O Charleys (CHUX) 10-Q 2006 Q2 Quarterly report

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 9, 2006

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 is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one): Large accelerated filer o Accelerated filer x Non-accelerated filer 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 14, 2006
Common Stock, no par value	23,182,870 shares

O’Charley’s Inc.

Form10-Q

For the Quarter Ended July 9, 2006

Index

	Page No.
Part I — Financial Information
Item1. Consolidated Financial Statements (unaudited):
Consolidated Balance Sheets as of July 9, 2006 and December 25, 2005		3
Consolidated Statements of Earnings for the 12 weeks ended July 9, 2006 and July 10, 2005		4
Consolidated Statements of Earnings for the 28 weeks ended July 9, 2006 and July 10, 2005		5
Consolidated Statements of Cash Flows for the 28 weeks ended July 9, 2006 and July 10, 2005		6
Notes to unaudited consolidated financial statements		7
Item2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		19
Item3. Quantitative and Qualitative Disclosures About Market Risk		29
Item4. Controls and Procedures		29
Part II — Other Information
Item1. Legal Proceedings		29
Item4. Submission of Matters to a Vote of Security Holders		30
Item6. Exhibits		30
Signatures		31

EX-31.1 SECTION 302 CEO CERTIFICATION

EX-31.2 SECTION 302 CFO CERTIFICATION

EX-32.1 SECTION 906 CEO CERTIFICATION

EX-32.2 SECTION 906 CFO CERTIFICATION

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PART I — FINANCIAL INFORMATION

Item1. Consolidated Financial Statements (Unaudited)

O’CHARLEY’S INC.

CONSOLIDATED BALANCE SHEETS

(In thousands, except share data)

(Unaudited)

	July 9,		December 25,
	2006		2005
ASSETS
Current Assets:
Cash and cash equivalents	$	14,562	$	5,699
Trade accounts receivable		10,702		12,852
Inventories		37,013		45,629
Deferred income taxes		8,511		9,838
Assets held for sale		5,461		5,708
Other current assets		8,753		4,399
Total current assets		85,002		84,125
Property and Equipment, net		458,703		464,048
Goodwill		93,074		93,074
Other Intangible Asset		25,921		25,921
Other Assets		19,387		20,442
Total Assets	$	682,087	$	687,610
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current Liabilities:
Trade accounts payable	$	27,119	$	21,874
Accrued payroll and related expenses		23,185		21,012
Accrued expenses		23,579		22,308
Deferred revenue		8,428		21,393
Federal, state and local taxes		15,113		10,713
Current portion of long-term debt and capitalized lease obligations		10,287		10,975
Total current liabilities		107,711		108,275
Deferred Income Taxes		6,321		7,407
Other Liabilities		46,056		47,633
Long-Term Debt, less current portion		133,257		148,299
Capitalized Lease Obligations, less current portion		21,453		26,409
Total liabilities		314,798		338,023
Shareholders’ Equity:
Common stock — No par value; authorized, 50,000,000 shares; issued and outstanding, 23,362,937 in 2006 and 22,988,401 in 2005		187,452		185,374
Accumulated other comprehensive loss, net of tax		—		(5	)
Unearned compensation		—		(4,027	)
Retained earnings		179,837		168,245
Total shareholders’ equity		367,289		349,587
Total Liabilities and Shareholders’ Equity	$	682,087	$	687,610

See accompanying notes to unaudited consolidated financial statements

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O’CHARLEY’S INC.

CONSOLIDATED STATEMENTS OF EARNINGS

12 Weeks Ended July 9, 2006 and July 10, 2005

(In thousands, except per share data)

(Unaudited)

	2006			2005
Revenues:
Restaurant sales	$	220,915		$		212,017
Commissary sales		2,648				2,148
Franchise revenue		79				84
		223,642				214,249
Costs and Expenses:
Cost of restaurant sales:
Cost of food and beverage		66,104				64,147
Payroll and benefits		74,353				73,294
Restaurant operating costs		41,438				38,854
Cost of commissary sales		2,253				1,966
Advertising expenses		6,478				5,853
General and administrative expenses		11,226				8,918
Depreciation and amortization, property and equipment		10,755				9,952
Asset impairment and disposals		114				(275	)
Pre-opening costs		1,441				1,012
		214,162				203,721
Income from Operations		9,480				10,528
Other Expense (Income):
Interest expense, net		3,808				3,491
Other, net		(4	)			43
		3,804				3,534
Earnings Before Income Taxes		5,676				6,994
Income Tax Expense		1,283				2,028
Net Earnings	$	4,393		$		4,966
Basic Earnings per Common Share:
Net earnings	$	0.19		$	0.22
Weighted average common shares outstanding		23,338			22,843
Diluted Earnings per Common Share:
Net earnings	$	0.19		$		0.21
Weighted average common shares outstanding		23,531				23,158

See notes to accompanying unaudited consolidated financial statements

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O’CHARLEY’S INC.

CONSOLIDATED STATEMENTS OF EARNINGS

28 Weeks Ended July 9, 2006 and July 10, 2005

(In thousands, except per share data)

(Unaudited)

	2006		2005
Revenues:
Restaurant sales	$	524,132	$		500,194
Commissary sales		5,726			4,356
Franchise revenue		236			190
		530,094			504,740
Costs and Expenses:
Cost of restaurant sales:
Cost of food and beverage		157,065			149,731
Payroll and benefits		176,863			170,579
Restaurant operating costs		97,948			90,329
Cost of commissary sales		4,932			3,879
Advertising expenses		14,928			13,863
General and administrative expenses		26,484			21,409
Depreciation and amortization, property and equipment		24,753			23,171
Asset impairment and disposals		114			60
Pre-opening costs		2,615			2,397
		505,702			475,418
Income from Operations		24,392			29,322
Other Expense:
Interest expense, net		8,895			8,039
Other, net		—			43
		8,895			8,082
Earnings Before Income Taxes		15,497			21,240
Income Tax Expense		3,905			6,160
Net Earnings	$	11,592	$		15,080
Basic Earnings per Common Share:
Net earnings	$	0.50	$	0.66
Weighted average common shares outstanding		23,196		22,749
Diluted Earnings per Common Share:
Net earnings	$	0.49	$		0.65
Weighted average common shares outstanding		23,424			23,103

See notes to accompanying unaudited consolidated financial statements

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O’CHARLEY’S INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

28 Weeks Ended July 9, 2006 and July 10, 2005

(In thousands)

(Unaudited)

	2006			2005
Cash Flows from Operating Activities:
Net earnings	$	11,592		$	15,080
Adjustments to reconcile net earnings to net cash provided by operating activities:
Depreciation and amortization, property and equipment		24,753			23,171
Amortization of debt issuance costs		769			768
Share-based compensation		1,086			117
Provision for deferred income taxes		237			2,097
Loss (gain) on the sale of assets		189			(72	)
Changes in assets and liabilities:
Trade accounts receivable		2,150			(854	)
Inventories		8,616			(5,243	)
Other current assets		(3,353	)		(1,154	)
Trade accounts payable		5,245			11,067
Deferred revenue		(12,965	)		(11,466	)
Accrued payroll, accrued expenses, and federal, state and local taxes		6,844			4,851
Other long-term assets and liabilities		(551	)		432
Tax benefit derived from exercise of stock options		—			822
Net cash provided by operating activities		44,612			39,616
Cash Flows from Investing Activities:
Additions to property and equipment		(19,771	)		(35,763	)
Proceeds from the sale of assets		391			2,109
Other, net		(702	)		853
Net cash used in investing activities		(20,082	)		(32,801	)
Cash Flows from Financing Activities:
Payments on long-term debt and capitalized lease obligations		(20,686	)		(16,401	)
Excess tax benefit from share-based payments		436			—
Exercise of stock options and issuances under stock purchase plan		4,583			4,211
Net cash used in financing activities		(15,667	)		(12,190	)
Increase (Decrease) in Cash and Cash Equivalents		8,863			(5,375	)
Cash and Cash Equivalents at Beginning of the Period		5,699			10,772
Cash and Cash Equivalents at End of the Period	$	14,562		$	5,397

See accompanying notes to unaudited consolidated financial statements

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O’CHARLEY’S INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

12 and 28 Weeks Ended July 9, 2006 and July 10, 2005

(Unaudited)

A. BASIS OF PRESENTATION

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 16 weeks and its second, third and fourth quarters consisting of 12 weeks each in most years; however, in fiscal 2006 the fourth quarter will consist of 13 weeks. Fiscal 2006 consists of 53 weeks and 2005 consisted of 52 weeks.

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 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.

These unaudited consolidated financial statements, footnote disclosures and other information should be read in conjunction with the financial statements and the notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 25, 2005. Certain reclassifications have been made to the prior year information to conform to the current year presentation.

B. SHARE-BASED COMPENSATION

Prior to December 26, 2005, the Company accounted for its stock-based compensation under the recognition and measurement principles of Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations (“APB 25”), and adopted the disclosure-only provisions of Statement of Financial Accounting Standards (“SFAS”) No. 123 and No. 148, “Accounting for Stock-Based Compensation.”  In accordance with APB 25, no stock-based compensation cost was reflected in net income for grants of stock options prior to December 26, 2005, because the Company granted stock options with an exercise price equal to the market value of the stock on the date of grant. The Company did, however, record restricted stock expense prior to December 26, 2005 in accordance with APB 25. As of the date of this filing, there were approximately 424,000 remaining shares available for issuance pursuant to the O’Charley’s 2000 Stock Incentive Plan.

Effective December 26, 2005, the Company adopted SFAS No. 123 (Revised 2004), “Share-Based Payment,” (“SFAS 123R”), which requires the measurement and recognition of compensation cost at fair value for all share-based payments. The Company has adopted the provisions of SFAS 123R using the modified prospective method of adoption.  As a result, share-based compensation for fiscal 2006 includes compensation expense, recognized over the applicable vesting periods, for share-based awards granted prior to, but not vested, as of December 25, 2005 as well as compensation cost for new share-based awards granted during the first two quarters of 2006.  Total net share-based compensation expense for the 12 and 28-week periods ended July 9, 2006 was approximately $640,000 and $1,086,000 ($495,000 and $813,000 net of tax), respectively, and consisted of expense associated with stock options, restricted stock and the Company’s employee share purchase plan. Total net share-based compensation (benefit) expense for the 12 and 28-week periods ended July 10, 2005 was ($151,000) and $117,000, respectively and consisted of expense associated with time-based restricted stock and the reversal of expense associated with the Company’s performance-based restricted stock. The Company recognized a tax benefit of approximately $436,000 and $822,000 during the 28-week periods ended July 9, 2006 and July 10, 2005, respectively, related to the exercise of stock options.

