Good afternoon. My name is Rob. I will be your conference operator today. At this time, I would like to welcome everyone to The Cheesecake Factory Second Quarter Fiscal 2019 Earnings Conference Call. All lines have been placed on mute to prevent any background noise.
After the speaker's remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press star, then the number one on your telephone keypad. If you would like to withdraw your question, press the pound key. Thank you. Ms. Stacy Feit, Vice President of Investor Relations, you may begin your conference.
Thank you. Good afternoon, welcome to our second quarter fiscal 2019 earnings call. On the call today are David Gordon, our President, and Matt Clark, our Executive Vice President and Chief Financial Officer. David Overton, our Chairman and Chief Executive Officer, is traveling internationally, but will be on the call for Q&A.
As you have probably seen, in addition to our second quarter fiscal 2019 earnings release, we also issued a press release this afternoon announcing that we have entered into agreements to acquire Fox Restaurant Concepts, which also includes the remaining interest in Flower Child and the remaining interest in North Italia. To help with the discussion today, we have provided a short presentation summarizing the transactions, which can be downloaded from our investor relations website at investors.thecheesecakefactory.com in the Latest Presentation section.
We will begin today's call with some opening remarks regarding the transaction and will provide an operational update. We will review our second quarter financial results, provide our outlook for the third quarter and the full year 2019, and then take you through the North Italia and Fox Restaurant Concepts transactions in more detail. Before we begin, let me quickly remind you that during this call, items will be discussed that are not based on historical fact and are considered forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.
Actual results could be materially different from those stated or implied in forward-looking statements as a result of the factors detailed in today's press releases, which are available on our website at investors.thecheesecakefactory.com and in our filings with the Securities and Exchange Commission.
All forward-looking statements made on this call speak only as of today's date, and the company undertakes no duty to update any forward-looking statements. In addition, throughout this conference call, we will be presenting results on an adjusted basis. An explanation of our use of non-GAAP financial measures and reconciliations to the most directly comparable GAAP measures appear in our press release on our website, as previously described. With that, I'll turn the call over to David Gordon.
Thank you, Stacy. I am pleased to announce that we have entered into agreements to bring The Cheesecake Factory, North Italia, and all of the Fox Restaurant Concepts together to reinforce our leadership position in experiential dining. Since making our initial minority investments in North Italia and Flower Child in 2016, we have not only helped fuel the growth of both concepts, but also developed a relationship with Sam Fox and his team at Fox Restaurant Concepts.
We realized the true potential of this relationship as we worked through the integration process for our planned acquisition of North Italia. It became evident that the combination of two of the most experiential and entrepreneurial restaurant companies could drive even greater value as one organization.
As we've gotten to know Sam and his team, we've been very impressed with their concept curation, menu innovation, commitment to hospitality, eye for design, and importantly, business discipline. In turn, we believe Fox Restaurant Concepts is the ideal incubation engine to develop concepts of the future. With regard to North Italia specifically, we're very excited about the immediate and long-term growth potential of the concept. North Italia turns a modern lens on Italian cooking in the upscale casual dining segment.
All dishes are handmade from scratch daily. We believe the unique structure of these transactions will accelerate our growth potential while enabling us and FRC to maintain our focus on our core businesses. Following the completion of the transactions, North Italia's operations will be located at The Cheesecake Factory's corporate headquarters to help scale the concept nationally.
Fox Restaurant Concepts will operate as a wholly owned subsidiary and continue to be led by Sam from their headquarters in Phoenix, Arizona. This combination will embrace FRC's creative spirit, enabling them to innovate concepts while providing the infrastructure and capital to scale.
With the power of The Cheesecake Factory brand, infrastructure, and growth potential, complemented by an additional growth vehicle in the North Italia concept and an incubation engine to develop concepts of the future, we expect to be even better positioned to provide our guests with exceptional dining experiences, offer growth and opportunities for our respective teams, and maximize long-term value for our shareholders. We look forward to welcoming Sam and his entire team.
Turning to our second quarter results. Adjusted earnings per share was within our expectations, supported by solid operational execution during the quarter. This was despite a soft restaurant industry sales environment, in which we continued to outperform. Our off-premise business again supported our comp store sales outperformance as we continued to take share in the channel. Off-premise continues to grow, comprising approximately 16% of total sales during the second quarter of 2019.
We believe our differentiated positioning, high quality, made fresh from scratch menu, and value proposition, supported by our creative on-brand marketing, are driving this performance. More broadly with regards to marketing, we continue to see positive results from our various initiatives. We celebrated National Cheesecake Day yesterday with the return of our pineapple upside-down cheesecake. A popular TV show cast was the first to taste the cheesecake and generated great social media engagement, with a number of other celebrities weighing in and joining our guests in their excitement.
In addition, our marketing team secured 50 on-air segments, and National Cheesecake Day was a trending item on Twitter again this year. This is an excellent example of how our team ties our marketing to on-brand events to generate as much publicity as possible to increase The Cheesecake Factory's awareness and drive sales.
To complement the publicity we received, we are utilizing a number of additional marketing channels, including year-round paid search and social advertising, influencer marketing, and the collaborations to more frequently remind people about The Cheesecake Factory to attain top-of-mind status. To continue to build on our sales-driving capabilities in the ongoing industry environment, we'll be taking another step forward with our marketing this summer and fall with a test of a Cheesecake Factory TV commercial.
