O CHARLEYS INC - FORM 10-Q - August 11, 2010

Attached files

file	filename
EX-31.1 - SECTION 302 CERTIFICATION OF THE CEO - O CHARLEYS INC	exhibit31-1.htm
EX-10.2 - EXECUTIVE EMPLOYMENT AGREEMENT - O CHARLEYS INC	exhibit10-2.htm
EX-32.1 - SECTION 906 CERTIFICATION OF THE CEO - O CHARLEYS INC	exhibit32-1.htm
EX-31.2 - SECTION 302 CERTIFICATION OF THE CFO - O CHARLEYS INC	exhibit31-2.htm
EX-32.2 - SECTION 906 CERTIFICATION OF THE CFO - O CHARLEYS INC	exhibit32-2.htm
EX-10.1 - RELEASE AGREEMENT - O CHARLEYS INC	exhibit10-1.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

________________

FORM 10-Q


x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended July 11, 2010

Commission file number 0-18629

O’Charley’s Inc.

(Exact name of registrant as specified in its charter)


Tennessee		62-1192475

(State or other jurisdiction of		(I.R.S. Employer
incorporation or organization)		Identification No.)


3038 Sidco Drive, Nashville, Tennessee		37204

(Address of principal executive offices)		(Zip Code)

(615) 256-8500

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. Large accelerated filer o Accelerated filer x Non-accelerated filer o (Do not check if a smaller reporting company) Smaller reporting company o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x

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


Class		Outstanding as of August 6, 2010

Common Stock, no par value		21,681,919 shares

O’Charley’s Inc.

Form 10-Q

Index


	Page No.
Part I — Financial Information
Item 1. Consolidated Financial Statements (Unaudited):
Consolidated Balance Sheets as of July 11, 2010 and December 27, 2009		3
Consolidated Statements of Operations for the 12 weeks ended July 11, 2010 and July 12, 2009		4
Consolidated Statements of Operations for the 28 weeks ended July 11, 2010 and July 12, 2009		5
Consolidated Statements of Cash Flows for the 28 weeks ended July 11, 2010 and July 12, 2009		6
Consolidated Statements of Shareholders’ Equity and Comprehensive Loss for the 28 weeks ended July 11, 2010		7
Notes to Unaudited Consolidated Financial Statements		8
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		20
Item 3. Quantitative and Qualitative Disclosures About Market Risk		30
Item 4. Controls and Procedures		30
Part II — Other Information
Item 1. Legal Proceedings		31
Item 1A. Risk Factors		31
Item 2. Issuer Purchases of Equity Securities		31
Item 6. Exhibits		31
Signatures

EX-10.1 General Release Agreement, dated June 17, 2010, by and between Jeffrey D. Warne and O’Charley’s Inc.

EX-10.2 Executive Employment Agreement dated July 30, 2010, by and between O’Charley’s Inc. and David Head

EX-31.1 Section 302 Certification of the Interim Chief Executive Officer

EX-31.2 Section 302 Certification of the Chief Financial Officer

EX-32.1 Section 906 Certification of the Interim Chief Executive Officer

EX-32.2 Section 906 Certification of the Chief Financial Officer

PART I — FINANCIAL INFORMATION

Item 1. Consolidated Financial Statements (Unaudited)

O’CHARLEY’S INC.

CONSOLIDATED BALANCE SHEETS

(In thousands)

(Unaudited)

	July 11,		December 27,
	2010		2009
ASSETS
Current Assets:
Cash and cash equivalents	$	25,855	$	21,880
Trade accounts receivable, net		14,839		17,209
Inventories		8,764		10,594
Deferred income taxes		680		—
Assets held for sale		809		1,937
Other current assets		6,245		4,434
Total current assets		57,192		56,054

Property and equipment, net of accumulated depreciation of $376,812 and $356,818		345,557		366,850
Trade names and other intangible assets		25,946		25,946
Other assets		13,844		13,405
Total Assets	$	442,539	$	462,255

LIABILITIES AND SHAREHOLDERS’ EQUITY
Current Liabilities:
Trade accounts payable	$	7,859	$	5,101
Accrued payroll and related expenses		15,948		16,044
Accrued expenses		23,108		21,446
Deferred revenue		6,617		17,969
Federal, state and local taxes		15,025		10,459
Current portion of long-term debt and capitalized lease obligations		1,996		1,979
Total current liabilities		70,553		72,998

Deferred income taxes		1,333		1,386
Other liabilities		47,679		48,833
Long-term debt, less current portion		117,548		128,121
Capitalized lease obligations, less current portion		820		1,798

Shareholders’ Equity:
Common stock — No par value; authorized, 50,000 shares; issued and outstanding, 21,682 in 2010 and 21,547 in 2009		163,871		161,514
Retained earnings		40,735		47,605
Total shareholders’ equity		204,606		209,119
Total Liabilities and Shareholders’ Equity	$	442,539	$	462,255

See accompanying notes to unaudited consolidated financial statements

O’CHARLEY’S INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

12 Weeks Ended July 11, 2010 and July 12, 2009

(In thousands, except per share data)

(Unaudited)

	2010			2009

Revenues:
Restaurant sales	$	193,848		$	206,028
Franchise and other revenue		239			189
		194,087			206,217
Costs and Expenses:
Cost of restaurant sales:
Cost of food and beverage		57,595			59,796
Payroll and benefits		68,531			72,480
Restaurant operating		40,313			39,949
Cost of restaurant sales, exclusive of depreciation and
amortization shown separately below		166,439			172,225

Advertising and marketing		7,922			8,107
General and administrative		10,190			8,075
Depreciation and amortization of property and equipment		9,942			10,956
Impairment and disposal charges, net		126			1,543
Pre-opening costs		—			80
		194,619			200,986
(Loss) Income from Operations		(532	)		5,231

Other Expense (Income):
Interest expense, net		2,874			2,741
Other, net		(1	)		(82	)
		2,873			2,659
(Loss) Earnings Before Income Taxes		(3,405	)		2,572
Income Tax (Benefit)		(882	)		(322	)
Net (Loss) Earnings	$	(2,523	)	$	2,894

Net (Loss) Attributable/Earnings Available to Common Shareholders	$	(2,523	)	$	2,822

Basic (Loss) Earnings per common share:
Net (loss) earnings	$	(0.12	)	$	0.14
Weighted average common shares outstanding		21,230			20,883

Diluted (Loss) Earnings per common share:
Net (loss) earnings	$	(0.12	)	$	0.13
Weighted average common shares outstanding		21,230			21,378

See accompanying notes to unaudited consolidated financial statements

O’CHARLEY’S INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

28 Weeks Ended July 11, 2010 and July 12, 2009

(In thousands, except per share data)

(Unaudited)

	2010			2009

Revenues:
Restaurant sales	$	465,001		$	497,392
Franchise and other revenue		572			483
		465,573			497,875
Costs and Expenses:
Cost of restaurant sales:
Cost of food and beverage		137,149			144,820
Payroll and benefits		163,289			171,803
Restaurant operating		95,140			96,537
Cost of restaurant sales, excluding depreciation and
amortization shown separately below		395,578			413,160

Advertising and marketing		19,689			18,558
General and administrative		21,139			20,783
Depreciation and amortization of property and equipment		23,566			25,978
Impairment and disposal charges, net		5,678			1,836
Pre-opening		7			345
		465,657			480,660
(Loss) Income from Operations		(84	)		17,215

Other Expense (Income):
Interest expense, net		6,918			6,784
Other, net		1			(72	)
		6,919			6,712
(Loss) Earnings Before Income Taxes		(7,003	)		10,503
Income Tax (Benefit) Expense		(135	)		468
Net (Loss) Earnings	$	(6,868	)	$	10,035

Net (Loss) Attributable/Earnings Available to Common Shareholders	$	(6,868	)	$	9,746

Basic (Loss) Earnings per common share:
Net (loss) earnings	$	(0.32	)	$	0.47
Weighted average commons shares outstanding		21,136			20,721

Diluted (Loss) Earnings per common share:
Net (loss) earnings	$	(0.32	)	$	0.47
Weighted average diluted common shares outstanding		21,136			20,933

See accompanying notes to unaudited consolidated financial statements

O’CHARLEY’S INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

28 Weeks Ended July 11, 2010 and July 12, 2009

(In thousands)

(Unaudited)

	2010			2009

Cash Flows from Operating Activities:
Net (loss) earnings	$	(6,868	)	$	10,035
Adjustments to reconcile net (loss) earnings to net cash provided by operating activities:
Depreciation and amortization of property and equipment		23,566			25,978
Amortization of debt issuance costs and swap termination payment		552			151
Share-based compensation		2,211			2,371
Loss on early extinguishment of debt		198			—
Amortization of deferred gain on sale-leasebacks		(569	)		(569	)
Deferred income taxes and other income tax related items		(924	)		(1,695	)
Loss on the sale of assets		52			62
Impairment and disposal charges, net		5,678			1,689
Noncontrolling interests		—			(84	)
Changes in assets and liabilities:
Trade accounts and other receivables		2,609			4,961
Inventories		1,830			3,346
Other current assets		(1,811	)		(1,444	)
Trade accounts payable		2,758			(6,381	)
Deferred revenue		(11,352	)		(11,114	)
Accrued payroll, accrued expenses, and federal, state and local taxes		6,474			1,485
Other long-term assets and liabilities		(1,220	)		985
Net cash provided by operating activities		23,184			29,776

Cash Flows from Investing Activities:
Additions to property and equipment		(7,661	)		(6,532	)
Proceeds from the sale of assets		1,131			1,023
Other, net		1			42
Net cash used in investing activities		(6,529	)		(5,467	)

Cash Flows from Financing Activities:
Payments on long-term debt and capitalized lease obligations		(1,168	)		(28,256	)
Repurchase of senior notes		(9,993	)		—
Debt issuance costs		(1,640	)		—
Payments to noncontrolling interests		—			(50	)
Proceeds from swap cancellation		—			3,510
Proceeds from the exercise of stock options and issuances under CHUX Ownership Plan		388			404
Shares tendered and retired for minimum tax withholdings		(271	)		(129	)
Excess tax benefit from share-based payments		6			—
Dividends paid		(2	)		—
Net cash used in financing activities		(12,680	)		(24,521	)
Increase (decrease) in cash and cash equivalents		3,975			(212	)
Cash and cash equivalents at beginning of the period		21,880			6,818
Cash and cash equivalents at end of the period	$	25,855		$	6,606

See accompanying notes to unaudited consolidated financial statements

O’CHARLEY’S INC.

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY AND

COMPREHENSIVE LOSS

28 Weeks Ended July 11, 2010

(In thousands)

(Unaudited)

	Common Stock						Retained
	Shares			Amount			Earnings			Total
Balance, December 27, 2009		21,547		$	161,514		$	47,605		$	209,119
Comprehensive loss:
Net loss		—			—			(6,868	)		(6,868	)
Shares tendered and retired for minimum tax withholdings		(36	)		(271	)		—			(271	)
Excess tax benefit from share-based payments		—			6			—			6
Shares issued under CHUX Ownership Plan and exercise of stock options		53			388			—			388
Dividends paid		—			—			(2	)		(2	)
Share-based compensation expense		118			2,234			—			2,234
Balance, July 11, 2010		21,682		$	163,871		$	40,735		$	204,606

See accompanying notes to unaudited consolidated financial statements

O’CHARLEY’S INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

12 and 28 Weeks Ended July 11, 2010 and July 12, 2009

(Unaudited)

A.	BASIS OF PRESENTATION

O’Charley’s Inc. (the “Company”) operates 234 (at July 11, 2010) full-service restaurant facilities in 17 states in the East, Southeast and Midwest under the trade name “O’Charley’s,” 113 full-service restaurant facilities in nine states throughout New England and the Mid-Atlantic under the trade name “Ninety Nine Restaurants,” and 11 full-service restaurant facilities in six states in the East, Southeast and Midwest under the trade name “Stoney River Legendary Steaks.” As of July 11, 2010, the Company had nine franchised O’Charley’s restaurants in five states.