Had the Company used the fair value based accounting method for share compensation expense prescribed by SFAS No. 123, the Company’s net earnings and net earnings per common share for the 12 and 28-week periods ended July 10, 2005 would have been reduced to the pro-forma amounts as follows (in thousands, except per share amounts):

	12 Week			28 Week
	Period Ended			Period Ended
	July 10, 2005			July 10, 2005
Net earnings – as reported	$	4,966		$	15,080
(Deduct) Add: Reported stock-based compensation (benefit) expense, net of taxes	(105		)	83
Deduct: Fair value based compensation expense, net of taxes	(383		)	(1,551		)
Net earnings – pro-forma	$	4,478		$	13,612
Net earnings per share:
Basic – as reported	$	0.22		$	0.66
Basic – pro-forma	$	0.20		$	0.60
Diluted – as reported	$	0.21		$	0.65
Diluted – pro-forma	$	0.20		$	0.59

(a) Stock Options

The Company has various incentive stock option plans that provide for the grant of both statutory and nonstatutory stock options to officers, key team members and nonemployee directors of the Company. Options are granted at 100 percent of the fair market value of common stock on the date of the grant, expire ten years from the date of the grant and are exercisable at various times as previously determined by the Board of Directors. As described below, the Company discontinued issuing stock options during fiscal 2004. The fair value of the Company’s stock options is estimated using the Black-Scholes-Merton option-pricing model. As previously reported, the Company accelerated the vesting of all its outstanding stock options with an exercise price of $15.25 per share and higher during the fourth quarter of 2005 in

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anticipation of the adoption of SFAS 123R. As a result, as of July 9, 2006, the Company had 87,645 unvested stock options outstanding of which 73,347 are expected to vest. As of July 9, 2006, the total compensation cost related to stock option awards not yet recognized was $376,277. Stock option transactions during the 28 weeks ended July 9, 2006 were as follows:

					Weighted
			Weighted		Average
			Average		Remaining	Aggregate
	Number of		Exercise		Contractual	Intrinsic
	Options		Price		Life (Years)	Value
Options outstanding at December 25, 2005	2,768,896		$	17.63
Granted	—
Exercised	(272,041	)	13.31
Forfeited	(34,943	)	12.76
Expired	(159,327	)		20.53
Options outstanding at July 9, 2006	2,302,585			18.01	4.68	$	2,346,385
Options vested and exercisable at July 9, 2006	2,214,940		$	18.22	4.71	$	1,997,469

The intrinsic value of stock options exercised was $1,110,020 and $2,096,431 for the 28 weeks ended July 9, 2006 and July 10, 2005, respectively.

(b) Restricted Stock Awards

During 2004, the Company changed its approach to equity-based compensation and discontinued issuing stock options, choosing to only issue restricted stock. This change impacted the Company’s earnings as the accounting for restricted stock differs from the accounting for stock options. The accounting for restricted stock is based on the vesting schedule for the shares. If the vesting schedule is based merely on the passage of time and continued employment (time-based), the accounting treatment requires expensing from the grant date to the expected vesting date based on the number of shares expected to vest and the stock price on the date of grant. The Company recognizes expense on a straight-line basis for the time-based awards. If the vesting is based on performance criteria (performance-based) that could cause the awards to vest over varying periods of time, or to not vest at all, the accounting treatment requires expensing from the grant date to the expected vesting date at the stock price at the date of grant using a graded vesting approach for those awards that the Company determines are probable of vesting. During 2004 and 2005, the Company granted both time-based and performance-based restricted stock awards that vest over periods ranging from three to five years. For the 28 weeks ended July 9, 2006, the Company issued only time-based grants that vest ratably over the next three to five years.

Upon the adoption of SFAS 123R, the Company applied an estimated forfeiture rate of 7.01 percent for its restricted stock awards which resulted in a cumulative reduction to expense of $358,008 before tax which was reflected in general and administrative expense in the Company’s consolidated statement of earnings during the first quarter of 2006. The forfeiture rate was calculated for the Company by a third party using the prior history of the Company's restricted stock grants. The fair value of the restricted stock awards was determined by using the closing market price for the Company’s stock on the date of grant for each restricted stock award.

During the first two quarters of 2006, the Company granted approximately 322,075 shares of restricted stock to certain members of senior management and the board of directors. The Company recognized net compensation expense of approximately $346,000 and $581,000 related to these restricted stock awards during the 12 and 28-week periods ended July 9, 2006.

The following table sets forth the restricted stock activity during the 28 weeks ended July 9, 2006.

��	Number of		Weighted
	Restricted		Average
	Stock		Grant Date
	Awards		Fair Value
Restricted Stock Awards outstanding at December 25, 2005	722,443		$	9.41
Granted	322,075		17.76
Vested	(60,647	)	17.83
Forfeited	(183,918	)		8.58
Restricted Stock Awards outstanding at July 9, 2006	799,953		$	12.33

During the second quarter of 2006, the Company recognized pretax restricted stock expense of approximately $538,000. During the first two quarters of 2006, the Company recognized pretax restricted stock expense of approximately $783,000 net of the cumulative adjustment for the forfeiture rate applied to restricted stock awards issued and outstanding prior to December 25, 2005. As of July 9, 2006, the total compensation cost related to time-based restricted stock awards not yet recognized was approximately $8.0 million and the weighted average period over which it is expected to be recognized is 3.8 years. The Company has 249,805 performance-based restricted shares outstanding included in the 799,953 restricted shares outstanding at July 9, 2006. The Company does not expect these performance-based awards to vest due to the Company’s recent and projected performance in comparison to vesting targets for those awards. The expense associated with the vesting of all these performance-based restricted shares would be approximately $4.6 million.

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C. NET EARNINGS PER COMMON SHARE AND SHARE-BASED COMPENSATION

Basic earnings per common share have been computed on the basis of the weighted average number of common shares outstanding. Diluted earnings per common share have been computed on the basis of the weighted average number of common shares outstanding plus the dilutive effect of stock options and restricted (un-vested) stock awards outstanding.

Following is a reconciliation of the weighted average common shares used in the Company’s basic and diluted earnings per share calculation (in thousands).

	12 Weeks Ended				28 Weeks Ended
	July 9,		July 10,		July 9,		July 10,
	2006		2005		2006		2005
Weighted average common shares outstanding		23,338		22,843		23,196		22,749
Incremental and restricted option shares outstanding		193		315		228		354
Weighted average diluted common shares outstanding		23,531		23,158		23,424		23,103

Options for approximately 1.4 million shares were excluded from the 12 and 28-week weighted average diluted common share calculation in 2006 as compared to 1.3 million for the same prior year periods due to these shares being anti-dilutive.

D. DERIVATIVE INSTRUMENTS

At July 9, 2006, the Company’s derivative financial instruments consisted of interest rate swaps with a combined notional amount of $100.0 million which effectively convert an equal portion of the fixed-rate indebtedness related to the $125.0 million senior subordinated notes due 2013 into variable-rate obligations (fair value hedges). The terms and conditions of the swaps accounted for as a fair value hedge mirrors the terms and conditions of the respective debt. The Company’s purpose for holding such instruments is to hedge its exposure to fair value fluctuations due to changes in market interest rates, as well as to maintain, in the Company’s opinion, an appropriate mix of fixed and floating rate debt.

E. COMPREHENSIVE INCOME

Comprehensive income consists of net earnings and other comprehensive income items attributable to unrealized gains on derivative financial instruments designated as cash flow hedges. The Company had no cash flow hedges as of July 9, 2006. The components of total comprehensive income for all periods presented are as follows:

	12 Weeks Ended			28 Weeks Ended
	July 9, 2006	July 10, 2005	July 9, 2006			July 10, 2005
	(In thousands)
Net earnings	$4,393	$4,966			$11,592		$15,080
Other comprehensive income, net of tax	—	40			—		109
Total comprehensive income	$4,393	$5,006			$11,592		$15,189

F. LEGAL PROCEEDINGS

In September 2003, the Company became aware that customers and employees at one of its O’Charley’s restaurants located in Knoxville, Tennessee were exposed to the Hepatitis A virus, which resulted in a number of its employees and customers becoming infected. As of the date of this filing, all of these cases have been settled and dismissed. The Company has insurance that provides coverage, subject to limitations, for lost income at its restaurants whose results of operations were adversely affected by the Hepatitis A incident. The Company has submitted a claim pursuant to its insurance policy for this type of loss, but its carrier has disagreed with the Company’s claim. On July 11, 2005, certain underwriters at Lloyd’s, the Company’s insurance carrier, filed suit against the Company in the Circuit Court for Knox County, Tennessee seeking declaration by the court regarding certain limits in this policy which would effectively limit the Company’s recovery under the policy to $100,000. The Company has filed an answer and counterclaim requesting that the court declare that its coverage is not limited as asserted by the carrier. The Company filed a motion for Partial Summary Judgment seeking a determination of the coverage of the policy which was denied. At this point, the Company cannot reasonably estimate the value of any potential resolution of this claim or the timing thereof.

The Company is involved in an arbitration in the matter of Ballantyne Village, LLC v. O’Charley’s Inc. filed in April 2005. Ballantyne Village, LLC has alleged that the Company breached a lease on a retail center for a proposed Stoney River Legendary Steaks restaurant in Charlotte, North Carolina. The Company believes it terminated this lease prior to the commencement of its tenancy in accordance with its terms, and that the counterparty’s claims are without merit. The Company intends to defend the allegations against it in this matter vigorously. The arbitration is scheduled for January 29, 2007.

On May 19, 2006, Meritage Hospitality Group, Inc. and certain of its affiliated entities (“Meritage”), which franchise five O’Charley’s restaurants in Michigan, filed suit against the Company in the United States District Court for the Western District of Michigan. The suit alleges that the Company engaged in fraud and violations of the Michigan Franchise Investment Law and Michigan Consumer Protection Act in connection with Meritage becoming a franchisee of the Company’s O’Charley’s restaurant concept. The suit seeks rescission of the development agreement and five franchise agreements with the Company and related damages. The Company is continuing its discussions with Meritage in an effort to resolve this matter. In the event the Company and Meritage are not able to resolve their dispute, the Company intends to defend the allegations against it vigorously.

