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Executives

Jeffrey Warne – President & CEO

Lawrence Hyatt – CFO

Gene Marbach - IR

Analysts

Bryan Elliott – Raymond James

Robert Derrington – Morgan Keegan

Jeffrey Omohundro – Wells Fargo

Dan DeYoung – Wells Fargo

O’Charley’s Inc. (CHUX) Q1 2010 Earnings Call May 13, 2010 11:00 AM ET

Operator

Good morning ladies and gentlemen and welcome to the O'Charley's Inc. first quarter 2010 earnings conference call. (Operator Instructions) I would now like to turn the conference over to Gene Marbach.

Gene Marbach

Good morning all and thank you for joining O'Charley's fiscal 2010 first quarter conference call. On the call today are Jeffrey Warne, the company’s President and Chief Executive Officer, and Lawrence Hyatt, the company’s Chief Financial Officer.

The order of business this morning will be some brief remarks from Jeffrey and Lawrence about the first quarter. We will then open the call to questions. In the time allotted we will take as many questions as possible.

Before we begin, I would like to note that certain statements made by O'Charley's management on this call may be deemed to constitute forward-looking statements made pursuant to the Safe Harbor provision of the Private Securities Litigation Reform Act of 1995.

These forward-looking statements may be affected by certain risks and uncertainties including risks described in the company's filing with the Securities and Exchange Commission. In light of the significant uncertainties inherent in the forward-looking statements included in the company's comments, you should not regard the inclusion of such information as a representation that its objectives, plans, and projected results will be achieved and the company's actual results could differ materially from such forward-looking statements.

I would now like to turn the call over to Mr. Jeffrey Warne, CEO of O'Charley's.

Jeffrey Warne

Good morning everyone and thank you Gene. While Lawrence will review our financial results in detail in a few moments, let me share with you an overview of the quarter’s performance and our response.

We are keenly aware that our sales were below the low end of our previously issued guidance, our income from operations were at the low end of that guidance, and that we underperformed several of our peers. We also understand that these results are disappointing to those of you on this call, and to our shareholders.

I assure you that they are disappointing to me as well. While our results were negatively impacted by general economic conditions and harsh winter weather, this does not fully explain our performance. Guest counts in each of our three brands outperformed their relevant Knapp-Track averages for the first quarter and we continued to see improvement in our guest satisfaction scores.

However average check and same store sales underperformed their Knapp-Track averages. We emphasize value priced entrées in the quarter expecting the lower average entrée prices to be partially offset by incremental sales of appetizers, beverages, and desserts.

While our value priced entrées positively impacted guest counts, we did not get the anticipated incremental sales. The deleveraging impact of the relatively large reductions in average check reduced our profit margins in the quarter.

During this past two years our management team focused on controlling margins, managing overhead costs, maximizing free cash flow and reducing debt. We had considerable success in all of these areas and the tools that we brought to the task such as our theoretical food, labor, and beverage cost systems, continue to yield positive results for us.

However, we need to refocus our efforts on positioning each of our brands to drive profitable sales. Let me begin with O’Charley’s which is our largest and in many ways our most challenged brand. During the past year we spent many times more than we have ever spent previously on market research to better understand the perceptions of the brand by our loyal occasional and [last] guest and by our non-users.

Through this research we learned that many guests no longer perceive O’Charley’s to have O'Charley's to have better food and service than its competitors causing many of them to defect or reduce their frequency of visits.

With the addition of Wilson Craft as President of the O’Charley’s brand, we are approaching this challenge with a sense of urgency. We have a series of initiatives underway to build upon the brands existing strengths by simplifying the menu, improving the quality of every menu item, and sharpening our focus on our steaks, our unique cedar plank cooking platforms, fresh hamburgers, and signature salads.

Every menu category will have a cravable value priced offering to appeal to the price sensitive guest. During the remainder of the year we plan to retrain and recertify every member of management and then cascade this training to every team member of O’Charley's’.

We expect our guests to begin to notice a measurably improved level of service and a measurably improved consistency and timing of food execution. However I want to caution you that this turnaround may not happen quickly.