The accompanying unaudited consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial reporting and in accordance with Rule 10-01 of Regulation S-X. The Company’s fiscal year ends on the last Sunday in December with its first quarter consisting of sixteen weeks and its second, third and fourth quarters consisting of twelve weeks each in most years.

In the opinion of management, the unaudited interim consolidated financial statements contained in this report reflect all adjustments, consisting primarily of normal recurring accruals, which are necessary for a fair presentation of the consolidated financial position and the results of operations for the interim periods presented. The results of operations for any interim period are not necessarily indicative of results for the full year.

The Company’s significant interim accounting policies include the recognition of certain advertising and marketing costs, generally in proportion to revenue.

These unaudited interim consolidated financial statements and footnote disclosures should be read in conjunction with the consolidated financial statements and the notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 27, 2009. Management of the Company has made certain estimates and assumptions relating to the reporting of assets and liabilities and the disclosure of contingent liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the period to prepare these unaudited interim consolidated financial statements in conformity with GAAP.

B.	FAIR VALUE MEASUREMENTS

Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 825, “Fair Value of Financial Instruments,” (“ASC 825”), requires disclosure of the fair values of most on- and off-balance sheet financial instruments for which it is practicable to estimate that value. The scope of ASC 825 excludes certain financial instruments, such as trade receivables and payables when the carrying value approximates the fair value, employee benefit obligations, lease contracts, and all nonfinancial instruments, such as land, buildings, and equipment. The fair values of the financial instruments are estimates based upon current market conditions and quoted market prices for the same or similar instruments as of July 11, 2010 and December 27, 2009. Book value approximates fair value for substantially all of the Company’s financial assets and liabilities that fall under the scope of ASC 825, except for the Company’s nine percent senior subordinated notes (the “Senior Notes”). The fair value of the Senior Notes was $119.4 million and $123.8 million as of July 11, 2010 and December 27, 2009, respectively, compared to the carrying value of $115.2 million and $125.0 million as of July 11, 2010 and December 27, 2009, respectively. The fair value of the Senior Notes was based on quoted market prices as of the last day of the second quarter of fiscal 2010 and last day of fiscal 2009.

ASC 820, “Fair Value Measurements and Disclosures,” (“ASC 820”) defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. Fair value is defined under ASC 820 as the price that would be received to sell an asset or paid to transfer a liability (an exit price) in an orderly transaction between market participants on the measurement date. ASC 820 also establishes a three-level hierarchy, which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The valuation hierarchy is based upon the transparency of inputs to the valuation of an asset or liability on the measurement date.

Level 1 Inputs based on quoted prices in active markets for identical assets.

Level 2 Inputs other than quoted prices included within Level 1 that are observable for the asset, either directly or indirectly.

Level 3 Inputs that are unobservable for the asset.

There were no transfers among levels within the fair value hierarchy during the 12 and 28 week periods ended July 11, 2010. Assets measured at fair value on a recurring basis are summarized in the table below (in thousands):

	Fair Value Measurement
Description	Level		July 11, 2010		December 27, 2009

Deferred compensation plan assets		1	$	3,942	$	4,644

The deferred compensation plan assets are comprised of various investment funds, which are valued based upon their quoted market prices.

There were no assets and liabilities measured at fair value on a nonrecurring basis during the second quarter of fiscal 2010. In certain prior periods significant adjustments were made to assets and liabilities where observable inputs were not available. As such, when future positive cash flows are projected, but less than the carrying value, Level 3 fair value is determined by projected future discounted cash flows for each restaurant location. The discount rate is the Company’s weighted average borrowing rate on outstanding debt during fiscal 2010 which the Company believes is commensurate with the required rate of return that a potential buyer would expect to receive when purchasing a similar restaurant and the related long-lived assets. The Company limits assumptions about important factors such as sales and margin change to those that are supportable for the restaurant. When the real estate value is deemed the highest and best use of the property, the fair value is determined using a valuation model that is based upon recent appraisals of the most representative operating location(s) based upon proximity, sales level, square footage, and land area.

C.	IMPAIRMENT AND DISPOSAL, NET

Long-lived assets, such as property and equipment, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. During the 12 and 28 weeks ended July 11, 2010, impairment and disposal charges, net were $0.1 million and $5.7 million, respectively, as compared to $1.5 million and $1.8 million for the same prior-year periods. The net charge during the 12 weeks ended July 11, 2010 is primarily insurance deductibles related to flood damage at the Company’s Clarksville, Tennessee properties.

Included in the $5.7 million of impairment and disposal charges, net, for the 28 weeks ended July 11, 2010, is $0.6 million of net exit and disposal costs related to three Ninety Nine restaurants closed during the first quarter of fiscal 2010 and one O’Charley’s restaurant that was previously closed. These four restaurant locations currently have operating lease obligations with lease termination dates ranging from 2010 to 2014. The present value of remaining lease obligations expected to be paid for these four restaurants was $0.8 million at the time of the restaurants’ closure.

A reconciliation of the liability balance is summarized in the table below (in millions):

Abandonment of Excess Leased Facilities
Balance, December 27, 2009	$	—
Charges		0.8
Payments		(0.1	)
Balance, July 11, 2010	$	0.7

D.	SHARE-BASED COMPENSATION

Total net share-based compensation expense was $0.8 million and $2.2 million for the 12 and 28 weeks ended July 11, 2010 and $1.0 million and $2.4 million for the 12 and 28 weeks ended July 12, 2009, respectively. The Company’s net share-based compensation expense primarily consisted of expense associated with restricted stock awards and to a lesser extent expense associated with unvested stock options and the Company’s employee share purchase plan.

During the 12 and 28 weeks ended July 11, 2010, the Company issued 86,020 and 163,020 shares of restricted stock awards, respectively, to its Board of Directors and certain employees. The Company also issued 25,000 and 55,000 shares of non-qualified stock options to certain members of senior management during the 12 and 28 weeks ended July 11, 2010, respectively. As of July 11, 2010, there were 1.9 million options outstanding and 0.4 million restricted stock awards outstanding.

E. LONG-TERM DEBT

On January 26, 2010 the Company entered into its Third Amended and Restated Credit Agreement (the “Credit Agreement”). The maximum borrowing capacity was reduced from $83 million (originally scheduled to be reduced to $65 million on April 18, 2010) to $45 million. The prior credit agreement had participation from nine banks, while the current credit agreement has participation from three banks. The maximum adjusted leverage ratio was reduced from 5.50 to 5.25. The definitions of adjusted leverage ratio and senior secured ratio have been changed, and capital expenditures for expansion (as defined by the Credit Agreement) are limited to 15% of EBITDA in 2010 and 30% of EBITDA in subsequent years. Under the Credit Agreement, the Company is permitted to repurchase its Senior Notes due in 2013, subject to certain limitations. The Credit Agreement also reduced the number of company-owned restaurants subject to collateral mortgages from 88 to 47. The Credit Agreement also “resets” the restricted payments basket for dividends and bond repurchases; however, such payments are currently restricted by the governing bond indenture. The Credit Agreement also permits sale-leaseback transactions, subject to certain limitations. At July 11, 2010, the Company had no amounts outstanding on its revolving credit facility and $12.6 million outstanding in letters of credit, which reduced its available capacity under the Credit Agreement to $32.4 million. During the 28 weeks ended July 11, 2010, the Company repurchased $9.8 million of its Senior Notes due 2013 resulting in a loss on early extinguishment of debt of $0.2 million, which is included in interest expense, net.

F. NET (LOSS) EARNINGS PER COMMON SHARE

The two-class method is an earnings allocation formula that determines earnings per share for common stock and participating securities, according to dividends declared and participation rights in undistributed earnings. Under this method, net earnings are reduced by the amount of dividends declared in the current period for common shareholders and participating security holders. The remaining earnings or “undistributed earnings” are allocated between common stock and participating securities to the extent that each security may share in earnings as if all of the earnings for the period had been distributed. Since the Company had net losses for the 12 and 28 weeks ended July 11, 2010, undistributed losses were not allocated to participating securities. Since the Company had net earnings for the 12 and 28 weeks ended July 12, 2009, undistributed earnings were allocated to participating securities; however, there was only a minimal impact on diluted earnings per share. No dividends were declared in the 12 and 28 weeks ended July 11, 2010 or July 12, 2009.

Following is a reconciliation of the Company’s basic and diluted (loss) earnings per share calculation applying the two-class method (in thousands, except per share data):

	12 Weeks Ended						28 Weeks Ended
	July 11,			July 12,			July 11,			July 12,
	2010			2009			2010			2009

Net (loss) earnings	$	(2,523	)	$	2,894		$	(6,868	)	$	10,035
Less: Net earnings allocated to unvested participating restricted stock		—			(72	)		—			(289	)
(Loss) attributable/ earnings available to common shareholders	$	(2,523	)	$	2,822		$	(6,868	)	$	9,746

Weighted average common shares outstanding		21,230			20,883			21,136			20,721
Incremental options and restricted shares outstanding		—			495			—			212
Weighted average diluted common shares outstanding		21,230			21,378			21,136			20,933

Basic (loss) earnings per common share	$	(0.12	)	$	0.14		$	(0.32	)	$	0.47
Diluted (loss) earnings per common share	$	(0.12	)	$	0.13		$	(0.32	)	$	0.47

Options for 1.9 million shares were excluded from the 12 and 28 weeks ended July 11, 2010 diluted weighted average share calculations and options for 1.7 million shares were excluded from 12 and 28 weeks ended July 12, 2009 diluted weighted average share calculations, due to these shares being anti-dilutive. In addition, restricted stock awards for 0.4 million shares were excluded from the 12 and 28 weeks ended July 11, 2010 diluted weighted average shares calculations and 0.6 million shares were excluded from the 12 and 28 weeks ended July 12, 2009 diluted weighted average shares calculations, due to these shares being anti-dilutive.

G. DERIVATIVE INSTRUMENTS

On December 17, 2008, the counterparties to the Company’s interest rate swap agreements exercised their right to exit the agreements in exchange for a $3.5 million payment of the remaining swap value. This amount is included as long-term debt in the Company’s consolidated balance sheet and is being amortized against interest expense over the remaining life of the Senior Notes. For the 12 and 28 weeks ended July 11, 2010, $0.2 million and $0.6 million, respectively, were amortized against interest expense. As of July 11, 2010, the amount remaining to be amortized was $2.2 million. The Company did not have any swap arrangements as of July 11, 2010.

H. LEGAL PROCEEDINGS

The Company is a defendant from time to time in various legal proceedings arising in the ordinary course of its business, including claims relating to injury or wrongful death under “dram shop” laws that allow a person to sue the Company based on any injury caused by an intoxicated person who was wrongfully served alcoholic beverages at one of its restaurants; claims relating to workplace, workers compensation and employment matters, discrimination and similar matters; claims resulting from “slip and fall” accidents; claims relating to lease and contractual obligations; claims relating to its franchising initiatives; and claims from guests or employees alleging illness, injury or other food quality, health or operational concerns.

