(a)  Fiscal 2002 excludes current portion of debt ($118.4 million) as described in Note 6 of the Notes to Consolidated Financial Statements.

Cost of food decreased $14.3 million, or 12.2%, due primarily to fewer restaurants and the decline in same-store sales.  Food cost as a percentage of sales increased from 25.2% to 25.9% in the current fiscal year in comparison with the prior fiscal year.  Various "manager's special" promotions coupled with new "all-you-can-eat" offerings at selected locations have contributed to higher food costs as a percent of sales.

Payroll and related costs decreased $34.5 million, or 20.7%, due primarily to restaurant closures, lower workers' compensation expense, and three fewer days in the current fiscal year.  Of the total reduction, $20.4 million is due to lower wages resulting from numerous store closures and $12.0 million is due to lower workers' compensation costs.  Relative to the latter, in the prior year, there was a large increase for estimated claims expense under the Company's historical third-party program.  The Company initiated a safety training and accident prevention program in October 2001 that substantially lowered current year costs.

Occupancy and other operating expenses decreased $18.0 million, or 10.8%.  Although the dollar decrease is primarily due to store closures, other factors contributed to the fluctuation.  Utility costs decreased due to lower energy costs coupled with moderate temperatures and conservation.  Depreciation expense decreased due to less depreciable properties resulting from previous impairments and property sales.  Advertising costs declined due to reduced emphasis on television advertising.  Food-to-go packaging costs further declined due to the intentional redirection at many locations to inside dining coupled with less expensive packaging.  

General and administrative expenses decreased $4.0 million, or 15.9%.  Several factors contributed to the decline.  Officers' compensation decreased principally due to a reduction in relative headcount coupled with accelerated vesting of noncash compensation in the prior year.  Charges related to the proxy and restructuring advice contributed to the higher professional costs in the prior year.  Consulting fees were less principally due to a preliminary search for new senior management in fiscal 2001.

The provision for asset impairments and restaurant closings decreased by $30.1 million due to numerous impairments and provisions for impairment recorded in the prior year.  Charges of $314,000 were provided for in the current year principally to account for labor termination costs and an additional store closing, net of unrelated lease settlements that were more favorable than anticipated.

Interest expense decreased $1.4 million, or 12.0%, due primarily to lower effective interest rates on outstanding debt, the payoff of the loans on surrendered officers' life insurance policies, and payment reductions in the line of credit.  These factors were offset by interest on the $10 million in subordinated debt, amortization of the loss on interest rate Swaps, and the amortization of amendment fees for the credit facility.

The income tax benefit decreased by $12.2 million, or 72.1%, primarily due to a significantly lower incurred loss in fiscal 2002 versus fiscal 2001.

At August 28, 2002, and August 31, 2001, the Company had a reserve for store closings of $3.1 million and $4.5 million, respectively.  Excluding lease settlements, it is anticipated that all material cash outlays required for the store closings originally planned as of August 31, 2001, will be made prior to August 27, 2003.  See further discussion in Note 7 of the Notes to Consolidated Financial Statements.

EBITDA
EBITDA, excluding noncash stock compensation, increased by $.7 million for the current fiscal year in comparison with the prior fiscal year.

The operating performance of the Company is evaluated using several measures, one of which is EBITDA.  The Company's amended credit agreement defines EBITDA as operating income before interest, taxes, depreciation, amortization, and the noncash portion of the CEO's and the COO's stock option compensation.  While the Company and many in the financial community consider EBITDA to be an important measure of operating performance, it should be considered in addition to, but not as a substitute for or superior to, other measures of financial performance prepared in accordance with accounting principles generally accepted in the United States, such as operating income and net income.  In addition, the Company's definition of EBITDA is not necessarily comparable to similarly titled measures reported by other companies.

Cost of food decreased $7.4 million, or 5.9%, due to various factors, including store closures and the discontinuance of more costly product purchases.

Although sales decreased, payroll and related costs increased by $10.6 million, or 6.8%, in comparison to the prior year.  A significant portion of this, $9.2 million, was due to higher claims accruals.  The Company incurred higher than average and more frequent workers' compensation claims than were experienced in prior years.  (To help prevent injuries and better control costs, the Company launched a new in-house safety and claims program the following fiscal year.)