F avorability and the cost structure of our media buy has made this an economically feasible option for our business model. We are launching a test in 12 markets with a modest but highly targeted media buy to determine if this could be effective sales driver. There will be no offer associated with the spot. We will be leveraging the strength of our brand and our more than 250 dishes made fresh from scratch messaging to remind guests about The Cheesecake Factory to capture more of their dining occasions.
Along with driving comp store sales, we are committed to our objective of maintaining flat restaurant level margins. We had good results on this front during the second quarter. Labor productivity increased year-over-year. We continued to reduce overtime hours and maintained industry-leading food efficiencies. These results underscore the importance of strong staff engagement and retention, areas where we continue to excel with both manager and hourly staff retention rates up year-over-year.
With regard to unit development for 2019, we now expect to open as many as five The Cheesecake Factory restaurants as one location has moved into early 2020. This expectation for the year includes the Oxnard, California location that opened during the second quarter. We continue to expect as many as five restaurants to open internationally under licensing agreements in 2019, including the third location in Saudi Arabia that opened during the second quarter. With that, I'll now turn the call over to Matt for our financial review.
Thank you, David. Second quarter comparable sales at The Cheesecake Factory restaurants increased 1%, including $12.4 million in external bakery sales. Total revenues were $602.6 million. Cost of sales was 22.3% of revenues, a decrease of about 20 basis points from the second quarter of last year, reflecting menu price leverage partially offset by higher produce costs. Labor was 36.2% of revenues, an increase of about 20 basis points from the same period last year. This is primarily attributable to higher hourly wage rates, partially offset by lower group medical insurance costs year-over-year.
Other operating costs were 24.7% of revenues, up 80 basis points from the same period last year. This is mainly due to the additional non-cash rent associated with the adoption of the new lease accounting standard.
There were a variety of puts and takes in other areas, including planned higher marketing costs, offset by the lapping of the final stages of our West Coast bakery infrastructure upgrade during the second quarter last year. G&A was 6.2% of revenues in the second quarter of fiscal 2019, down 90 basis points from the same quarter of the prior year, primarily driven by the lapping of legal expenses incurred in the prior year period.
Pre-opening expense was approximately $2.2 million in the second quarter of 2019 versus $1.4 million in the same period last year. We had one opening in the second quarter of 2019, we did not have any openings in the same period last year. Our tax rate this quarter was approximately 8%.
Excluding the loss on our minority investments in North Italia and Flower Child, which is primarily driven by high pre-opening costs given their unit growth levels as expected, adjusted earnings per share was $0.82. Cash flow from operations was approximately $50 million during the second quarter. Net of roughly $16 million of cash used for capital expenditures and $7 million in growth capital provided to North Italia and Flower Child, we generated over $27 million in free cash flow.
We completed approximately $28 million in share repurchases and returned nearly $15 million to shareholders via our dividend during the quarter. That wraps up our financial review for the second quarter. Now, I'll spend a few minutes on our outlook for the third quarter and full year 2019.
Please note our outlook and CapEx range do not reflect the impact from the North Italia and Fox Restaurant Concepts transactions, including any one-time integration costs. As we've done in the past, we continue to provide our best estimate for earnings per share ranges based on realistic comparable sales assumptions and the most current cost information we have at this time. These assumptions factor in everything we know as of today, which includes quarter-to-date trends, what we think will happen in the weeks ahead, and the effect of any impacts associated with holidays or weather.
For the third quarter of 2019, we are estimating adjusted diluted earnings per share between $0.52 and $0.57, based on comparable sales in a range of flat to up 1% at The Cheesecake Factory restaurants, reflecting continued softness in the industry sales environment and ongoing pressure in produce costs.
Turning to full year 2019, we now expect comparable sales in a range of 1%-1.5% at The Cheesecake Factory restaurants. On the cost side, we now expect food inflation for our 2019 market basket to be closer to 2%, given the recent inflation in produce, which we currently expect to have the greatest impact during the third quarter. We continue to estimate wage inflation of about 6%. For modeling purposes, we now anticipate a 2019 tax rate of approximately 7%-8%.
In turn, we now estimate adjusted diluted earnings per share between $2.58-$2.68, which reflects our second quarter actuals and the uncertainty around produce costs. As a reminder, our anticipated Q3 and full year EPS ranges exclude our portion of any loss from the operations of North Italia and Flower Child, driven by their high levels of pre-opening costs to support their current growth rate.
With regard to capital allocation, we now expect our cash CapEx in 2019 to be between $85 million and $95 million to support our anticipated unit growth and ongoing maintenance needs. Now turning to the North Italia and Fox Restaurant Concepts transactions we announced this afternoon. The acquisitions will be completed for $308 million in cash at closing. An additional $45 million will be due ratably over the next four years. Including the $88 million we previously invested in North Italia and Flower Child, total consideration will be approximately $440 million, equating to approximately 1.1x run rate revenues.
The FRC transaction also includes an earn-out provision based on the financial performance of the FRC brands outside of North Italia and Flower Child. Further detail on both of the individual transactions can be found in the presentation summarizing the acquisitions on our investor relations website.
The cash at closing will be funded by drawing on our upsized $400 million revolving credit facility, which we closed earlier this week, and cash on hand. With just one turn of projected leverage, we will continue to maintain a strong balance sheet and ample financial flexibility following the acquisitions. Excluding integration expenses, the transactions are expected to be approximately neutral to earnings per share in fiscal 2020 and accretive thereafter.
