.

1

---

SCHLOTZSKY'S, INC. AND SUBSIDIARIES  CONDENSED CONSOLIDATED STATEMENTS OF INCOME  (Unaudited)

|                              |                        | Three months ended     |                                          | Six months ended |          
|----------------------------- | ---------------------- | ---------------------- | ---------------------------------------- | ---------------- | ---------
|
|Revenue:                      |                        |                        |                                          |                  |          
|                              | Royalties              |                        | $                                        | 5,264,312        |          
|                              | Franchise fees         |                        |                                          | 42,000           |          
|                              | Developer fees         |                        |                                          | 60,034           |          
|                              | Restaurant sales       |                        |                                          | 8,269,362        |          
|                              | Brand contribution     |                        |                                          | 1,991,130        |          
|                              | Other fees and revenue |                        |                                          | 276,294          |          
|                              |                        |                        |                                          |                  |          
|                              |                        |                        | Total revenue                            |                  |          
|                              |                        |                        |                                          |                  |          
|Expenses:                     |                        |                        |                                          |                  |          
|                              | Service costs:         |                        |                                          |                  |          
|                              |                        | Royalties              |                                          |                  | 1,106,100
|                              |                        | Franchise fees         |                                          |                  | 15,955   
|                              |                        |                        |                                          |                  |          
|                              |                        |                        | 1,122,055                                |                  |          
|                              |                        |                        |                                          |                  |          
|                              | Restaurant operations: |                        |                                          |                  |          
|                              |                        | Cost of sales          |                                          |                  | 2,311,986
|                              |                        | Personnel and benefits |                                          |                  | 3,292,578
|                              |                        | Operating expenses     |                                          |                  | 1,869,095
|                              |                        |                        |                                          |                  |          
|                              |                        |                        | 7,473,659                                |                  |          
|                              |                        |                        |                                          |                  |          
|Equity loss on investments    |                        |                        | 48,074                                   |                  |          
|                              |                        |                        |                                          |                  |          
|General and administrative    |                        |                        | 4,835,390                                |                  |          
|                              |                        |                        |                                          |                  |          
|Depreciation and amortization |                        |                        | 1,086,438                                |                  |          
|                              |                        |                        |                                          |                  |          
|                              |                        |                        | Total expenses                           |                  |          
|                              |                        |                        |                                          |                  |          
|                              |                        |                        | Income from operations                   |                  |          
|Other:                        |                        |                        |                                          |                  |          
|                              | Interest income        |                        |                                          | 94,618           |          
|                              | Interest expense       |                        |                                          | (655,436         | )        
|                              |                        |                        |                                          |                  |          
|                              |                        |                        | Income before provision for income taxes |                  |          
|Provision for income taxes    |                        |                        | 288,000                                  |                  |          
|                              |                        |                        |                                          |                  |          
|Net income                    |                        | $                      | 488,698                                  |                  | $        
|                              |                        |                        |                                          |                  |          
|Earnings per share-basic      |                        | $                      | 0.07                                     |                  | $        
|                              |                        |                        |                                          |                  |          
|Earnings per share-diluted    |                        | $                      | 0.07                                     |                  | $        
|                              |                        |                        |                                          |                  |          

The accompanying notes are an integral part of the condensed consolidated financial statements.

2

---



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

|                                                                         |  | Common Stock |  |   |        |  |   |            |  |   |           
|------------------------------------------------------------------------ |  | ------------ |  | - | ------ |  | - | ---------- |  | - | ----------
|
|Balance, January 1, 2001                                                 |  | 7,443,342    |  | $ | 63,291 |  | $ | 57,877,642 |  | $ | 14,686,095
|Issuance of common stock in connection with employee stock purchase plan |  | 18,348       |  |   | 184    |  |   | 38,806     |  |   |          
|Issuance of warrants                                                     |  |             |  |   |       |  |   | 57,000     |  |   |          
|Treasury stock purchases (176,300 shares)                                |  |             |  |   |       |  |   |           |  |   |          
|Options exercised                                                        |  | 2,300        |  |   | 23     |  |   | 6,877      |  |   |          
|Tax benefit from employee stock transactions                             |  |             |  |   |       |  |   | 6,221      |  |   |          
|Net income                                                               |  |             |  |   |       |  |   |           |  |   | 2,489,139 
|                                                                         |  |              |  |   |        |  |   |            |  |   |           
|Balance, December 31, 2001                                               |  | 7,463,990    |  |   | 63,498 |  |   | 57,986,546 |  |   | 17,175,234
|Issuance of common stock in connection with employee stock purchase plan |  | 7,199        |  |   | 72     |  |   | 33,339     |  |   |          
|Treasury stock purchases (3,225 shares)                                  |  |             |  |   |       |  |   |           |  |   |          
|Options exercised                                                        |  | 12,000       |  |   | 180    |  |   | 46,748     |  |   |          
|Tax benefit from employee stock transactions                             |  |             |  |   |       |  |   | 4,852      |  |   |          
|Net income                                                               |  |             |  |   |       |  |   |           |  |   | 1,116,427 
|                                                                         |  |              |  |   |        |  |   |            |  |   |           
|Balance, June 30, 2002                                                   |  | 7,483,189    |  | $ | 63,750 |  | $ | 58,071,485 |  | $ | 18,291,661
|                                                                         |  |              |  |   |        |  |   |            |  |   |           

PREFERRED STOCK

Authorized 1,000,000 Class C shares, no par value; no shares outstanding at June 30, 2002, December 31, 2001, or January 1, 2001.

COMMON STOCK

Authorized 30,000,000 shares, no par value; 7,483,189 shares issued at June 30, 2002, 7,463,990 shares issued at December 31, 2001, and 7,443,342
shares issued at January 1, 2001. Shares issued include 189,525, 186,300 and 10,000 shares in treasury at June 30, 2002, December 31, 2001, and January 1, 2001,
respectively.

The accompanying notes are an integral part of the condensed consolidated financial statements.

3

---

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

|                                                     |                                                                               | For the six months ended                                       |                                         
|---------------------------------------------------- | ----------------------------------------------------------------------------- | -------------------------------------------------------------- | ----------------------------------------
|
|Cash flows from operating activities:                |                                                                               |                                                                |                                         
|                                                     | Net income                                                                    |                                                                | $                                       
|                                                     | Adjustments to reconcile net income to cash provided by operating activities: |                                                                |                                         
|                                                     |                                                                               | Depreciation and amortization                                  |                                         
|                                                     |                                                                               | Provisions for uncollectible accounts and impairment of assets |                                         
|                                                     |                                                                               | Amortization of deferred revenue                               |                                         
|                                                     |                                                                               | Equity loss on investments                                     |                                         
|                                                     |                                                                               | Changes in:                                                    |                                         
|                                                     |                                                                               |                                                                | Accounts receivable                     
|                                                     |                                                                               |                                                                | Prepaid expenses and other assets       
|                                                     |                                                                               |                                                                | Accounts payable and accrued liabilities
|                                                     |                                                                               |                                                                |                                         
|                                                     |                                                                               |                                                                |                                         
|                                                     |                                                                               |                                                                |                                         
|Cash flows from investing activities:                |                                                                               |                                                                |                                         
|                                                     | Purchase of property, equipment and real estate available for sale            |                                                                |                                         
|                                                     | Sale of property, equipment and real estate available for sale                |                                                                |                                         
|                                                     | Acquisition of investments and intangible assets                              |                                                                |                                         
|                                                     | Issuance of notes receivable                                                  |                                                                |                                         
|                                                     | Repayments of notes receivable                                                |                                                                |                                         
|                                                     | Sale of investments and intangible assets                                     |                                                                |                                         
|                                                     |                                                                               |                                                                |                                         
|                                                     |                                                                               |                                                                |                                         
|                                                     |                                                                               |                                                                |                                         
|Cash flows from financing activities:                |                                                                               |                                                                |                                         
|                                                     | Sale of stock                                                                 |                                                                |                                         
|                                                     | Issuance of warrants                                                          |                                                                |                                         
|                                                     | Acquisition of treasury stock                                                 |                                                                |                                         
|                                                     | Proceeds from issuance of debt                                                |                                                                |                                         
|                                                     | Repayment of debt                                                             |                                                                |                                         
|                                                     |                                                                               |                                                                |                                         
|                                                     |                                                                               |                                                                |                                         
|                                                     |                                                                               |                                                                |                                         
|Net increase (decrease) in cash and cash equivalents |                                                                               |                                                                | (1,586,169                              
|Cash and cash equivalents at beginning of period     |                                                                               |                                                                | 2,567,904                               
|                                                     |                                                                               |                                                                |                                         
|Cash and cash equivalents at end of period           |                                                                               | $                                                              | 981,735                                 
|                                                     |                                                                               |                                                                |                                         

The accompanying notes are an integral part of the condensed consolidated financial statements.