In the short-term we hope to drive sales by refocusing on value. Starting next Monday we will introduce a new tiered value menu with 12 entrée items priced between $7.99 and $9.99. In order to address the incremental sales challenge that we faced in the first quarter we have introduced value priced appetizers and cocktails starting at $3.99 and the opportunity to upgrade an entrée to a full meal with soup or salad and a dessert for an additional $2.99.

This promotion will be supported with television advertising starting at the end of May. Turning now to Ninety Nine, we are strengthening the concepts ties to its core guests who appreciate a friendly environment that offers generous portions of high quality traditional fair at moderate prices.

Our nine real size entrées for $9.99 offering continues to prove popular with our guests and profitable for us. So we continued to refresh the nine items to reinforce the notion of every day value. We now feature the nine for $9.99 in a regular menu across a two page spread rather than its prior placement as a menu insert.

Given the popularity and profitability of this offering we believe that we can gradually reduce Ninety Nine’s reliance upon coupon and discounting. However we have expanded last year’s successful promotion of kids eat free when the Red Sox win to the full season. This promotion unites two great New England institutions, namely, Ninety Nine with its 50-year heritage and the beloved Boston Red Sox.

While this may offend some of today’s participants, particularly those from [inaudible], we look forward to the Red Sox returning to their winning ways. We are positioning Stoney River to be the best steakhouse in the United States at a $35.00 to $40.00 check average. We reduced prices of certain menu items, added new menu items, and added more affordable choices to the wine list, while we continue to offer our loyal Stoney River guests all of their signature favorites such as our popular lodge fillet.

We completed the rollout of these repositioning elements last year, and focused on refreshing our menu choices and bringing Stoney River’s cost structure in line with the lower check average during the first quarter.

We believe that two consecutive quarters of increased guest counts and this quarter’s increase of 590 basis points in restaurant operating margin validates that these efforts are on track. In closing while this was a difficult quarter we believe that we are engaged in a battle that we can win.

We remain confident in the long-term prospects of our industry and our company and remain proud of 24,000 team members and what they do every day to serve our guests. For those team members listening in this morning, thank you for your continued dedication and hard work.

I will now turn the call over to Lawrence Hyatt, thank you.

Lawrence Hyatt

Good morning everyone, and thank you Jeffrey. I would like to discuss our financial performance for the first quarter of 2010, some items that impacted that performance and our outlook for the current quarter.

In this morning’s release we provided a greater level of detail about the financial performance of each of our three concepts, than we have provided in prior quarterly earnings releases. We have also started to report adjusted EBITDA, a non-GAAP financial measure which we believe is a useful measure of the company’s operating performance.

Historical quarterly information on adjusted EBITDA is now available on the Investor Relations section of the company’s web page. We are providing this increased level of disclosure in the interest of transparency in order to help you better understand our performance and in response to your feedback after our last earnings release.

For the first quarter of 2010 revenue declined 6.9% to $271.5 million from $291.7 million in last year’s first quarter. Our restaurant level margin which we define as restaurant sales minus cost of food and beverage, payroll and benefits costs, and restaurant operating costs was $42 million, or 15.5% of restaurant sales compared to $50.4 million or 17.3% of restaurant sales in the prior year quarter.

Results for the quarter include impairment charges of $5.6 million or 2.0% of revenue primarily related to four O’Charley’s restaurants all of which will remain open. Including these impairment charges income from operations was $0.5 million or 0.2% of revenue compared with $12 million or 4.1% of revenue in the prior year quarter.

Our adjusted EBITDA for the quarter was $21.3 million or 7.9% of revenue compared to $28.8 million or 9.9% of revenue in the prior year quarter. Now reviewing our performance on a concept by concept basis, same store sales at our company operated O’Charley’s restaurants decreased by 6.7% which was the result of decrease in guest count of 1.2% and the decline in average check of 5.6%.

The decline in average check reflects the impact of two for $14.99 and other promotional offerings as well as the decline in incremental sales of appetizers, beverages, and desserts. We estimate that inclement weather during the quarter negatively impacted O’Charley’s year over year same store sales in the quarter by between 1% and 1.5%.

Restaurant level margin at the O’Charley’s concept declined to 16.9% of restaurant from 19.1% in the prior year quarter. Cost of food and beverage increased by 40 basis points as lower commodity costs were offset by the impact of promotional offerings on average check.

