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Edited Transcript of CHEF earnings conference call or presentation 30-Oct-19 9:00pm GMT

Q3 2019 Chefs' Warehouse Inc Earnings Call

Ridgefield Nov 2, 2019 (Thomson StreetEvents) -- Edited Transcript of Chefs' Warehouse Inc earnings conference call or presentation Wednesday, October 30, 2019 at 9:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Alexandros Aldous

The Chefs' Warehouse, Inc. - General Counsel, Chief Government Relations Officer & Corporate Secretary

* Christopher Pappas

The Chefs' Warehouse, Inc. - Founder, Chairman, CEO & President

* James F. Leddy

The Chefs' Warehouse, Inc. - CFO & Assistant Secretary

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Conference Call Participants

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* Andrew Paul Wolf

Loop Capital Markets LLC, Research Division - MD

* Blake Anderson

Jefferies LLC, Research Division - Equity Associate

* Stephen Robert Caputo

BMO Capital Markets Equity Research - Associate

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Presentation

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Operator [1]

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Greetings, and welcome to The Chefs' Warehouse Third Quarter 2019 Earnings Conference Call. As a reminder, this conference is being recorded.

I would now like to turn the conference over to your host, Alex Aldous, General Counsel, Corporate Secretary and Chief Government Relations Officer. Please go ahead, sir.

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Alexandros Aldous, The Chefs' Warehouse, Inc. - General Counsel, Chief Government Relations Officer & Corporate Secretary [2]

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Thank you, operator. Good afternoon, everyone. With me on today's call are Chris Pappas, Founder, Chairman and CEO; and Jim Leddy, our CFO. By now, you should have access to our third quarter 2019 earnings press release. It can also be found at www.chefswarehouse.com under the Investor Relations section. Throughout this conference call, we will be presenting non-GAAP financial measures, including, among others, historical and estimated EBITDA and adjusted EBITDA as well as both historical and estimated adjusted net income and adjusted earnings per share. These measurements are not calculated in accordance with GAAP and may be calculated differently in similarly titled non-GAAP financial measures used by other companies. Quantitative reconciliations of our non-GAAP financial measures to their most directly comparable GAAP financial measures appear in today's press release.

Before we begin our formal remarks, I need to remind everyone that part of our discussion today will include forward-looking statements, including statements regarding our estimated financial performance. Such forward-looking statements are not guarantees of future performance, and therefore, you should not put undue reliance on them. These statements are subject to numerous risks and uncertainties that could cause actual results to differ materially from what we expect. Some of these risks are mentioned in today's release. Others are discussed in our annual report on Form 10-K and quarterly reports on Form 10-Q, which are available on the SEC website. Today, we are going to provide a business update, go over our third quarter results in detail and review our 2019 full-year guidance. Then we will open up the call for questions.

With that, I will turn the call over to Chris Pappas. Chris?

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Christopher Pappas, The Chefs' Warehouse, Inc. - Founder, Chairman, CEO & President [3]

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Thank you, Alex, and thank you all for joining our Third Quarter 2019 Earnings Call. Our team delivered solid third quarter revenue and gross profit performance. While year-over-year unit volume growth remained below our typical range due to changes in product mix and continued cycling out of lower-margin, high-volume placements, organic revenue growth continued to meet expectations, and our team delivered a positive gross profit to adjusted operating expense spread in the quarter. During the quarter, we also continued to invest in growth. We added seasoned sales and category specialist talent to both our East Coast and West Coast regions. We also continued to invest in our brands, our customers and supplier partners via targeted marketing events across our expanding geography. A few highlights from the third quarter include: 4.5% organic growth in net sales. Specialty sales were up 5.8% organically over the prior year, which was driven by unique customer growth of approximately 3.9%, placement growth of 3.1% and specialty case growth of 3.2%. Organic pounds growth in center-of-the-plate was approximately 0.9%. While sequentially higher than the second quarter of 2019, product mix changes continue to drive specialty case growth trends in the third quarter. On a year-over-year basis as compared to the third quarter of 2018, this represents a shift from higher-volume dairy category cases to lower- volume, higher revenue per case categories, such as specialty oils and vinegars as well as pastry and bakery products. Looking on a 2-year basis, third quarter specialty case growth averaged approximately 4.6% and specialty organic revenue growth averaged 6.8%. Center-of-the-plate pound growth compares to a strong third quarter of 2018 and continues to cycle through attrition of some higher-volume, lower-margin placements. Gross profit margins increased approximately 25 basis points. Gross margin in the specialty category increased 24 basis points as compared to the third quarter of 2018, while gross margins in center-of-the-plate category increased 54 basis points year-over-year.