4

---



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

Note 1.Basis of Presentation

The accompanying unaudited condensed 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 three months ended June 30, 2002, are not necessarily indicative of the results that may be expected for the year
ended December 31, 2002. This information should be read in conjunction with the consolidated financial statements and footnotes thereto included in the Schlotzsky's, Inc. Annual Report
on Form 10-K for the year ended December 31, 2001.

Reclassifications

Certain reclassifications have been made to the condensed consolidated financial statements for the periods ended June 30, 2001, to correspond with the
presentation used at June 30, 2002, and for the periods then ended.

Note 2.Restaurant Operations

A summary of certain operating information for Company-owned restaurants is presented below for the three and six month periods ended June 30, 2002 and
2001 (dollars in thousands).

|                                                             |                        | Long-term Portfolio Restaurants |       | Available for Sale
Restaurants |  
|------------------------------------------------------------ | ---------------------- | ------------------------------- | ----- | ------------------------------ | -
|
|
|Three months ended June 30, 2002                             |                        |                                 |       |                                |  
|Restaurant sales                                             |                        | $                               | 4,031 |                                | $
|                                                             |                        |                                 |       |                                |  
|Restaurant operations:                                       |                        |                                 |       |                                |  
|                                                             | Cost of sales          |                                 |       | 1,101                          |  
|                                                             | Personnel and benefits |                                 |       | 1,384                          |  
|                                                             | Operating expenses     |                                 |       | 685                            |  
|                                                             |                        |                                 |       |                                |  
|                                                             |                        |                                 | 3,170 |                                |  
|                                                             |                        |                                 |       |                                |  
|Operating income (loss) before depreciation and amortization |                        | $                               | 861   |                                | $
|                                                             |                        |                                 |       |                                |  
|Three months ended June 30, 2001                             |                        |                                 |       |                                |  
|Restaurant sales                                             |                        | $                               | 3,610 |                                | $
|                                                             |                        |                                 |       |                                |  
|Restaurant operations:                                       |                        |                                 |       |                                |  
|                                                             | Cost of sales          |                                 |       | 967                            |  
|                                                             | Personnel and benefits |                                 |       | 1,295                          |  
|                                                             | Operating expenses     |                                 |       | 606                            |  
|                                                             |                        |                                 |       |                                |  
|                                                             |                        |                                 | 2,868 |                                |  
|                                                             |                        |                                 |       |                                |  
|Operating income (loss) before depreciation and amortization |                        | $                               | 742   |                                | $
|                                                             |                        |                                 |       |                                |  

5

---

|                                                             |                        | Long-term Portfolio Restaurants |       | Available for Sale
Restaurants |  
|------------------------------------------------------------ | ---------------------- | ------------------------------- | ----- | ------------------------------ | -
|
|
|Six months ended June 30, 2002                               |                        |                                 |       |                                |  
|Restaurant sales                                             |                        | $                               | 8,007 |                                | $
|                                                             |                        |                                 |       |                                |  
|Restaurant operations:                                       |                        |                                 |       |                                |  
|                                                             | Cost of sales          |                                 |       | 2,174                          |  
|                                                             | Personnel and benefits |                                 |       | 2,754                          |  
|                                                             | Operating expenses     |                                 |       | 1,364                          |  
|                                                             |                        |                                 |       |                                |  
|                                                             |                        |                                 | 6,292 |                                |  
|                                                             |                        |                                 |       |                                |  
|Operating income (loss) before depreciation and amortization |                        | $                               | 1,715 |                                | $
|                                                             |                        |                                 |       |                                |  
|Six months ended June 30, 2001                               |                        |                                 |       |                                |  
|Restaurant sales                                             |                        | $                               | 7,141 |                                | $
|                                                             |                        |                                 |       |                                |  
|Restaurant operations:                                       |                        |                                 |       |                                |  
|                                                             | Cost of sales          |                                 |       | 1,884                          |  
|                                                             | Personnel and benefits |                                 |       | 2,599                          |  
|                                                             | Operating expenses     |                                 |       | 1,169                          |  
|                                                             |                        |                                 |       |                                |  
|                                                             |                        |                                 | 5,652 |                                |  
|                                                             |                        |                                 |       |                                |  
|Operating income (loss) before depreciation and amortization |                        | $                               | 1,489 |                                | $
|                                                             |                        |                                 |       |                                |  

As
of June 30, 2002, the net book value of property and equipment and intangible assets related to each of the above categories was as follows (dollars in thousands):

June 30,
2002
(Unaudited)Long-term Portfolio RestaurantsSchlotzsky's® Delis

$
15,630Marketplaces


7,543Available for Sale Restaurants


11,844$
35,017


Note 3.Segments

The Company and its subsidiaries are principally engaged in franchising and operating fast casual restaurants that feature upscale
made-to-order sandwiches with unique sourdough buns, pizzas and salads. At June 30, 2002, the Schlotzsky's® Deli system included 671 Company-owned and
franchised restaurants in 38 states, the District of Columbia and nine foreign countries. The Company operated 35 restaurants as of June 30, 2002.

The
Company identifies segments based on management responsibility within the corporate structure. The Restaurant Operations segment includes restaurants operated for the purposes of
market leadership and redevelopment of certain markets, demonstrating profit potential and key operating

6

---

metrics, operational leadership of the franchise system, product development, concept refinement, product and process testing, and training and building brand awareness. The Restaurant Operations
segment also includes restaurants developed for or acquired from franchisees which are available for sale to franchisees. The Franchise Operations segment encompasses the franchising of restaurants,
assisting franchisees in the development of restaurants, providing franchisee training and operating the national training center, communicating with franchisees, conducting regional and national
franchisee meetings, developing and monitoring supplier and distributor relationships, planning and coordinating advertising and marketing programs, and the licensing of brand products for sale to the
franchise system and retailers. The Company measures segment profit as operating income, which is defined as income before interest and income taxes. Segment information and a reconciliation to income
before interest and income taxes are as follows (dollars in thousands):

|Three months ended June 30, 2002 |  | Restaurant
Operations |        | Franchise
Operations |   | Consolidated
|-------------------------------- |  | --------------------- | ------ | -------------------- | - | ------------
|Revenue from external customers  |  | $                     | 8,269  |                      | $ | 7,634       
|Depreciation and amortization    |  |                       | 531    |                      |   | 555         
|Operating income                 |  |                       | 264    |                      |   | 1,074       
|Total assets                     |  | $                     | 37,292 |                      | $ | 75,576      

|Three months ended June 30, 2001 |  | Restaurant
Operations |        | Franchise
Operations |   | Consolidated
|-------------------------------- |  | --------------------- | ------ | -------------------- | - | ------------
|Revenue from external customers  |  | $                     | 7,648  |                      | $ | 8,416       
|Depreciation and amortization    |  |                       | 450    |                      |   | 589         
|Operating income                 |  |                       | 123    |                      |   | 1,572       
|Total assets                     |  | $                     | 34,789 |                      | $ | 77,547      

Of
the Restaurant Operations depreciation and amortization for the three months ended June 30, 2002, $359,000 was allocated to the long-term portfolio of restaurants
($149,000 for Marketplaces and $210,000 for Schlotzsky's® Delis) and $172,000 to restaurants available for sale. For the three months ended June 30, 2001, $309,000 of depreciation
and amortization was allocated to the long-term portfolio of restaurants ($146,000 for Marketplaces and $163,000 for Schlotzsky's® Delis) and $141,000 to restaurants available
for sale.

|Six months ended June 30, 2002  |  | Restaurant
Operations |        | Franchise
Operations |   | Consolidated
|------------------------------- |  | --------------------- | ------ | -------------------- | - | ------------
|Revenue from external customers |  | $                     | 16,140 |                      | $ | 15,009      
|Depreciation and amortization   |  |                       | 1,036  |                      |   | 1,134       
|Operating income                |  |                       | 498    |                      |   | 2,214       
|Total assets                    |  | $                     | 37,292 |                      | $ | 75,576      

|Six months ended June 30, 2001  |  | Restaurant
Operations |        | Franchise
Operations |   | Consolidated
|------------------------------- |  | --------------------- | ------ | -------------------- | - | ------------
|Revenue from external customers |  | $                     | 15,064 |                      | $ | 16,347      
|Depreciation and amortization   |  |                       | 902    |                      |   | 1,136       
|Operating income                |  |                       | 268    |                      |   | 2,905       
|Total assets                    |  | $                     | 34,789 |                      | $ | 77,547      

7

---

Of
the Restaurant Operations depreciation and amortization for the six months ended June 30, 2002, $720,000 was allocated to the long-term portfolio of restaurants
($297,000 for Marketplaces and $423,000 for Schlotzsky's® Delis) and $316,000 to restaurants available for sale. For the six months ended June 30, 2001, $612,000 of depreciation and
amortization was allocated to the long-term portfolio of restaurants ($289,000 for Marketplaces and $323,000 for Schlotzsky's® Delis) and $290,000 to restaurants available for
sale.