Payroll and benefit costs and restaurant operating costs each increased by 90 basis points, both due primarily to the deleveraging impact of reduced sales and average check.

For Ninety Nine, same store sales decreased by 6% in the quarter which was the result of a 3.8% decline in guest count and a 2.3% decline in average check. We estimate that inclement weather negatively impacted Ninety Nine’s year over year same store sales in the quarter by between 0.5% and 1.0%.

Restaurant level margin at Ninety Nine declined to 12.5% of restaurant sales from 14.2% in the prior year quarter. Cost of food and beverage declined by 20 basis points reflecting lower commodity costs and the relatively attractive margin from our nine for $9.99 offering. Labor and benefit costs increased by 130 basis points and restaurant operating costs increased by 60 basis points, both due primarily to the deleveraging impact of reduced sales.

For Stoney River, same store sales declined 8.3% in the quarter as a 6.4% increase in guest count was offset by a 13.8% decline in average check. We estimate that inclement weather negatively impacted Stoney River’s year over year same store sales in the quarter by between 0.5% and 1%.

We began our repositioning efforts in the first quarter of last year and the year over year reduction in average check is consistent with our expectation and reflects the rollout of the new lower price positioning to all restaurants by year end 2009.

We believe the guests are responding positively to the new positioning as the first quarter was the second consecutive quarter with guest count increases in mid to high single-digits. As Jeffrey noted in his remarks, we are now focused on bringing Stoney River’s cost structure in line with the lower check average.

We believe these efforts are beginning to show success as Stoney River’s restaurant level margin improved in the quarter by 590 basis points compared to the prior year quarter. Advertising and marketing expense was $11.8 million or 4.3.% of revenue in the quarter compared to $10.5 million or 3.6% of revenue in the prior year quarter reflecting the increase in our planned advertising spend for 2010.

Our general and administrative expenses were $10.9 million or 4% of revenue in the first quarter compared with $12.7 million or 4.4% of revenue in the first quarter of 2009. We continue to tightly control all G&A cost centers.

Our interest expense for the first quarter was $4 million compared with $4 million in the first quarter of 2009. In January we completed our new revolving credit facility. The write-off of unamortized financing costs from the prior facility increased our interest expense by $0.5 million in the first quarter.

During the quarter we retired $9.8 million of our 9% senior subordinate notes through open market purchases. At the end of the quarter we had a cash balance of $29 million and no drawings on our revolving line of credit.

Our results for the quarter include an income tax expense of $0.7 million. We expect our tax provision for the year to be between $2 million and $3 million and to be comprised primarily of state income taxes, and adjustments to the tax valuation reserves that we established in the prior year.

Our loss attributable to common shareholders in the quarter was $4.3 million or $0.21 per diluted share compared to earnings available to common shareholders in the prior year quarter of $6.9 million or $0.34 per diluted share.

Our capital expenditures in the quarter were $3 million compared to $2 million in the prior year quarter. While we expect economic conditions and consumer spending to gradually improve in [inaudible] we do not believe that we have sufficient visibility to offer a full year forecast of our sales or financial performance at this time.

However I would like to share some information that may be helpful when thinking our prospects for 2010. With respect to food and beverage costs for the remainder of 2010 we have locked in our pricing for almost 70% of our estimated requirements for beef, approximately 60% of our estimated requirements for pork, virtually all of our estimated requirements for poultry, and approximately 20% of our estimated seafood requirements.

Based upon this locked in pricing and our current forecast we expect the percentage decline in our food costs on a constant mix basis to be in the low single-digits while we expect our alcoholic beverage costs to increase in the low to mid single-digits.

Adjusting for our first quarter impairment charges we project depreciation and amortization expense of approximately $10 million per quarter for each of the remaining three quarters of the year. We expect capital expenditures of between $14 million and $16 million.

No new restaurant development is planned for the year and we expect to complete approximately 12 restaurant remodels. Our first quarter is a 16-week quarter. While our subsequent quarters are each 12 weeks.

Based upon historical seasonal patterns average weekly sales per restaurant are typically higher in the first quarter than in the subsequent quarters and given our relatively leveraged cost structure we typically generate a disproportionate share of our income from operations in the first quarter.