In addition, gross profit dollars grew approximately 10.9% versus the prior year quarter. Jim will provide more detail on margin in a few moments. During the quarter, we continued to progress on several growth and integration priorities. The conversion of our Texas business onto our ERP platform was completed in August and the team commenced preparations for integrating Southern New Jersey-Philadelphia, which we expect to complete in the first half of 2020. In addition, our Southern California facility expansion continues to move forward. We've substantially completed the design phase and expect to commence construction in the first quarter of 2020. In terms of e-commerce, our digital and customer experience team continues to leverage customer feedback and input in creating value-add features and processes.

During the third quarter, we implemented improved search functionality within our mobile app, and we expect to introduce enhancements related to product selection and menu design in the coming months. As of October, we estimate online sales represented approximately 14% of organic revenue. This included website, mobile and electronic order applications linked directly to certain customer order systems. Approximately 20% of all specialty orders were placed on e-commerce platform. Our off-truck scanning implementation continued to progress with our South Florida operation reaching completion in the third quarter. Portland-Seattle operations will adopt this process in early 2020, followed by our West Coast distribution centers post-ERP conversion later in 2020.

I would like to thank our team members, customers and supplier partners for producing a successful third quarter. During the quarter, as we do every year in our major markets, we brought hundreds of our Chef customers and orders and supplier partners together from around the globe in New York, San Francisco and Texas. These events showcased innovative new products, ingredients, curate new relationships and strengthen existing bonds, help our customers continue to grow creatively and enhance the culinary experience for their customers.

As we get ready for 2020, our 35th year building The Chefs' Warehouse, our team has never been stronger, more focused or excited about our future as the leading national marketer and distributor to the chef-driven customer base that continues to grow with Chef's Warehouse and its family of companies as its partner.

With that, I'll turn it over to Jim to discuss more detailed financial information. Jim?

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James F. Leddy, The Chefs' Warehouse, Inc. - CFO & Assistant Secretary [4]

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Thank you, Chris, and good afternoon, everyone. Our net sales for the quarter ended September 27, 2019, increased approximately 9.8% to $396.9 million from $361.5 million in the third quarter of 2018. The increase in net sales was the result of organic growth of approximately 4.5% as well as the contribution of sales from acquisitions, which added approximately 5.3% to sales growth for the quarter. Net inflation was 2.1% in the third quarter, consisting of 2.5% inflation in our specialty category and inflation of 1.5% in our center-of-the-plate category versus the prior year quarter.

Gross profit increased 10.9% to $102 million for the third quarter of 2019 versus $92 million for the third quarter of 2018. Gross profit margins increased approximately 25 basis points to 25.7%. Specialty inflation was driven by above-average increases in cheese and dairy categories, with pastry and bakery products showing a mix of moderate inflation and deflation. Significant inflation in certain primal center-of-the-plate meats, particularly prime tenderloins, was partially offset by deflation in lower and middle meat cuts.