Our board of directors has unanimously approved the transactions, which are expected to close around the end of the third quarter of fiscal 2019, subject to customary closing conditions. We are making these long-term strategic investments to reinforce our position as a leader in experiential dining and complement the continued domestic and international licensed expansion of The Cheesecake Factory.
Specific to North Italia, we see significant white space for an on-trend Italian concept and believe North Italia is an ideal fit for the experiential dining occasions we want to offer. With the support of our growth capital investments, North Italia has expanded nationally and now has 20 restaurants in nine states and Washington, D.C., including the Reston, Virginia location, which opened today. With one more opening planned in the next two months, annualized run rate revenues are expected to be approximately $150 million upon close of the transaction.
There are two more openings planned for the fourth quarter, as well as a pipeline for 2020 in place. North's comp store sales increased over 5% in 2018, and they have sustained mid-single-digit comp store sales performance this year, underscoring the strong underlying fundamentals of the concept.
North Italia has very strong unit economics, generating about $7 million in sales on average, which equates to roughly $1,200 per sq ft. Target restaurant level margin is 18%-20% and is typically achieved by year three of operations. With an average cash CapEx investment of $3 million-$3.5 million, equating to a 2:1 sales to investment ratio, target cash on cash return is 35%+. With Italian cuisine the number one ethnic food category in the U.S., coupled with strong national reception of the North Italia concept to date, we believe there is potential for 200 domestic locations over time.
This supports our plan for 20%+ annual unit growth for the concept. Fox Restaurant Concepts is a restaurant group comprising multiple unique concepts, including Flower Child, Culinary Dropout, and The Henry.
FRC's annualized run rate revenues are anticipated to be approximately $250 million at the close of the transaction, and we believe there is potential for 20% annual unit growth for their aggregate portfolio. We have provided some additional metrics to help you with your modeling on slides eight and 10 of the presentation.
The combined company is expected to be an experiential dining category leader with nearly $3 billion in pro forma revenues in 2020 and anticipated 8%+ revenue growth, comprised of targeted comparable sales growth of 1%-2% and 6%-7% unit growth. We believe our aligned cultures and philosophies and close existing relationship that has supported a good deal of knowledge-sharing already should support a smooth integration.
We expect to capture supply chain, real estate, and additional synergies over time, which we believe, coupled with the North Italia and FRC unit economics, will support our margin recapture objective. We also expect cash flow generation to accelerate after completing the integration and plan to maintain a balanced capital allocation strategy comprised of investing in new restaurants that are expected to meet our targeted returns, repaying borrowings under the credit facility, and continuing the dividend and share repurchase program.
To assist with your modeling for next year, we're providing some initial assumptions around the acquisition impact. These are just estimates at this point and will depend on a variety of factors, including purchase accounting. We anticipate the acquisitions to contribute as much as $450 million in aggregate incremental revenue in 2020.
For next year, we estimate restaurant level margins for North Italia and FRC combined to be approximately 15.5%, which reflects a 17% level for North Italia. Both of these margin figures include a significant number of new units that haven't achieved steady state margin levels yet, given the high number of openings in 2019. When rolling in North Italia and FRC's G&A, we continue to believe that we will be able to accomplish our longer term G&A leverage objective.
We currently estimate D&A for North Italia and FRC of approximately 4%-5%, which will ultimately depend on the impact of the new lease accounting standard and purchase accounting. Finally, we project pre-opening costs per unit of roughly 12% of average unit volume for North Italia and the FRC concepts.
In closing, with diversified concepts, meaningful unit growth drivers, significant scale, robust cash flow generation, and a strong balance sheet, we believe the combined company will be uniquely positioned to drive long-term, profitable growth in today's restaurant industry.
We believe the North Italia and Fox Restaurant Concepts acquisitions are meaningful value creation opportunities to complement the power and potential of the core The Cheesecake Factory business. With that said, we'll take your questions. In order to accommodate as many questions as possible, please limit yourself to one question, and then re-queue with any additional questions. Operator?
At this time, I would like to remind everyone, in order to ask a question, press star, then the number one on your telephone keypad. Your first question comes from the line of John Glass from Morgan Stanley. Your line is open.
Thanks very much. If I could maybe just first on your outlook and your revised outlook for the year, it doesn't seem like your annual outlook changed much, just given where you came out in the second quarter, and your third quarter objectives now are a little bit lower. Can you just walk us through what the changes are? Do you think this produce issue is the primary issue within the third quarter in the comp, and that things get better on both fronts in the fourth quarter? How do you look at the year on balance now, particularly given what you've talked about in the third quarter?
Yeah, John, this is Matt. I think you're right. I would just lead with the fact that not much has changed. We feel very good about the steady, productive nature of our core business. We're right on track, really, for the EPS objectives. The few puts and takes, as you noted, certainly avocado costs have come up, predominantly hitting in the third quarter. We are 90% contracted for our total basket.
The small piece out there is produce. I think we feel good about where that outlook is. When we look at the comp for the year, it's pretty close to where we thought, maybe a little bit softer for third quarter. I think that we're seeing some of that in the industry.
When we've looked at that, there seems to be a multi-year trend where July has started off a little bit slow across the industry, maybe some changing patterns with school or other behavior there. That doesn't give us cause for concern. I think, pretty steady comp store sales in our projected range. Very small puts and takes, and pretty much in line with where we thought we would be when we started the year.
When you think about the restaurant-level margin projections for the Fox restaurants that you've provided, and you've talked about the accretion or the break-even in 2020, have you built in, or to what extent have you built in synergies, assumptions about your purchasing being better or some of the G&A reductions that you can achieve? Can you just talk about what you have or haven't assumed in those ranges [crosstalk]--
Sure.