For the second quarter of 2010 we forecast total revenue of between $196 million and $200 million and income from operations of between negative $1 million and positive $2 million. We also forecast adjusted EBITDA for the second quarter of between $10 million and $13 million based upon estimated depreciation and amortization expense of approximately $10 million and estimated stock compensation expense in the quarter of approximately $1 million.

Our forecast includes the impact of the recent flood event in Tennessee which we estimate will reduce revenues by approximately $0.5 million and reduce income from operations by between $0.2 million and $0.3 million in the second quarter.

During the first three weeks of the second quarter same store sales at O’Charley’s and Stoney River declined in high single-digits, while same store sales at Ninety Nine declined in low single-digits. Our forecast for the quarter assumes that the new value offerings at the O’Charley’s brand will mitigate this trend.

While debt reduction remains a priority use of our free cash flow we will make decisions about future bond repurchases based upon the future financial performance of the company, the financial requirements of our turnaround efforts, and our desire to maintain conservative cash balances.

Therefore we cannot predict at this time whether we will repurchase additional bonds during the remainder of the year or the potential magnitude of such purchases. And with that I will turn the call back over for your questions. Thank you very much.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Bryan Elliott – Raymond James

Bryan Elliott – Raymond James

Just a quick clarification on the quarter to date, first three week comps you gave I believe without checking my calendar here that that included Easter and so there’s some Easter shift impact. Wondered if you have some guesstimates on what the underlying run rate might be adjusted for that.

Lawrence Hyatt

First calendar, our first quarter ended on Sunday, April 18 so the first three weeks are the weeks that ended April 25, May 2, May 9.

Bryan Elliott – Raymond James

So no calendar shift.

Operator

Your next question comes from the line of Robert Derrington – Morgan Keegan

Robert Derrington – Morgan Keegan

If you could help us understand a little bit about the O’Charley’s brand specifically during the first quarter you had a promotional plan which sounds like you weren’t satisfied with, yet beginning here in the second quarter you’re going to come back to value which sounds like it may drive traffic but may impact the check average. What is your view, how is it going to be different this time that will benefit the business versus what it did in the first quarter.

Jeffrey Warne

That’s a great question, when you look at our first quarter and really the lead time of our marketing efforts we were really testing a lot of different things to really effect the turnaround in sales and to hit the sweet spot of our value message that would be a good mix between driving guest counts and driving profits.

And really toward the last four weeks of the promotion is really when we kind of hit that sweet spot but we had already made a commitment through menu print and different creative that we were going to shift to the burger message. And if you really look at where we were in that timeframe, we had the two for $14.99 value message on the table tents in our restaurants.

We had put a menu insert in that highlighted our signature favorites, the signature items, cedar plank salmon, our Louisiana sirloin, which are higher priced items, and to really arrest what we were confronted with was this [dearth] of add-on sales.

We were trying to promote our signature items, our signature tangerine and grapefruit margarita at $6.99, and our signature twisted chip appetizer which has a $6.99 price tag. And that was a tough sell to get that we’re buying entrées at $7.49. So we introduced a $3.99 house margarita, and a $3.99 chips and Southwestern cheese dip and really the take up rate on that was very strong.

And so what you’re really seeing now this tiered value menu is really going to be a reflection of the accumulated learnings from where we had kind of hit the sweet spot. The tiered value menu will be promoted via table tent. We will have an insert of our signature favorites again highlighting the signature cravable items.

We will be selling our $3.99 house margarita again and our $3.99 chips and [casoe] and then really reflecting too kind of how we’re accumulating learnings across our brands, we’re going to introduce a full meal option. For $2.99 a guest can add a soup or a salad and a mini dessert to any entrée whether it be in the tiered value or any other entrée that the guest may order.

And that’s been very successful at the Ninety Nine concept. In fact they’ve got a high opt-in rate for that program. So if you take that $2.99 up sell and if we only get a 5% take up rate that’s going to add $0.15 to check and that will definitely help us in the short run.

Robert Derrington – Morgan Keegan

Is there any risk that your core customers get confused by all the different changes and promotions and moving strategy that you’ve got going on.