Total operating expense increased approximately 11.8% to $91.3 million for the third quarter of 2019 from $81.7 million for the third quarter of 2018. Excluding the impact of the earn-out adjustment, third quarter total operating expenses increased 11.1% versus the prior year quarter. On an adjusted basis and as a percentage of net sales, operating expenses were 20.3% for the third quarter of 2019, relatively unchanged as compared to the prior year quarter as increased operating costs related to our investment in Texas and in additional sales and business development talent were materially offset by lower distribution-related costs as a percentage of revenue.

Third quarter year-over-year gross profit growth to adjusted operating expense growth was a positive spread of approximately 80 basis points. Operating income for the third quarter of 2019 was $10.6 million compared to $10.3 million for the third quarter of 2018. The increase in operating income was driven primarily by increased gross profit, offset in part by higher operating expenses. As a percentage of net sales, operating income was 2.7% in the third quarter of 2019 versus 2.8% in the third quarter of 2018. Interest expense decreased to $4.5 million for the third quarter of 2019 compared to $4.7 million for the third quarter of 2018, due primarily to lower effective interest rates charged to the company's outstanding debt.

Income tax expense was $1.7 million for the third quarter of 2019 compared to $1.4 million for the third quarter of 2018. The increase in income tax expense is primarily due to higher pretax income versus the prior year third quarter. Our GAAP net income was $4.4 million or $0.15 per diluted share for the third quarter of 2019 compared to net income of $4.2 million or $0.14 per diluted share for the third quarter of 2018. On a non-GAAP basis, adjusted EBITDA was $21.6 million for the third quarter of 2019 compared to $18.9 million for the third quarter of the prior year. Adjusted net income was $6.8 million or $0.23 per diluted share for the third quarter of 2019 compared to adjusted net income of $5.5 million or $0.19 per diluted share for the prior year third quarter.

We ended the third quarter of 2019 with $21.5 million in cash. And at the end of the third quarter, net debt to adjusted EBITDA was 3.1x. Turning to our guidance for 2019. Based on the current trends in the business, we are updating our financial guidance to be as follows: We estimate net sales for the full year of 2019 will be in the range of $1.58 billion to $1.6 billion; gross profit to be between $402 million and $410 million; net income to be between $23.5 million and $25.7 million; GAAP net income per diluted share to be between $0.79 and $0.86; and adjusted EBITDA to be between $88 million and $91 million; and adjusted net income per diluted share to be between $0.96 and $1.03. This guidance is based on an effective tax rate of approximately 27.5% for 2019. Our full year estimated diluted share count is approximately 30 million shares. Thank you.

And at this point, we will open it up to questions. Operator?

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Questions and Answers

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Operator [1]

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(Operator Instructions) The first question comes from Andrew Wolf of Loop Capital Markets.

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Andrew Paul Wolf, Loop Capital Markets LLC, Research Division - MD [2]

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So on the quarter, I just wanted to -- on gross margin and profits, Chris, I think you had commented in September that prime beef was, or parts of it, some of the prime was at record high prices. It looks like you managed that okay. Or did that impact the quarter getting -- passing that through? And what is the outlook? I know the prime market can kind of vary quarter -- pretty quickly.

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Christopher Pappas, The Chefs' Warehouse, Inc. - Founder, Chairman, CEO & President [3]

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Yes. So prime has been a headwind. It's finally -- there's finally more prime. So I think the availability of total prime was like a 2%. And if I'm not mistaken, I think it's now more 7%, 8%, 9%. So availability is starting to increase until we get through probably mid-December. Tenderloins have held pretty high at record prices. And I don't think -- I mean, they're going to break. It's a question of when we get back to some normality. But we've been managing through it. It's definitely been a headwind, and we look forward to more availability and more normality, and we have -- every time that we see a market like this, Andrew, we look at it as an opportunity to rethink it for the following year, and come out with new programs and things that we could offer our customers more solutions to put steak on the menu at more affordable prices.

So we've learned -- again, we've learned a lot in this process, and I think it's going to make us better marketers in the future.

