Schlotzsky's, Inc., incorporated in 1971, is a franchisor and operator of restaurants in the fast, casual sector under the Schlotzsky's brand. Schlotzsky's restaurants offer made-to-order, hot sandwiches and pizzas, served on the Company's buns and crusts, wraps, chips, salads, soups, fresh baked cookies and other desserts and beverages. During the year ended December 31, 2003, there were 561 Schlotzsky's restaurants, of which 37 were Company-operated and 524 were franchised, located in 37 states, the District of Columbia and six foreign countries. Approximately 31.4% of the restaurants are located in Texas, and 3.9% in foreign countries. The Company operates through two business segments: restaurant operations and franchise operations. The restaurant operations segment includes 15 restaurants in its long-term portfolio that Schlotzsky's intends to operate for the purposes of leadership of the franchise system and, in certain cases, to stimulate the redevelopment of certain markets. These stores are also used to demonstrate sales potential and key operating metrics to build brand awareness, and to serve as laboratories for product development, concept refinement, product and process testing and training. Schlotzsky's also operates 22 restaurants that were developed for or acquired from franchisees, and are being operated until they are refranchised or divested, until their leases expire. Beginning in late 2003, the Company designated four of the 37 restaurants as training restaurants, where franchisees can learn or refine their operating techniques. The franchise operations segment is a key source of revenue, through royalties the Company collects from its franchisees for the use of its trademarks and operating systems, and license fees it receives from manufacturers and supply chain managers of Schlotzsky's brand products. This segment encompasses franchising of restaurants, assisting franchisees and licensing the manufacture of Schlotzsky's brand products. Several brand products, including chips, cheeses and meats, are available for retail sale in grocery and other retail stores. In 2003, the Company formed three wholly owned limited liability companies: Schlotzsky's Franchisor, LLC (Franchisor), Schlotzsky's Brand Products, LLC (Brand Products) and Schlotzsky's Franchise Operations, LLC (Franchise Operations). On June 7, 2003, it contributed, to Franchisor, all of its intellectual property. Franchisor, thus, became the franchisor of the Schlotzsky's restaurant concept, and licensor of the Schlotzsky's brand. Franchisor concurrently contributed the brand licensing agreements to Brand Products. Franchisor and Brand Products entered into a management agreement with Franchise Operations to manage the intellectual property, administer the franchise and brand license agreements, and enter into additional franchise and brand agreements. Schlotzsky's often assists franchisees in identifying restaurant sites, although franchisees are responsible for selecting restaurant locations acceptable to it. Site-selection criteria are based on several factors, such as accessibility and visibility of the site, and selected demographic factors, including population, residential and commercial density, income, age and traffic patterns. The Company also assists owners of older restaurants in finding economically feasible ways to upgrade or remodel their restaurants. Schlotzsky's has developed a variety of standard restaurant designs and specifications for freestanding and shopping-center restaurants that can be adapted to a variety of real estate layouts. These designs may be adapted to existing restaurants and other retail spaces with the Company's approval, such as rehabilitating or renovating buildings that were originally designed for completely different concepts. In 2003, Schlotzsky's initiated a gradual evolution and transition of the concept from the Schlotzsky's Deli version, to Schlotzsky's Sandwich Cafe and Bakery. This sandwich cafe initiative, originally referred to as Concept 2005, was launched as the Company's

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