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In addition, the Company is a defendant from time to time in various other 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 and employment matters, discrimination and similar matters; claims resulting from “slip and fall” accidents; claims with respect to insurance recoveries; and claims from customers 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 or accrue expenses relating to legal proceedings which may adversely affect its results of operations.

G. ASSETS HELD FOR SALE

The amount shown in assets held for sale as of July 9, 2006 on the consolidated balance sheet consists of assets related to six Company-owned O’Charley’s restaurants that were closed during the fourth quarter of 2005, a corporate aircraft and certain other non-operating assets. The Company decided to close six under-performing restaurants as part of a plan to improve existing restaurants. The net book value related to closed restaurants is approximately $3.5 million. The Company decided to sell a corporate aircraft with a net book value of $1.6 million. The Company also decided to sell certain other non-operating assets with a net book value of approximately $0.3 million. The Company estimates that the fair value of these assets exceeds their net book value and has therefore concluded that these assets are not impaired. The Company has ceased recognizing depreciation expense for all of these assets while they are being held for sale.

H. FRANCHISE AND JOINT VENTURE ARRANGEMENTS

In connection with the Company’s franchising initiative, the Company may from time to time enter into joint venture and franchise arrangements to develop and operate O’Charley’s restaurants. For any joint venture in which the Company has an ownership interest, the Company may make loans to the joint venture entity and/or guarantee certain of the joint venture’s debt and obligations. As of July 9, 2006, the Company has a 50% interest in two joint ventures to operate O’Charley’s restaurants. Under Financial Accounting Standards Board Interpretation (FIN) No. 46R, the joint ventures (JFC Enterprises, LLC and Wi-Tenn Restaurants, LLC) are considered variable interest entities, as we do not anticipate them having sufficient equity to fund their operations. The joint venture partners have neither the obligation nor the ability to contribute their proportionate share of expected future losses. Such losses may require additional financial support from the Company. Since the Company bears a disproportionate share of the financial risk associated with the joint ventures, it has been deemed to be the primary beneficiary of the joint ventures and, in accordance with FIN 46R, the Company consolidates the joint ventures in its consolidated financial statements. As of July 9, 2006 JFC Enterprises, LLC, which owns and operates three O’Charley’s restaurants in Louisiana, had loans outstanding due to the Company of approximately $7.5 million. In addition, the Company has provided this joint venture entity a debt service guarantee and as of July 9, 2006 there was $1.2 million outstanding under this arrangement. See the Company’s Annual Report on Form 10-K for the year ended December 25, 2005 and the related notes thereto for a complete description of its franchise and joint venture initiatives.

I. RECENT ACCOUNTING PRONOUCEMENTS

In July 2006, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement No. 109 (“FIN 48”), which clarifies the accounting and disclosure for uncertain tax positions, as defined. FIN 48 seeks to reduce the diversity in practice associated with certain aspects of the recognition and measurement related to accounting for income taxes. This interpretation is effective for fiscal years beginning after December 15, 2006. The Company has not yet determined the impact this interpretation will have on its results of operations or financial position.

In October 2005, the Financial Accounting Standards Board (“FASB”) issued Staff Position No. FSP 13-1, “Accounting for Rental Costs Incurred During a Construction Period” (“FSP No. 13-1”). FSP No. 13-1 states that rental costs associated with ground or building operating leases that are incurred during a construction period shall be recognized as rental expense in income from continuing operations as opposed to capitalizing such rental costs. The provisions of FSP No. 13-1 are effective for the first reporting period beginning after December 15, 2005, the Company adopted this guidance in its first quarter of 2006. The adoption of FSP No. 13-1 did not affect the Company’s consolidated results of operations or financial position since this treatment did not differ from the Company’s then-existing accounting policy.

On March 28, 2006, the Financial Accounting Standards Board (“FASB”) issued EITF 06-3, “How Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (That is, Gross versus Net Presentation)” that clarifies how a company discloses its recording of taxes collected that are imposed on revenue producing activities. EITF 06-3 is effective for the first interim reporting period beginning after December 31, 2006. The Company has not yet determined the impact this EITF will have on its results of operations or financial position.

J. SUPPLEMENTARY CONSOLIDATING FINANCIAL INFORMATION OF SUBSIDIARY GUARANTORS

In the fourth quarter of 2003, the Company issued $125 million aggregate principal amount of 9 percent senior subordinated notes due 2013. The obligations of the Company under the senior subordinated notes are guaranteed by all of the Company’s subsidiaries, with the exception of certain minor subsidiaries. The guarantees are made on a joint and several basis. The claims of creditors of the non-guarantor subsidiaries have priority over the rights of the Company to receive dividends or distributions from such subsidiaries. Presented below is supplementary consolidating financial information for the Company and the subsidiary guarantors as of July 9, 2006 and December 25, 2005 and for the 12 and 28-week periods ended July 9, 2006 and July 10, 2005.

10

Consolidating Balance Sheet

As of July 9, 2006

(Unaudited)

							Minor
							Subsidiaries and
	Parent			Subsidiary			Consolidating
	Company			Guarantors			Adjustments			Consolidated
	(In thousands)
ASSETS
Current Assets (Liabilities):
Cash and cash equivalents	$	(4,529	)	$	5,571		$	13,520		$	14,562
Trade accounts receivable		4,865			6,760			(923	)		10,702
Intercompany receivable (payable)		(144,458	)		153,422			(8,964	)		—
Inventories		3,562			33,399			52			37,013
Deferred income taxes		8,127			384			—			8,511
Assets held for sale		3,541			1,920			—			5,461
Other current assets		4,871			1,491			2,391			8,753
Total current assets (liabilities)		(124,021	)		202,947			6,076			85,002
Property and Equipment, net		312,153			139,627			6,923			458,703
Goodwill		—			93,074			—			93,074
Other Intangible Asset		—			25,921			—			25,921
Other Assets		215,783			29,459			(225,855	)		19,387
Total Assets (Liabilities)	$	403,915		$	491,028		$	(212,856	)	$	682,087
LIABILITIES AND SHAREHOLDERS’ EQUITY (DEFICIT)
Current Liabilities:
Trade accounts payable	$	6,981		$	9,844		$	10,294		$	27,119
Accrued payroll and related expenses		14,420			8,758			7			23,185
Accrued expenses		13,793			10,843			(1,057	)		23,579
Deferred revenue		3,584			4,760			84			8,428
Federal, state and local taxes		(2,714	)		17,715			112			15,113
Current portion of long-term debt and capitalized lease obligations		9,859			382			46			10,287
Total current liabilities		45,923			52,302			9,486			107,711
Deferred Income Taxes		7,105			(784	)		—			6,321
Other Liabilities		29,211			15,942			903			46,056
Long-Term Debt, less current portion		149,812			—			(16,555	)		133,257
Capitalized Lease Obligations, less current portion		20,395			1,058			—			21,453
Total Liabilities (Assets)		252,446			68,518			(6,166	)		314,798
Shareholders’ Equity (Deficit):
Common stock		187,073			204,699			(204,320	)		187,452
Retained earnings (accumulated deficit)		(35,604	)		217,811			(2,370	)		179,837
Total shareholders’ equity (deficit)		151,469			422,510			(206,690	)		367,289
Total Liabilities and Shareholders’ Equity (Deficit)	$	403,915		$	491,028		$	(212,856	)	$	682,087
`

11

Consolidating Balance Sheet

As of December25, 2005

(Unaudited)

							Minor
							Subsidiaries and
	Parent			Subsidiary			Consolidating
	Company			Guarantors			Adjustments			Consolidated
	(In thousands)
ASSETS
Current Assets (Liabilities):
Cash and cash equivalents	$	2,611		$	3,072		$	16		$	5,699
Trade accounts receivable		5,268			7,542			42			12,852
Intercompany receivable (payable)		(132,173	)		141,466			(9,293	)		—
Inventories		3,923			41,169			537			45,629
Deferred income taxes		9,454			384			—			9,838
Assets held for sale		3,541			2,167			—			5,708
Other current assets		2,502			3,233			(1,336	)		4,399
Total current assets (liabilities)		(104,874	)		199,033			(10,034	)		84,125
Property and Equipment, net		323,827			134,622			5,599			464,048
Goodwill		—			93,074			—			93,074
Other Intangible Asset		—			25,921			—			25,921
Other Assets		217,397			28,558			(225,513	)		20,442
Total Assets (Liabilities)	$	436,350		$	481,208		$	(229,948	)	$	687,610
LIABILITIES AND SHAREHOLDERS’ EQUITY (DEFICIT)
Current Liabilities:
Trade accounts payable	$	12,412		$	16,515		$	(7,053	)	$	21,874
Accrued payroll and related expenses		12,880			7,738			394			21,012
Accrued expenses		13,543			10,671			(1,906	)		22,308
Deferred revenue		9,466			11,881			46			21,393
Federal, state and local taxes		(6,020	)		16,669			64			10,713
Current portion of long-term debt and capitalized lease obligations		10,559			372			44			10,975
Total current liabilities		52,840			63,846			(8,411	)		108,275
Deferred Income Taxes		8,191			(784	)		—			7,407
Other Liabilities		30,248			16,266			1,119			47,633
Long-Term Debt, less current portion		164,827			—			(16,528	)		148,299
Capitalized Lease Obligations, less current portion		25,127			1,283			(1	)		26,409
Total Liabilities (Assets)		281,233			80,611			(23,821	)		338,023
Shareholders’ Equity (Deficit):
Common stock		185,374			203,101			(203,101	)		185,374
Accumulated other comprehensive loss, net of tax		(5	)		—			—			(5	)
Unearned compensation		(4,027	)		—			—			(4,027	)
Retained earnings (accumulated deficit)		(26,225	)		197,496			(3,026	)		168,245
Total shareholders’ equity (deficit)		155,117			400,597			(206,127	)		349,587
Total Liabilities and Shareholders’ Equity (Deficit)	$	436,350		$	481,208		$	(229,948	)	$	687,610

12

Consolidating Statement of Operations

12 Weeks Ended July 9, 2006

(Unaudited)