Occupancy and other operating expenses increased $6.7 million, or 4.2%.  This increase was due primarily to higher utility costs resulting from increased commodity rates, higher property taxes related to new stores and remodels, and higher repair expenses incurred as part of an initiative by new management to bring all stores up to a higher standard of maintenance and appearance.  These increases were partially offset by lower advertising expense due to a new strategic focus.  Lower preopening expenses due to opening fewer restaurants in the current fiscal year also contributed to the offset.

General and administrative expenses increased by $4.4 million, or 20.7%, in comparison to the prior year.  The increase was due primarily to noncash compensation of $1.9 million related to stock options granted to the Company's CEO and the COO.  Other costs that contributed to the increase included legal and consulting fees primarily related to restructuring advice and bank negotiations, the proxy, and the transaction to hire the CEO and the COO.  

As a result of its continuing efforts to redeploy both capital and human resources to improve financial performance and strengthen the organization, the Company recorded a pretax charge of $30.4 million during the year for store closings, associated costs, and asset impairment charges.  The principal components of the 2001 charge were as follows:  

Interest expense of $11.7 million for fiscal 2001 was incurred in conjunction with borrowings under the credit facility and is net of $336,000 capitalized on qualifying properties.  The increase from fiscal 2000 of $5.8 million, or 97.4%, was due primarily to higher average borrowings under the credit-facility agreement and less capitalized interest in the current year due to decreased construction.  

The provision for income taxes decreased $21.2 million, or 493.3%, due primarily to lower income before income taxes.

The $7.2 million total income tax receivable balance as of August 28, 2002, relates to current year tax benefits that are recoverable in the form of refunds in fiscal 2003.  These refunds accrued from recently enacted changes in tax legislation that extended carrybacks of net operating losses.

Excluding the reclassification of the credit facility balance as explained in the Debt section below, the Company had a working capital deficit of $1.1 million at August 28, 2002, in comparison to a working capital deficit of $2.2 million at August 31, 2001.  The decline in the deficit was primarily attributable to lower accruals for claims and insurance under the Company's new safety training and accident prevention programs offset by an increase in payables associated with the Company's new accounting close system.  Under this system, the Company closes each period on Wednesdays.  Fiscal 2001 ended on a Friday, while Company disbursement runs were consistently on Fridays for both fiscal years.

As of August 28, 2002, the Company owned 15 properties held for sale, including six undeveloped land sites.  The Company also had six properties held for future use.

Capital expenditures for the fiscal year ended August 28, 2002, were $13.1 million.  The Company intends to fund all capital expenditures for fiscal 2003 from cash flows from operations and expects them to be no more than $15 million for that fiscal year. Management continues to focus on improving the appearance, functionality, and sales at existing restaurants.  These efforts also include, where feasible, remodeling certain locations to other dining concepts.  In the second quarter of fiscal 2002, one existing property was remodeled to create the Company's first new concept, Luby's Seafood, in Huntsville, Texas.  After year-end, the Company remodeled and reopened another previously closed location as its first Steak Buffet.  Potential dining themes for the three planned remodels in fiscal 2003 are still under consideration.  

Under the agreement terms that were in place during fiscal 2002 and through the first quarter of fiscal 2003, the Company was required to meet certain indicated EBITDA levels.  EBITDA is defined in the agreement as earnings before interest, taxes, depreciation, amortization, and noncash executive compensation.  The annual EBITDA requirement was met for fiscal year 2002.  However, the Company fell short of its fourth-quarter EBITDA requirement.  After the end of the 2002 fiscal year, management obtained a waiver for the fourth-quarter requirement and an amendment to the debt agreement.

The amendment extended the debt's maturity to October 31, 2004, and increased the applicable interest rate from prime plus 1.5% to prime plus 2.5%.  Additionally, the financial covenant was changed from quarterly and annual EBITDA measurements to one that assesses liquidity and future debt service. Management believes the new covenant is achievable and considers it to be more appropriate for the collateralized credit facility.

Meanwhile, the Company has executed a commitment letter with another financial entity for an $80 million loan.  Its purpose is to replace that amount of debt in the existing credit facility.  Thus, the amendment discussed above requires that the entire proceeds from this other financial entity be used to pay down the credit facility.  In the event the Company is unable to make the $80 million payment as currently planned, the amended loan would be in default.  The existing lenders would then have the right to exercise any and all remedies, including the right to demand immediate repayment of the entire outstanding balance or the right to pursue foreclosure on the assets pledged as collateral.  As of August 28, 2002, $246.4 million of the Company's total book value, or 71.9% of its total assets, including the Company's owned real estate, improvements, equipment, and fixtures, was pledged as collateral under the credit facility.  Th e nonbinding commitment letter with the new lender is subject to conditions the Company must satisfy before the actual financing can occur.  Management is currently working toward this goal and has high confidence that the transaction will be completed and the financing closed by January 31, 2003.  