All
general and administrative expenses are included in Franchise Operations for the periods presented.

Note 4.Debt

The Company's debt structure as of June 30, 2002, and December 31, 2001, is as follows (dollars in thousands):

|                 |                                                      | June 30,
2002 |        | December 31,
2001 |  
|---------------- | ---------------------------------------------------- | ------------- | ------ | ----------------- | -
|
|Short-term debt: |                                                      |               |        |                   |  
|                 | Interim financing for real estate development        |               | $      | 674               |  
|                 | Notes payable to officer under employment agreement  |               |        | 252               |  
|                 |                                                      |               |        |                   |  
|                 |                                                      | $             | 926    |                   | $
|                 |                                                      |               |        |                   |  
|Long-term debt:  |                                                      |               |        |                   |  
|                 | Term note under bank group Credit Agreement          |               | $      | 7,313             |  
|                 | Mortgages on Company-owned restaurants and equipment |               |        | 14,002            |  
|                 | Other obligations                                    |               |        | 4,859             |  
|                 | Capital leases                                       |               |        | 2,866             |  
|                 |                                                      |               |        |                   |  
|                 |                                                      |               | 29,040 |                   |  
|                 | Less current maturities of long-term debt            |               |        | (6,065            | )
|                 |                                                      |               |        |                   |  
|                 | Long-term debt                                       |               | $      | 22,975            |  
|                 |                                                      |               |        |                   |  

8

---

As
of June 30, 2002, the Company had received commitments for real estate mortgage-secured bank financings of up to approximately $10.0 million. The financings under these
commitments closed on August 13, 2002. The proceeds from these financings were used to retire approximately $900,000 of existing mortgage debt on certain properties, repay the entire amount
then outstanding under the
Company's bank group Credit Agreement (approximately $6.4 million) and provide working capital. The new mortgage debt is as follows (dollars in thousands):

|Mortgage notes payable to a bank; interest at 7.5%; monthly payments of principal and interest based on a 20 year amortization through August 2007; secured by three operating Company-owned restaurants                                 |  | $ | 2,350
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | - | -----
|Mortgage note payable to a bank; interest at prime; monthly payments of principal and interest based on a 15 year amortization through August 2005; secured by three operating Company-owned restaurants                                 |  |   | 2,700
|Mortgage note payable to a bank; interest at prime; six months interest only then monthly principal and interest payments based on a 10 year amortization through August 2005; secured by real estate and real estate
available for sale |  |   | 4,422
|                                                                                                                                                                                                                                         |  |  
|                                                                                                                                                                                                                                         |  | $ | 9,472
|                                                                                                                                                                                                                                         |  |  

On
a pro-forma basis, assuming this refinancing had occurred as of June 30, 2002, the current portion of long-term debt as of June 30, 2002 would
have been $2,226,511 instead of the reported amount of $6,065,058.

Note 5.Related Party Receivables

As of June 30, 2002, and December 31, 2001, receivables from related parties were as follows (dollars in thousands):

|                                                                                                             |  | June 30,
2002 |       | December 31,
2001
|------------------------------------------------------------------------------------------------------------ |  | ------------- | ----- | -----------------
|
|Included in accounts receivableother                                                                        |  | $             | 894   |                  
|Included in other noncurrent assets (advances to officers during second quarter under employment agreements) |  |               | 527   |                  
|Included in notes receivable                                                                                 |  |               | 5,136 |                  
|                                                                                                             |  |               |       |                  
|Total related party receivables                                                                              |  | $             | 6,557 |                  
|                                                                                                             |  |               |       |                  

Note 6.Earnings Per Share

Basic earnings per share are computed by dividing reported earnings available to common stockholders by weighted average common shares outstanding. Diluted
earnings per share give effect to

9

---

dilutive potential common shares. Earnings per share are calculated as follows (in thousands, except per share data):

|                                                                                                                               |                                                              | Three Months Ended |      | Six Months Ended
|------------------------------------------------------------------------------------------------------------------------------ | ------------------------------------------------------------ | ------------------ | ---- | ----------------
|
|Basic earnings per share                                                                                                       |                                                              |                    |      |                 
|                                                                                                                               | Net income                                                   |                    | $    | 489             
|                                                                                                                               |                                                              |                    |      |                 
|                                                                                                                               | Weighted average common shares outstanding                   |                    |      | 7,288           
|                                                                                                                               |                                                              |                    |      |                 
|                                                                                                                               | Basic earnings per share                                     |                    | $    | 0.07            
|                                                                                                                               |                                                              |                    |      |                 
|Diluted earnings per share                                                                                                     |                                                              |                    |      |                 
|                                                                                                                               | Net income                                                   |                    | $    | 489             
|                                                                                                                               |                                                              |                    |      |                 
|                                                                                                                               | Weighted average common shares outstanding                   |                    |      | 7,288           
|                                                                                                                               | Dilutive stock options and warrants                          |                    |      | 154             
|                                                                                                                               |                                                              |                    |      |                 
|                                                                                                                               | Weighted average common shares outstandingassuming dilution |                    |      | 7,442           
|                                                                                                                               |                                                              |                    |      |                 
|Diluted earnings per share                                                                                                     |                                                              | $                  | 0.07 |                 
|                                                                                                                               |                                                              |                    |      |                 
|Outstanding options and warrants that were not included in the diluted calculation because their effect would be anti-dilutive |                                                              |                    | 687  |                 
|                                                                                                                               |                                                              |                    |      |                 

Note 7.Adoption of New Accounting Pronouncements

The Financial Accounting Standards Board has issued Statement of Financial Accounting Standards (SFAS) Nos. 141, 142 and 144, concerning accounting for business
combinations, amortization of certain acquired intangible assets, and the impairment or disposal of long-lived assets, respectively. The Company adopted these statements as of
January 1, 2002. There was no cumulative impact of these changes in accounting. The adoption of SFAS No. 142 had the effect of decreasing amortization expense and increasing income
before provision for income taxes for the quarter ended June 30, 2002 by approximately $60,000, and increasing net income and diluted earnings per share by approximately $36,000 and $0.01,
respectively. For the six months ended June 30, 2002, amortization expense decreased and income before provision for income taxes increased by approximately $121,000, and net income and diluted
earnings per share increased by approximately $73,000 and $0.01, respectively.

10

---

As
of June 30, 2002, and December 31, 2001, intangible assets consisted of the following (dollars in thousands):

|                                               |                                       |  |          | June 30, 2002
(Unaudited) |        | December 31, 2001
|---------------------------------------------- | ------------------------------------- |  | -------- | ------------------------- | ------ | -----------------
|
|Intangible assets subject to amortization:     |                                       |  |          |                           |        |                  
|                                               | Royalty value                         |  | 20       |                           | $      | 2,474            
|                                               | Developer rights                      |  | 20 to 40 |                           |        | 35,133           
|                                               | Restaurant development rights         |  | 13 to 25 |                           |        | 1,343            
|                                               | Debt issue costs                      |  | 3 to 20  |                           |        | 463              
|                                               | Other intangible assets               |  | 5        |                           |        | 546              
|                                               |                                       |  |          |                           |        |                  
|                                               |                                       |  |          |                           | 39,959 |                  
|                                               |                                       |  |          |                           |        |                  
|Intangible assets not subject to amortization: |                                       |  |          |                           |        |                  
|                                               | Original franchise and royalty rights |  |          |                           |        | 5,689            
|                                               | Goodwill                              |  |          |                           |        | 3,223            
|                                               |                                       |  |          |                           |        |                  
|                                               |                                       |  |          |                           | 8,912  |                  
|                                               |                                       |  |          |                           |        |                  
|Total intangible assets                        |                                       |  |          | $                         | 48,871 |                  
|                                               |                                       |  |          |                           |        |                  

Amortization
of intangible assets totaled approximately $260,000 and $302,000 for the three months ended June 30, 2002, and 2001, respectively. For the six months ended
June 30, 2002, and 2001, amortization expense totaled $472,000 and $587,000 respectively. Estimated amortization expense for intangible assets with determinable lives is as follows (dollars in
thousands):