							Minor
							Subsidiaries and
		Parent		Subsidiary			Consolidating
	Company			Guarantors			Adjustments			Consolidated
				(In thousands)
Revenues:
Restaurant sales	$	125,927		$	89,021		$	5,967		$	220,915
Commissary sales		—			67,997			(65,349	)		2,648
Franchise revenue		149			—			(70	)		79
		126,076			157,018			(59,452	)		223,642
Costs and Expenses:
Cost of restaurant sales:
Cost of food and beverage		40,256			26,459			(611	)		66,104
Payroll and benefits		43,981			32,104			(1,732	)		74,353
Restaurant operating costs		26,229			16,586			(1,377	)		41,438
Cost of commissary sales		—			64,610			(62,357	)		2,253
Advertising expenses		(4,241	)		4,245			6,474			6,478
General and administrative expenses		1,385			9,797			44			11,226
Depreciation and amortization, property and equipment		6,302			4,351			102			10,755
Asset impairment and disposals		114			—			—			114
Pre-opening costs		653			572			216			1,441
		114,679			158,724			(59,241	)		214,162
Income (loss) from Operations		11,397			(1,706	)		(211	)		9,480
Other Expense (Income):
Interest expense, net		3,479			222			107			3,808
Other, net		20,189			(20,193	)		—			(4	)
		23,668			(19,971	)		107			3,804
(Loss) Earnings Before Income Taxes		(12,271	)		18,265			(318	)		5,676
Income Tax (Benefit) Expense		(1,105	)		2,486			(98	)		1,283
Net (Loss) Earnings	$	(11,166	)	$	15,779		$	220		$	4,393

13

Consolidating Statement of Operations

12 Weeks Ended July 10, 2005

(Unaudited)

							Minor
							Subsidiaries and
		Parent		Subsidiary			Consolidating
	Company			Guarantors			Adjustments			Consolidated
				(In thousands)
Revenues:
Restaurant sales	$	126,844		$	80,689		$	4,484		$	212,017
Commissary sales		—			56,732			(54,584	)		2,148
Franchise revenue		103			—			(19	)		84
		126,947			137,421			(50,119	)		214,249
Costs and Expenses:
Cost of restaurant sales:
Cost of food and beverage		41,112			24,879			(1,844	)		64,147
Payroll and benefits		45,721			26,645			928			73,294
Restaurant operating costs		22,500			15,370			984			38,854
Cost of commissary sales		—			52,662			(50,696	)		1,966
Advertising expenses		—			5,853			—			5,853
General and administrative expenses		1,058			7,820			40			8,918
Depreciation and amortization, property and equipment		7,111			2,809			32			9,952
Asset impairment and disposals		—			(275	)		—			(275	)
Pre-opening costs		679			306			27			1,012
		118,181			136,069			(50,529	)		203,721
Income (loss) from Operations		8,766			1,352			410			10,528
Other Expense (Income):
Interest expense, net		3,285			168			38			3,491
Other, net		12,441			(12,398	)		—			43
		15,726			(12,230	)		38			3,534
(Loss) Earnings Before Income Taxes		(6.960	)		13,582			372			6,994
Income Tax (Benefit) Expense		(2,018	)		4,046			—			2,028
Net (Loss) Earnings	$	(4,942	)	$	9,536		$	372		$	4,966

14

Consolidating Statement of Operations

28 Weeks Ended July 9, 2006

(Unaudited)

							Minor
							Subsidiaries and
		Parent		Subsidiary			Consolidating
	Company			Guarantors			Adjustments			Consolidated
				(In thousands)
Revenues:
Restaurant sales	$	303,572		$	206,959		$	13,601		$	524,132
Commissary sales		—			160,695			(154,969	)		5,726
Franchise revenue		376			—			(140	)		236
		303,948			367,654			(141,508	)		530,094
Costs and Expenses:
Cost of restaurant sales:
Cost of food and beverage		97,494			61,837			(2,266	)		157,065
Payroll and benefits		106,384			74,547			(4,068	)		176,863
Restaurant operating costs		61,889			40,801			(4,742	)		97,948
Cost of commissary sales		—			152,071			(147,139	)		4,932
Advertising expenses		(9,767	)		9,771			14,924			14,928
General and administrative expenses		3,032			23,352			100			26,484
Depreciation and amortization, property and equipment		14,674			9,890			189			24,753
Asset impairment and disposals		114			—			—			114
Pre-opening costs		1,059			1,160			396			2,615
		274,879			373,429			(142,606	)		505,702
Income from Operations		29,069			(5,775	)		1,098			24,392
Other Expense (Income):
Interest expense, net		8,201			507			187			8,895
Other, net		37,959			(37,959	)		—			—
		46,160			(37,452	)		187			8,895
(Loss) Earnings Before Income Taxes		(17,091	)		31,677			911			15,497
Income Tax (Benefit) Expense		(2,392	)		6,067			230			3,905
Net (Loss) Earnings	$	(14,699	)	$	25,610		$	681		$	11,592

15

Consolidating Statement of Operations

28 Weeks Ended July 10, 2005

(Unaudited)

							Minor
							Subsidiaries and
		Parent		Subsidiary			Consolidating
	Company			Guarantors			Adjustments			Consolidated
				(In thousands)
Revenues:
Restaurant sales	$	302,092		$	187,532		$	10,570		$	500,194
Commissary sales		—			131,132			(126,776	)		4,356
Franchise revenue		233			—			(43	)		190
		302,325			318,664			(116,249	)		504,740
Costs and Expenses:
Cost of restaurant sales:
Cost of food and beverage		97,068			57,180			(4,517	)		149,731
Payroll and benefits		107,075			61,346			2,158			170,579
Restaurant operating costs		51,174			36,659			2,496			90,329
Cost of commissary sales		—			121,549			(117,670	)		3,879
Advertising expenses		—			13,859			4			13,863
General and administrative expenses		2,144			19,175			90			21,409
Depreciation and amortization, property and equipment		16,623			6,470			78			23,171
Asset impairment and disposals		—			60			—			60
Pre-opening costs		1,739			625			33			2,397
		275,823			316,923			(117,328	)		475,418
Income from Operations		26,502			1,741			1,079			29,322
Other Expense (Income):
Interest expense, net		7,555			400			84			8,039
Other, net		30,288			(30,245	)		—			43
		37,843			(29,845	)		84			8,082
(Loss) Earnings Before Income Taxes		(11,341	)		31,586			995			21,240
Income Tax (Benefit) Expense		(3,289	)		9,267			182			6,160
Net (Loss) Earnings	$	(8,052	)	$	22,319		$	813		$	15,080

16

Consolidating Statement of Cash Flows

28 Weeks Ended July 9, 2006

(Unaudited)

							Minor
							Subsidiaries and
	Parent			Subsidiary			Consolidating
	Company			Guarantors			Adjustments			Consolidated
	(In thousands)
Cash flows from Operating Activities:
Net (loss) earnings	$	(14,699	)	$	25,610		$	681		$	11,592
Adjustments to reconcile net (loss) earnings to net cash provided by operating activities:
Depreciation and amortization, property and equipment		14,674			9,890			189			24,753
Amortization of debt issuance costs		769			—			—			769
Share–based compensation		1,086			—			—			1,086
Provision for deferred income taxes		237			—			—			237
Loss (gain) on the sale of assets		189			—			—			189
Changes in assets and liabilities:
Trade accounts receivable		403			782			965			2,150
Inventories		362			7,770			484			8,616
Other current assets		(2,370	)		2,742			(3,725	)		(3,353	)
Trade accounts payable		(5,431	)		(6,670	)		17,346			5,245
Deferred revenue		(5,883	)		(7,121	)		39			(12,965	)
Accrued payroll, other accrued expenses and federal, state, and local taxes		5,096			1,236			512			6,844
Other long-term assets and liabilities		577			(1,253	)		125			(551	)
Net cash (used in) provided by operating activities		(4,990	)		32,986			16,616			44,612
Cash flows from Investing Activities:
Additions to property and equipment		(3,391	)		(14,895	)		(1,485	)		(19,771	)
Proceeds from the sale of assets		391			—			—			391
Other, net		16,517			(15,592	)		(1,627	)		(702	)
Net cash provided by (used in) investing activities		13,517			(30,487	)		(3,112	)		(20,082	)
Cash flows from Financing Activities:
Payments on long-term debt and capitalized lease obligations		(20,686	)		—			—			(20,686	)
Excess tax benefit from share-based payments		436			—			—			436
Exercise of stock options and issuances under stock purchase plan		4,583			—			—			4,583
Net cash used in financing activities		(15,667	)		—			—			(15,667	)
(Decrease) Increase in Cash and Cash Equivalents		(7,140	)		2,499			13,504			8,863
Cash and Cash Equivalents at Beginning of the Period		2,611			3,072			16			5,699
Cash and Cash Equivalents at End of the Period	$	(4,529	)	$	5,571		$	13,520		$	14,562

17

Consolidating Statement of Cash Flows

28 Weeks Ended July 10, 2005

(Unaudited)

							Minor
							Subsidiaries and
	Parent			Subsidiary			Consolidating
	Company			Guarantors			Adjustments			Consolidated
	(In thousands)
Cash flows from Operating Activities:
Net (loss) earnings	$	(8,052	)	$	22,319		$	813		$	15,080
Adjustments to reconcile net (loss) earnings to net cash provided by (used in) operating activities:
Depreciation and amortization, property and equipment		16,623			6,470			78			23,171
Amortization of debt issuance costs		768			—			—			768
Share–based compensation		117			—			—			117
Provision for deferred income taxes		2,097			—			—			2,097
(Gain) loss on the sale of assets		(87	)		15			—			(72	)
Changes in assets and liabilities:
Trade accounts receivable		(2,268	)		1,424			(10	)		(854	)
Inventories		(188	)		(4,901	)		(154	)		(5,243	)
Other current assets		(1,992	)		401			437			(1,154	)
Trade accounts payable		9,184			2,895			(1,012	)		11,067
Deferred revenue		(4,952	)		(6,507	)		(7	)		(11,466	)
Accrued payroll, other accrued expenses and federal, state, and local taxes		3,233			1,231			387			4,851
Other long-term assets and liabilities		5,367			1,911			(6,846	)		432
Tax benefit derived from exercise of stock options		822			—			—			822
Net cash provided by (used in) operating activities		20,672			25,258			(6,314	)		39,616
Cash flows from Investing Activities:
Additions to property and equipment		(21,835	)		(11,827	)		(2,101	)		(35,763	)
Proceeds from the sale of assets		2,109			—			—			2,109
Other, net		11,663			(19,725	)		8,915			853
Net cash (used in) provided by investing activities		(8,063	)		(31,552	)		6,814			(32,801	)
Cash flows from Financing Activities:
Payments on long-term debt and capitalized lease obligations		(16,401	)		—			—			(16,401	)
Exercise of employee incentive stock options and issuances under stock purchase plan		4,211			—			—			4,211
Net cash used in financing activities		(12,190	)		—			—			(12,190	)
Increase (decrease) in Cash and Cash Equivalents		419			(6,294	)		500			(5,375	)
Cash and Cash Equivalents at Beginning of the Period		2,491			7,733			548			10,772
Cash and Cash Equivalents at End of the Period	$	2,910		$	1,439		$	1,048		$	5,397