The Company does not believe that any of the legal proceedings pending against it as of the date of this report will have a material adverse effect on its liquidity or financial condition. The Company may incur liabilities, settle disputes, sustain judgments, or accrue expenses relating to legal proceedings in a particular fiscal quarter which may adversely affect its consolidated results of operations, or on occasion, receive settlements that favorably affect its consolidated results of operations.

I. ASSETS HELD FOR SALE

The $0.8 million shown in assets held for sale as of July 11, 2010 on the consolidated balance sheet is a site the Company no longer plans to utilize that is currently being marketed for sale. The Company does not recognize depreciation expense for assets held for sale. During the second fiscal quarter of 2010, a restaurant that was previously an asset held for sale was sold for a nominal gain.

J. INCOME TAXES

During the second quarter ended July 11, 2010, the Company performed its quarterly assessment of its net deferred tax assets. Companies are required to assess whether valuation allowances should be established against their deferred tax assets based on the consideration of all available evidence using a “more likely than not” standard. In making such judgments, significant weight is given to evidence that can be objectively verified. As a result of the goodwill impairment charge recognized by the Company during fiscal 2008 and current year losses, the Company had a three-year cumulative pre-tax loss. In evaluating all of the positive and negative evidence in determining that a valuation allowance was required, the Company evaluated future reversals of existing taxable temporary differences, future taxable income exclusive of reversing temporary differences and carryforwards, taxable income in prior carryback years, if applicable, and tax planning strategies, and compared the likelihood of these sources of income in light of the recent pre-tax losses and determined that it is more likely than not that the Company will not be able to realize the majority of its net deferred tax assets in the future. A cumulative pre-tax loss is given considerably more weight than projections of future income, and a recent historical cumulative loss is considered a significant factor that is difficult to overcome.

For the 12 and 28 weeks ended July 11, 2010, the Company has recorded an income tax benefit of $0.9 million and $0.1 million, respectively. The Company projects that its tax credits, which are primarily the FICA (Social Security and Medicare taxes) tip credits and the WOTC (Work Opportunity Tax Credit), will be $7.8 million for the year. The FICA tip credit is a non-refundable federal income tax credit available to offset a portion of employer’s FICA tax paid on employee cash tips. WOTC is available for wages paid by employers who hire individuals from certain target groups of hard-to-employ individuals.

The Company’s provision for income taxes for the first 28 weeks of 2010 was a benefit of $0.1 million, a rate of approximately 1.9 percent, versus tax expense of $0.5 million in the prior year period, a rate of approximately 4.5 percent. Based upon its estimated full year results combined with its estimated full year tax credits, the Company expects its full year effective tax rate to be approximately negative 13.8 percent, excluding discrete items. Under U.S. GAAP, the Company is required to apply its estimated full year tax rate to its pretax (loss) earnings on a year-to-date basis in each interim period. The difference between its estimated annual tax rate of negative 13.8 percent and the 1.9 percent rate for the first 28 weeks of 2010 relates to certain discrete items, primarily the $1.3 million benefit for the valuation allowance reversal related to a revision in estimate on the carryback of 2008 net operating losses due to the completion of its evaluation of the alternative financial impacts of the elective provisions of the Worker, Homeownership and Business Assistance Act of 2009 which expanded net operating loss (NOL) carryback provisions to five years for certain NOL’s generated in 2008 or 2009. Additionally, a $0.1 million reduction in expense associated with uncertain tax positions was partially offset by $0.3 million for the establishment of a valuation allowance associated with certain state net operating loss carry-forwards. The change in the effective tax rate from fiscal 2009 to fiscal 2010 is the result of fluctuations in pre-tax net (loss) earnings and the related rate impacts of federal tax credits on the expected full year results, as well as changes in the fiscal 2010 valuation allowance.

K. RECENT ACCOUNTING PRONOUNCEMENTS

In January 2010, the FASB issued Accounting Standards Update (“ASU”) 2010-06, “Fair Value Measurements and Disclosures” (“ASU 2010-06”), which adds new disclosure requirements for transfers into and out of Levels 1 and 2 in the fair value hierarchy and additional disclosures about purchases, sales, issuances and settlements relating to Level 3 fair value measurements. This ASU also clarifies existing fair value disclosures about the level of disaggregation about inputs and valuation techniques used to measure fair value. The ASU is effective for the first reporting period beginning after December 15, 2009, except for the requirement to provide the Level 3 activity on a gross basis, which is effective for fiscal years beginning after December 15, 2010 and interim periods within those years. The adoption of ASU 2010-06, except for the requirement to provide the Level 3 activity on a gross basis, did not have any impact on the Company’s consolidated financial statements. The Company does not expect the requirement to provide the Level 3 activity on a gross basis to have an impact on its consolidated financial statements.

L. SUPPLEMENTARY CONSOLIDATING FINANCIAL INFORMATION OF SUBSIDIARY GUARANTORS

Presented below is supplementary consolidating financial information for the Company and the subsidiary guarantors as of July 11, 2010 and December 27, 2009 and for the 12 and 28 week periods ended July 11, 2010 and July 12, 2009.

Consolidating Balance Sheet

As of July 11, 2010

(Unaudited)

							Minor
							Subsidiaries and
	Parent			Subsidiary			Consolidating
	Company			Guarantors			Adjustments			Consolidated
	(In thousands)

ASSETS
Current Assets:
Cash and cash equivalents	$	1,156		$	24,699		$	—		$	25,855
Trade accounts receivable, net		5,794			9,752			(707	)		14,839
Intercompany (payable) receivable		(229,050	)		198,564			30,486			—
Inventories		3,971			4,793			—			8,764
Deferred income taxes		680			—			—			680
Assets held for sale		809			—			—			809
Other current assets		3,299			2,916			30			6,245
Total current (liabilities) assets		(213,341	)		240,724			29,809			57,192

Property and equipment, net		242,669			102,888			—			345,557
Trade names and other intangible assets		25			25,921			—			25,946
Other assets		209,551			29,548			(225,255	)		13,844
Total Assets (Liabilities)	$	238,904		$	399,081		$	(195,446	)	$	442,539

LIABILITIES AND SHAREHOLDERS’ EQUITY (DEFICIT)
Current Liabilities:
Trade accounts payable	$	8,595		$	(1,365	)	$	629		$	7,859
Accrued payroll and related expenses		11,684			4,264			—			15,948
Accrued expenses		18,293			5,492			(677	)		23,108
Deferred revenue		—			7,246			(629	)		6,617
Federal, state and local taxes		(9,736	)		24,761			—			15,025
Current portion of long-term debt and capitalized lease obligations		1,853			143			—			1,996
Total current liabilities (assets)		30,689			40,541			(677	)		70,553

Deferred income taxes		1,333			—			—			1,333
Other liabilities		27,355			20,224			100			47,679
Long-term debt, less current portion		140,901			326			(23,679	)		117,548
Capitalized lease obligations, less current portion		665			155			—			820

Shareholders’ Equity (Deficit):
Common stock		121,495			343,431			(301,055	)		163,871
Retained (deficit) earnings		(83,534	)		(5,596	)		129,865			40,735
Total shareholders’ equity (deficit)		37,961			337,835			(171,190	)		204,606
Total Liabilities and Shareholders’ Equity (Deficit)	$	238,904		$	399,081		$	(195,446	)	$	442,539

Consolidating Balance Sheet

As of December 27, 2009

(Unaudited)

							Minor
							Subsidiaries and
	Parent			Subsidiary			Consolidating
	Company			Guarantors			Adjustments			Consolidated
	(In thousands)

ASSETS
Current Assets:
Cash and cash equivalents	$	2,127		$	19,753		$	—		$	21,880
Trade accounts receivable, net		8,280			9,139			(210	)		17,209
Intercompany (payable) receivable		(257,253	)		226,774			30,479			—
Inventories		4,663			5,931			—			10,594
Assets held for sale		809			1,128			—			1,937
Other current assets		1,961			2,462			11			4,434
Total current (liabilities) assets		(239,413	)		265,187			30,280			56,054

Property and equipment, net		256,799			110,051			—			366,850
Trade names and other intangible assets		25			25,921			—			25,946
Other assets		208,619			30,042			(225,256	)		13,405
Total Assets (Liabilities)	$	226,030		$	431,201		$	(194,976	)	$	462,255

LIABILITIES AND SHAREHOLDERS’ EQUITY (DEFICIT)
Current Liabilities:
Trade accounts payable	$	4,484		$	(12	)	$	629		$	5,101
Accrued payroll and related expenses		12,052			3,992			—			16,044
Accrued expenses		16,287			5,365			(206	)		21,446
Deferred revenue		—			18,598			(629	)		17,969
Federal, state and local taxes		(14,234	)		24,693			—			10,459
Current portion of long-term debt and capitalized lease obligations		1,835			144			—			1,979
Total current liabilities (assets)		20,424			52,780			(206	)		72,998

Deferred income taxes		1,386			—			—			1,386
Other liabilities		28,234			20,499			100			48,833
Long-term debt, less current portion		151,272			528			(23,679	)		128,121
Capitalized lease obligations, less current portion		1,548			250			—			1,798

Shareholders’ Equity (Deficit):
Common stock		119,138			343,431			(301,055	)		161,514
Retained (deficit) earnings		(95,972	)		13,713			129,864			47,605
Total shareholders’ equity (deficit)		23,166			357,144			(171,191	)		209,119
Total Liabilities and Shareholders’ Equity (Deficit)	$	226,030		$	431,201		$	(194,976	)	$	462,255

Consolidating Statement of Operations

12 Weeks Ended July 11, 2010

(Unaudited)

							Minor
							Subsidiaries and
	Parent			Subsidiary			Consolidating
	Company			Guarantors			Adjustments			Consolidated
	(In thousands)

Revenues:
Restaurant sales	$	109,417		$	81,410		$	3,021		$	193,848
Franchise and other revenue		157			82			—			239
		109,574			81,492			3,021			194,087

Costs and Expenses:
Cost of restaurant sales:
Cost of food and beverage		32,249			24,240			1,106			57,595
Payroll and benefits		40,949			29,463			(1,881	)		68,531
Restaurant operating		21,190			15,810			3,313			40,313
Cost of restaurant sales, exclusive of depreciation and amortization shown separately below		94,388			69,513			2,538			166,439

Advertising and marketing		—			7,887			35			7,922
General and administrative		1,348			9,014			(172	)		10,190
Depreciation and amortization of property and equipment		5,531			4,299			112			9,942
Impairment and disposal charges, net		116			10			—			126
Pre-opening costs		—			—			—			—
		101,383			90,723			2,513			194,619
Income (Loss) from Operations		8,191			(9,231	)		508			(532	)
Other Expense (Income):
Interest expense, net		2,740			134			—			2,874
Other, net		(1	)		—			—			(1	)
		2,739			134			—			2,873
Earnings (Loss) Before Income Taxes		5,452			9,365			508			(3,405	)
Income Tax (Benefit)		(531	)		(351	)		—			(882	)
Net Earnings (Loss)	$	5,983		$	(9,014	)	$	508		$	(2,523	)

Consolidating Statement of Operations

12 Weeks Ended July 12, 2009

(Unaudited)

							Minor
							Subsidiaries and
	Parent			Subsidiary			Consolidating
	Company			Guarantors			Adjustments			Consolidated
	(In thousands)