Remainder of 2002

$
4742003


9292004


8712005


8632006


861$
3,998


The
changes in the gross value of goodwill for the six months ended June 30, 2002, are as follows (dollars in thousands):

Restaurant
Operations

Franchise
Operations

TotalBalance as of December 31, 2001

$
2,931

$
261

$
3,192Goodwill acquired


31





31Impairment








Balance as of June 30, 2002

$
2,962

$
261

$
3,223


11

---

The following table provides a reconciliation of reported net income for the three and six month periods ended June 30, 2001 adjusted as though SFAS No. 142 had
been effective (in thousands, except per share data):

|                                           |                     | For the three months ended
June 30, 2001
(Unaudited) |     | For the six months ended
June 30, 2001
(Unaudited)
|------------------------------------------ | ------------------- | ---------------------------------------------------- | --- | --------------------------------------------------
|
|Reported net income                        |                     | $                                                    | 751 |                                                   
|Add back amortization expense (net of tax) |                     |                                                      | 36  |                                                   
|                                           |                     |                                                      |     |                                                   
|                                           | Adjusted net income |                                                      | $   | 787                                               
|                                           |                     |                                                      |     |                                                   

Note 8.Commitments and Contingencies



In June 2002, the Company and its largest area developer amended the option agreement pursuant to which the Company may reacquire the territorial rights of
the area developer. The Company's option to reacquire the rights was extended to August 30, 2002. The purchase price under the option was changed to $28,850,000, of which nonrefundable deposits
totaling $5,082,000 have been paid through August 1, 2002. Upon exercise of the option, the Company must make a $500,000 cash payment and enter into a seller-financed note for $23,268,000. The
note will bear interest at 8% and require monthly payments of principal and interest of $520,000 through May 2005. Remaining principal is due in June 2005. In the event the option is not
exercised by August 30, 2002, the Company will be required to pay a fee of $1.7 million. Additionally, under an amendment to a management agreement with this area developer, the Company
will continue to manage these territories for the area developer through August 31, 2002 for a fee of 50% of the compensation due to the area developer under the area developer agreement.



The Company is named a defendant in various legal proceedings in the normal course of its business. The ultimate outcome of legal proceedings cannot be projected
with certainty. The following are proceedings in which the plaintiffs have alleged significant damages. Based on its knowledge of these matters and its experience to date, the Company does not believe
that the outcome of these proceedings will have a material impact on the Company's financial condition and results of operations.

Lone Star Ladies Investment Club, a Texas General Partnership, et al, on Behalf of Themselves and All Others Similarly Situated v. Schlotzsky's, Inc., et
al,(Case No. A-98CA-550-JN), was filed in the United States District Court, Western District of Texas, Austin Division on
February 8, 1999, as a class action lawsuit against the Company and certain of its past and present officers and directors. A more detailed description of the lawsuit may be found in Footnote
15 of the Company's Consolidated Financial Statements for the year ended December 31, 2001. On April 2, 2002, the Court granted final approval of the Stipulation of Settlement and Plan
of Allocation of Settlement Proceeds, which was funded by the Company's insurer and which settled all claims with prejudice, and entered a Final Judgment and Order of Dismissal with Prejudice.

12

---

Kimberly Garland v. Schlotzsky's, Inc., Schenck & Associates, John Wooley, Darrell Kolinek, Kelly Arnold, Joyce Cates, Brian Wieters, David Gerstner
and Jeffrey Noeldner,(Case No. 01-CV 2377), was filed on December 26, 2001, in the United States District Court for the District of Minnesota.
Plaintiff is a franchisee in Apple Valley, Minnesota. She brought claims against the Company, her Area Developer (Noeldner), several officers and past and present employees of the Company (Wooley,
Kolinek, Arnold, Wieters, and Cates), her accountant (Gerstner), and his accounting firm. Plaintiff purchased her restaurant pursuant to the Company's Turnkey Program. She claims she was fraudulently
induced into participating in the Program. She contends that, at the urging of defendant Noeldner, she submitted cash flow projections, prepared by defendant Gerstner, that were allegedly unreasonable
and inflated. Plaintiff alleges that the Turnkey Program was a scheme to promote rapid growth, recognize revenue, and develop restaurants that were not financially viable. The Complaint includes
claims of fraudulent and/or negligent misrepresentations and omissions, and alleged violations of the Minnesota Uniform Deceptive Trade Practices Act ("DTPA"), the Minnesota Franchise Act, and the
Texas DTPA. Plaintiff is seeking rescission and actual and compensatory damages of an unspecified amount and attorneys' fees. On May 7, 2002, the Company filed a motion to dismiss, or in the
alternative, to stay the proceedings in order to compel arbitration pursuant to a provision contained in Plaintiff's franchise agreement. The Company denies all of Plaintiff's claims, believes they
are without merit, and will continue to vigorously defend this action.

Robert Coshott v. Schlotzsky's, Inc.,(Cause No. GN 1-02279), was filed on July 24, 2001, in the
200th Judicial District Court of Travis County, Texas. Plaintiff is the Master Licensee for Australia and New Zealand, and he opened a Schlotzsky's® Deli restaurant in
Melbourne, Australia. In his petition, Plaintiff makes the following allegations: that he experienced problems with certain equipment specified or approved by the Company; that the Company's system
and equipment did not generate enough finished food product to service his potential customers; that the Company misrepresented the level of revenue the restaurant could reasonably be expected to
achieve; that the Company delayed his ability to develop restaurants by failing to timely secure certain trademarks and trade names; and that the Company misrepresented whether it would allow
Plaintiff to franchise Schlotzsky's® Deli restaurants in certain gas station or convenience store locations in his territories. Plaintiff claims these acts constitute fraud and/or
negligent misrepresentation and requests actual and punitive damages of $3.75 million plus lost profits and incidental and consequential damages of an unspecified amount. The case is currently
set for trial on November 4, 2002. The Company denies all of Plaintiff's claims, believes they are without merit, and will continue to vigorously defend this action.

Dae W. Kim, DWK Enterprises, Inc. and Aecon International, Inc. v. John Wooley, Schlotzsky's, Inc., Schlotzsky's Franchising Limited
Partnership, and Schlotzsky's NAMF, Inc., Schlotzsky's National Advertising Association, Inc. and Schlotzsky's Brands, Inc.(Cause
No. 2001-CI-13672), was originally filed in the 73rd Judicial District Court of Bexar County, Texas, on September 25, 2001, after a similar lawsuit
was filed and later withdrawn in Harris County, Texas. Plaintiffs are, or claim to be, franchisees in Houston and San Antonio, Texas, and Plaintiff Kim was an area developer for Houston and San
Antonio, Texas. One of the Plaintiff's franchise agreements was terminated for repeatedly failing its Quality, Service, Cleanliness, and Compliance ("QSCC") evaluations prior to the litigation.
Plaintiffs allege that the QSCC evaluations and sales audits were harassing and disruptive to business. They also allege that in recent years, the Company favored developing larger, freestanding
locations rather than their smaller shopping center restaurants. The complaint includes claims of tortious interference,

13

---

breach of the duty of good faith, fraud, fraudulent concealment, restraint of trade, violation of the Texas DTPA, breach of fiduciary duty, breach of contract, civil conspiracy, and an accounting of
advertising funds. In July 2002 Plaintiffs estimated $4.2 million of actual and $8.4 million of exemplary damages. Defendants' counterclaims include breach of contract, a request
for an accounting, and attorneys' fees.

On
or about June 26, 2002, the court granted partial summary judgment in favor of the Company and other Defendants. Specifically, summary judgment was granted in favor of
Defendants on Plaintiffs' claims of breach of the two area developer agreements, tortious interference, all claims arising prior to March 25, 1998, and all claims of breach of good faith, of
violation of the DTPA, and of conspiracy arising prior to September 25, 1999. Defendants deny all of Plaintiff's remaining claims, believe they are without merit, and will continue to
vigorously defend this action.

