On Thursday, Aug. 3, O'Charleys (NASDAQ:CHUX) will announce its earnings for the second quarter. Analysts are expecting a margin decline. Will they be right, or will management's initiatives begin to take hold? The suspense is killing me.

What analysts say:

  • Buy, sell, or waffle? Analysts' five hold and two buy ratings haven't changed in the last three months.
  • Revenues. Wall Street expects $225.25 million, a 5.1% increase over last year.
  • Earnings. The analysts polled came to a $0.18-per-share consensus, down from last year's $0.21 per share.

What management says:
In commenting on first-quarter results, Chairman and CEO Gregory L. Burns said, "As expected, operating costs as a percentage of sales were higher in the first quarter of 2006 than in the prior-year first quarter."

Increasing costs have been a problem at O'Charleys. Last quarter, for instance, as a percentage of restaurant revenue, food and beverages increased 30 basis points year over year, while restaurant operating costs increased by 70 basis points. General and administrative costs also increased 70 basis points as a percentage of revenue.

What management does:
While gross margins have held pretty steady on a trailing-12-month basis, both operating and net margins have declined steadily over the last three periods. Labor, restaurant operating, and general & administrative costs have all risen more quickly than revenue. In the October 2005 quarter, O'Charleys had an operating and net loss, partly due to impairment charges related to closing some restaurants, and partly due to hurricane Katrina effects. The likely passage of an increase in the federal minimum wage in the near future should put further pressure upon these margins.

Margins %*

12/04

4/05

7/05

10/05

12/05

4/06

Gross**

69.8

69.9

70.1

70.1

69.8

69.8

Operating

5.3

5.6

5.4

3.8

3.2

2.7

Net

2.7

2.9

2.8

1.8

1.3

0.9

Sales Growth %***

10.5

8.5

6.5

5.7

5.7

5.5

* Trailing-12-month data for quarter ending in month indicated.
** Based on gross profit defined as sales less cost of food, without franchise or commissary revenue.
*** Year-over-year comparison for quarter ending in month indicated.
All data from relevant company 10-K and 10-Q filings.

One Fool says:
It may seem obvious, but keeping costs under control is one of the keys to running a successful business. Occasionally, that control slips -- which may be a longer-term problem at O'Charleys than the above discussion indicates. Operating margin for 2002 was 9.3%, versus 3.1% in 2005. The company is currently working to return margins to respectable levels.

Jet Capital Investors thinks the effort will bear fruit, since it recently increased its stake to 8.5% of O'Charleys. However, in a letter sent to senior management last May, Jet Capital signaled that its patience won't last forever. If margin improvement does not happen rapidly enough, the capital firm would probably encourage O'Charleys to recapitalize itself, or even put itself up for sale. This should be an interesting situation to watch over the next year or two.

Competitors:

  • Applebee's (NASDAQ:APPB)
  • Brinker International (NYSE:EAT)
  • Darden Restaurants (NYSE:DRI)
  • OSI Restaurant Partners (NYSE:OSI)
  • Ruby Tuesday (NYSE:RI)

Whatever your investing tastes, our menu of Foolish newsletters has something to please every portfolio's palate. Sample any of our premium investing services with a free 30-day trial.

Fool contributor Jim Mueller does not own shares in any company mentioned.