18

Item 2. Management’s Discussion and Analysis of Financial Condition and Resultsof 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 future profitability, operating and growth strategy, and financing plans. These forward-looking statements may be affected by certain risks and uncertainties, including, but not limited to, our ability to increase operating margins and increase same restaurant sales at our restaurants; the effect that increases in food, labor, energy, interest costs and other expenses have on our results of operations; our ability to successfully implement changes to our supply chain; our ability to sell closed restaurants and other surplus assets; the possible adverse effect on our sales of any decrease in consumer spending; the effect of increased competition; the resolution of our dispute with Meritage Hospitality Group, Inc.; the impact on our results of operations of restarting development of our Stoney River concept; and the other risks described in our Annual Report on Form 10-K for the fiscal year ended December 25, 2005 under the caption “Risk Factors” and in our other filings with the Securities and Exchange 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 leading casual dining restaurant company operating 227 O’Charley’s company-operated restaurants in 16 states in the Southeast and Midwest, 112 Ninety Nine restaurants in nine Northeastern states, and eight Stoney River restaurants in the Southeast and Midwest as of July 9, 2006. We also have five O’Charley’s restaurants in Michigan operated by a franchisee and three O’Charley’s restaurants located in Louisiana operated by a joint venture franchisee in which we have a financial interest. Our fiscal year ends on the last Sunday of the calendar year. We have one reportable segment.

We believe our results for the second quarter of 2006 reflect our progress in our turnaround and transformation efforts. Our turnaround

strategy is focused on:

Strengthening the organization with a new core of talent and building a winning team. During the second quarter of 2006, we continued to develop a cohesive team focused on implementing strategic insights into areas critical to our future success. Larry Taylor, our Chief Supply Chain Officer, and Roland Ornelas, our Vice President of Strategic Sourcing, joined our Quality Product Center team in the second quarter. Larry and his team are aggressively pursuing cost saving opportunities, exploring ways to improve the quality of our products, and performing a detailed analysis of our Quality Product Center operations. Dr. Steve McMillen also joined us as Vice President of Human Resource Development. Steve has brought new insight into the assessment, evaluation and development of our management teams. With these and other previously announced additions, we believe that we have in place a management team that is substantially complete and that will be able to execute successfully our turnaround and transformation efforts.

Improving the box economics through the execution of product and labor cost management and increasing same restaurant sales through new product offerings, new marketing, and a more analytical approach to menu pricing. . For the second quarter of 2006, cost of food and beverage and payroll and benefits as a percentage of restaurant sales were both lower than in the prior year quarter. We believe this improvement resulted primarily from a higher average check in all of our concepts, the impact of our theoretical food cost system and our increased focus on team member and management labor productivity as well as changes we made to our restaurant-level incentive bonus plans. At our O’Charley’s restaurants, average check increased by 3.4 percent. We implemented a three-tier menu pricing structure that enabled us to selectively raise prices. We also have reduced the availability of Kids Eat Free in a number of our markets. The new menu now features O’Charley’s Butcher’s Cut Premium Steaks as well as limited-time offerings. All of these changes contributed to the increase in average check at O’Charley’s restaurants. At Ninety Nine, we reported a 4.5 percent increase in average check, which also resulted from the introduction of a newly-designed menu, featuring nine new food and nine new beverage items and the implementation of a three-tier menu pricing structure. Our Project RevO’lution and Project Dressed to the Nines teams continue to focus on box economics by, among other initiatives, fine-tuning the brand images, developing new team member selection and training tools, introducing new kitchen technology and engineering, capitalizing on dining room efficiencies and applying these improvements to new restaurants and remodels.

Enhancing guest satisfaction and intent to return by instilling ’A Passion to Serve’^TM. In 2005, we adopted a vision statement: ‘A Passion to Serve’^TM. This statement describes our commitment to our guests, each other, our stakeholders and our communities. Our vision is to be the best of class in food and service in our segments of the restaurant industry. We are holding ourselves to higher standards as measured by our Guest Satisfaction Index or “GSI”. Many of our Project RevO’lution and Project Dressed to the Nines initiatives have a direct correlation to improving the guest experience. While we have seen improvement over the last year, we know much more must be achieved. Through GSI and other initiatives, we are able to obtain objective information from our guests which has enabled us to focus on the areas that matter to them, including atmosphere and speed of service. We believe driving guest satisfaction stimulates repeat visits and generates guest loyalty, even in a challenging environment.

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

Revenues consist of Company-operated and joint venture restaurant sales and, to a lesser extent, commissary sales and franchise revenue. Restaurant sales include food and beverage sales and are net of applicable state and local sales taxes and discounts. Commissary sales represent sales to outside parties consisting primarily of sales of O’Charley’s branded food items, primarily salad dressings, to retail grocery chains, mass merchandisers, wholesale clubs and franchisees. Franchise revenue consists of development fees and royalties on sales of franchised units. Our development fees for franchisees in which we do not have an ownership interest are generally $50,000 for the first two restaurants and $25,000 for each additional restaurant opened by the franchisee. The development fees are recognized during the reporting period in which the developed restaurant begins operation. The royalties are recognized in revenue in the period corresponding to the franchisees’ sales.

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Cost of Food and Beverage primarily consists of the costs of beef, poultry, seafood, produce and alcoholic and non-alcoholic beverages. The two most significant commodities that may affect our cost of food and beverage are beef and seafood, which account for approximately 19 percent to 21 percent and 8 percent to 10 percent, respectively, of our overall cost of food and beverage. 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 and bonuses, hourly wages for restaurant level team members, payroll taxes, workers’ compensation, various health, life and dental insurance programs, vacation expense and sick pay. We have various incentive bonus 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. Supplies, rent, supervisory salaries, bonuses and related expenses, management training salaries, general liability and property insurance, property taxes, utilities, repairs and maintenance, outside services and credit card fees account for the major expenses in this category.

Advertising Expenses include all advertising-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.

General and Administrative Expenses include the costs of restaurant support center 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 and related expenses, data processing, legal and accounting expenses, and office expenses account for the major expenses in this category. This category also includes all recruiting and 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 lease term plus one renewal term for leasehold improvements, if shorter.

Asset Impairment and Disposals includes costs associated with the impairment of 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. Disposal costs include the costs incurred to prepare the asset or assets for sale including the following: repair and maintenance, clean up costs, broker commissions, independent appraisals, and insurance deductibles. Gains and/or losses associated with the sale of assets are also included in this financial statement category.

Pre-opening Costs represent costs associated with opening a new restaurant and 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 restaurants opened and under development. Our pre-opening costs may vary significantly from period to period primarily due to the timing of restaurant development and openings.

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The following section should be read in conjunction with our unaudited consolidated financial statements and the related notes thereto included elsewhere herein. The following table highlights the operating results for the 12 and 28-week periods ended July 9, 2006 and July 10, 2005 as a percentage of total revenues unless specified otherwise. Certain reclassifications have been made to the prior year information to conform to the current year presentation.

	12 Weeks Ended						28 Weeks Ended
	July 9,			July 10,			July 9,			July 10,
	2006			2005			2006			2005
Revenues:
Restaurant sales		98.8	%		99.0	%		98.9	%		99.1	%
Commissary sales		1.2			1.0			1.1			0.9
Franchise Revenue		0.0			0.0			0.0			0.0
		100.0	%		100.0	%		100.0	%		100.0	%
Costs and Expenses:
Cost of restaurant sales: (1)
Cost of food and beverage		29.9			30.3			30.0			29.9
Payroll and benefits		33.7			34.6			33.7			34.1
Restaurant operating costs		18.8			18.3			18.7			18.1
Cost of commissary sales (2)		1.0			0.9			0.9			0.8
Advertising expenses		2.9			2.7			2.8			2.7
General and administrative expenses		5.0			4.2			5.0			4.2
Depreciation and amortization		4.8			4.6			4.7			4.6
Asset impairment and disposals		0.1			(0.1	)		—			—
Pre-opening costs		0.6			0.5			0.5			0.5
Income from Operations		4.2			4.9			4.6			5.8
Other Expense:
Interest expense, net		1.7			1.6			1.7			1.6
Earnings before Income Taxes		2.5			3.3			2.9			4.2
Income Tax Expense		0.6			0.9			0.7			1.2
Net Earnings		2.0	%		2.3	%		2.2	%		3.0	%

(1)	Shown as a percentage of restaurant sales.
(2)		Cost of commissary sales as a percentage of commissary sales was 85.1 percent and 91.5 percent for the 12 weeks ended July 9, 2006 and July 10, 2005, respectively. Cost of commissary sales as a percentage of commissary sales was 86.1 percent and 89.0 percent for the 28 weeks ended July 9, 2006 and July 10, 2005, respectively.

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The following table reflects margin performance of each of our concepts for the 12 and 28-week periods ended July 9, 2006 and July 10, 2005.

	12 Weeks Ended		28 Weeks Ended
	July 9,	July 10,	July 9,	July 10,
	2006	2005	2006	2005
	($ in millions)		($ in millions)
O’Charley’s Concept:(1)
Restaurant Sales:	$    143.1	$    141.6	$    345.1	$    337.6
Cost and expenses: (2)
Cost of food and beverage	29.9%	30.6%	30.0%	29.8%
Payroll and benefits	32.9%	34.9%	33.1%	34.3%
Restaurant operating costs	18.8%	18.7%	18.2%	17.7%
Ninety Nine Concept:
Restaurant Sales:	$      70.7	$      64.9	$    163.1	$    149.6
Cost and expenses: (2)
Cost of food and beverage	28.9%	28.6%	29.1%	29.5%
Payroll and benefits	35.7%	34.6%	35.8%	34.4%
Restaurant operating costs	18.9%	18.2%	19.5%	18.9%
Stoney River Concept:
Restaurant Sales:	$        7.1	$        5.5	$      15.9	$      13.0
Cost and expenses: (2)
Cost of food and beverage	39.3%	40.4%	39.3%	38.9%
Payroll and benefits	28.0%	25.0%	26.7%	24.7%
Restaurant operating costs	19.4%	12.8%	19.2%	18.2%
(1) Includes results from O’Charley’s joint venture operations but excludes revenue from franchised restaurants. (2) Shown as a percentage of restaurant sales.