14

---



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

RESULTS OF OPERATIONS

OVERVIEW

The following table reflects the changes in the Schlotzsky's® Deli system for the three and six months ended June 30, 2002 and 2001. Systemwide
data reflects both franchised and Company-owned restaurants. Percentage changes in sales-related data are based on comparison to the same period in the previous fiscal year.

|                                            |            | Three Months Ended |             | Six Months Ended |  
|------------------------------------------- | ---------- | ------------------ | ----------- | ---------------- | -
|
|Restaurants OpenBeginning of Period        |            |                    | 672         |                  |  
|                                            |            |                    |             |                  |  
|Openings During Period                     |            |                    |             |                  |  
|                                            | New        |                    |             | 5                |  
|                                            | Reopenings |                    |             | 2                |  
|                                            |            |                    |             |                  |  
|                                            |            | Total Openings     |             |                  | 7
|Closings During Period                      |            |                    | (8          | )                |  
|                                            |            |                    |             |                  |  
|Restaurants OpenEnd of Period              |            |                    | 671         |                  |  
|                                            |            |                    |             |                  |  
|Systemwide Sales                            |            | $                  | 102,645,000 |                  | $
|Increase (decrease) in Systemwide Sales     |            |                    | (6.5        | %)               |  
|Increase (decrease) in Same Store Sales     |            |                    | (5.5        | %)               |  
|Average Weekly Sales                        |            | $                  | 11,800      |                  | $
|Increase (decrease) in Average Weekly Sales |            |                    | (1.7        | %)               |  

THREE MONTHS ENDED JUNE 30, 2002 AND 2001

REVENUE. Total revenue decreased 1.0% to $15,903,000 from $16,064,000.

ROYALTIES
decreased 8.2% to $5,264,000 from $5,733,000. The decrease was due to a decreased number of franchised restaurants in 2002 compared to 2001 and a decrease in same store sales
of 5.5%, partially offset by a continuing shift in restaurant mix towards larger, higher volume units.

FRANCHISE
FEES increased 20.0% to $42,000 from $35,000. The increase was principally the result of more openings of franchised restaurants during the three month period ended
June 30, 2002 as compared to the same period in the prior year, partially offset by a decrease in average franchise fee recognized per opening during the quarter as compared to the prior year
quarter. The decrease in franchise fee per restaurant opening is due to the Company's incentive program that was initiated at the beginning of 2002 for existing franchisees to open up additional
locations during the year.

DEVELOPER
FEES decreased 30.2% to $60,000 from $86,000. The decrease is primarily attributed to the expiration of amortization on certain agreements.

RESTAURANT
SALES increased 8.1% to $8,269,000 from $7,648,000. The increase was primarily due to an increase in the average number of restaurants operated by the Company during the
second quarter of 2002, compared to the second quarter of 2001, partially offset by a 8.2% decrease in same store sales. As of June 30, 2002, there were 35 Company-owned restaurants, compared
to 30 at June 30, 2001, of which 20 and 17, respectively, were available for sale.

15

---

SCHLOTZSKY'S®
DELI BRAND LICENSING FEES (BRAND CONTRIBUTION) increased 1.2% to $1,991,000 from $1,967,000. The increase was primarily due to more favorable terms with certain
major suppliers than in the prior year period, a recognition of $151,000 in past due fees from a licensee and an increase in sales through retail channels, partially offset by the effect of the
decrease in systemwide sales for the quarter.

OTHER
FEES AND REVENUE decreased 53.6% to $276,000 from $595,000. The decrease was due to reduced vendor contributions to conventions and franchisee meetings, a decrease in expired
franchise fees, a gain of approximately $141,000 on the sale of a restaurant available for sale recognized in the prior year quarter, and approximately $112,000 in real estate and transaction fees
from the former Turnkey program recorded in the prior year quarter.

OPERATING
EXPENSES. SERVICE COSTS decreased 7.2% to $1,122,000 from $1,209,000, and as a percentage of royalties and franchise fees increased to 21.1% from 21.0%. This decrease is
primarily due to the Company's reacquisition of certain area developer territory rights during the fourth quarter of 2001, as well as a decrease in royalty revenue. The Company expects royalty service
costs, as a percentage of royalties, to further decrease in the third quarter of 2002 as a result of the anticipated exercise of an option to reacquire the Company's largest area developer territorial
rights.

RESTAURANT
OPERATIONS EXPENSES increased 5.6% to $7,474,000 from $7,075,000. This increase was primarily due to the 8.1% increase in restaurant sales. RESTAURANT COST OF SALES increased
7.7% to $2,312,000 from $2,146,000 and decreased as a percentage of net restaurant sales to 28.0% from 28.1%. RESTAURANT PERSONNEL AND BENEFITS COST increased 4.1% to $3,293,000 from $3,164,000 and
decreased as a percentage of net restaurant sales to 39.8% from 41.4%. The decrease, as a percentage of net restaurant sales, was due to improved labor scheduling. RESTAURANT OPERATING EXPENSES
increased 5.9% to $1,869,000 from $1,765,000 and decreased as a percentage of net restaurant sales to 22.6% from 23.1%. The decrease in operating costs, as a percentage of net restaurant sales, was
primarily due to increased operational efficiencies and cost controls, partially offset by higher voluntary contributions to the Austin advertising cooperative. On an overall basis, costs, as a
percentage of net restaurant sales, are higher at restaurants available for sale, and the proportion of restaurants available for sale to total Company-owned restaurants was higher this year than last
year.

EQUITY
LOSS ON INVESTMENTS increased 23.1% to a loss of $48,000 from a loss of $39,000. The equity investment represents the Company's 50% interest in a limited liability company that
operates a Schlotzsky's® Deli restaurant which opened in 2000.

GENERAL
AND ADMINISTRATIVE EXPENSES decreased 3.4% to $4,835,000 from $5,007,000, and decreased to 30.4% from 31.2% as a percentage of total revenue. The decrease from the prior year
quarter was principally due to reduced salaries and benefits, reduced property taxes, and reduced provision for uncollectible accounts and impairment of assets, partially offset by increases in
professional fees, convention and franchisee meeting expenses, advertising and marketing, and lease guarantee expense.

DEPRECIATION
AND AMORTIZATION increased 4.5% to $1,086,000 from $1,039,000. The increase was primarily due to the amortization of reacquired area developer territory rights and
depreciation related to an increase in the average number of Company-owned and operating restaurants during the quarter, partially offset by a reduction of approximately $60,000 in intangible asset
amortization expense related to the adoption of SFAS No. 142. The Company expects a further increase in amortization expense in the third quarter of 2002 as a result of the anticipated exercise
of an option to reacquire the Company's largest area developer territorial rights.

16

---

INTEREST
INCOME decreased 64.4% to $95,000 from $267,000. The decrease was due to the decrease in the amount of outstanding notes receivable as well as a decrease in average interest
rate during the three month period ended June 30, 2002 as compared to the same period in the prior year.

INTEREST
EXPENSE decreased 7.4% to $655,000 from $707,000 due to reduced debt levels and lower average interest rates, partially offset by a decrease of approximately $47,000 of interest
capitalized on Company-owned restaurants under construction as compared to the prior year quarter. The Company expects an increase in interest expense in the third quarter of 2002 as a result of the
seller financed debt related to the anticipated exercise of an option to reacquire the Company's largest area developer territorial rights.

PROVISION
FOR INCOME TAXES reflected a combined federal and state effective tax rate of 37.1% for the second quarter of 2002, which was lower than the effective combined tax rate of
40.2% for the comparable period in 2001 primarily due to certain state taxes being based in part on factors other than income.

NET
INCOME decreased to $489,000 from $751,000 and decreased as a percentage of total revenue to 3.1% from 4.7% due to the factors discussed above. Earnings per share, both basic and
diluted, were $0.07 for the quarter ended June 30, 2002 compared to $0.10 in the prior year quarter.