--of restaurant margin? Thanks.
I think importantly for everybody, this opportunity is about growth. We know we think it's an excellent opportunity for us to expand in experiential dining, and the Fox team does a great job there. I think we see a lot of upside in terms of revenue production, cash flow production over time. It's not really a deal predicated on synergies. We don't expect there to be G&A synergies, only that we can leverage off of the growth that both companies can produce over time. That being said, certainly we will have more buying power, we will have greater real estate capabilities.
There will be some, but we're not factoring any of that into our current projections. That will be something that we work very closely with Sam and his team on to evaluate, and could be a benefit in the out years for us.
Okay, thank you.
Your next question comes from the line of Sharon Zackfia from William Blair. Your line is open.
Hi, good afternoon. I guess a couple of questions on the acquisition. I think you gave us enough that we can get to, obviously, restaurant level profit for Fox in its entirety. From an EBITDA perspective, could you break what that might be for the entity that you're buying? Then secondarily, I'm just wondering from a, I guess I'll use the word synergy perspective, could you leverage some of your third-party delivery relationships with the Fox concepts? How do you think about Fox as a menu incubator as well, that could feed back into some of the larger concepts like Cheesecake Factory?
Sharon, this is Matt. I'll try to tackle the first one. I think if you think about $450 million of revenue above the baseline, we will record, I guess, some in the fourth quarter. We're thinking the $450 is above what you would have previously modeled absent North. If you look at around 15.5% margins, then you've got the depreciation and amortization of 4%-5%. I think the G&A will be essentially in line, absent any one-time integration cost with our G&A target there. Then pre-opening, we tried to give a metric there. We're using 12% of AUVs.
From that perspective, with the interest cost on the revolve, you're basically getting to a breakeven EPS, and I think you can work backwards into an EBITDA number for the entity. We'd be happy to help you do that offline as well. I think that'll get everybody pretty close on the overall financials. I'll let David talk about the synergies with DoorDash, et cetera.
Hi, Sharon, it's David Gordon.
Hi.
Over the past 2.5 years and working very closely with Sam and his team, certainly Sam is quite the entrepreneur and has created some wonderful concepts. All of them based around fresh quality ingredients, taking great care of people. There's so many similarities in our two organizations.
As Matt said, as we evaluate those opportunities, whether it's DoorDash to leverage some of the scale of The Cheesecake Factory and whatever deal we have today and may have moving forward, we'll look at each one of those individually and decide what's best for the team in Arizona and also best for the broader The Cheesecake Factory company. Over time, as Sam continues to create, if there are concepts that we believe would be great to scale nationally, we'll talk about those together as a team.
If and when that time comes, we would think about having that fall under The Cheesecake Factory umbrella and then scale nationally like we've done with North, and would hope to do in the future, all goes well with Flower Child.
I guess I was asking from a menu standpoint.
Sharon... [crosstalk]
Yeah. Thank you, David.
Yes. From a menu standpoint, this is David Overton. Our team will still be doing Cheesecake Factory, and they will be doing their concepts and incubating the new ones. We want to keep their concepts very much the way they are and not Cheesecake-ize them in terms of what they're offering guests, and we want to keep ours the same. That is our plan for the future as of now.
That's very helpful. Thank you.
Your next question comes from the line of Nicole Miller from Piper Jaffray. Your line is open.
Thank you. Good afternoon. My question for the call is going back to your comment about turning on TV. It sounds very much like you will be having branding or brand equity attributes. I'm wondering if you imagine attaching any call to action, how you would measure the return. Just a quick clarification, could you translate your one turn of leverage to the approximate total dollar debt amount? Thank you very much.
Yeah. This is Matt. Nicole, we're probably going to be in the ballpark of about $300 million of debt associated with the transaction, and we would imagine the combined entity would have about that much of operating cash flow. That's our one turn.
On the TV, it's just a pilot, Nicole, that we're going to start and test in 12 markets. We will be leveraging our Made from Scratch messaging and all the attributes about how experiential The Cheesecake Factory is without a call to action, without an offer. We think that we want to test the aided awareness and see what that does, and we'll measure it over time during the pilot phase and then see what we want to do moving forward.
In terms of measuring Oh, I guess you'll just measure the pilot phase. I guess that's the answer there. Just wondering if you need a move in something besides, I guess, the obvious.
I think you're right. Since it's a pilot and not in every market, I think statistically, we'll be able to build a very valid model that evaluates sort of pre-post net on the comp store sales line, and that'll give us some perspective. Obviously, when making an investment like that, you also hope there's a tail. We'll be watching it carefully over time.
Thank you.
Your next question comes from the line of Gregory Francfort from Bank of America. Your line is open.
Hey, just one clarification, then a question. Is the percent of AUVs different than percent of sales? I guess just clarifying maybe what that difference is. Then, maybe a longer term question, does this acquisition change how you're thinking about allocating growth capital long- term between cake and nascent concepts? I guess I ask that Cheesecake store growth, are you thinking about any differently now that you have maybe 16 brands to play with rather than seven? Thank you.
Greg, this is Matt. The first question, it is sort of one and the same, we're using the percent of AUV because really it's as a percentage of the growth, right? If you use percentage of sales of the total base, it would be a totally different number. If you think about 20% growth on a $400 million run rate business and 12% of that being the cost of pre-opening, I think that'll get you in the ballpark. I think with respect initially to capital allocation, essentially, the acquisitions will be pretty close to self-funding by year two.