The Company also could pursue other options if its current refinancing plans cannot be finalized.  Those options include financing through high-yield debt at higher than commercial rates or conducting additional equity security sales through public or private offerings.  Dilution to existing shareholders would result in the case of equity security sales.

Assuming the $80 million requirement is met, the amended facility also includes two principal payments.  The first is a target of $15 million that is also to be paid by January 31, 2003, from either operating cash flow or proceeds from the sale of property.  Failure to pay the entire $15 million would result in a 1% increase in the applicable interest rate from prime plus 2.5% to prime plus 3.5%.  The second payment, from operating cash flow or property sales, is an additional $10 million by September 1, 2003.  Again, payment of any amount less than $10 million would result in another 1% increase in the applicable interest rate.

While negotiations and plan execution are under way, the Company continues to take steps to improve its cash position, operating results and cash flows, including the launch of new restaurant offerings and cost-saving initiatives in the areas of risk management, labor optimization, and purchasing.

In prior fiscal years, the Company had Interest Rate Protection Agreements (Swaps) that effectively fixed the interest rate on a portion of its floating-rate debt under its line of credit.  The Company terminated its Swaps effective July 2, 2001, due to declining interest rates.  (See Note 12 of the Notes to Consolidated Financial Statements.)

In connection with the Luby's Incentive Stock Plan as approved by the shareholders of the Company at the January 8, 1999, annual meeting of shareholders, the Company guaranteed loans in fiscal 1999 of approximately $1.9 million to enable officers to purchase stock in the Company.  As of August 28, 2002, the notes, which each officer obtained from JPMorgan Chase Bank and mature in fiscal 2004, have a total outstanding balance of approximately $1.6 million.  The purchased Company stock has been and can be used by the borrowers to satisfy a portion of their obligation. The Company does not anticipate default on the loans by any of the borrowers; however, in the event of default, the Company is obligated to purchase the specific borrower's loan from JPMorgan Chase Bank and would therefore become the holder of the note.  If the Company becomes the holder of any defaulted notes, it intends to pursue collection using all available remedies.  ; (See Note 8 of the Notes to Consolidated Financial Statements.)

The Company entered into an Affiliate Services Agreement effective August 31, 2001, with two companies, Pappas Partners, L.P. and Pappas Restaurants, Inc., which are restaurant entities owned by Christopher J. Pappas and Harris J. Pappas.  That agreement, as amended on July 23, 2002, limited the scope of expenditures therein to professional and consulting services.  The Company completed this amendment due to a significant decline in the use of professional and consulting services from Pappas entities.  In hiring its own employees to internally provide these services, the Company's relative costs decreased from $51,000 in fiscal 2001 to $8,000 in fiscal 2002.

Additionally, on July 23, 2002, the Company entered into a Master Sales Agreement with the same Pappas entities.  Through this agreement, the Company contractually separated the design and fabrication of equipment and furnishings from the Affiliate Services Agreement.  The Master Sales Agreement covers the costs incurred for modifications to existing equipment, as well as custom fabrication, including stainless steel stoves, shelving, rolling carts, and chef tables.  These items are custom-designed and built to fit the designated kitchens and are also engineered to give a longer service life than comparably manufactured equipment.

The pricing of equipment, repair, and maintenance is set and evaluated periodically and is considered by management to be primarily at or below market for comparable goods and services.  The Finance and Audit Committee of the Company's Board of Directors also uses independent valuation consultants to assist in periodically monitoring pricing of the transactions associated with the Master Sales Agreement and the Affiliate Services Agreement.  The Company's external auditors performed agreed upon procedures related to the affiliate services.  The scope and sufficiency of such procedures are determined by management and the Board of Directors, and results are submitted to the Board for its use in evaluating the fairness of the transactions.