Supplemental Restaurant Operations InformationPerformance of Long-term Portfolio Deli Restaurants

The following table is presented for the Schlotzsky's® Delis in the Company's long-term portfolio for the quarter ended June 30,
2002. As of June 30, 2002, this restaurant group included nine restaurants in the Austin area, two in College Station, Texas and one in suburban Atlanta, Georgia. This group includes eleven
freestanding restaurants (ten recently constructed and one older facility converted from another concept) and one shopping center endcap restaurant. In accordance with the Company's internal
management reporting practices for consistent comparisons, line item categories have been expanded and percentages are calculated based on gross sales, instead of net sales as used elsewhere in this
report. Facility costs vary by restaurant because some facilities are rented and some are owned. The table provides the average percentage results for each line item for the twelve

17

---

Schlotzsky's® Deli restaurants in the long-term portfolio group as a whole, as well as the best and worst percentage performance for each line item for any restaurant in the
group.

|                        |                       | Three Months Ended
June 30, 2002
(in thousands)                          |       | Percentage of
Gross Sales |       | Best Percentage
Performance |      | Worst Percentage
Performance |     
|----------------------- | --------------------- | ------------------------------------------------------------------------ | ----- | ------------------------- | ----- | --------------------------- | ---- | ---------------------------- | ----
|Gross sales             |                       | $                                                                        | 4,247 |                           | 100.0 | %                           |      |                              |     
|Less-discounts          |                       |                                                                          | 216   |                           | 5.1   | %                           | 4.4  | %                            | 5.9 
|                        |                       |                                                                          |       |                           |       |                             |      |                              |     
|                        | Net sales             |                                                                          |       | 4,031                     |       | 94.9                        | %    |                              |     
|Cost of sales           |                       |                                                                          | 1,101 |                           | 25.9  | %                           | 25.0 | %                            | 26.7
|Personnel and benefits: |                       |                                                                          |       |                           |       |                             |      |                              |     
|                        | Crew costs            |                                                                          |       | 970                       |       | 22.8                        | %    | 21.2                         | %   
|                        | Management costs      |                                                                          |       | 414                       |       | 9.7                         | %    | 6.4                          | %   
|Operating expenses:     |                       |                                                                          |       |                           |       |                             |      |                              |     
|                        | Advertising           |                                                                          |       | 249                       |       | 5.9                         | %    | 3.5                          | %   
|                        | Controllable expenses |                                                                          |       | 271                       |       | 6.4                         | %    | 4.7                          | %   
|                        |                       |                                                                          |       |                           |       |                             |      |                              |     
|                        |                       | Operating income before facility costs and depreciation and amortization |       |                           | 1,026 |                             | 24.2 | %                            | 30.2
|                        | Facility costs        |                                                                          |       | 165                       |       | 3.9                         | %    | 1.4                          | %   
|                        |                       |                                                                          |       |                           |       |                             |      |                              |     
|                        |                       | Operating income before depreciation and amortization                    |       | $                         | 861   |                             | 20.3 | %                            |     
|                        |                       |                                                                          |       |                           |       |                             |      |                              |     

---

SIX MONTHS ENDED JUNE 30, 2002 AND 2001

REVENUE. Total revenue decreased 0.8% to $31,149,000 from $31,411,000.

ROYALTIES
decreased 7.0% to $10,384,000 from $11,168,000. The decrease was due to a decreased number of franchised restaurants in 2002 compared to 2001 and a decrease in same store sales
of 5.4%, partially offset by a continuing shift in restaurant mix towards larger, higher volume units.

FRANCHISE
FEES decreased 66.5% to $62,000 from $185,000. The decrease was principally the result of fewer openings of franchised restaurants as well as a decrease in average franchise
fee recognized per opening during the six month period ended June 30, 2002 as compared to the same period in the prior year. The fewer number of openings was principally the result of the
termination of the Turnkey program during 2000, as well as the Company's increased emphasis on superior site selection for new restaurants and on more highly qualified franchisees. The decrease in
franchise fee per restaurant opening is due to the Company's incentive program that was initiated at the beginning of 2002 for existing franchisees to open up additional locations during the year.

DEVELOPER
FEES decreased 29.4% to $120,000 from $170,000. The decrease is primarily attributed to the expiration of amortization on certain agreements.

RESTAURANT
SALES increased 7.1% to $16,140,000 from $15,064,000. The increase was primarily due to an increase in the average number of restaurants operated by the Company during 2002
compared to 2001, partially offset by a 7.9% decrease in same store sales. As of June 30, 2002,

18

---

there were 35 Company-owned restaurants, compared to 30 at June 30, 2001, of which 20 and 17, respectively, were available for sale.

SCHLOTZSKY'S®
DELI BRAND LICENSING FEES (BRAND CONTRIBUTION) increased 4.8% to $3,874,000 from $3,696,000. The increase was primarily due to more favorable terms with certain
major suppliers than the prior year period, the recognition of $151,000 in past due fees from a licensee and an increase in sales through retail channels, partially offset by the effect of the
decrease in systemwide sales.

OTHER
FEES AND REVENUE decreased 49.6% to $569,000 from $1,128,000. The decrease was due to reduced vendor contributions to conventions and franchisee meetings, a decrease in expired
franchise fees and transfer fees, gains of approximately $176,000 on the sale of restaurants available for sale recognized in the prior year, and approximately $112,000 in real estate and transaction
fees from the former Turnkey program recorded in the prior year.

OPERATING
EXPENSES. SERVICE COSTS decreased 11.5% to $2,267,000 from $2,562,000, and as a percentage of royalties and franchise fees declined to 21.7% from 22.6%. This decrease is
primarily due to the Company's reacquisition of certain area developer territory rights during the fourth quarter of 2001, as well as a decrease in royalty and franchise fee revenue. The Company
expects royalty service costs, as a percentage of royalties, to further decrease in the third quarter of 2002 as a result of the anticipated exercise of an option to reacquire the Company's largest
area developer territorial rights.

RESTAURANT
OPERATIONS EXPENSES increased 5.1% to $14,606,000 from $13,894,000. This increase was primarily due to the 7.1% increase in restaurant sales. RESTAURANT COST OF SALES
increased 7.5% to $4,508,000 from $4,194,000 and increased as a percentage of net restaurant sales to 27.9% from 27.8%. RESTAURANT PERSONNEL AND BENEFITS COST increased 1.8% to $6,462,000 from
$6,347,000, but decreased as a percentage of net restaurant sales to 40.0% from 42.1%. The decrease, as a percentage of net restaurant sales, was due to improved labor scheduling. RESTAURANT OPERATING
EXPENSES increased 8.4% to $3,636,000 from $3,353,000 and increased as a percentage of net restaurant sales to 22.5% from 22.3%. The increase in operating costs, as a percentage of net restaurant
sales, was due to higher voluntary contributions to the Austin advertising cooperative as well as increased facility costs, partially offset by increased operational efficiencies and cost controls.
The use of some Company-owned restaurants in the long-term portfolio for product, process and equipment testing and for systemwide training also adversely impacts their operating
performance. On an overall basis, costs, as a percentage of net restaurant sales, are higher at restaurants available for sale, and the proportion of restaurants available for sale to total Company-
owned restaurants was higher this year than last year.

EQUITY
LOSS ON INVESTMENTS increased 44.4% to a loss of $78,000 from a loss of $54,000. The equity investment represents the Company's 50% interest in a limited liability company that
operates a Schlotzsky's® Deli restaurant which opened in 2000.

GENERAL
AND ADMINISTRATIVE EXPENSES decreased 3.9% to $9,315,000 from $9,690,000, and decreased to 29.9% from 30.8% as a percentage of total revenue. The decrease from the prior year was
principally due to reduced salaries and benefits, reduced convention and franchisee meeting expenses, reduced property taxes, and reduced provision for uncollectible accounts and impairment of assets,
partially offset by increases in lease guarantee expense, professional fees, advertising and marketing, start-up fees for a technology help desk, and charitable contributions.

DEPRECIATION
AND AMORTIZATION increased 6.5% to $2,170,000 from $2,038,000. The increase was primarily due to the amortization of reacquired area developer territory rights and
depreciation related to an increase in the average number of Company-owned and operating restaurants during 2002 as compared to the prior year, partially offset by a reduction of approximately

19

---

$121,000 in intangible asset amortization expense related to the adoption of SFAS No. 142. The Company expects a further increase in amortization expense in the third quarter of 2002 as a
result of the anticipated exercise of an option to reacquire the Company's largest area developer territorial rights.

INTEREST
INCOME decreased 41.1% to $312,000 from $530,000. The decrease was due to the decrease in the amount of outstanding notes receivable, the nonrecognition of interest income on
certain underperforming notes receivable and a decrease in average interest rate during the six month period ended June 30, 2002 as compared to the same period in the prior year, partially
offset by the cash receipt of $77,000 in interest on a nonaccruing note receivable.

INTEREST
EXPENSE decreased 15.7% to $1,258,000 from $1,493,000 due to reduced debt levels and lower average interest rates, partially offset by a decrease of approximately $19,000 of
interest capitalized on Company-owned restaurants under construction as compared to the prior year. The Company expects an increase in interest expense in the third quarter of 2002 as a result of the
seller financed debt related to the anticipated exercise of an option to reacquire the Company's largest area developer territorial rights.

PROVISION
FOR INCOME TAXES reflected a combined federal and state effective tax rate of 36.8% for the six months ended June 30, 2002, which was lower than the effective combined
tax rate of 39.3% for the comparable period in 2001 primarily due to certain state taxes being based in part on factors other than income.

NET
INCOME decreased to $1,116,000 from $1,342,000 and decreased as a percentage of total revenue to 3.6% from 4.3% due to the factors discussed above. Earnings per share, both basic and
diluted, were $0.15 for the six months ended June 30, 2002 compared to $0.18 in the prior year.