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The following table sets forth certain financial and other restaurant data for the quarters ended July 9, 2006 and July 10, 2005:

	July 9,			July 10,
	2006			2005
Number of Restaurants:
O’Charley’s Restaurants:
In operation, beginning of quarter		225			224
Restaurants opened		2			3
Restaurant closed		—			(1	)
In operation, end of quarter		227			226
Ninety Nine Restaurants:
In operation, beginning of quarter		111			101
Restaurants opened		1			1
Restaurants closed		—			—
In operation, end of quarter		112			102
Stoney River Restaurants:
In operation, beginning of quarter		7			6
Restaurants opened		1			—
Restaurants closed		—			—
In operation, end of quarter		8			6
Franchised / Joint Venture Restaurants (O’Charley’s)
In operation, beginning of quarter		7			3
Restaurants opened		1			1
Restaurants closed		—			—
In operation, end of quarter		8			4
Average Weekly Sales per Restaurant:
O’Charley’s	$	52,397		$	52,309
Ninety Nine		52,836			53,525
Stoney River		74,936			76,306
Increase (Decrease) in Same Restaurant Sales (1):
O’Charley’s		(0.7	%)		0.4	%
Ninety Nine		(0.9	%)		0.7	%
Stoney River		2.7	%		1.9	%
Increase (Decrease) in Same Restaurant Guest Visits (1):
O’Charley’s		(3.9	%)		(0.5	%)
Ninety Nine		(5.1	%)		2.8	%
Stoney River		(1.6	%)		(0.5	%)
Increase (Decrease) in Average Check per Guest(1):
O’Charley’s		3.4	%		0.9	%
Ninety Nine		4.5	%		(2.1	%)
Stoney River		4.4	%		2.4	%
Average Check per Guest (2):
O’Charley’s	$	11.96		$	11.55
Ninety Nine		14.04			13.46
Stoney River		40.00			39.56

(1)	When computing same restaurant sales, guest visits and average check per guest, 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 at the end of the quarter.

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Second Fiscal Quarter and First 28 weeks of 2006 Versus Second Fiscal Quarter and First 28 weeksof 2005

Revenues

During the 12 weeks ended July 9, 2006, total revenues increased $9.4 million, or 4.4 percent, to $223.6 million from $214.2 million for the 12 weeks ended July 10, 2005. Total revenues for the first 28 weeks of 2006 increased $25.4 million, or 5.0 percent, to $530.1 million from $504.7 million in the same prior-year period. During the quarter we experienced a decrease in guest counts at all of our concepts due to several factors including: high gasoline prices, increasing interest rates, and the phase out of our kids eat free program at O’Charley’s. We are taking measures to offset this decline in guest counts through greater use of promotional menu items, a more analytical approach in determining our menu prices, and by more closely monitoring the feedback received through our Guest Satisfaction Index.

O’Charley’s company-owned restaurant sales increased $0.2 million, or 0.1 percent, to $141.3 million during the second quarter of 2006. However, same store sales at our company-owned O’Charley’s restaurants declined by 0.7 percent which was the result of an increase in average check of 3.4 percent offset by a decrease in guest counts of 3.9 percent. A net addition of one O’Charley’s restaurant in the last 12 months contributed to the increase in sales. Sales for the first 28 weeks of 2006 at company-owned O’Charley’s restaurants increased $4.8 million, or 1.4 percent, to $341.6 million from $336.8 million in the same prior-year period as a result of same restaurant sales increases of 0.1 percent and the net addition of one new restaurant over the last 12 months.

Ninety Nine restaurant sales increased $5.7 million, or 8.8 percent, to $70.7 million during the second quarter of 2006. However, same restaurant sales declined 0.9 percent in the quarter which was the result of a 4.5 percent increase in average check offset by a 5.1 percent decrease in guest counts. There was a net addition of 10 new Ninety Nine restaurants in the last 12 months. Ninety Nine restaurant sales for the first 28 weeks of 2006 increased $13.5 million, or 9.1 percent, to $163.1 million from $149.6 million in the same prior-year period as a result of same restaurant sales increases of 0.2 percent and the addition of 10 new restaurants over the last 12 months.

Stoney River restaurant sales increased $1.6 million, or 29.7 percent, to $7.1 million during the second quarter of 2006. Same restaurant sales increased 2.7 percent on a 4.4 increase in average check partially offset by a 1.6 percent decrease in guest counts. There was a net addition of two new Stoney River restaurants in the last 12 months. Average weekly sales per restaurant were impacted by the lower than average sales volume at the Dublin, Ohio restaurant, which opened in the fourth quarter of 2005. Stoney River restaurant sales for the first 28 weeks of 2006 increased $2.9 million, or 22.4 percent, to $15.9 million from $13.0 million in the same prior-year period as a result of same restaurant sales increases of 4.1 percent.

Cost of Food and Beverage

During the second quarter of 2006, our cost of food and beverage was $66.1 million, or 29.9 percent of restaurant sales, compared with $64.1 million, or 30.3 percent of restaurant sales, in the second quarter of 2005. This decline in food and beverage cost as a percentage of sales in the quarter reflects the impact of lower costs for poultry, pork and cheese, and the further narrowing of the gap between our theoretical and actual food costs at the O’Charley’s concept, partially offset by higher costs for beef, and produce and higher fuel-related distribution costs. During the first 28 weeks of 2006, cost of food and beverage was $157.1 million, or 30.0 percent of restaurant sales, compared to $149.7 million, or 29.9 percent of restaurant sales, in the same prior year period.

Payroll and Benefits

During the second quarter of 2006, payroll and benefits were $74.4 million, or 33.7 percent of restaurant sales, compared to $73.3 million, or 34.6 percent of restaurant sales, in the same prior-year period. This improvement of 90 basis points represents reductions in employee benefits expense, management salaries, and restaurant-level bonus expenses that were partially offset by higher hourly wage expenses. The reduction in management salaries reflects reductions in the average number of managers per restaurant in the O’Charley’s concept, while the reduction in bonus expense reflects the impact of our new performance focused bonus plans. The cost of our employee benefit plans was approximately 20 basis points lower as a percentage of restaurant sales in the second quarter of 2006 than in the second quarter of 2005, reflecting reductions negotiated with certain health care plans earlier in 2006. During the first 28 weeks of 2006, payroll and benefits were $176.9 million, or 33.7 percent of restaurant sales, compared to $170.6 million, or 34.1 percent of restaurant sales, in the same prior year period.

Restaurant Operating Costs

During the second quarter of 2006, restaurant operating costs were $41.4 million, or 18.8 percent of restaurant sales, compared to $38.9 million, or 18.3 percent of restaurant sales, in the same prior year period. The increase is primarily the result of increases in electricity costs, general liability insurance and repair and maintenance costs. During the first 28 weeks of 2006, restaurant operating costs were $97.9 million, or 18.7 percent of restaurant sales, compared to $90.3 million, or 18.1 percent of restaurant sales, in the same prior year period.

Advertising Expenses

During the second quarter of 2006, advertising expenditures increased 10.7% to $6.5 million from $5.9 million in the second quarter of 2005 and, as a percentage of total revenues, increased to 2.9 percent from 2.7 percent in the same prior-year period. For the first 28 weeks of 2006, advertising expenditures increased 7.7 percent to $14.9 million from $13.9 million in the same prior year period.

General and Administrative Expenses

General and administrative expenses increased 25.9 percent to $11.2 million in the second quarter of 2006 from $8.9 million in the second quarter of 2005, and as a percentage of total revenues, increased to 5.0 percent from 4.2 percent in the same prior-year period. The increase in general and administrative expenses in the quarter includes pretax charges of $0.7 million, or $0.02 per diluted share for severance, recruiting and relocation expenses and $0.6 million of increased salaries and expenses related to strengthening our management team. General and administrative expenses in the prior year quarter reflect charges of $0.02 per diluted share for our financial systems conversion project. Our general and administrative expenses also reflect increases in stock-based compensation of $0.8 million or $0.03 per diluted share, in the second quarter of 2006. Stock-based compensation expense primarily includes restricted share expense but also includes the expensing of stock options and the

24

employee stock purchase plan discount as a result of the adoption Financial Accounting Standards Board Statement No. 123R, “Share-based Payments”. General and administrative expenses in the first 28 weeks of 2006 increased 23.7 percent to $26.5 million from $21.4 million during the same prior year period and increased as a percentage of total revenues to 5.0 percent from 4.2 percent in the prior year period.

Depreciation and Amortization, Property and Equipment

During the second quarter and first 28 weeks of 2006, depreciation and amortization increased as a percentage of total revenues. The increase was primarily attributable to lower average unit volumes in the Ninety Nine and Stoney River concepts.

Asset Impairment and Disposal Costs

During the 12 and 28 weeks ended July 9, 2006 asset impairment and disposal costs increased primarily related to the write off of certain Company assets related to one of our restaurants, as compared to the prior year period, where certain impairment charges were offset by the gain on the sale of assets from one our restaurants.

Pre-opening Costs

Pre-opening costs in the second quarter of 2006 were $1.4 million compared to $1.0 million in the second quarter of 2005 reflecting five new restaurant openings compared to four restaurants opened in the prior year quarter.

Interest Expense, Net

Interest expense for the second quarter of 2006 was $3.8 million compared to $3.5 million in the second quarter of 2005. This increase is a result of the impact of higher short-term interest rates on the Company’s variable rate debt partially offset by lower borrowings under the Company’s revolving credit facility.

Income Taxes

The effective tax rate applied to pretax income in the second quarter of 2006 was 22.6 percent, compared to a tax rate of 29 percent in the prior year period. Based upon our actual and anticipated results, we estimate that our effective tax rate for the 2006 fiscal year will be 25.2 percent. Since this is lower than the estimated rate of 26.7 percent applied in the first quarter of the year, our income tax provision for the second quarter includes a change in estimate of $0.1 million dollars to adjust the year-to-date amount. The estimated rate for 2006 fiscal year does not include the impact of the work opportunities tax credit, which expired at the end of 2005. If Congress renews this credit during 2006, our effective tax rate for the year could be lower than our current estimate.