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Andrew Paul Wolf, Loop Capital Markets LLC, Research Division - MD [4]

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Okay. And just sort of a follow-up. From what I remember, Allen Brothers' catalog business and online business is pretty heavy this quarter. Does that impact the quarter? I mean, or can you raise those prices to the catalog customers, retail customers ahead of...

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Christopher Pappas, The Chefs' Warehouse, Inc. - Founder, Chairman, CEO & President [5]

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Yes, it's a balancing act. We try to get ahead of it because that product is frozen. So we try to get ahead of it when we -- as -- during the year, as we see markets that we think are very favorable, we're able to make buys. So you don't have to wait till the last minute to buy it at record prices. So we do get way ahead of that.

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James F. Leddy, The Chefs' Warehouse, Inc. - CFO & Assistant Secretary [6]

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Andy, the retail is not a huge percentage of our overall revenue [at this point].

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Andrew Paul Wolf, Loop Capital Markets LLC, Research Division - MD [7]

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No, I realize that. Just, on the operating costs, could you just sort of either, if you would, quantify the kind of deleveraging you got out of Texas and L.A.? And when and -- and if you don't want to quantify it, maybe at least answer when and how that turns into leveraging? Is it -- obviously, it's volume driven, but timing and what kind of events? How would the normal flow go? And how would an event like a tuck-in acquisition impact?

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James F. Leddy, The Chefs' Warehouse, Inc. - CFO & Assistant Secretary [8]

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Yes. Sure. So from a leverage perspective, the L.A situation is just a duplicate rent until we move in. So we're adding that back. And from an operating leverage perspective, we did generate operating leverage from a gross profit to adjusted OpEx perspective. In terms of Texas, really, the costs there are building the team. Going through the transition, over the summer, of the ERP system, we've built sales and business development talent; we've added to the warehouse; we've added to the distribution platform. So that's basically just ramping up the business really ahead of the revenue growth, which will come over the next couple of years.

We expect Texas to move closer to breakeven next year. Obviously, it won't be breakeven this year, but we didn't expect that. And in terms of L.A., we will definitely have the room for fold-in acquisitions. We expect to move into that facility in the third quarter of 2020.

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Andrew Paul Wolf, Loop Capital Markets LLC, Research Division - MD [9]

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Okay. And if I could just ask about guidance. Just in one part, in sales, I think it's like a $20 million spread for the fourth quarter. It's like 5% variability. So I'm -- it seems pretty wide. Is there choppiness in the market? Or are there -- are you looking that you might have some attrition? I'm just trying to understand (inaudible).

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Christopher Pappas, The Chefs' Warehouse, Inc. - Founder, Chairman, CEO & President [10]

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No. It's consistent, Andy, with the -- it's consistent the way -- with the way we've guided in the past. We've narrowed it from roughly a $40 million or $50 million spread as we go through the year. We tightened it last quarter, and it's consistent with the way we've tightened it in prior years.

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James F. Leddy, The Chefs' Warehouse, Inc. - CFO & Assistant Secretary [11]

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Yes. And always, the fourth quarter, Andy, it's always strong. The question is whether, when -- how does Christmas and New Year's fall? How does it affect people leaving? We had real surprises this year with the way the 4th of July week went and some of the Jewish holidays and Labor Day. It just seemed the way the holidays fell this year, they really affected our business. We did much less business than a normal week. So we -- when we look at our past quarters, we had -- our trends were strong on where our forecasts were. And the holiday weeks, really, were disappointing. It seemed almost the economy is too good, and people just take the whole week off. So looking at the fourth quarter, I think we're optimistic with -- our customers look strong. Spending is -- spending seems to be well, but you just don't know about the weather and how the holidays affect it.

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Operator [12]

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The next question comes from Christopher Mandeville of Jefferies.

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Blake Anderson, Jefferies LLC, Research Division - Equity Associate [13]

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This is Blake on for Chris. Just on the guidance again. I know you tightened the EBITDA a little bit. Was that just because we're entering the fourth quarter? Or was there anything to read into versus your expectations?