20

---



Supplemental Restaurant Operations InformationPerformance of Long-term Portfolio Deli Restaurants

The following table is presented for the Schlotzsky's® Delis in the Company's long-term portfolio for the six months ended June 30,
2002. As of June 30, 2002, this restaurant group included nine restaurants in the Austin area, two in College Station, Texas and one in suburban Atlanta, Georgia. This group includes eleven
freestanding restaurants (ten recently constructed and one older facility converted from another concept) and one shopping center endcap restaurant. In accordance with the Company's internal
management reporting practices for consistent comparisons, line item categories have been expanded and percentages are calculated based on gross sales, instead of net sales as used elsewhere in this
report. Facility costs vary by restaurant because some facilities are rented and some are owned. The table provides the average percentage results for each line item for the twelve
Schlotzsky's® Deli restaurants in the long-term portfolio group as a whole, as well as the best and worst percentage performance for each line item for any restaurant in the
group.

|                        |                       | Six Months
Ended
June 30, 2002                                           |       | Percentage
of Gross
Sales |       | Best
Percentage
Performance |      | Worst
Percentage
Performance |     
|----------------------- | --------------------- | ------------------------------------------------------------------------ | ----- | ------------------------- | ----- | --------------------------- | ---- | ---------------------------- | ----
|
|Gross sales             |                       | $                                                                        | 8,431 |                           | 100.0 | %                           |      |                              |     
|Less-discounts          |                       |                                                                          | 424   |                           | 5.0   | %                           | 4.4  | %                            | 5.8 
|                        |                       |                                                                          |       |                           |       |                             |      |                              |     
|                        | Net sales             |                                                                          |       | 8,007                     |       | 95.0                        | %    |                              |     
|Cost of sales           |                       |                                                                          | 2,174 |                           | 25.8  | %                           | 25.0 | %                            | 26.4
|Personnel and benefits: |                       |                                                                          |       |                           |       |                             |      |                              |     
|                        | Crew costs            |                                                                          |       | 1,914                     |       | 22.7                        | %    | 21.3                         | %   
|                        | Management costs      |                                                                          |       | 840                       |       | 10.0                        | %    | 6.5                          | %   
|Operating expenses:     |                       |                                                                          |       |                           |       |                             |      |                              |     
|                        | Advertising           |                                                                          |       | 501                       |       | 5.9                         | %    | 4.0                          | %   
|                        | Controllable expenses |                                                                          |       | 523                       |       | 6.2                         | %    | 4.5                          | %   
|                        |                       |                                                                          |       |                           |       |                             |      |                              |     
|                        |                       | Operating income before facility costs and depreciation and amortization |       |                           | 2,055 |                             | 24.4 | %                            | 30.2
|                        | Facility costs        |                                                                          |       | 340                       |       | 4.0                         | %    | 1.0                          | %   
|                        |                       |                                                                          |       |                           |       |                             |      |                              |     
|                        |                       | Operating income before depreciation and amortization                    |       | $                         | 1,715 |                             | 20.3 | %                            |     
|                        |                       |                                                                          |       |                           |       |                             |      |                              |     

---

LIQUIDITY AND CAPITAL RESOURCES

Cash and cash equivalents decreased $1,586,000 in the six months ended June 30, 2002, and increased $803,000 in the six months ended June 30, 2001.
Cash flows are impacted by operating, investing and financing activities.

Operating
activities provided $3,525,000 of cash in 2002 and $5,244,000 of cash in 2001. The decrease in cash provided in 2002 compared to 2001 was the net result of an increased use of
cash for certain working capital accounts, reduced net income, and decreased provisions for uncollectible accounts and impairment of assets, partially offset by increased depreciation and amortization
and a decrease in the amount of deferred revenue amortized.

21

---

Investing
activities used $1,248,000 and $937,000 of cash in 2002 and 2001, respectively. The increase in cash used in 2002 compared to 2001 was the net result of a decrease in proceeds
from the sale of real estate available for sale and reduced collections of notes receivable, partially offset by a decrease in expenditures for intangible assets and new Company-owned restaurants and
reduced issuance of notes receivable.

Financing
activities used $3,863,000 and $3,504,000 of cash in 2002 and 2001, respectively. The increase in cash used in 2002 compared to 2001 is primarily the net result of increased
repayments of debt and reduced proceeds from issuance of debt, partially offset by reduced treasury stock purchases.

Through
August 13, 2002, when it was paid off with the proceeds from real estate mortgage financing, the Company had a Credit Agreement, as amended, with a group of banks that
prohibited the payment of dividends and imposed a number of restrictions on the Company, including limitations on additional borrowings, capital expenditures, contingent liabilities and stock
repurchases. The Credit Agreement required the Company to maintain certain financial ratios, working capital and net worth. As of August 13, 2002, when the term note under the Credit Agreement
was paid off, the Company is no longer subject to these restrictive covenants. Certain mortgage debt of the Company also contains restrictive covenants. At June 30, 2002, the Company was in
compliance with or had obtained waiver of such covenants. However, any failure to remain in compliance with the restrictive covenants of the Company's mortgages in the future could have material
adverse consequences to the Company.

As
of June 30, 2002, the Company's scheduled maturities of debt for the ensuing twelve months approximate $6,992,000 (including short-term debt). In addition, the
Company's Credit Agreement required the application to the term note of 75% of the net cash proceeds from the sale or refinancing of certain real estate and restaurants available for sale.

On
a pro-forma basis, assuming the August 2002 mortgage financing, of which a portion of the proceeds fully retired the bank group Credit Agreement term note, had
occurred as of June 30, 2002, the scheduled maturities of debt for the ensuing twelve months would have approximated $3,153,000 (including short-term debt). The August 2002
mortgage financing included five mortgage notes payable, totaling approximately $9,472,000, at interest rates ranging from prime to 7.5%, amortization periods ranging from ten to twenty years and
terms ranging from 3 to 5 years.

The
Company guarantees certain loans, leases and other obligations of franchisees and others. At June 30, 2002, these contingent liabilities totaled approximately $29,221,000. The
following tables present certain of the Company's obligations and commitments to make future payments, excluding interest payments, under contracts and contingent commitments as of June 30,
2002.

|                 |  | Payments Due by Period
As of June 30, 2002
|---------------- |  | ------------------------------------------
|
|Short-term Debt  |  | $                                         
|Long-term Debt   |  |                                           
|Operating Leases |  |                                           

|           |  |   |            | Amount of Commitment Expiration Per Period
As of June 30, 2002
|---------- |  | - | ---------- | --------------------------------------------------------------
|
|Guarantees |  | $ | 29,220,834 |                                                               

The
Company plans to develop additional Company-owned restaurants for market leadership purposes, beginning with key markets in its home state of Texas. One restaurant is under
construction in the Austin area, which is expected to open in 2003. The Company has received a lending

22

---

commitment for this restaurant. The Company has also acquired the building sites for three additional restaurants in the Austin area, two of which the Company intends to be opened by limited
liability companies in which the Company will have an equity interest. An operating lease has also been signed for a restaurant in the Houston area and sites for additional restaurants in Texas are
under consideration.

The
Company has an option, as amended, through August 30, 2002 to reacquire the territorial rights held by its largest area developer. The exercise price of the option is
$28,850,000, of which a nonrefundable deposit in the amount of $5,082,000 has been paid through August 1, 2002. The exercise of the option will require further payment of $500,000 in cash at
closing and the execution of a $23,268,000 promissory note to the area developer. The note would bear interest at 8% and require monthly payments of principal and interest in the amount of $520,000
commencing September 30, 2002, with all remaining principal due on June 30, 2005. In the event the option is not exercised on or before August 30, 2002, the Company will be
required to pay a fee of $1,700,000.

The
Company is working to develop other credit facilities that would replace the seller financing on the area developer territorial rights acquisition with longer-term
financing as well as fund the growth of Company-owned restaurants.

The
Company's Board of Directors has authorized the repurchase of up to 1,000,000 shares of the Company's outstanding Common Stock. In 1998, 10,000 shares were repurchased for $105,000.
Since December 31, 2000, through June 30, 2002, the Company has repurchased an additional 179,525 shares at a total cost of approximately $738,000.

Management's
Discussion and Analysis of Financial Condition and Results of Operations in this Form 10-Q should be read in conjunction with Management's Discussion and
Analysis of Financial Condition and Results of Operations and other material included in the Company's Annual Report on Form 10-K for the year ended December 31, 2001.