LIQUIDITY AND CAPITAL RESOURCES

Our primary sources of capital have historically been cash provided by operations, borrowings under our credit facilities, capital leases and sales of common stock. 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 the fact that most of our sales are received as cash or credit card charges, and we have reinvested our cash in new restaurant development. We do not believe this indicates a lack of liquidity. As previously announced, we have slowed our restaurant development in order to focus on improving the performance of our existing restaurants. We opened two company-operated O’Charley’s and one Ninety Nine restaurant during the second quarter of 2006 and two company-operated O’Charley’s and three Ninety Nine restaurants during the first 28 weeks of 2006. Unlike most restaurant companies, we have a vertically integrated supply chain in which our commissary provides distribution services to all restaurants and manufactures certain items. As we continue to increase the amount of investment we are making in food inventory in our commissary, we expect to see a reduction in the negative working capital.

The bank credit facility consists of a revolving credit facility with a maximum principal amount of $125.0 million. At July 9, 2006, the outstanding balance on the revolving credit facility was $7.0 million, which excludes approximately $9.0 million in letters of credit which reduces the capacity of the credit facility. The facility has a four-year term maturing in November, 2007, and bears interest, at our option, at either LIBOR plus a specified margin ranging from 1.25 percent to 2.25 percent based on certain financial ratios or the base rate, which is the higher of the lender’s prime rate and the federal funds rate plus 0.5 percent, plus a specified margin from 0.0 percent to 1.0 percent based on certain financial ratios. As of the end of the second quarter, our LIBOR loans were priced using a margin of 1.25 percent. The credit facility imposes restrictions on us with respect to the incurrence of additional indebtedness, sales of assets, mergers, acquisitions, joint ventures, investments, repurchases of stock and the payment of dividends. In addition, the credit facility requires us to comply with certain specified financial covenants, including covenants and ratios relating to our senior secured leverage, maximum adjusted leverage, minimum fixed charge coverage, minimum asset coverage and maximum capital expenditures. We were in compliance with such covenants at July 9, 2006. The credit facility contains certain events of default, including an event of default resulting from certain changes in control. All amounts owing under the facility are secured by 100 percent of our equity interests in each of our existing subsidiaries and substantially all of our subsidiaries’ tangible and intangible assets, other than real property acquired after the date of the credit facility and equipment. The lenders may, under certain circumstances, also require that we pledge such real estate and equipment as collateral.

From time to time, we have entered into interest rate swap agreements with certain financial institutions. These swap agreements effectively convert some of our obligations that bear interest at variable rates into fixed-rate obligations and effectively convert some of our obligations that bear interest at fixed rates into variable-rate obligations. During the first quarter of 2004, we entered into interest rate swap agreements with a financial institution that effectively convert a portion of the fixed-rate indebtedness related to the $125 million aggregate principal amount of senior subordinated notes due 2013 into variable-rate obligations. The total notional amount of these swaps was $100.0 million and is based on the six-month LIBOR rate in arrears plus a specified margin, the average of which is 3.9 percent. The terms and conditions of these swaps mirror the interest terms and conditions on our 9.0 percent senior subordinated notes due 2013 and are accounted for as fair value hedges. These swap agreements expire in November 2013. Our weighted average interest rate for the second quarters ended July 9, 2006 and July 10, 2005 was 9.9 percent and 8.5 percent, respectively.

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In October 2003, we announced an authorization to repurchase up to $25.0 million of our common stock. Any repurchases will be made from time to time in open market transactions or privately negotiated transactions at our discretion. To date, we have not repurchased any shares of our common stock under this authorization. Any repurchases will be funded by cash provided by operations or proceeds from short-term borrowings under our credit facility and will be reported in the Company’s quarterly reports on Form 10-Q or annual report on Form 10-K for the period in which any such repurchase occurs in accordance with applicable SEC rules.

In 2006, net cash flows used by investing activities included capital expenditures incurred principally for building new restaurants, improvements to existing restaurants, new equipment and improvements at our commissary, and technological improvements at our restaurant support center. The Company did not finance any capital expenditures during the 28-week periods ended July 9, 2006 and July 10, 2005, through capitalized lease obligations. Capital expenditures for the 28-week period ended July 9, 2006 and July 10, 2005, were as follows:

	July 9,		July 10,
	2006		2005
	(In thousands)
New restaurant capital expenditures	$	13,088	$	25,562
Other capital expenditures		6,683		10,201
Total capital expenditures	$	19,771	$	35,763

We expect the full year 2006 capital expenditures to be between $45.0 million and $50.0 million. As part of our focus on improving results in our existing restaurants, we plan to develop and open fewer restaurants in 2006 than were opened in 2005. We expect to open between three and four Company-operated O’Charley’s restaurants, between four and six Ninety Nine restaurants, and two or three new Stoney River restaurants in 2006.

The following table sets forth our capital structure and certain financial data as of and for the 28 weeks ended July 9, 2006 and as of and for the year ended December 25, 2005:

	July 9,					December 25,
	2006					2005
	$		%			$		%
	(Dollars in thousands)
Revolving credit facility	$	7,000		1.3	%	$	22,000		4.1	%
Secured mortgage note payable		112		0.0			125		0.0
GE Capital Financing arrangement		1,216		0.2			1,247		0.2
Capitalized lease obligations		31,669		6.0			37,311		7.0
Total senior debt		39,997		7.5			60,683		11.3
Senior subordinated notes		125,000		23.5			125,000		23.4
Total debt(1)(2)		164,997		31.0			185,683		34.7
Shareholders’ equity		367,289		69.0			349,587		65.3
Total capitalization	$	532,286		100.0	%	$	535,270		100.0	%
Adjusted total debt(1)(3)	$	423,989				$	432,555
Adjusted total capitalization(1)(3)	$	791,278				$	782,142
EBITDA(1)(4)	$	49,145				$	80,032

____________

(1) We believe EBITDA, total debt, adjusted total debt and adjusted total capitalization are useful measurements to investors because they are commonly used as analytical indicators to evaluate performance, measure leverage capacity and debt service ability. These measures should not be considered as measures of financial performance or liquidity under U.S. generally accepted accounting principles. EBITDA, total debt, adjusted total debt and adjusted total capitalization should not be considered in isolation or as alternatives to financial statement data presented in our consolidated financial statements as an indicator of financial performance or liquidity. EBITDA, total debt, adjusted total debt and adjusted total capitalization, as presented, may not be comparable to similarly titled measures of other companies.

(2) Total debt represents the sum of long-term debt and capitalized lease obligations, in each case including current portion. The following table reconciles total debt, as described above, to the long-term debt and capitalized lease obligations, in each case including current portion, as reflected in our consolidated balance sheets:

	July 9,		December 25,
	2006		2005
	(In thousands)
Current portion of long-term debt and capitalized leases	$	10,287	$	10,975
Add:
Long-term debt, excluding current portion		133,257		148,299
Capitalized lease obligations, less current portion		21,453		26,409
Total debt	$	164,997	$	185,683

26

(3) Adjusted total debt represents the sum of long-term debt and capitalized lease obligations, in each case including current portion, plus the product of (a) rent expense for the 52 weeks ended July 9, 2006 and December 25, 2005, respectively, multiplied by (b) eight. Adjusted total capitalization represents the sum of long-term debt and capitalized lease obligations, in each case including current portion, shareholders’ equity, plus the product of (a) rent expense for the 52 weeks ended July 9, 2006 and December 25, 2005, respectively, multiplied by (b) eight. The following table reconciles adjusted total debt and adjusted total capitalization, as described above, to the long-term debt and capitalized lease obligations, in each case including current portion, shareholders’ equity and rent expense as reflected in our consolidated financial statements and the notes to the consolidated financial statements:

	July 9,		December 25,
	2006		2005
	(In thousands)
Current portion of long-term debt and capitalized leases	$	10,287	$	10,975
Add:
Long-term debt, excluding current portion		133,257		148,299
Capitalized lease obligations, less current portion		21,453		26,409
Total debt		164,997		185,683
Add eight times rent expense:		258,992		246,872
Adjusted total debt		423,989		432,555
Add:
Shareholders’ equity		367,289		349,587
Adjusted total capitalization	$	791,278	$	782,142

(4) EBITDA represents earnings before interest expense, income taxes, asset impairments and depreciation and amortization. The following table reconciles EBITDA, as described above, to net earnings and to cash flows provided by operating activities as reflected in our consolidated statements of earnings and cash flows:

	28 Weeks		Fiscal Year
	Ended		Ended
	July 9,		December 25,
	2006		2005
	(In thousands)
Net earnings	$	11,592	$	11,878
Add:
Income tax expense		3,905		1,904
Interest expense, net		8,895		15,124
Asset impairments		—		7,320
Depreciation and amortization, property and equipment		24,753		43,806
EBITDA	$	49,145	$	80,032

	28 Weeks			Fiscal Year
	Ended			Ended
	July 9,			December 25,
	2006			2005
	(In thousands)
Cash flows provided by operating activities	$	44,612		$	62,058
Adjustment for items included in cash provided by operating activities but excluded from the calculation of EBITDA:
Expense related to share-based compensation		(1,086	)		(485	)
Deferred income taxes		(237	)		3,653
Amortization of deferred gain on sale lease back		569			1,056
Loss on sale of assets		(189)			(233	)
Changes in operating assets and liabilities		(6,537	)		1,312
Changes in long-term assets and liabilities		(18	)		(2,931	)
Income tax expense		3,905			1,904
Interest and other expense		8,126			13,698
EBITDA	$	49,145		$	80,032

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Based upon the current level of operations and anticipated growth for our restaurant concepts, we believe that cash flow from operations and borrowings under our bank credit facility are sufficient to fund our working capital needs over the next 12 months. There can be no assurances that such sources of financing will be available to us or that any such financing would not negatively impact our earnings.

Critical Accounting Policies

In our Annual Report on Form 10-K for the year ended December 25, 2005, we identified our critical accounting policies related to property and equipment, lease accounting, share-based compensation, excess of cost over fair value of net assets acquired (goodwill), impairment of long-lived assets, and tax provision and related financial statement items. We consider an accounting policy to be critical if it is most important to the portrayal of our 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 2006, there have been no material changes in our critical accounting policies.