We don't see a need to really shift any capital allocation decisions around The Cheesecake Factory or our balanced approach. We have gotten a very good deal on the financing piece. They're highly profitable businesses.
We expect to continue to be able to grow The Cheesecake Factory, just as we have been planning to. We expect to continue to provide our dividend, and as we did this time, continue to grow that. I think we will balance a little bit in the near- term, the share repurchase program with paying down some of the debt, and that's kind of a fungible pool. Otherwise, it will be essentially this story that we had before plus. We're going to be able to do all of this growth and everything else we were doing before.
Got it. Thank you very much.
Your next question comes from the line of Jeffrey Bernstein from Barclays. Your line is open.
Great. Thank you. Two questions. Maybe first for David or David, I guess. As I think kind of bigger picture, back in the day, it was just Cheesecake Factory, and then it was Grand Lux and RockSugar, and then we were excited for the North Italia and ultimately The Flower Child. Now it seems like we've got another 10 or so more. I'm just wondering whether there's any concern on your part, because it does seem like the other secondary brands didn't ultimately maybe become the growth engine you wanted or maybe didn't achieve the synergies you wanted.
I don't know whether there's just how you think about the additional brands, whether or not that just complicates the portfolio versus historical, just maniacal focus on the Cheesecake Factory. I'm just wondering if you can lay out how you viewed the pros over the cons for that acquisition. I'm going to add one follow-up.
Thanks, Jeff. This is David. I think our maniacal approach to how we operate and run Cheesecake Factories is going to continue and will never change. As far as Grand Lux and RockSugar, as we stated previously, we don't have any plans to open up any new ones at this time. We will stay just as focused on running those brands as we always have. They have to operate perfectly and deliver great memorable guest experiences, so we'll continue to do that as well.
During this integration period with North, we've also able to stay squarely focused on Cheesecake Factory. As North, we start to operate those North restaurants, we'll continue to be able to do the same thing. 90% of our business is Cheesecake Factory today. Over time, as North continues to grow at a 20% growth rate, we'll leverage all of our expertise in growing a brand to grow North appropriately across the country.
As Sam continues to lead his team, and those other restaurants that are running through Phoenix, he's going to continue to operate them and stay squarely focused on providing exceptional guest experiences, learning from his guests as he's done over years, and being a creative force. That gives us the ability to know that he's able to do that while we stay focused on everything that's important and has been important for 40 years at Cheesecake Factory.
Got it. My follow-up was just on the operating margin for the portfolio. I know in the past in slide decks, you talked about kind of openly going from the 6% range to the 7% range and maybe 25 basis points per year of expansion on that operating margin. I just was wondering whether there's any change to that strategy or any change to the buckets within it, in terms of maybe how you could see those expanding over the next few years now that you layer in this acquisition. I didn't see that particular metric in the newest slide deck.
Hey, Jeff, this is Matt. I think that's a great question. We're currently in the process of evaluating that. We did not include it because it is still something that we're doing the math around. Our objectives around leveraging G&A still exist. Our opportunities to expand our margins with the international and the CPG business still exist. We are pursuing those. I think we're right on track for this year.
Certainly, we need to kind of recalibrate around the portfolio component of this. Nothing has changed with respect to keeping core Cheesecake Factory margins flat. That still maintains the objective. Those pieces are still in motion. Given the portfolio component here, we wanted to pull that back and make sure that we get the math correct. Certainly, nothing about it would be dilutive to any of those targets in the future.
Very helpful. Thank you.
Your next question comes from the line of Will Slabaugh from Stephens. Your line is open.
Yeah. Thanks, guys. Just a question about your comment on the consumer. You mentioned it was a more challenging consumer environment during the quarter, that your results reflected that somewhat, and your guidance into 3Q as well. It seems like this is at least somewhat new versus what you'd been saying in past quarters. I'm curious what you've been seeing maybe change within consumer activity, and if there's anything to call out either, whether it be geographically, around day parts or around different parts of the menu.
No, Will, I think that a couple of things. One, the holiday shift. Easter was significantly later this year, and there was a lot of turbulent weather. Certainly that may have been a little bit of the noise. As we referenced earlier in the call, July, I think if you look at whether it's Knapp-Track or Black Box or MillerPulse, all of those tracking mechanisms seems to year-over-year, July settling a little bit.
I think we're just as an industry, seeing that. I think other companies are reporting that. I don't think it's significant. I think these are just some of the normal ebbs and flows throughout the year. Our guidance for comps for the year has barely changed. I think it's just some of those components around the edge. The same geographies I think, are performing very consistently. We haven't seen any of the volatility that we've seen historically when there's been more of an anomaly in the sales pattern.
Okay. That's helpful. Thank you.
Your next question comes from the line of Andy Barish from Jefferies. Your line is open.
Hey, guys. Just a couple on the acquisition, congrats. You're buying some really interesting concepts. On the pipeline for 2020, can you give us any color on how much visibility you have? Should we think about unit growth as going forward as a handful of Cheesecake, maybe a handful of North's, and then sort of 8- 10 other Fox concepts per year? Is that how you're kind of thinking about that number to get to sort of the mid to high single digit overall unit growth?
I think we don't have a specific number, but I think your math is pretty close. For The Cheesecake Factory, we still think 3%, and we feel good that target is very achievable and are looking at real estate to support that for next year already. As referenced, we have a good pipeline for North Italia that would be at least at 20% growth, if not a little bit more for next year. That's pretty much in place. I would say, you're right on.