Forward-Looking Statements

This report contains some statements that are not historical information and are considered "forward-looking statements," as defined under the federal securities
laws. Forward-looking statements reflect the Company's expectations based on current information. Forward-looking statements include those regarding the business plans and prospects of the Company.
The Company undertakes no obligation to update any forward-looking statements. Shareholders and prospective investors are cautioned that actual future results may be materially different because of
various risks and uncertainties, including but not limited to the following: the Company's ability to obtain credit facilities to accommodate reacquisition of rights from area developers and the
development of new Company-owned restaurants; the success of the Company's new restaurant development strategy and the Company's efforts to sell new franchise licenses; the financial stability of the
Company's franchisees; the results of pending or threatened legal proceedings; the disposition of restaurants available for sale; and factors identified in the Company's Form 10-K
under the heading "Risk Factors."

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Changes in short-term interest rates on loans from financial institutions could materially affect the Company's earnings because the interest rates
charged on certain underlying obligations are variable.

At
June 30, 2002, a hypothetical 100 basis point increase in interest rates would result in a decrease of approximately $73,100 in annual pre-tax earnings. The
estimated decrease is based upon the increased interest expense of the Company's variable rate debt and assumes no change in the volume or composition of debt at June 30, 2002.

23

---



PART II  OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

The Company is named a defendant in various legal proceedings in the normal course of its business. The ultimate outcome of legal proceedings cannot be projected
with certainty. The following are proceedings in which the plaintiffs have alleged significant damages. Based on its knowledge of these matters and its experience to date, the Company does not believe
that the outcome of these proceedings will have a material impact on the Company's financial condition and results of operations.

Lone Star Ladies Investment Club, a Texas General Partnership, et al, on Behalf of Themselves and All Others Similarly Situated v. Schlotzsky's, Inc., et
al, (Case No. A-98CA-550-JN), was filed in the United States District Court, Western District of Texas, Austin Division on
February 8, 1999, as a class action lawsuit against the Company and certain of its past and present officers and directors. A more detailed description of the lawsuit may be found in the
Company's Annual Report on Form 10-K for the year ended December 31, 2001 (seePart I., Item 3). On April 2,
2002, the Court granted final approval of the Stipulation of Settlement and Plan of Allocation of Settlement Proceeds, which was funded by the Company's insurer and which settled all claims with
prejudice, and entered a Final Judgment and Order of Dismissal with Prejudice.

Kimberly Garland v. Schlotzsky's, Inc., Schenck & Associates, John Wooley, Darrell Kolinek, Kelly Arnold, Joyce Cates, Brian Wieters, David Gerstner
and Jeffrey Noeldner, (Case No. 01-CV 2377), was filed on December 26, 2001, in the United States District Court for the District of Minnesota.
Plaintiff is a franchisee in Apple Valley, Minnesota. She brought claims against the Company, her Area Developer (Noeldner), several officers and past and present employees of the Company (Wooley,
Kolinek, Arnold, Wieters, and Cates), her accountant (Gerstner), and his accounting firm. Plaintiff purchased her restaurant pursuant to the Company's Turnkey Program. She claims she was fraudulently
induced into participating in the Program. She contends that, at the urging of defendant Noeldner, she submitted cash flow projections, prepared by defendant Gerstner, that were allegedly unreasonable
and inflated. Plaintiff alleges that the Turnkey Program was a scheme to promote rapid growth, recognize revenue, and develop restaurants that were not financially viable. The Complaint includes
claims of fraudulent and/or negligent misrepresentations and omissions, and alleged violations of the Minnesota Uniform
Deceptive Trade Practices Act ("DTPA"), the Minnesota Franchise Act, and the Texas DTPA. Plaintiff is seeking rescission and actual and compensatory damages of an unspecified amount and attorneys'
fees. On May 7, 2002, the Company filed a motion to dismiss, or in the alternative, to stay the proceedings in order to compel arbitration pursuant to a provision contained in Plaintiff's
franchise agreement. The Company denies all of Plaintiff's claims, believes they are without merit, and will continue to vigorously defend this action.

Robert Coshott v. Schlotzsky's, Inc., (Cause No. GN 1-02279), was filed on July 24, 2001, in the
200th Judicial District Court of Travis County, Texas. Plaintiff is the Master Licensee for Australia and New Zealand, and he opened a Schlotzsky's® Deli restaurant in
Melbourne, Australia. In his petition, Plaintiff makes the following allegations: that he experienced problems with certain equipment specified or approved by the Company; that the Company's system
and equipment did not generate enough finished food product to service his potential customers; that the Company misrepresented the level of revenue the restaurant could reasonably be expected to
achieve; that the Company delayed his ability to develop restaurants by failing to timely secure certain trademarks and trade names; and that the Company misrepresented whether it would allow
Plaintiff to franchise Schlotzsky's® Deli restaurants in certain gas station or convenience store locations in his territories. Plaintiff claims these acts constitute fraud and/or
negligent misrepresentation and requests actual and punitive damages of $3.75 million plus lost profits and incidental and consequential damages of an unspecified amount. The case is

24

---

currently set for trial on November 4, 2002. The Company denies all of Plaintiff's claims, believes they are without merit, and will continue to vigorously defend this action.

Dae W. Kim, DWK Enterprises, Inc. and Aecon International, Inc. v. John Wooley, Schlotzsky's, Inc., Schlotzsky's Franchising Limited
Partnership, and Schlotzsky's NAMF, Inc., Schlotzsky's National Advertising Association, Inc. and Schlotzsky's Brands, Inc.(Cause
No. 2001-CI-13672), was originally filed in the 73rd Judicial District Court of Bexar County, Texas, on September 25, 2001, after a similar lawsuit
was filed and later withdrawn in Harris County, Texas. Plaintiffs are, or claim to be, franchisees in Houston and San Antonio, Texas, and Plaintiff Kim was an area developer for Houston and San
Antonio, Texas. One of the Plaintiff's franchise agreements was terminated for repeatedly failing its Quality, Service, Cleanliness, and Compliance ("QSCC") evaluations prior to the litigation.
Plaintiffs allege that the QSCC evaluations and sales audits were harassing and disruptive to business. They also allege that in recent years, the Company favored developing larger, freestanding
locations rather than their smaller shopping center restaurants. The complaint includes claims of tortious interference, breach of the duty of good faith, fraud, fraudulent concealment, restraint of
trade, violation of the Texas DTPA, breach of fiduciary duty, breach of contract, civil conspiracy, and an accounting of advertising funds. In July 2002 Plaintiffs estimated $4.2 million
of actual and $8.4 million of exemplary damages. Defendants' counterclaims include breach of contract, a request for an accounting, and attorneys' fees.

On
or about June 26, 2002, the court granted partial summary judgment in favor of the Company and other Defendants. Specifically, summary judgment was granted in favor of
Defendants on Plaintiffs' claims of breach of the two area developer agreements, tortious interference, all claims arising prior to March 25, 1998, and all claims of breach of good faith, of
violation of the DTPA, and of conspiracy arising prior to September 25, 1999. Defendants deny all of Plaintiff's remaining claims, believe they are without merit, and will continue to
vigorously defend this action.

ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS

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 24, 2002. At the meeting, the following items were voted on:

Election
of directors, whose terms expired at the meeting.

|                     |  | FOR       |  | AGAINST
|-------------------- |  | --------- |  | -------
|Jeffrey J. Wooley    |  | 6,162,609 |  | 76,789 
|Raymond A. Rodriguez |  | 6,180,211 |  | 59,187 

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

Floor Mouthaan
Azie Taylor Morton
John C. Wooley


25

---



|FOR       |  | AGAINST |  | WITHHELD
|--------- |  | ------- |  | --------
|6,209,813 |  | 13,950  |  | 15,635  

ITEM 5. OTHER INFORMATION

None.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K



10.37

Amendment to Amended and Restated Option Agreement, dated effective June 1, 2002, between DFW Restaurant Transfer Corp., NS Associates I, Ltd. and the Company.10.38

Amendment to Amended and Restated Management Agreement, dated effective June 1, 2002, between NS Associates I, Ltd., DFW Restaurant Transfer Corp. and the Company.10.39

Promissory Note, dated effective January 31, 2002, from the Company to Jeffrey J. Wooley.10.40

Promissory Note, dated effective January 31, 2002, from the Company to Jeffrey J. Wooley.99.1

Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, signed by John C. Wooley, Chief Executive Officer.99.2

Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, signed by Richard H. Valade, Chief Financial Officer.






26

---



SIGNATURES

Pursuant to the requirements of Section 13 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:               
| |  |                   
| |  | By:               
| |  |                   
| |  | By:               
| |  |                   

Austin,
Texas
August 14, 2002

27

---