Revenues:
Restaurant sales	$	117,993		$	83,314		$	4,721		$	206,028
Commissary sales		—			18,656			(18,656	)		—
Franchise and other revenue		190			65			(66	)		189
		118,183			102,035			(14,001	)		206,217

Costs and Expenses:
Cost of restaurant sales:
Cost of food and beverage		33,966			24,530			1,300			59,796
Payroll and benefits		43,493			30,093			(1,106	)		72,480
Restaurant operating		21,172			15,170			3,607			39,949
Cost of restaurant sales, exclusive of depreciation and amortization shown separately below		98,631			69,793			3,801			172,225

Cost of commissary sales		—			18,246			(18,246	)		—
Advertising and marketing		—			8,052			55			8,107
General and administrative		1,078			7,394			(397	)		8,075
Depreciation and amortization of property and equipment		6,300			4,467			189			10,956
Impairment and disposal charges, net		1,345			52			146			1,543
Pre-opening costs		—			80			—			80
		107,354			108,084			(14,452	)		200,986
Income (Loss) from Operations		10,829			(6,049	)		451			5,231
Other Expense (Income):
Interest expense, net		2,476			152			113			2,741
Other, net		(82	)		—			—			(82	)
		2,394			152			113			2,659
Earnings (Loss) Before Income Taxes		8,435			(6,201	)		338			2,572
Income Tax (Benefit)		(267	)		(55	)		—			(322	)
Net Earnings (Loss)	$	8,702		$	(6,146	)	$	338		$	2,894

Consolidating Statement of Operations

28 Weeks Ended July 11, 2010

(Unaudited)

							Minor
							Subsidiaries and
	Parent			Subsidiary			Consolidating
	Company			Guarantors			Adjustments			Consolidated
	(In thousands)

Revenues:
Restaurant sales	$	266,201		$	191,532		$	7,268		$	465,001
Franchise and other revenue		369			203			—			572
		266,570			191,735			7,268			465,573

Costs and Expenses:
Cost of restaurant sales:
Cost of food and beverage		78,196			56,323			2,630			137,149
Payroll and benefits		97,935			69,467			(4,113	)		163,289
Restaurant operating		50,005			37,554			7,581			95,140
Cost of restaurant sales, exclusive of depreciation and amortization shown separately below		226,136			163,344			6,098			395,578

Advertising and marketing		—			19,607			82			19,689
General and administrative		3,075			18,497			(433	)		21,139
Depreciation and amortization of property and equipment		13,209			10,079			278			23,566
Impairment and disposal charges, net		5,141			537			—			5,678
Pre-opening costs		—			7			—			7
		247,561			212,071			6,025			465,657
Income (Loss) from Operations		19,009			(20,336	)		1,243			(84	)
Other Expense:
Interest expense, net		6,603			315			—			6,918
Other, net		1			—			—			1
		6,604			315			—			6,919
Earnings (Loss) Before Income Taxes		12,405			(20,651	)		1,243			(7,003	)
Income Tax (Benefit)		(37	)		(98	)		—			(135	)
Net Earnings (Loss)	$	12,442		$	(20,553	)	$	1,243		$	(6,868	)

Consolidating Statement of Operations

28 Weeks Ended July 12, 2009

(Unaudited)

							Minor
							Subsidiaries and
	Parent			Subsidiary			Consolidating
	Company			Guarantors			Adjustments			Consolidated
	(In thousands)

Revenues:
Restaurant sales	$	283,815		$	201,669		$	11,908		$	497,392
Commissary sales		—			44,778			(44,778	)		—
Franchise and other revenue		488			164			(169	)		483
		284,303			246,611			(33,039	)		497,875

Costs and Expenses:
Cost of restaurant sales:
Cost of food and beverage		81,834			59,627			3,359			144,820
Payroll and benefits		102,394			72,209			(2,800	)		171,803
Restaurant operating		49,577			38,209			8,751			96,537
Cost of restaurant sales, exclusive of depreciation and amortization shown separately below		233,805			170,045			9,310			413,160

Cost of commissary sales		—			43,741			(43,741	)		—
Advertising and marketing		—			18,383			175			18,558
General and administrative		2,954			18,529			(700	)		20,783
Depreciation and amortization of property and equipment		15,015			10,524			439			25,978
Impairment and disposal charges, net		1,340			350			146			1,836
Pre-opening		1			344			—			345
		253,115			261,916			(34,371	)		480,660
Income (Loss) from Operations		31,188			(15,305	)		1,332			17,215
Other Expense (Income):
Interest expense, net		6,131			348			305			6,784
Other, net		(72	)		—			—			(72	)
		6,059			348			305			6,712
Earnings (Loss) Before Income Taxes		25,129			(15,653	)		1,027			10,503
Income Tax Expense		421			47			—			468
Net Earnings (Loss)	$	24,708		$	(15,700	)	$	1,027		$	10,035

Consolidating Statement of Cash Flows

28 Weeks Ended July 11, 2010

(Unaudited)

							Minor
							Subsidiaries and
	Parent			Subsidiary			Consolidating
	Company			Guarantors			Adjustments			Consolidated
	(In thousands)

Cash Flows from Operating Activities:
Net earnings (loss)	$	12,442		$	(20,552	)	$	1,242		$	(6,868	)
Adjustments to reconcile net earnings (loss) to net cash provided by (used in) operating activities:
Depreciation and amortization of property and equipment		13,209			10,079			278			23,566
Amortization of debt issuance costs and swap termination payment		552			—			—			552
Share–based compensation		2,211			—			—			2,211
Loss on early extinguishment of debt		198			—			—			198
Amortization of deferred gain on sale-leasebacks		(569	)		—			—			(569	)
Deferred income taxes and other income tax related items		(924	)		—			—			(924	)
Loss on the sale of assets		37			15			—			52
Impairment and disposal charges, net		5,032			646			—			5,678
Changes in assets and liabilities:
Trade accounts and other receivables		2,725			(614	)		498			2,609
Inventories		692			1,138			—			1,830
Other current assets		(1,337	)		(454	)		(20	)		(1,811	)
Trade accounts payable		4,111			(1,353	)		—			2,758
Deferred revenue		—			(11,352	)		—			(11,352	)
Accrued payroll, accrued expenses, and federal, state and local taxes		6,478			466			(470	)		6,474
Other long-term assets and liabilities		(1,454	)		234			—			(1,220	)
Net cash provided by (used in) operating activities		43,403			(21,747	)		1,528			23,184

Cash Flows from Investing Activities:
Additions to property and equipment		(4,315	)		(3,068	)		(278	)		(7,661	)
Proceeds from the sale of assets		2			1,129			—			1,131
Other, net		1			—			—			1
Net cash (used in) investing activities		(4,312	)		(1,939	)		(278	)		(6,529	)

Cash Flows from Financing Activities:
Payments on long-term debt and capitalized lease obligations		(1,168	)		—			—			(1,168	)
Repurchase of senior notes		(9,993	)		—			—			(9,993	)
Debt issuance costs		(1,640	)		—			—			(1,640	)
Proceeds from the exercise of stock options and issuances under CHUX Ownership Plan		388			—			—			388
Shares tendered and retired for minimum tax withholding		(271	)		—			—			(271	)
Excess tax benefit from share-based payments		6			—			—			6
Dividends paid		(2	)		—			—			(2	)
Net cash used in financing activities		(12,680	)		—			—			(12,680	)

Increase (decrease) in cash and cash equivalents		26,411			(23,686	)		1,250			3,975
Cash and cash equivalents at beginning of the period		2,127			19,753			—			21,880
Cash and cash equivalents at end of the period	$	28,538		$	(3,933	)	$	1,250		$	25,855

Consolidating Statement of Cash Flows

28 Weeks Ended July 12, 2009

(Unaudited)

							Minor
							Subsidiaries and
	Parent			Subsidiary			Consolidating
	Company			Guarantors			Adjustments			Consolidated
	(In thousands)

Cash Flows from Operating Activities:
Net earnings (loss)	$	24,708		$	(15,700	)	$	1,027		$	10,035
Adjustments to reconcile net earnings (loss) to net cash provided by (used in) operating activities:
Depreciation and amortization of property and equipment		15,015			10,524			439			25,978
Amortization of debt issuance costs		151			—			—			151
Share–based compensation		2,371			—			—			2,371
Amortization of deferred gain on sale-leasebacks		(569	)		—			—			(569	)
Deferred income taxes and other income tax related items		(1,695	)		—			—			(1,695	)
Loss on the sale of assets		47			15			—			62
Impairment and disposal charges, net		(8	)		1,697			—			1,689
Noncontrolling interests		—			—			(84	)		(84	)
Changes in assets and liabilities:
Trade accounts receivable		6,011			(1,522	)		472			4,961
Inventories		122			3,195			29			3,346
Other current assets		(1,315	)		1,354			(1,483	)		(1,444	)
Trade accounts payable		267			(1,527	)		(5,121	)		(6,381	)
Deferred revenue		—			(11,072	)		(42	)		(11,114	)
Accrued payroll, accrued expenses, and federal, state and local taxes		2,893			(1,109	)		(299	)		1,485
Other long-term assets and liabilities		352			1,380			(747	)		985
Net cash provided by (used in) operating activities		48,350			(12,765	)		(5,809	)		29,776

Cash Flows from Investing Activities:
Additions to property and equipment		(2,938	)		(3,680	)		86			(6,532	)
Proceeds from the sale of assets		11			1,012			—			1,023
Other, net		(22,578	)		23,277			(657	)		42
Net cash (used in) provided by investing activities		(25,505	)		20,609			(571	)		(5,467	)

Cash Flows from Financing Activities:
Payments on long-term debt and capitalized lease obligations		(28,256	)		—			—			(28,256	)
Payments to noncontrolling interests		(50	)		—			—			(50	)
Proceeds from swap cancellation		3,510			—			—			3,510
Proceeds from the exercise of stock options and issuances under CHUX Ownership Plan		404			—			—			404
Shares tendered and retired for minimum tax withholding		(129	)		—			—			(129	)
Net cash used in financing activities		(24,521	)		—			—			(24,521	)

(Decrease) increase in cash and cash equivalents		(1,676	)		7,844			(6,380	)		(212	)
Cash and cash equivalents at beginning of the period		2,924			(2,639	)		6,533			6,818
Cash and cash equivalents at end of the period	$	1,248		$	5,205		$	153		$	6,606

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

RESULTS OF OPERATIONS

Note Regarding Forward-Looking Statements

This report contains certain forward-looking statements within the meaning of the federal securities laws, which are intended to be covered by the safe harbors created thereby. Those statements include, but may not be limited to, all statements regarding our intent, belief and expectations such as statements concerning our estimated results in future periods, operating and growth strategy, and financing plans. Forward-looking statements are generally identifiable by the use of the words “anticipate,” “will,” “believe,” “estimate,” “expect,” “plan,” “intend,” “seek,” “forecast,” or similar expressions. These forward-looking statements may be affected by certain risks and uncertainties, including, but not limited to, the continued deterioration in the United States economy and the related adverse effect on our sales of decreases in consumer spending; our ability to achieve our internal forecast of sales and profitability; our ability to comply with the terms and conditions of our financing agreements; our ability to maintain or increase same store sales and operating margins at our restaurants; the effect that increases in food, labor, energy, interest costs and other expenses have on our results of operations; the effect of increased competition; our ability to successfully implement changes to our supply chain; our ability to sell closed restaurants and other surplus assets; our ability to successfully implement and realize projected benefits of our turnaround and transformation process, and other initiatives; the result of existing or proposed government laws and regulation; the resolution of outstanding legal proceedings; and the other risks described in our Annual Report on Form 10-K for the fiscal year ended December 27, 2009 under the caption “Risk Factors” and in our other filings with the Securities and Exchange Commission (“the Commission”). Although we believe that the assumptions underlying the forward-looking statements contained herein are reasonable, any of the assumptions could be inaccurate and, therefore, there can be no assurance that the forward-looking statements included in this report will prove to be accurate. In light of the significant uncertainties inherent in the forward-looking statements included herein, the inclusion of such information should not be regarded as a representation by us or any other person that our objectives and plans will be achieved. We undertake no obligation to publicly release any revisions to any forward-looking statements contained herein to reflect events and circumstances occurring after the date hereof or to reflect the occurrence of unanticipated events.