As part of the affiliation with the Pappas entities, the Company leases a facility, the Houston Service Center, in which Luby's has installed a centralized restaurant service center to support field operations.  The building at this location has 21,000 square feet of warehouse space and 5,664 square feet of office space.  It is leased from the Pappas entities by the Company at a monthly rate of $.24 per square foot.  From this center, Luby's repair and service teams are dispatched to the Company's restaurants when facility or equipment maintenance and servicing are needed.  The facility is also used for repair and storage of new and used equipment.

The following compares fiscal and inception-to-date charges incurred under the Master Sales Agreement and the Affiliate Services Agreement to total general and administrative expenses, capital expenditures, and occupancy and other operating expenses:

The following shows the comparative change in same-store sales:

The Company enacted price increases in the third and fourth quarters of fiscal 2001.  The first quarter of fiscal 2002 includes September 11, 2001.  In the third and fourth quarters of fiscal 2002, the Company was able to maintain its comparative cash flow level with declining sales by lowering operating costs.  

The Company may find additional opportunities to lower costs; however, continued declines in net same-store sales could reduce operating cash flow.  If severe declines in cash flow were to develop without offsetting reductions in uses of cash, such as capital expenditures, the Company's ability to maintain compliance with the financial covenants of the amended credit facility may be impaired.  In such an event, the lender would have the right to terminate the credit facility, accelerate the maturity of any outstanding obligation under that facility, and pursue foreclosure on assets pledged as collateral.

The Company may be the subject of claims or litigation from guests and employees alleging injuries as a result of its operations.  In addition, unfavorable publicity from such allegations could have an adverse impact on financial results, regardless of their validity or ultimate outcome.

The reserve for restaurant closings declined from $4.5 million at August 31, 2001, to $3.1 million at August 28, 2002, primarily due to the payment of lease settlement costs of approximately $856,000 and further reductions associated with more favorable lease settlements than originally anticipated.  (See Note 7 of the Notes to Consolidated Financial Statements.)

The Company has identified the following policies as critical to its business and the understanding of its results of operations.  The Company believes it is improbable that materially different amounts would be reported relating to the accounting policies described below if other acceptable approaches were adopted.  However, the application of these accounting policies, as described below, involve the exercise of judgment and use of assumptions as to future uncertainties; therefore, actual results could differ from estimates generated from their use.

In August 2001, the Financial Accounting Standards Board (FASB) issued SFAS 144, "Accounting for the Impairment or Disposal of Long-Lived Assets."  This Standard requires the recognition and measurement of the impairment of long-lived assets to be held and used and the measurement of long-lived assets to be disposed of by sale.  The Company plans to adopt the pronouncement in fiscal 2003.  The Company does not expect a material impact on its results of operations or financial condition as a result of the adoption of this Standard.

The Company has accounted for the cessation of operations under the provisions of Emerging Issues Task Force No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity."  In June 2002, FASB issued SFAS 146, "Accounting for Costs Associated with Exit or Disposal Activities."  The Company will also adopt the accounting requirement of SFAS 146 in fiscal 2003 and does not anticipate the effects to the financial statements to be material.

At year-end, the Company had $118.4 million outstanding under its credit facility at prime plus 1.5%.  Additionally, the Company had $10 million in notes which bear interest at LIBOR plus 2%.  The total amount of debt subject to interest rate fluctuations was $128.4 million.  Assuming a consistent level of debt, a 1% change in interest rate effective from the beginning of the year would result in an increase or decrease in annual interest expense of $1.3 million.

Report of Independent Auditors

The Board of Directors and Shareholders of Luby's, Inc. and Subsidiaries  

We have audited the accompanying consolidated balance sheets of Luby's, Inc. and Subsidiaries at August 28, 2002, and August 31, 2001, and the related consolidated statements of operations, shareholders' equity, and cash flows for each of the three years in the period ended August 28, 2002.  These financial statements are the responsibility of the Company's management.  Our responsibility is to express an opinion on these consolidated financial statements based on our audits.  

We conducted our audits in accordance with auditing standards generally accepted in the United States.  Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement.  An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements.  An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation.  We believe that our audits provide a reasonable basis for our opinion.  

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Luby's, Inc. and Subsidiaries at August 28, 2002, and August 31, 2001, and the results of their operations and their cash flows for each of the three years in the period ended August 28, 2002, in conformity with accounting principles generally accepted in the United States.  

/s/ERNST & YOUNG LLP
San Antonio, Texas
October 15, 2002
except for Note 6 as
to which the date is