There's roughly some 45 restaurants within the FRC group that includes Flower Child, and we would target that to be about 20% on an annual basis. Certainly, they get a lot of interesting real estate opportunities given the different concepts. We feel, from a real estate perspective and the ability to sort of count on the unit growth, this only helps us in a variety of ways and gives us further leverage, pretty good opportunity to hit those targets.
Just quickly, anything we should be thinking about in 2020 on incremental labor costs from a people retention perspective at Fox, just as you move through the acquisition and into the kind of first year of ownership to maintain some of the talent there?
Well, Sam and his team are going to still be there. They're going to operate the business just as they have been. I think all the great things that they already do to be a world-class talent provider, they will continue to do that. As we noted, this is not about a synergy situation, but more about the growth opportunity. They already do a great job with that. It's already embedded in the run rates that we've put out there. The philosophies that we share around that will continue, and I think that the people knowing that we're working together will only benefit each other.
Thank you.
Your next question comes from the line of John Ivankoe from JPMorgan. Your line is open.
Hi. A couple of things. Firstly, on labor, you mentioned wage inflation of 6%. What's the outlook there? I ask that in the context in terms of where your exposure is. Are you seeing stability? Are you seeing acceleration in those costs for any jobs, whether front of house or back of house? Are there any markets that are actually experiencing any staffing shortages at this point that you're beginning to become concerned about?
John, this is Matt. On the rate, it's been pretty predictable. I would say once we sort of got into the rhythm of the increases mandated by minimum wage, tip credit changes, et cetera, it's been relatively following and has not been outside of our expectations in any of the quarters. We would imagine next year would probably be around 5.5% again, the reason it could be slightly different is just the math. As the wage goes up, the minimum wage impact on a percentage basis is slightly lower.
Certainly, with this, we get a little bit more diversified as a company in total. We'll evaluate what impact that has. From The Cheesecake Factory brand perspective, we are an employer of choice and number 25 on the best 100 places to work, and we're continuing to be able to staff our restaurants. There's a market or two that are more challenging, but not causing us to have a shortfall in any situation.
Great. Thank you. The second question on commodities. I obviously understand that your protein basket is diversified. You don't sell a lot of pork, but you also sell non-commodity chicken. Could you comment on your view on the protein market at this point? Do you foresee any challenges? If you could elaborate on the produce side, do you view avocados as just a seasonal shortfall and if there's anything else on the produce side that actually does give you concern over a quarter or two?
Sure, John, this is Matt. On the proteins, for this year, we're contracted. I think that there's still a lot of noise out there around what's going to happen with proteins. We have such a flexible kitchen, and we've worked around many situations before where you've seen ups and downs, and I think the balance does protect us to some degree. We don't have an outlook yet for 2020 on that, but I think just historically, we've been able to accommodate what we've needed to do.
I would imagine it to be in a similar range as it has been for the past couple of years in aggregate for the basket. With respect to produce, really predominantly around avocados. It's been a smaller growing season relative to last year. I think the demand continues to rise.
You had a little bit of that spike associated with what was happening in Mexico around the farms there, and I think it never really subsided. Some of this is a little bit makeshift, but I think, again, very transitory in nature based on the historical, and we've built that expectation into our guidance regardless.
Thank you.
Your next question comes from the line of Dennis Geiger from UBS. Your line is open.
Great. Thanks. Just a clarification and then a question. Just first, just wondering if your long-term five-year targets remain largely unchanged given the commentary you mentioned on the margins. The question is about off-premise, and if you could just share what that online ordering mix of off-premise looks like, what the delivery mix looks like, and then just some thoughts on where that mix can go over the next few years, perhaps as it relates to Cheesecake, and if there's anything to add as it relates to off-premise in relation to the acquisition. Thanks.
Sure, Dennis. I'll start. This is Matt. We are reevaluating those long-term targets. What I would tell you is that we feel more confident about our long-term opportunities to drive profitable growth given these additional growth engines, and just reiterating that our margin targets around the G&A and the incremental ability for international and CPG to contribute haven't changed.
We just kind of needed to reevaluate the math around the portfolio. I would say that this just gives us a significant boost to hitting any target that we've put out there before, and once we really figure out the math again, we'll be able to provide an update.
Just on the off-premise front, Dennis. Total off-premise was 16% of sales in the second quarter, which was some nice growth over the second quarter of last year. Delivery is about 35% of that 16%, and the online ordering has moved up to about 13%. That's incrementally grown over time since we rolled out online ordering, and about 50% of our guests are still phoning in. We did roll out new packaging actually last quarter, at the end of the first quarter, and that's gone very, very well.
That packaging allows the food to travel at the appropriate temperature, and also allows for the integrity and the look and feel of the food to be very close to The Cheesecake Factory experience you would get when you're dining in. We feel great about the continued growth in off-premise.
We think that there's still room across the country for many of our restaurants to continue to grow off-premise sales. As far as the acquisition goes, a lot of the concepts in FRC are offering off-premise today. We've already talked to, and some of the markets use DoorDash today, and there'll be opportunity to continue to grow that business as well.
Thank you.
Your next question comes from the line of Matthew DiFrisco from Guggenheim Securities. Your line is open.
Thank you. Just one point I wanted to clarify, and then I had a question. With respect to Easter, was that a benefit or a drag in 2Q?