Overview

We are a multi-concept restaurant company headquartered in Nashville, Tennessee. We operate three restaurant concepts under the “O’Charley’s,” “Ninety Nine” and “Stoney River Legendary Steaks” trade names. As of July 11, 2010, we operated 234 O’Charley’s restaurants in 17 states in the East, Southeast and Midwest, 113 Ninety Nine restaurants in nine states throughout New England and the Mid-Atlantic, and 11 Stoney River restaurants in six states in the East, Southeast and Midwest. As of July 11, 2010, we had nine franchised O’Charley’s restaurants in five states. Our fiscal year ends on the last Sunday of the calendar year. We have one reportable segment.

During the second fiscal quarter, Jeffrey D. Warne resigned as President and Chief Executive Officer of O’Charley’s Inc. (the “Company”), from its Board of Directors and from all other positions with the Company’s subsidiaries and other affiliates. The Company’s Board of Directors appointed Philip J. Hickey, Jr., the Company’s Chairman of the Board, to serve as Interim President and Chief Executive Officer. On August 2, 2010, the Company announced the hiring, effective no later than September 1, 2010, of David Head as the Company’s President, Chief Executive Officer and a member of its Board of Directors.

In response to the macroeconomic conditions of the past two years, much of management’s focus has been on improving guest satisfaction, controlling margins, reducing overhead costs, maximizing cash flow, and reducing debt. While we believe that we have made progress in these areas, and that the tools we applied, such as our theoretical food, labor, and beverage cost systems, continue to contribute positively to our operating results, we understand that we still have considerable opportunities to improve our business model, especially at the O’Charley’s brand. We continue to improve our Guest Satisfaction Index “GSI” scores, with a 300 basis point improvement in overall satisfaction at O’Charley’s and a 200 basis point improvement at Ninety Nine in the second quarter of fiscal 2010 compared to the prior year quarter. Going forward, we believe that our primary focus must be on positioning each of our brands to increase guest counts and drive profitable sales.

At our O’Charley’s restaurants, we have conducted extensive market research over the past year to better understand the perceptions of the brand, and have recently sought feedback from current and lapsed guests. Based upon this research, we believe that many guests no longer perceive O’Charley’s to have better food and service than our competitors, causing many of them to leave the brand or reduce their frequency of visits. We also learned that many of our formerly loyal guests have a strong attachment to the brand. In response, we have a series of initiatives underway to build upon the brand’s existing strengths by simplifying the menu and improving the quality of every menu item. We recognize that the turnaround in guest perceptions of O’Charley’s is not likely to happen quickly. In the short term, we plan to drive sales by increasing the focus on value with attractively-priced entrées, appetizers and cocktails. In addition, we plan to improve the level of service and the timing of food execution and consistency by re-training and re-certifying our management teams and then cascade this training to every team member at our O’Charley’s restaurants.

At our Ninety Nine restaurants, we plan to continue to strengthen the loyalty of our core guests, who we believe appreciate a friendly environment that offers generous portions of high quality traditional fare at moderate prices. Our “Nine Real-Sized Entrées for $9.99” continues to prove popular with our guests, and we plan to continue to refresh the nine menu items over time. This offering is now featured in the regular menu rather than as a menu insert as previously placed. Additionally, our guests continue to respond favorably to the opportunity to upgrade their entrée into a full meal for an additional $3.00 and our “Red Sox Win, Kids Eat Free” promotion continues to be popular. We are encouraged that during the quarter Ninety Nine outperformed its relevant Knapp-Track averages for same store sales and guest counts, and had its first quarter of positive guest count growth in more than four years.

At our Stoney River restaurants, in the interest of providing increased brand relevance to our guests, we have reduced prices on certain menu items, added new menu items and added more affordable choices to our wine list while continuing to offer our signature favorite menu items and outstanding guest service. We completed the roll out of these repositioning elements last year and are now focused on refreshing our menu choices as well as bringing Stoney River’s cost structure in line with the lower check average. We believe these efforts are beginning to show success as we have had three consecutive quarters of increased guest counts and an increase of 530 basis points in restaurant operating margin for the second quarter of fiscal 2010 compared to the second quarter of fiscal 2009.

Following is an explanation of certain items in our consolidated statements of operations:

Revenues consist primarily of company-operated restaurant sales and, to a lesser extent, royalty and franchise revenue. Restaurant sales include food and beverage sales and are net of applicable state and local sales taxes and discounts. Franchise and other revenue consists of development fees, royalties on sales by franchised units, and royalties on sales of branded food items, particularly salad dressings. The development fees are recognized during the reporting period in which the developed restaurant begins operation. The royalties are recognized as revenue in the period corresponding to the franchisees’ sales. Revenue resulting from the sale of gift cards is recognized in the period redeemed. A percentage of gift card redemptions, based upon actual experience, are recognized as a reduction in restaurant operating costs for gift cards sold that will not be redeemed.

Cost of Food and Beverage primarily consists of the costs of beef, poultry, seafood, and alcoholic and non-alcoholic beverages net of vendor discounts and rebates. The three most significant commodities that may affect our cost of food and beverage are beef, poultry and seafood which accounted for approximately 25 percent, 9 percent and 11 percent, respectively, of our overall cost of food and beverage in the second quarter of fiscal 2010. Generally, temporary increases in these costs are not passed on to guests; however, in the past, we have adjusted menu prices to compensate for increased costs of a more permanent nature.

Payroll and Benefits include payroll and related costs and expenses directly relating to restaurant level activities including restaurant management salaries, bonuses, share-based compensation, 401(k) compensation match, hourly wages for restaurant level team members, payroll taxes, workers’ compensation programs, various health, life and dental insurance programs, vacation expense and sick pay. We have various incentive plans that compensate restaurant management for achieving certain restaurant level financial targets and performance goals.

Restaurant Operating Costs include occupancy and other expenses at the restaurant level, except property and equipment depreciation and amortization. In addition to occupancy costs, supplies, straight-line rent, supervisory salaries, bonuses, share-based compensation, 401(k) and deferred compensation match for multi-unit operational employees and related expenses, management training salaries, general liability and property insurance programs, property taxes, utilities, repairs and maintenance, outside services and credit card fees account for the major expenses in this category.

Advertising and Marketing Expenses include all advertising and marketing-related expenses for the various programs that we utilize to promote traffic and brand recognition for our three restaurant concepts. This category also includes the administrative costs of our marketing departments. We expense advertising and marketing costs in the year incurred, except for certain advertising production costs that are initially capitalized and subsequently expensed the first time the advertising takes place. On a quarterly basis and for purposes of interim reporting, we expense a portion of the projected annual advertising and marketing expenses in proportion to revenue for the quarter compared to projected annual revenue.

General and Administrative Expenses include the costs of the administrative functions that support the existing restaurant base and provide the infrastructure for future growth. Executive management and support staff salaries, bonuses, share-based compensation, 401(k) and deferred compensation match for support employees, benefits and related expenses, legal and accounting expenses, changes in the liabilities associated with plan gains or losses in employees’ self-directed non-qualified deferred compensation plan accounts and office expenses account for the major expenses in this category. This category also includes recruiting, relocation and most severance-related expenses.

Depreciation and Amortization, Property and Equipment primarily includes depreciation on property and equipment calculated on a straight-line basis over the estimated useful lives of the respective assets or the base lease term plus one renewal term for leasehold improvements, if shorter. Based on the size of the investment that we make, the economic penalty incurred by discontinuing use of the leased facility, our historical experience with respect to the length of time a restaurant operates at a specific location and leases that typically have multiple five-year renewal options that are exercised entirely at our discretion, we have concluded that one five-year renewal option is reasonably assured.

Impairment and Disposal Charges, net includes asset impairments, either operating or held for sale, exit and disposal costs related to restaurant closings, asset disposals, and gains and losses incurred upon the sale of assets or from insurance proceeds, net of deductibles. Impairment charges are taken for land, buildings and equipment and certain other assets whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of the assets to the future undiscounted net cash flows expected to be generated by the assets. The impairment to be recognized is measured by the amount by which the carrying amount of the asset exceeds the fair value of the asset. Impairment charges for assets that are held for sale represent the difference between their current book value and the estimated net sales proceeds. Disposal charges include the costs incurred to prepare the asset or assets for sale, including repair and maintenance; clean up costs; broker commissions; and independent appraisals. Exit and disposal costs are primarily future lease obligations net of expected sublease income, if any.

We evaluate restaurant closures for potential disclosure as discontinued operations based on an assessment of quantitative and qualitative factors, including the nature of the closure, potential for revenue migration to other company-operated and franchised restaurants, planned market development in the area of the closed restaurant and the significance of the impact on the related consolidated financial statement line items.

Pre-opening Costs represent costs associated with our restaurant opening teams, as well as other costs associated with opening a new restaurant. These costs are expensed as incurred. These costs also include straight-line rent related to leased properties from the period of time between when we have waived any contingencies regarding use of the leased property and the date on which the restaurant opens. The amount of pre-opening costs incurred in any one period includes costs incurred during the period for new or recently opened restaurants and those under development. Our pre-opening costs may vary significantly from period to period primarily due to the timing of restaurant development and openings. Pre-opening costs also include training, supply, and other incremental costs necessary to prepare for the re-opening of an existing restaurant as part of re-branding or re-modeling initiatives.

Interest Expense, net represents the sum of the following: interest on our 9 percent Senior Subordinated Notes due 2013 (the “Senior Notes”); interest and fees associated with our credit facility; amortization of prepaid interest and finance charges; amortization of the swap exit payment; changes in the value of the assets associated with our non-qualified deferred compensation plan resulting from gains and losses in the underlying funds; interest on capital lease obligations; and the premiums paid over the face value of any Senior Notes repurchased during the relevant fiscal period.

Income Tax Expense (Benefit) represents the provision for income taxes, including the impact of permanent tax differences, uncertain tax positions and valuation allowances on our income tax provision.

The following sections should be read in conjunction with our unaudited interim consolidated financial statements and the related notes thereto included elsewhere herein.

Operating Results

The following table highlights the operating results for the 12 and 28 week periods ended July 11, 2010 and July 12, 2009 as a percentage of total revenues unless specified otherwise.