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Christopher Pappas, The Chefs' Warehouse, Inc. - Founder, Chairman, CEO & President [14]

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We raised the midpoint of our gross profit dollar guidance just to reflect the improvement in gross profit margin and gross profit dollar growth that we've seen throughout the year. And we look for that to continue. And then we raised adjusted OpEx to reflect the OpEx pressures that I went through earlier. So that's really the guidance changes.

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Blake Anderson, Jefferies LLC, Research Division - Equity Associate [15]

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Got it. Can you talk about your exposure to European imports? And any impact you expect from tariffs?

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Christopher Pappas, The Chefs' Warehouse, Inc. - Founder, Chairman, CEO & President [16]

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Yes. We haven't seen really any impact to date. If you look at the list of items, they're very specific to certain locations and very unique specifications. And given that we have over 50,000 SKUs, we benefit from that diversified portfolio of product. We also have a significant private label portfolio that gives us a lot of flexibility in the supply chain. So we're working with our customers and supplier partners. We're working with all the stakeholders involved to make sure that we can provide our customers with the right value and pricing. And so right now, we don't estimate anything...

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James F. Leddy, The Chefs' Warehouse, Inc. - CFO & Assistant Secretary [17]

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Major.

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Christopher Pappas, The Chefs' Warehouse, Inc. - Founder, Chairman, CEO & President [18]

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Major in 2019.

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Blake Anderson, Jefferies LLC, Research Division - Equity Associate [19]

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Great. That's good to hear. Last one, have you seen any impact from the buyers in California on your business?

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Christopher Pappas, The Chefs' Warehouse, Inc. - Founder, Chairman, CEO & President [20]

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Yes. Well, obviously, it's devastating to watch. We experienced this, I think it was, last year or the year before. It seems to be the new norm, unfortunately. We pray for everybody's safety and to get through this, but there's an impact. At this point, it's hundreds into hundreds of thousands of dollars, I would say, of, probably, lost sales. So I think we always kind of put in a piece of our forecast, knowing that there's going to be some fires. So we're praying that this thing gets put down to bed pretty soon, and everyone's safe. We can get some normality.

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James F. Leddy, The Chefs' Warehouse, Inc. - CFO & Assistant Secretary [21]

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It's very recent in the quarter. I think we'll know more if this thing extends. But generally, it gets calmed down fairly quickly.

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Operator [22]

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(Operator Instructions) The next question comes from Kelly Bania of BMO Capital Markets.

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Stephen Robert Caputo, BMO Capital Markets Equity Research - Associate [23]

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This is Steve Caputo on for Kelly. Just looking at your organic growth trends, if you could highlight anything that was outside of your expectations for the quarter, that would be helpful.

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Christopher Pappas, The Chefs' Warehouse, Inc. - Founder, Chairman, CEO & President [24]

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Within the ranges that we expected, the July 4 shift was a very weak week for us, that a lot of people left for the entire week. And then the hurricane in Florida. We think those two combined cost us a couple of cents in terms of top line. Other than that, the cadence of the quarter was generally as expected, and our organic growth is right around mid-single digits, kind of in the ranges that we expected.

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Operator [25]

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This concludes the question-and-answer session. I would now like to turn the conference back over to Mr. Chris Pappas for any closing remarks.

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Christopher Pappas, The Chefs' Warehouse, Inc. - Founder, Chairman, CEO & President [26]

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Yes. We thank everybody for joining us on our earnings call. Our team did a great job. It was a good quarter. Sales were strong. Profitability was strong. And we look forward to a strong fourth quarter, and everybody joining us once again. Thank you very much, and thank you for joining.

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James F. Leddy, The Chefs' Warehouse, Inc. - CFO & Assistant Secretary [27]

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Thank you.

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Operator [28]

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This concludes today's conference call. You may disconnect your lines. Thank you for participating, and have a pleasant day.