Matt, we anticipated it being a benefit. I think it was slightly, but not as much as we thought. We obviously get a benefit from the holiday weeks, and we're a little bit opposite of some of the other casual diners, if you will.
Yep.
I think that it was so late in the season this year that maybe it was spread out a little bit between March and April, and maybe muted a little bit.
Just to clarify one more point and then my question, the structure here of the deal, are you owning 100% of Fox, or does Sam Fox still have a percentage ownership of the entity that will remain in Arizona?
We will have 100% ownership, and Sam will be staying on, and they have opportunities to, as we've structured the deal, there is an earn-out over the time period, but it'll be 100%.
Okay. My question to the Davids also, I guess, with respect to what you're seeing here as far as the off-premise growth and the correlation with somewhat of the waning business in the dining room. Does that call into question maybe the incrementality that you're getting from delivery and off-premise, that maybe there could be some greater cannibalization or substitution than we're led to believe initially?
I think we still feel like there's incrementality there. I think we've said in the past that probably think it's 60% incremental. We can still see that as it's grown over time. I think as Matt stated earlier, some of where we ended up with same-store sales in Q2, we don't really feel is attributed necessarily to the growth in off-premise. There could be a small part of that where that is happening as guests continue to look for more convenience, not want to come into the restaurant. We don't see that as being meaningful right now. We'll certainly continue to evaluate it moving forward.
What was the 16% a year ago?
13%.
Thank you.
Your next question comes from the line of Jeff Farmer from Gordon Haskett. Your line is open.
Thanks. I have a question and then some modeling clarification. First up on the question. Your labor costs have been kept very well under control over the last two quarters, especially in that 2Q looking at our model. I'm just curious, you gave us a couple of examples, but what is driving that, and how sustainable is that as we move into 2020?
Well, I think the real noise that we've ever had has been around group medical insurance costs. I think our operators do a tremendous job. Our forecasting and labor management tools are best in class. I think as I noted on the wage piece, we have a pretty good read at this point in time. We also continuously look for opportunities to improve in every area. We're not a step function. We're not going to take the busers out, for example. We're just going to look to be incrementally better.
I think that, Jeff, is absolutely sustainable going into next year. Then, if we have higher insurance costs, we do. We've explained that that's the right long-term business decision for the company, but I feel very good about our ability to manage our labor going forward.
I would just add that, as we said earlier, that our retention rates really are industry leading, and our ability to keep our people, being on the Fortune 100 list, as Matt talked about. Just more importantly, historically, the way we care for people really helps us because we can be more productive, we can cross-train people. There's not as much lead time because there's not as much churn. That's something we feel for sure will continue into next year.
Just on modeling. Again, you know this, so you currently just have two revenue lines, one for the Cheesecake restaurants and then another line for everything else. I'm just curious, and I know it's a little bit early, but will there be a new revenue line for Fox? In terms of thinking about this on a segmentation basis, are you going to break out Fox as a separate segment? Again, more unsolicited advice that just makes everyone's life far easier in terms of modeling this thing moving forward.
Well, I hear you loud and clear. We're in the process of evaluating all of those with our auditors, and we'll make the decisions as we get closer to the actual close of the transaction and probably be able to provide an update on that in the third quarter call.
Okay. Thank you.
Your next question comes from the line of Peter Saleh from BTIG. Your line is open.
Great, thanks. I just wanted to come back to the TV commercial test in the 12 markets. Is this an increase in investment spending in advertising, or is this a shift? If this is a shift, where are you shifting the dollars from to support this small test?
It is an increase from the marketing spend historically. We have that in our plan for this year, and it's been part of our AOP and part of what we discussed previously. We'll continue to evaluate the strategy. Again, as I said earlier, we'll see how it goes. It is just a pilot. Certainly, if it drives some incrementality and we see that it's making a difference, then we'll decide moving forward in next year's plan exactly what that marketing budget's going to look like.
Great. Just for clarification on one of the Fox Restaurant Concepts that you guys are acquiring. For Zinburger, are you just acquiring the six stores in Arizona, or are you acquiring the 24 stores that are across the country?
Great question, Peter. Very good catch on your part. It will be the ones that are based in Phoenix. That is a concept that Sam successfully launched previously and did sell the development rights but has retained the ownership of the ones in Phoenix, and that's the part that will be part of our company.
The other 18, were they still developed by Sam?
No, they're not. Those rights were purchased by a different company quite a number of years ago. Sam will continue to operate the Zinburgers that he has, and that'll be part of what we're doing, but not the other piece of it.
Thank you very much.
Your next question comes from the line of Mary Hodes from Baird. Your line is open.
Good afternoon. Thanks for taking the questions. Could you just provide the breakdown of traffic and check during Q2? As you look toward the second half of 2019 and work through your summer menu update, are you still anticipating roughly 3% pricing for the second half of the year?
The answer to the second part is yes. I think we were about at 3% pricing, we'll continue to be at about 3% pricing. The traffic was -2.8%, but the mix was a +0.7%, and as we've noted, it's really driven by delivery and the higher check average. If we were to adjust it in the way that some companies do, you're talking about traffic of about -2%, which was a little bit shorter than what we had guided to, and I think that's related to some of the Easter shift and the weather that we discussed.
Thank you very much.
Your next question comes from the line of Jon Tower from Wells Fargo. Your line is open.
Great. Thanks. A lot of my questions have been answered, but I was just going to follow up on the acquisition. The landscape in restaurants, regarding acquisitions, has really a relatively poor track record on companies being able to deliver on the synergies that they projected at the beginning of the acquisition.