Jeffrey Warne

I think there is always that risk. The reality is we’re confronted with the length of time in our marketing calendar to produce creative and produce menus and while a lot of people profess that they are moving away from discounts and we wanted to do the same thing, the reality is the value message is very important right now.

And if we erred, we erred in walking away from it kind of cold turkey. What we will do now is really lay down this value platform because we do believe that at this price tier and with this opportunity to kind of get the incremental sales that we saw in that critical last four weeks of the program, that we think that this is going to work for us and it clearly resonated with the guests.

So while this little, this hiatus was not ideal, we’re in recovery mode here and we’re going to put this value message out there and we think it can last a good long time. And if you really look at what we’re doing at Ninety Nine we put the value message really into the permanent menu. Its not even an insert any more. It’s a two-page spread in the core menu really telling the guests that there’s an every day value opportunity and that they can count on it being there.

And we think that this value platform can be a more permanent aspect of the O’Charley’s menu for those who are more price sensitive and for those that aren’t. We’ll layer on our signature favorites and put new product news on top of that value foundation.

Operator

Your next question comes from the line of Jeffrey Omohundro – Wells Fargo

Jeffrey Omohundro – Wells Fargo

Wondered if you could comment on any regional or day part shifts you might have seen in the quarter and then also if you could just remind us, I know you mentioned a remodel target on the conference call, if you could just remind us where we stand in terms of the rebranding at O’Charley’s in terms of what percentage of the system has been done.

Lawrence Hyatt

Let me walk you through day part shifts, we saw a greater decline in same store sales in the O’Charley’s concept in the dinner day part than we saw in the lunch day part. That was a spread roughly it was 200 basis points more in the dinner day part than in the lunch day part.

Ninety Nine, similarly the decline in the dinner day part was about 100 basis points greater than it was in the lunch day part. Regionally which is really relevant more for the O’Charley’s concept than for the Ninety Nine concept because of its very heavy concentration in the New England market we saw a lot of variation region to region, we tended to see some of our softer sales in the core middle and [inaudible] market continued to perform relatively well in the Atlanta market and it was kind of mixed bag everywhere else.

Jeffrey Warne

Just to kind of follow-on Lawrence comments, Ohio was another relatively strong market for us and for the rebrandings, we’re bringing, and really we’ve kind of walked away from the term rebranding because we’re really incorporated all the service elements that were part of the rebranding into the core O’Charley’s system.

Now we have the same uniforms across the system, the same plate ware, all the service, plate ware and other elements of what would have been called a rebranding are done across the system. We just have the physical remodels now to do. We are going to add 12 remodels to the system this year and a fair number of those will be in Ohio which has been a strong market for us for the last couple of years.

Operator

Your next question is a follow-up from the line of Bryan Elliott – Raymond James

Bryan Elliott – Raymond James

It would appear there was no gain or loss disclosed so where the notes repurchased off the open market essentially on average at par it would appear.

Lawrence Hyatt

Notes were purchased on average at about 101.7 and that went through interest expense but was offset by the ability to accelerate the gain on the portion of the swap repayment that was attributable to those bonds.

Bryan Elliott – Raymond James

And that also went to interest expense.

Lawrence Hyatt

Yes sir.

Operator

Your final question comes from the line of Dan DeYoung – Wells Fargo

Dan DeYoung – Wells Fargo

Just curious any impact from the Tennessee flooding and any impact on seafood prices due to the oil spill in the Gulf.

Jeffrey Warne

Yes, we did have some impact as a result of the flood. We had about a half a dozen restaurants here in the Nashville area that were shut down either for all or part of the flood week and we have one restaurant in Clarksville that remains closed. So we estimate that the sales impact for the flood is about $0.50 million that will be in quarter two.

And that the income from operations impact is going to be between $200,000 and $300,000. As it relates to the Gulf oil spill, we’re not anticipating any impact from that.

Operator

There are no additional questions at this time; I would like to turn it back over to management for any additional or closing comments.

Jeffrey Warne

We’d like to thank everyone who participated on today’s conference call. We greatly appreciate your interest in O’Charley’s. If you have any additional questions, Lawrence and I stand ready to answer them and we look forward to speaking with you in the future. Again, thank you very much.

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