	12 Weeks Ended				28 Weeks Ended
	July 11,		July 12,		July 11,		July 12,
	2010		2009		2010		2009
Revenues:
Restaurant sales	99.9	%	99.9	%	99.9	%	99.9	%
Franchise and other revenue	0.1		0.1		0.1		0.1
	100.0	%	100.0	%	100.0	%	100.0	%

Costs and Expenses:
Cost of restaurant sales: (1)
Cost of food and beverage	29.7		29.0		29.5		29.1
Payroll and benefits	35.4		35.2		35.1		34.5
Restaurant operating costs	20.8		19.4		20.5		19.4
Cost of restaurant sales, exclusive of depreciation and amortization shown separately below	85.9		83.6		85.1		83.1

Advertising and marketing	4.1		3.9		4.2		3.7
General and administrative	5.3		3.9		4.5		4.2
Depreciation and amortization	5.1		5.3		5.1		5.2
Impairment, and disposal charges, net	0.1		0.7		1.2		0.4
Pre-opening costs	0.0		0.0		0.0		0.1

(Loss) Income from Operations	(0.3	)	2.5		0.0		3.5

Other Expense:
Interest expense, net	1.5		1.3		1.5		1.4
(Loss) Earnings before Income Taxes	(1.8	)	1.2		(1.5	)	2.1
Income Tax (Benefit) Expense	(0.5	)	(0.2	)	0.0		0.1
Net (Loss) Earnings	(1.3	)%	1.4	%	(1.5	)%	2.0	%

(1)		Percentages calculated as a percentage of restaurant sales.

Adjusted EBITDA

We present Adjusted EBITDA to assist investors and analysts in comparing our performance across reporting periods on a consistent basis by excluding items that we do not believe are indicative of our core operating performance. Also, our credit agreement uses measures similar to Adjusted EBITDA to measure our compliance with certain covenants. The following table is a reconciliation of U.S. generally accepted accounting principles (“GAAP”) financial measure of (Loss) Income from Operations to Adjusted EBITDA, a non-GAAP financial measure, for the 12 and 28 week periods ended July 11, 2010 and July 12, 2009 (1):

	12 Weeks Ended					28 Weeks Ended
	July 11, 2010			July 12, 2009		July 11, 2010			July 12, 2009
(Loss) Income from Operations	$	(532	)	$	5,231	$	(84	)	$	17,215

Add:
Depreciation and amortization		9,942			10,956		23,566			25,978
Impairment and disposal charges, net (2)		126			1,543		5,678			1,836
Share-based compensation expense (3)		777			1,033		2,211			2,371
Severance, recruiting and relocation expense (4)		2,395			25		2,395			290
Changes in deferred compensation balances (5)		(280	)		125		—			39

Adjusted EBITDA	$	12,428		$	18,913	$	33,766		$	47,729

(1)

We present Adjusted EBITDA as a supplemental measure which we believe supplements a discussion and analysis of our results of operations. We define Adjusted EBITDA as (Loss) Income from Operations plus (i) depreciation and amortization, (ii) impairment and disposal charges, net, (iii) share-based compensation expense, (iv) severance, recruiting and relocation costs for management changes, and (v) changes in deferred compensation balances. You are encouraged to evaluate these adjustments and the reasons we consider them appropriate for supplemental analysis. In evaluating Adjusted EBITDA, you should be aware that it is reasonable to expect we will incur expenses that are the same as or similar to some of the adjustments in this presentation, but the amounts recognized can vary significantly from period to period, may not directly relate to the ongoing operations of our restaurants and complicate period comparisons of our results of operations and operations comparisons to other restaurant companies.

Adjusted EBITDA is not a measure of financial performance under GAAP, and should not be considered an alternative to (Loss) Income from Operations as a measure of operating performance. Because Adjusted EBITDA is not a measure determined in accordance with GAAP and is susceptible to varying calculations, Adjusted EBITDA as presented may not be comparable to other similarly titled measures presented by other companies.

Adjusted EBITDA has limitations as an analytical tool. Some of these limitations are:

·	Adjusted EBITDA does not reflect our cash expenditures, or future requirements, for capital expenditures or contractual commitments;

·	Adjusted EBITDA does not reflect changes in, or cash requirements for, our working capital needs;

·	Adjusted EBITDA does not reflect significant interest expense, or the cash requirements necessary to service interest or principal payments, on our debts;

·	although depreciation and amortization are non-cash charges, the assets being depreciated and amortized will often have to be replaced in the future, and Adjusted EBITDA does not reflect any cash requirements for such replacements; and

·	non-cash compensation is a key element of our overall long-term incentive compensation package, although we exclude it as an expense when evaluating our ongoing operating performance for a particular period.

(2)

Long-lived assets are tested for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Charges include the non-cash write-down of assets to their estimated recovery value as well as certain cash expenses related to the holding and disposition of assets no longer in service and, in fiscal 2009, various costs associated with restructuring our supply chain.

(3)	Includes charges relating to the “discount” on the Company’s Employee Stock Purchase Plan and share-based compensation expense.

(4)

Cash and non-cash charges relating to significant organization changes. Charges in the 12 and 28 weeks ended July 11, 2010, relate primarily to the severance associated with the resignation of the Company’s former CEO and other operational changes. Charges in the 28 weeks ended July 12, 2009, related primarily to the retirement of the Company’s former CEO and the recruitment of a new CEO. These charges are reflected in general and administrative expenses in our unaudited consolidated statements of operations.

(5)	The Company sponsors a deferred compensation plan for certain management employees, which is fully funded with a “Rabbi Trust.” Changes in the value of the employee’s self-directed balances are reported in compensation expense, with an offsetting amount in interest expense, net.

Concept Performance Measures

The following table reflects margin performance of each of our concepts for the 12 and 28 week periods ended July 11, 2010 and July 12, 2009.


	12 Weeks Ended						28 Weeks Ended
	July 11,			July 12,			July 11,			July 12,
	2010			2009			2010			2009
	($ in millions)						($ in millions)
O’Charley’s Concept: (1)
Restaurant Sales	$	122.3		$	133.6		$	297.6		$	322.2

Cost and expenses: (2)
Cost of food and beverage		29.5	%		28.8	%		29.4	%		28.9	%
Payroll and benefits		35.5	%		35.0	%		34.9	%		34.2	%
Restaurant operating costs (3)		20.4	%		19.0	%		19.8	%		18.5	%
Cost of restaurant sales, exclusive of depreciation and amortization shown separately below		85.4	%		82.8	%		84.1	%		81.6	%


Ninety Nine Concept:
Restaurant Sales	$	64.2		$	65.4		$	149.5		$	157.2

Cost and expenses: (2)
Cost of food and beverage		29.4	%		28.6	%		28.9	%		28.7	%
Payroll and benefits		36.0	%		35.9	%		36.5	%		35.7	%
Restaurant operating costs (3)		21.4	%		20.0	%		21.9	%		20.9	%
Cost of restaurant sales, exclusive of depreciation and amortization shown separately below		86.8	%		84.5	%		87.3	%		85.3	%

Stoney River Concept:
Restaurant Sales	$	7.4		$	7.0		$	17.9		$	18.0

Cost and expenses: (2)
Cost of food and beverage		36.3	%		36.6	%		35.7	%		36.8	%
Payroll and benefits		27.3	%		31.5	%		26.6	%		30.0	%
Restaurant operating costs (3)		21.0	%		21.8	%		20.6	%		21.8	%
Cost of restaurant sales, exclusive of depreciation and amortization shown separately below		84.6	%		89.9	%		82.9	%		88.6	%
(1) Includes restaurant sales from O’Charley’s joint venture operations of $1.7 million and $4.2 million for the 12 and 28 weeks ended July 12, 2009, respectively. These restaurants became company-owned restaurants later in 2009. This line excludes revenue from franchised restaurants. (2) Shown as a percentage of restaurant sales. (3) Includes rent, where 100% of the Ninety Nine restaurant locations are leased (land or land and building) as compared to 58% for O’Charley’s and 73% for Stoney River.

Concept Restaurant Count and Operating Statistics

The following table sets forth certain financial and other restaurant data for the quarters ended July 11, 2010 and July 12, 2009:

	July 11,			July 12,
	2010			2009
Number of Restaurants:
O’Charley’s Restaurants:
In operation, beginning of quarter		234			232
Restaurants opened		—			1
Restaurant closed		—			—
In operation, end of quarter		234			233
Ninety Nine Restaurants:
In operation, beginning of quarter		113			116
Restaurants opened		—			—
Restaurants closed		—			—
In operation, end of quarter		113			116
Stoney River Restaurants:
In operation, beginning of quarter		11			11
Restaurants opened		—			—
Restaurants closed		—			(1	)
In operation, end of quarter		11			10
Franchised / Joint Venture Restaurants (O’Charley’s)
In operation, beginning of quarter		10			13
Restaurants opened		—			—
Restaurants closed		(1	)		(1	)
In operation, end of quarter		9			12
Average Weekly Sales per Store:
O’Charley’s	$	43,640		$	47,284
Ninety Nine		47,355			47,016
Stoney River		55,720			55,174
Change in Same Store Sales (1):
O’Charley’s		(7.9	)%		(6.9	)%
Ninety Nine		(0.5	)%		(10.0	)%
Stoney River		(0.7	)%		(20.4	)%
Change in Same Store Guest Visits (1):
O’Charley’s		(5.7	)%		(7.4	)%
Ninety Nine		0.4	%		(8.4	)%
Stoney River		7.8	%		(9.0	)%
Change in Same Store Average Check per Guest (1):
O’Charley’s		(2.4	)%		0.6	%
Ninety Nine		(0.9	)%		(1.8	)%
Stoney River		(8.0	)%		(12.6	)%
Average Check per Guest (2):
O’Charley’s	$	12.68		$	12.98
Ninety Nine		14.49			14.61
Stoney River		36.13			40.19

(1)		When computing same store sales and guest visits, restaurants open for at least 78 weeks are compared from period to period.

(2)		The average check per guest is computed using all restaurants open during the quarter.

Second Quarter and First 28 Weeks of Fiscal 2010 Versus Second Quarter and First 28 Weeks of Fiscal 2009

Revenues

During the 12 weeks ended July 11, 2010, total revenues decreased 5.9 percent to $194.1 million from $206.2 million for the same prior year period. Total revenues for the first 28 weeks of 2010 decreased 6.5 percent to $465.6 million from $497.9 million in the same prior year period. We continue to see sales at each of our brands negatively impacted by the economic environment.

Restaurant sales for company-operated O’Charley’s decreased 7.3 percent to $122.3 million for the second quarter of fiscal 2010, reflecting a decline in same store sales of 7.9 percent, the acquisition of two former joint venture restaurants and the closure of one company-owned restaurant since the second quarter of fiscal 2009. The same-store sales decrease of 7.9 percent was comprised of a 2.4 percent decrease in average check and a 5.7 percent decrease in guest counts. The decline in average check reflects the impact of increased value offerings such as our Ultimate Choices value menu, which offers entrées at $7.99, $8.99 and $9.99, and the decline in incremental sales of appetizers, beverages and desserts. Restaurant sales for company-operated O’Charley’s decreased to $297.6 million for the first 28 weeks of 2010 from $318.0 million for the first 28 weeks of 2009, reflecting a same store sales decrease of 7.2 percent comprised of a 4.3 percent lower average check as well as a decrease in guest counts of 3.1 percent.

Restaurant sales for Ninety Nine decreased 1.9 percent to $64.2 million in the second quarter of fiscal 2010, reflecting a decline in same store sales of 0.5 percent, and the closure of three restaurants since the first quarter of fiscal 2009. The same-store sales decrease of 0.5 percent was comprised of a 0.9 percent decrease in average check and a 0.4 percent increase in guest counts. The decline in average check reflects the impact of the “Nine for $9.99” promotion in the quarter as well as the “Red Sox Win, Kids Eat Free” promotion which was not present for the entire second quarter of the prior year. Restaurant sales for Ninety Nine decreased to $149.5 million for the first 28 weeks of 2010 from $157.2 million for the first 28 weeks of 2009, reflecting a same store sales decrease of 3.7 percent comprised of 1.7 percent lower average check and a decrease in guest counts of 2.0 percent.