I'm curious to hear from you, what gives you confidence on your ability to do that? Is it the fact that, for three years now, you've had the minority investment in those businesses and therefore have a fairly strong line of sight into how they grow, how much it's going to cost in people retention? If you wouldn't mind just elaborating on that'd be great.
Jon, this is Matt. I think you answered your own question. That's exactly right. When we've spent as much time with them and collaborated to the degree that we have with Sam and his team, we're intimately involved in the growth of North Italia over the past three years, as well as Flower Child, and having witnessed the abilities. We have a very deep knowledge of that and a lot of confidence in them and our ability to work together to continue that momentum. I would just end by saying, again, it's not about the synergies.
I think we have taken a very unique approach in the world of restaurant M&A that may or may not have gone right. We have dated for three years before this marriage, and we are also maintaining Sam's team in Phoenix as a standalone entity so that we don't disrupt that. I think that we are just, as we always do at The Cheesecake Factory, taking a slightly different approach that we think is unique and value-driving.
Thank you.
Your next question comes from the line of John Glass from Morgan Stanley. Your line is open.
Thanks. I just had one follow-up, and it's more maybe philosophical in nature. Why is this a better arrangement to buy Fox versus your prior arrangement, where I think you had a good opportunity to invest in the concepts you were most enthusiastic about and let the others sort of incubate, and when they were ready, you could put more capital into it? Now you own a portfolio. You're spending $270 million for a portfolio of some smaller brands. Some may work, some may not. One, maybe what's the rationale for that?
Conversely, I guess, is this also maybe just a recognition that the consumers may be more interested in smaller brands and that maybe you'll grow a portfolio of smaller one, two, three offs or perceived independents? How do you see the trade-off for wanting to own the whole business versus just picking and choosing, and maybe your view on how the consumer is changing, and maybe this is a way to address those changing needs of smaller brands?
John, this is Matt. I'll take that first part. Relative to the deal, if you think about the amount of money we may have purchased North for in two years, Flower Child, the incremental amount of capital and the way that Sam and his team were willing to work with us on the way that we're financing part of it now and over time, it's just a great win-win financially, right? We're virtually getting another incremental revenue of $150 million that we're sort of able to pay for over time. To top that off, we have a lot of confidence in the ability of the FRC team to do exactly what you're talking about.
To be an incubation engine, to see what the consumer likes. They've been exceptionally well-received in their different endeavors. They're a very profitable business. Economically, we were just able to structure a win-win.
I think that's unique, as we said, and different. It sort of came together as we were working on the integration for North Italia, and we think that the combination of the entities today is more fruitful than waiting over time, and the assets that they bring to bear will help with that, both in the concepts that they have and then penetrating consumers, as you noted, could be shifting. It certainly gives us a lot of options while not diluting our focus on The Cheesecake Factory.
I think we know that experiential dining is what people want today, and certainly Millennials and Gen Z, and we provide that today at The Cheesecake Factory, and now we'll be able to provide that in other forms and other restaurant concepts that will be spread out throughout the country.
Thank you.
Your next question comes from the line of Brian Vaccaro from Raymond James. Your line is open.
Thanks, and good evening. Just a quick follow-up on the FRC acquisition. I think about 1/2 the units within FRC are Flower Child. If that's right, could you give just a little more color on that concept specifically, how it's performed as it's grown across the country to the East Coast? Maybe some specifics on comp trends, AUVs, margins for that concept specifically.
Brian, hey, this is Matt. The Flower Child, in terms of the revenue production, is maybe around 35%, maybe 40%. It's a little over a 1/3, so not as much weighted potentially because it is a fast casual and they do have some other concepts that do higher volumes. I think at this point in time, we're providing an aggregate margin because not one of the brands does comprise more than about 35% of the total revenue. I think it will be more helpful to think about it as sort of an aggregate target for the time being.
Certainly, we're still in the middle of closing the transaction over the next two months and figuring out, as Jeff Farmer noted, how we're going to report on the segments, and we'll provide additional updates as we go forward.
With respect to The Flower Child brand, though, continues to do very well. It continues to hit the average unit volumes that produce about $1,000 a sq ft in sales. That's been very strong throughout the country, and we've been visiting many of those locations with Sam over the past six months and very pleased with the progress of the brand.
Okay, that's helpful. Could you also just comment on the pipeline that you're acquiring and the specifics on the unit growth outlook into 2020? Sounds like five to six Cheesecake, but how many North versus other FRC locations are you planning on into 2020?
Cheesecake will continue with about the 3% unit growth that we've projected. No change there. North will be at least 20%, maybe a little bit more. We have a solid pipeline already identified for 2020 for North to achieve that target. The FRC side, they are well underway developing a pipeline that will also be at least 20% for the balance of the business. We've got a lot of tools in the shed here to hit that unit growth, and a lot of real estate expertise between the combined company to find those locations. We're well on our way and feel good about that.
Okay, great. Then just last one, the interest rate on the debt, can you remind us where that settled at on the expanded facility?
Yeah. It will obviously depend on where we're at in the bracket and where LIBOR sits. I think it'll probably end up being somewhere just slightly south of 4%, maybe, when that dust settles. If the Fed keeps lowering, it'll be somewhere between 3.5 and four for next year, I would guess.
All right. Thank you.
We have now reached the one-hour mark. This concludes The Cheesecake Factory second quarter fiscal 2019 earnings conference call. You may now disconnect.