Contractual Obligations and Commercial Commitments

The tables and discussion below set forth certain of our contractual obligations and commercial commitments at July 9, 2006. Other than the items listed and discussed below, no other material changes have occurred in the contractual obligations and commercial commitments disclosed in our Annual Report on Form 10-K for the year ended December 25, 2005.

			Payments Due by Period
			Less						More
			than						Than
Contractual Obligations	Total		1 Yr		1-3 Yrs		3-5 Yrs		5 Years
	(in thousands)
Long-term debt	$	133,327	$	78	$	7,057	$	31	$	126,161
Capitalized lease obligations(1)		32,451		10,632		15,588		5,210		1,021

			Amount of Commitment Expiration
			per Period
			Less				More
	Total		than				Than
Other Commercial Commitments	Committed		1 Yr	1-3 Yrs		3-5 Yrs	5 Years
	(in thousands)
Revolving credit facility(2)	$	125,000	—	$	125,000	—	—
Guarantee of joint-venture financing(3)	$	15,000	—	$	15,000	—	—

____________

(1) Capitalized lease obligations include the $0.8 million interest component.

(2) This pertains to our revolving credit facility of which $7.0 million is included in long-term debt shown above. We have approximately $9.0 million of outstanding letters of credit as of July 9, 2006 which reduces the capacity of the revolving credit facility but is not funded debt. As of July 9, 2006, we have $109.0 million remaining borrowing capacity under our revolving credit facility.

(3) This pertains to the financing arrangement for franchisees with GE Capital Franchise Finance Corporation and represents our maximum obligation. As of July 9, 2006, there were $1.2 million loans outstanding under this financing arrangement.

Consideration of Changes to Financial Structure

In February 2006, we indicated that we would consider opportunities to use our real estate and other assets to enhance shareholder value. Since that time, we have refined our business and strategic plans, and our board of directors explored a number of financial structuring alternatives with our external financial advisors, taking into account the covenants and restrictions in our existing bond indenture and credit agreement. After full consideration, our board has decided that we will not pursue a financial structuring transaction at this time. Management and the board will continue on a regular basis to review the opportunities to enhance shareholder value while maintaining financial flexibility for our anticipated future growth.

Outlook

On August, 3 2006, we stated that we expect to report net earnings per diluted share of between $0.11 and $0.16 for the 12-week period ending October 1, 2006. We revised our previously issued earnings guidance for the full year and stated that we expect to report net earnings per diluted share of between $0.90 and $0.96 for the fiscal year ending December 31, 2006. The 2006 fiscal year is a 53-week year. Our guidance for the full year reflects an estimated positive earnings impact from the 53rd week of between $0.08 and $0.10 per diluted share. Projected results for the second half of the year are based upon anticipated same-store sales increases of less than one percent for O’Charley’s, and between one percent and two percent for Ninety Nine. We expect year-over-year improvement in our operating margin in the second half of the year. We project an effective tax rate of approximately 25.2 percent for the full fiscal year, compared to 14.3 percent in 2005, and interest expense of between $16.5 million and $17.0 million for the year, compared to $15.1 million in the 2005 fiscal year. Our guidance does not reflect any impact for charges or expenses arising from decisions we may make during the second half of fiscal 2006 as part of our previously discussed turnaround efforts, or from our previously disclosed discussions with Meritage Hospitality Group, Inc.

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Recent Accounting Pronouncements

In July 2006, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement No. 109 (“FIN 48”), which clarifies the accounting and disclosure for uncertain tax positions, as defined. FIN 48 seeks to reduce the diversity in practice associated with certain aspects of the recognition and measurement related to accounting for income taxes. This interpretation is effective for fiscal years beginning after December 15, 2006. We have not yet determined the impact this interpretation will have on our results of operations or financial position.

In October 2005, the Financial Accounting Standards Board (“FASB”) issued Staff Position No. FSP 13-1, “Accounting for Rental Costs Incurred During a Construction Period” (“FSP No. 13-1”). FSP No. 13-1 states that rental costs associated with ground or building operating leases that are incurred during a construction period shall be recognized as rental expense in income from continuing operations as opposed to capitalizing such rental costs. The provisions of FSP No. 13-1 are effective for the first reporting period beginning after December 15, 2005, we adopted this guidance in our first quarter of 2006. The adoption of FSP No. 13-1 did not affect our consolidated results of operations or financial position since this treatment did not differ from our then-existing accounting policy.

On March 28, 2006, the Financial Accounting Standards Board (“FASB”) issued EITF 06-3, “How Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (That is, Gross versus Net Presentation)” that clarifies how a company discloses its recording of taxes collected that are imposed on revenue producing activities. EITF 06-3 is effective for the first interim reporting period beginning after December 31, 2006. We have not yet determined the impact this EITF will have on our results of operations or financial position.

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. Several states are considering changes to their minimum wage and/or benefit related laws which, if enacted, could have an adverse impact on the Company’s payroll and benefit costs. As a result of increased competition and the low unemployment rates in the markets in which our restaurants are located, we have continued to increase wages and benefits in order to attract and retain management personnel and hourly employees. 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 also believe that increased fuel costs over the past 18 months have had a negative impact on consumer behavior and have increased the cost of operating our Commissary. 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. We utilize a balanced mix of debt maturities along with both fixed-rate and variable-rate debt to manage our exposures to changes in interest rates. Our fixed-rate debt consists primarily of capitalized lease obligations and senior subordinated notes and our variable-rate debt consists primarily of our revolving credit facility.

As an additional method of managing our interest rate exposure on our credit facility, at certain times we enter into interest rate swap agreements whereby we agree to pay over the life of the swaps a fixed interest rate payment on a notional amount and in exchange we receive a floating rate payment calculated on the same amount over the same time period. The fixed interest rates are dependent upon market levels at the time the swaps are consummated. The floating interest rates are generally based on the monthly LIBOR rate and rates are typically reset on a monthly basis, which is intended to coincide with the pricing adjustments on our revolving credit facility.

At July 9, 2006 and July 10, 2005, we had interest rate swap agreements with a financial institution that effectively converted a portion of the fixed-rate indebtedness related to our $125.0 million senior subordinated notes due 2013 into variable-rate obligations. The total notional amount of these swaps is $100.0 million and is based on six-month LIBOR rates in arrears plus a specified margin, the average of which is 3.9 percent. The terms and conditions of these swaps mirror the interest terms and conditions on the notes. These swap agreements expire in November 2013.

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

Our Chief Executive Officer and Chief Financial Officer have reviewed and evaluated the effectiveness 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 Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures effectively and timely provide them with material information relating to us and our consolidated subsidiaries required to be disclosed in the reports we file or submit under the Exchange Act.

Changes in Internal Control Over Financial Reporting

There were no changes in our internal control over financial reporting during our fiscal quarter ended July 9, 2006 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

In September 2003, we became aware that customers and employees at one of our O’Charley’s restaurants located in Knoxville, Tennessee was exposed to the Hepatitis A virus, which resulted in a number of our employees and customers becoming infected. As of the date of this filing, all of these cases have been settled and dismissed. We have insurance that provides coverage, subject to limitations, for lost income at our restaurants whose results of operations were adversely affected by the Hepatitis A incident. We have submitted a claim pursuant to our insurance policy for this type of loss, but our carrier has disagreed with our claim. On July 11,

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2005, certain underwriters at Lloyd’s, our insurance carrier, filed suit against us in the Circuit Court for Knox County, Tennessee seeking declaration by the court regarding certain limits in this policy which would effectively limit our recovery under the policy to $100,000. We have filed an answer and counterclaim requesting that the court declare that our coverage is not limited as asserted by the carrier. We filed a motion for Partial Summary Judgment seeking a determination of the coverage of the policy which was denied. At this point, we cannot reasonably estimate the value of any potential resolution of this claim or the timing thereof.

We are in involved in an arbitration in the matter of Ballantyne Village, LLC v. O’Charley’s Inc. filed in April 2005. Ballantyne Village, LLC has alleged that we breached a lease on a retail center for a proposed Stoney River Legendary Steaks restaurant in Charlotte, North Carolina. We believe we terminated this lease prior to the commencement of our tenancy in accordance with its terms, and that the counterparty’s claims are without merit. We intend to defend the allegations against us in this matter vigorously. The arbitration is scheduled for January 29, 2007.

On May 19, 2006, Meritage Hospitality Group, Inc. and certain of our affiliated entities (“Meritage”), which franchise five O’Charley’s restaurants in Michigan, filed suit against us in the United States District Court for the Western District of Michigan. The suit alleges that we engaged in fraud and violations of the Michigan Franchise Investment Law and Michigan Consumer Protection Act in connection with Meritage becoming a franchisee of our O’Charley’s restaurant concept. The suit seeks rescission of the development agreement and five franchise agreements with us and related damages. We are continuing our discussions with Meritage in an effort to resolve this matter. In the event we are not able to resolve this dispute, we intend to defend the allegations against us vigorously.

In addition, we are defendants from time to time in various other 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 and employment matters, discrimination and similar matters; claims resulting from “slip and fall” accidents; claims with respect to insurance recoveries; and claims from our customers 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 or accrue expenses relating to legal proceedings which may adversely affect our results of operations.

Item 4. Submission of Matters to a Vote of Security Holders

We held our annual meeting of shareholders on May 18, 2006. At the annual meeting, our shareholders elected two Class I directors to hold office for a term of three years and until their successors are elected and qualified. The following table sets forth the number of votes cast for and withheld/abstain with respect to each of the director nominees:

Director	For	Withheld
Gregory L. Burns	19,440,601	188,561
Robert J. Walker	12,846,203	6,782,959

In addition to the foregoing directors, the following table sets forth the other members of our board of directors whose term of office continued after the meeting and the year in which his or her term expires:

Name	Term Expires
William F. Andrews	2007
John E. Stokely	2007
H. Steve Tidwell	2007
Richard Reiss, Jr.	2008
G. Nicholas Spiva	2008
Shirley A. Zeitlin	2008
Dale W. Polley	2008
	2008

Item 6. Exhibits

No.	Description
31.1	Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2	Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1	Certification of Gregory L. Burns, 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.

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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 17, 2006	By:	/s/ Gregory L. Burns
	Gregory L. Burns
	Chairman and Chief Executive Officer

Date: August 17, 2006 By: /s/ Lawrence E. Hyatt                                                                  

Lawrence E. Hyatt

Chief Financial Officer, Secretary andTreasurer

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