Restaurant sales for Stoney River Legendary Steaks increased 5.0 percent to $7.4 million for the second quarter of fiscal 2010, which reflects a same store sales decrease of 0.7 percent, and the addition of one new restaurant since the second quarter of fiscal 2009. The same-store sales decrease of 0.7 percent consisted of an 8.0 percent decrease in average check partially offset by a 7.8 percent increase in guest counts. The decline in average check is consistent with our strategic repositioning efforts involving the roll-out of new lower priced menu items that began in the first quarter of the prior year. Restaurant sales for Stoney River Legendary Steaks decreased to $17.9 million for the first 28 weeks of 2010 from $18.0 million for the first 28 weeks of 2009, reflecting a same store sales decrease of 5.2 percent comprised of an 11.4 percent lower average check and an increase in guest counts of 7.1 percent.

Cost of Food and Beverage

During the second quarter of 2010, our cost of food and beverage was $57.6 million, or 29.7 percent of restaurant sales, compared with $59.8 million, or 29.0 percent of restaurant sales, in the second quarter of 2009. This increase in food and beverage as a percent of restaurant sales is partially due to the impact of promotional offerings primarily at the O’Charley’s concept, and higher beverage costs, partially offset by lower commodity costs. During the first 28 weeks of 2010, cost of food and beverage was $137.1 million, or 29.5 percent of restaurant sales, compared to $144.8 million, or 29.1 percent of restaurant sales, in the same prior year period.

Payroll and Benefits

During the second quarter of 2010, payroll and benefits were $68.5 million, or 35.4 percent of restaurant sales, compared to $72.5 million, or 35.2 percent of restaurant sales, in the same prior-year period. This 20 basis point increase in labor costs as a percentage of restaurant sales was due to the deleveraging impact of reduced average weekly sales, partially offset by $0.9 million reduction in bonus expense and a $0.7 million reduction in the cost of our employee benefit plans. During the first 28 weeks of 2010, payroll and benefits were $163.3 million, or 35.1 percent of restaurant sales, compared to $171.8 million, or 34.5 percent of restaurant sales, in the same prior year period.

Restaurant Operating Costs

During the second quarter of 2010, restaurant operating costs were $40.3 million, or 20.8 percent of restaurant sales, compared to $39.9 million, or 19.4 percent of restaurant sales, in the same prior year period. This 140 basis point increase was primarily due to the deleveraging impact of reduced sales and a $0.4 million increase in repair and maintenance costs. During the first 28 weeks of 2010, restaurant operating costs were $95.1 million, or 20.5 percent of restaurant sales, compared to $96.5 million, or 19.4 percent of restaurant sales, in the same prior year period.

Advertising and Marketing Expenses

During the second quarter of 2010, advertising and marketing expenses were $7.9 million, or 4.1 percent of revenue, as compared to $8.1 million, or 3.9 percent of revenue, in the same prior year period. This year-over-year change in the quarter is due to changes in projected sales and a reduction in advertising and marketing. The increase in advertising and marketing expense as a percentage of revenue is due to the deleveraging impact of lower revenue. During the first 28 weeks of 2010, advertising and marketing expenses were $19.7 million, or 4.2 percent of revenue, as compared to $18.6 million, or 3.7 percent of revenue, in the same prior year period.

General and Administrative Expenses

General and administrative expenses were $10.2 million, or 5.3 percent of revenue, in the second quarter of 2010, compared to $8.1 million, or 3.9 percent of revenue, in the second quarter of 2009. This increase is attributed to $2.4 million, or 1.2 percent of revenue, for severance costs associated with the resignation of our former CEO and other operational changes. Otherwise, we continue to tightly control all general and administrative costs. During the first 28 weeks of 2010, general and administrative expenses were $21.1 million, or 4.5 percent of revenue, compared to $20.8 million, or 4.2 percent of revenue, in the same prior year period.

Depreciation and Amortization, Property and Equipment

During the second quarter of 2010, depreciation and amortization was $9.9 million, or 5.1 percent of revenue, as compared to $11.0 million, or 5.3 percent of revenue, in the same prior year period. This reduction in expense is primarily due to lower carrying values of assets following the restaurant impairment charges recognized in the prior quarter and prior year. During the first 28 weeks of 2010, depreciation and amortization was $23.6 million, or 5.1 percent of revenue, compared to $26.0 million, or 5.2 percent of revenue, in the same prior year period.

Impairment and Disposal Charges, net

During the second quarter of 2010, impairment and disposal charges, net were $0.1 million, or 0.1 percent of revenue, as compared to $1.5 million, or 0.7 percent of revenue, in the same prior year period. Approximately $0.1 million was recorded during the second fiscal quarter relating to insurance deductibles at our Clarksville, TN properties which were affected by the recent flooding in the area. We have filed our initial claim with our insurance carrier and anticipate the settlement of these claims in the second half of 2010. During the first 28 weeks of 2010, impairment and disposal charges, net were $5.7 million, or 1.2 percent of revenue, compared to $1.8 million, or 0.4 percent of revenue, in the same prior year period. Impairment charges of $4.9 million were recorded for four O’Charley’s restaurants, which will remain open. In addition, we recorded exit and disposal costs of $0.6 million relating to three Ninety Nine restaurants that were closed during the first quarter of fiscal 2010 and one O’Charley’s restaurant that was previously closed. These four restaurant locations currently have operating lease obligations with lease terminations ranging from 2010 to 2014. Impairment expense in the prior year primarily relates to impairment charges with respect to three O’Charley’s restaurants that remain open and an aircraft that was subsequently sold.

Pre-opening Costs

There were no pre-opening costs in the second quarter of 2010, compared to $0.1 million in the second quarter of 2009. Pre-opening costs for the 28 weeks ended July 11, 2010 were insignificant, compared to $0.3 million in the 28 weeks ended July12, 2009. This year-over-year reduction is the result of no new restaurant development.

Interest Expense, Net

Interest expense for the second quarter of 2010 was $2.9 million, or 1.5 percent of revenue, compared to $2.7 million, or 1.3 percent of revenue, in the second quarter of 2009. The impact of reduced debt levels was more than offset by a $0.4 million impact from changes in the value of deferred compensation balances. At the end of the quarter, we had $115.2 million of senior subordinated notes, a cash balance of $25.9 million and no drawings on our revolving line of credit. During the first 28 weeks of 2010, interest expense was $6.9 million, or 1.5 percent or revenue, compared to $6.8 million, or 1.4 percent of revenue, in the same prior year period.

Income Taxes

Our provision for income taxes for the first 28 weeks of 2010 was a benefit of $0.1 million, a rate of approximately 1.9 percent, versus tax expense of $0.5 million in the prior year period, a rate of approximately 4.5 percent. Based upon our estimated full year results combined with our estimated full year tax credits, we expect our full year effective tax rate to be approximately negative 13.8 percent, excluding discrete items. Under U.S. GAAP, we are required to apply our estimated full year tax rate to our pretax (loss) income on a year-to-date basis in each interim period. The difference between our estimated annual tax rate of negative 13.8 percent and the 1.9 percent rate for the first 28 weeks of 2010 relates to certain discrete items, primarily the $1.3 million benefit for the valuation allowance reversal related to a revision in estimate on the carryback of 2008 net operating losses due to the completion of our evaluation of the alternative financial impacts of the elective provisions of the Worker, Homeownership and Business Assistance Act of 2009 which expanded net operating loss (NOL) carryback provisions to five years for certain NOL’s generated in 2008 or 2009. Additionally, a $0.1 million reduction in expense associated with uncertain tax positions was partially offset by $0.3 million for the establishment of a valuation allowance associated with certain state net operating loss carry-forwards. The change in the effective tax rate from fiscal 2009 to fiscal 2010 is the result of fluctuations in pre-tax net (loss) earnings and the related rate impacts of federal tax credits on the expected full year results, as well as changes in the fiscal 2010 valuation allowance.

LIQUIDITY AND CAPITAL RESOURCES

Our primary sources of capital have historically been cash provided by operations, borrowings under our credit facilities and capital leases. Our principal capital needs have historically arisen from property and equipment additions, acquisitions, and payments on long-term debt and capitalized lease obligations. In addition, we lease a substantial number of our restaurants under operating leases and have substantial operating lease obligations. Like many restaurant companies, our working capital has historically had current liabilities in excess of current assets due to collection of our sales being received in four days or less while our typical accounts payable turnover, excluding food invoices, averages thirty days. We do not believe this indicates a lack of liquidity. We have slowed our restaurant development in recent years in order to focus on improving the performance of our existing restaurants and reducing our debt. As a result of these reductions in investment, we had a cash balance of $25.9 million and there were no amounts outstanding on our revolving line of credit at July 11, 2010. We have no plans to develop any new restaurants in 2010.

The following table presents a summary of our cash flows for the 28 weeks ended July 11, 2010 and July 12, 2009:

	July 11, 2010			July 12, 2009
Net cash provided by operating activities	$	23,184		$	29,776
Net cash used in investing activities		(6,529	)		(5,467	)
Net cash used in financing activities		(12,680	)		(24,521	)
Net increase (decrease) in cash and cash equivalents	$	3,975		$	(212	)

Net cash provided by operating activities during the 28 weeks ended July 11, 2010 was $23.2 million, a decrease of $6.6 million from the same prior year period. This reduction in net cash provided by operating activities is due to a $14.0 million reduction in net earnings, after adjusting for non-cash charges, partially offset by a $7.4 million net decrease in the change in working capital and other long-term assets and liabilities over the same prior year period. This $7.4 million net decrease in working capital change is primarily due to current year increases in accounts payable due to payment timing in both trade and other accrued payables and a prior year reduction in credit balances with certain financial institutions.

Net cash used in financing activities during the 28 weeks ended July 11, 2010 includes the repurchase of $9.8 million in face value of our Senior Notes. Net cash used in financing activities during the 28 weeks ended July 12, 2009 includes paying off the outstanding borrowings under our revolving line of credit of $23.8 million.

We believe that our various sources of capital, including cash flow from operating activities, and availability under our revolving credit facility, are adequate to fund our capital requirements for at least the next twelve months As of the end of the second quarter of fiscal 2010, our remaining borrowing capacity under our credit facility, net of $12.6 million of outstanding letters of credit, was $32.4 million. We do not expect to rely on our credit facility as a significant source of funds during 2010.

On January 26, 2010, we entered into a Third Amended and Restated Credit Agreement (as amended, the “Credit Agreement”). The maximum borrowing capacity was reduced from $83 million (originally scheduled to be reduced to $65 million on April 18, 2010) to $45 million. The prior credit agreement had participation from nine regional and national bank organizations, while the current credit agreement has participation from three regional and national bank organizations. The maximum adjusted leverage ratio was reduced from 5.50 to 5.25. The definitions of adjusted leverage ratio and senior secured ratio have been changed, and capital expenditures for expansion (as defined by the Credit Agreement) are limited to 15% of EBITDA in 2010 and 30% of EBITDA in subsequent years. Under the Credit Agreement, we are permitted to repurchase our Senior Notes subject to certain limitations. The Credit Agreement also reduced the number of our company-owned restaurants subject to collateral mortgages from 88 to 47. The Credit Agreement also “resets” the restricted payments basket for dividends and Senior Note repurchases; however, such payments are currently restricted by the indenture governing the Senior Notes. The Credit Agreement also permits sale-leaseback transactions, subject to certain limitations. In the event of a disruption or cessation of operations by one or more participants in our Credit Agreement, rendering them unable to fund their portion of any drawings, we believe that our available cash balance, and the available capacity from the other banks in the Credit Agreement, would be sufficient to permit us to continue meeting our current obligations and funding our operating activities.

In 2010 and 2009, net cash flows used by investing activities included capital expenditures incurred principally for improvements to existing restaurants and technological improvements in our information systems. The Company did not finance any capital expenditures using capital leases during the quarters ended July 11, 2010 or July 12, 2009. Capital expenditures for the 28 weeks ended July 11, 2010 and July 12, 2009 were as follows:

	July 11, 2010		July 12, 2009
New restaurant capital expenditures	$	—	$	1,872
Re-model capital expenditures		3,041		672
Other capital expenditures		4,620		3,988
Total capital expenditures	$	7,661	$	6,532

For fiscal 2010 we are projecting capital expenditures of between $14 million and $16 million.

Critical Accounting Policies

In our Annual Report on Form 10-K for the year ended December 27, 2009, we identified our critical accounting policies related to property and equipment, lease accounting, share-based compensation, trademarks, impairment of long-lived assets, and income taxes. We consider an accounting policy to be critical if it is most important to the portrayal of our consolidated financial condition and results, and it requires management’s most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. During the first 28 weeks of 2010, there have been no changes in our critical accounting policies.

Contractual Obligations and Commercial Commitments

There were no material changes in our contractual obligations and commercial commitments as of July 11, 2010 from that disclosed in our Annual Report on Form 10-K for the year ended December 27, 2009. As of July 11, 2010 and December 27, 2009, we had no amounts outstanding on our revolving credit facility.

Outlook

Our first quarter is a 16 week quarter, while our second through fourth quarters are each 12 weeks. Based on financial historical seasonal patterns, average weekly sales per restaurant are typically higher in the first quarter than in subsequent quarters and we typically generate a disproportionate share of our income from operations and adjusted EBITDA in the first quarter. For the third quarter of 2010, we are forecasting total revenue of between $186 million and $192 million, and a loss from operations of between $1 million and $4 million. We project adjusted EBITDA of between $7 million and $10 million in the third quarter, based upon estimated depreciation and amortization expense of approximately $10 million, and estimated stock compensation expense of approximately $1 million. With respect to our food and beverage costs for the remainder of fiscal 2010, we have locked in our pricing for over 85 percent our beef requirements, approximately 75 percent of our estimated pork requirements, almost all of our estimated poultry requirements, and approximately 40 percent of our estimated seafood requirements. Of the prices we have locked in, on a constant mix basis, we expect the percentage decline in our food costs to be in the low single digits. We project our alcoholic beverage costs to increase in the mid single digits. Capital expenditures are projected to be between $14 million and $16 million for the year. We do not plan to develop any new restaurants for the year.

Recent Accounting Pronouncements

In January 2010, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2010-06, “Fair Value Measurements and Disclosures” (“ASU 2010-06”), which adds new disclosure requirements for transfers into and out of Levels 1 and 2 in the fair value hierarchy and additional disclosures about purchases, sales, issuances and settlements relating to Level 3 fair value measurements. This ASU also clarifies existing fair value disclosures about the level of disaggregation about inputs and valuation techniques used to measure fair value. The ASU is effective for the first reporting period beginning after December 15, 2009, except for the requirement to provide the Level 3 activity on a gross basis, which is effective for the fiscal years beginning after December 15, 2010 and interim periods within those years. The adoption of ASU 2010-06, except for the requirement to provide the Level 3 activity on a gross basis, did not have any impact on our consolidated financial statements. We do not expect the requirement to provide the Level 3 activity on a gross basis to have an impact on our consolidated financial statements.

Impact of Inflation

The impact of inflation on the cost of food, labor, equipment, land, construction costs, and fuel/energy costs could adversely affect our operations. A majority of our employees are paid hourly rates related to federal and state minimum wage laws. The federal government and several states have instituted or are considering changes to their minimum wage and/or benefit related laws which, if and when enacted, could have an adverse impact on our payroll and benefit costs. In addition, most of our leases require us to pay taxes, insurance, maintenance, repairs and utility costs, and these costs are subject to inflationary pressures. Commodity inflation has had a significant impact on our operating costs. We attempt to offset the effect of inflation through periodic menu price increases, economies of scale in purchasing and cost controls and efficiencies at our restaurants.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

We are subject to market risk from exposure to changes in interest rates based on our financing, investing, and cash management activities and fluctuations in commodity prices. Our fixed-rate debt consists primarily of capitalized lease obligations and Senior Notes. A significant portion of our debt is at a fixed-rate; therefore a one percent fluctuation in interest rates is not expected to have a material impact on our results of operations.

We purchase certain commodities such as beef, pork, poultry, seafood, produce, and dairy. These commodities are generally purchased based upon market prices established with vendors. These purchase arrangements may contain contractual features that fix the price paid for certain commodities. We do not use financial instruments to hedge commodity prices because these purchase arrangements help control the ultimate cost paid and any commodity price aberrations are generally short-term in nature.

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

Under the supervision and with the participation of our management, including the principal executive officer and principal financial officer, we conducted an evaluation of our disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) as of the end of the period covered by this quarterly report. Based on that evaluation, the principal executive officer and principal financial officer have concluded that our disclosure controls and procedures were effective to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and that such information is accumulated and communicated to management, including our principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure.

Changes in Internal Control Over Financial Reporting

There were no changes in our internal control over financial reporting during our fiscal quarter ended July 11, 2010 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II — OTHER INFORMATION

Item 1. Legal Proceedings

We are a defendant from time to time in various legal proceedings arising in the ordinary course of our business, including claims relating to injury or wrongful death under “dram shop” laws that allow a person to sue us based on any injury caused by an intoxicated person who was wrongfully served alcoholic beverages at one of our restaurants; claims relating to workplace, workers compensation and employment matters, discrimination and similar matters; claims resulting from “slip and fall” accidents; claims relating to lease and contractual obligations; claims relating to our franchising initiatives; and claims from guests or employees alleging illness, injury or other food quality, health or operational concerns.

We do not believe that any of the legal proceedings pending against us as of the date of this report will have a material adverse effect on our liquidity or financial condition. We may incur liabilities, settle disputes, sustain judgments, or accrue expenses relating to legal proceedings in a particular fiscal quarter which may adversely affect our consolidated results of operations, or on occasion, receive settlements that favorably affect our consolidated results of operations.

Item 1A. Risk Factors

Various risks and uncertainties could affect our business. These risks are described elsewhere in this report and our other filings with the Commission, including our Annual Report on Form 10-K for the year ended December 27, 2009. The risks identified in the Annual Report on Form 10-K for the year ended December 27, 2009 have not changed in any material respect, except that the risk under the heading “We may incur costs or liabilities and lose revenue as the result of existing or proposed government laws or regulation” has been updated to reflect changes in federal healthcare law that will require us to disclose calorie amounts for menu items and may potentially impact our costs and practices related to employee health insurance. Such risk factor is hereby revised to read in its entirety as follows:

We may incur costs or liabilities and lose revenue as the result of existing or proposed government laws or regulation.

Our restaurants are subject to extensive federal, state and local government laws and regulation, including regulations related to the preparation and sale of food (such as regulations regarding labeling, allergens content, trans fat content and other menu information regarding nutrition), the sale of alcoholic beverages, employment matters (such as minimum wage, employee health insurance, organizing and collective bargaining, fair employment practices, and employee health and safety), zoning and building codes and other health, sanitation and safety matters. The federal healthcare reform legislation that became law in March 2010 (known as the Patient Protection and Affordable Care Act as amended by the Health Care and Education Reconciliation Act of 2010 or (“PPACA”)) will require restaurant companies such as ours to disclose calorie information on their menus. We do not expect to incur any material costs from compliance with this provision, but cannot anticipate any changes in guest behavior resulting from the implementation of this portion of the law, which could have an adverse effect on our sales and results of operations.

All of these regulations impact not only our current restaurant operations but also our ability to open new restaurants, if our business strategy calls for us to do so. We will be required to comply with applicable state and local regulations in any new locations into which we expand. Any difficulties, delays or failures in obtaining licenses, permits or approvals in such new locations could delay or prevent the opening of a restaurant in a particular area or reduce operations at an existing location, either of which could materially and adversely affect our growth and results of operations.

The revenues and costs of operating our restaurants may be adversely effected if there are changes in laws governing minimum hourly wages or tip credits, labor or collective bargaining laws, nutritional labeling, workers’ compensation insurance rates, employee health insurance, unemployment tax rates, sales taxes, corporate income tax or other laws and regulations, such as the federal Americans with Disabilities Act, the Family Medical Leave Act and the PPACA. The PPACA contains requirements that may significantly raise our employee health benefits costs or alter the benefits we provide, including mandatory enrollment of employees in company health plans, the elimination of caps on annual and lifetime coverage limits, a ban on pre-existing conditions as an exclusion for coverage, a prohibition on linking eligibility and premium rates to health-status related factors, and mandatory coverage availability for dependents through age 26. If our employee health insurance and other of the foregoing costs increase, we cannot ensure that we will be able to offset the increase by increasing our menu prices or by other means, which would adversely affect our results of operations.

Item 2. Issuer Purchases of Equity Securities

The following table sets forth information with respect to purchases of shares of the Company’s common stock made during the quarter ended July 11, 2010 by or on behalf of the Company or any “affiliated purchaser,” as defined by Rule 10b-18 of the Exchange Act:

O’Charley’s Accounting Periods	Total Number of Shares Purchased (1)		Average Price Paid Per Share		Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs		Maximum Number of Shares that May Yet Be Purchased Under the Plans or Programs
04/19/10-05/16/10		861	$	9.55		—		—
05/17/10-06/13/10		882		6.92		—		—
06/14/10-07/11/10		—		—		—		—
Total		1,743	$	8.21		—		—

(1)	Represents shares withheld to cover tax-withholding requirements relating to the vesting of restricted stock issued to employees pursuant to the Company's shareholder-approved stock incentive plans.

Item 6. Exhibits

No.	Description
10.1	General Release Agreement, dated June 17, 2010, by and between Jeffrey D. Warne and O’Charley’s Inc.
10.2	Executive Employment Agreement dated July 30, 2010, by and between O’Charley’s Inc. and David Head
31.1	Certification of Philip J. Hickey, Jr., Chairman of the Board, Interim President and Chief Executive Officer of O’Charley’s Inc., pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2	Certification of Lawrence E. Hyatt, Chief Financial Officer of O’Charley’s Inc., pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1	Certification of Philip J. Hickey, Jr., Chairman of the Board, Interim President and Chief Executive Officer of O’Charley’s Inc., pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2	Certification of Lawrence E. Hyatt, Chief Financial Officer of O’Charley’s Inc., pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

SIGNATURES

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

O’Charley’s Inc.

(Registrant)



Date: August 12, 2010	By:	/s/ PHILIP J. HICKEY, JR.
		Philip J. Hickey, Jr.
		Chairman of the Board,
		Interim President and Chief Executive Officer



	By:	/s/ LAWRENCE E. HYATT
		Lawrence E. Hyatt
		Chief Financial Officer and Treasurer

O CHARLEYS INC - FORM 10-Q - August 11, 2010

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O CHARLEYS INC Reports