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Edited Transcript of FAT.OQ earnings conference call or presentation 27-Apr-20 9:00pm GMT

Q4 2019 FAT Brands Inc Earnings Call

May 14, 2020 (Thomson StreetEvents) -- Edited Transcript of FAT Brands Inc earnings conference call or presentation Monday, April 27, 2020 at 9:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Andrew A. Wiederhorn

FAT Brands Inc. - President, CEO & Director

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Conference Call Participants

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* Joseph Anthony Gomes

NOBLE Capital Markets, Inc., Research Division - Senior Generalist Analyst

* Richard Ehrlich

JH Darbie & Co. Inc. - Investment Manager

* Alexis V. Tessier

ICR, LLC - SVP of Restaurants

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Presentation

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Operator [1]

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Good afternoon, ladies and gentlemen, and thank you for standing by. Welcome to the FAT Brands Inc. Fourth Quarter 2019 Earnings Conference Call. (Operator Instructions) Please note that this conference is being recorded today, April 27, 2020. On the call today from FAT Brands are President and Chief Executive Officer, Andy Wiederhorn; and Chief Financial Officer, Rebecca Hershinger.

I would now like to turn the call over to Alexis Tessier of ICR to begin.

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Alexis V. Tessier, ICR, LLC - SVP of Restaurants [2]

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Thank you, and good afternoon, everyone. By now, everyone should have access to our earnings release, which can be found on our Investor Relations website at ir.fatbrands.com in the Press Release section.

Before we begin, I need to remind everyone that part of our discussion today will include forward-looking statements. These forward-looking statements are not guarantees of future performance and therefore, undue reliance should not be placed upon them. Actual results may differ materially from those indicated by these forward-looking statements due to a number of risks and uncertainties. The company does not undertake to update these forward-looking statements at a later date. For a more detailed discussion of the risks that could impact future operating results and financial condition, please see today's earnings press release and our recent SEC filings.

During today's call, the company may discuss non-GAAP financial measures, which it believes can be useful in evaluating its performance. The presentation of this additional information should not be considered in isolation nor as a substitute for results prepared in accordance with GAAP. Reconciliations to the comparable GAAP measures are available in today's earnings release.

I would now like to turn the call over to Andy Wiederhorn, President and Chief Executive Officer.

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Andrew A. Wiederhorn, FAT Brands Inc. - President, CEO & Director [3]

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Thank you, Alexis. Good afternoon, everyone, and thank you all for joining us on the call today. The COVID-19 pandemic has brought many challenges for many people, and I hope you're all staying safe and healthy. I also want to refer you to our Investor Relations page of our website, which has an earnings supplement posted separate from the press release, which I think you'll find informative to look at, at some point after this call. While technically, today's call is intended to discuss our fourth quarter 2019 results, given the changing environment due to the pandemic, I'll touch briefly on 2019. And of course, our fourth quarter financials are in the press release and the earnings supplement. So feel free to ask any questions you have. But I really want to talk about the state of the nation and how FAT Brands is doing today. We will be filing our 10-K later today, and you should see it on the SEC website either tonight or tomorrow morning.

Before COVID-19 ramped up in U.S., we were excited about the year to come. We had ended 2019 with solid momentum across most of our brands. For the fiscal year of 2019, we saw a system-wide decline of 0.7%. That's less than 1%. However, when we exclude the Ponderosa and Bonanza brands from that metric, we see positive same-store sales growth of plus 0.9%. It's important to highlight this as we believe that this weakness in the Ponderosa and Bonanza brands, brands that are over 50 years old, is a direct result of limited marketing campaigns and expenditures we have been able to make in the past on behalf of those 2 brands.

At the beginning of 2020, the Ponderosa and Bonanza franchisees approved using a national marketing fund, which increased marketing and advertising spending, similar to the increase we implemented in 2019 for the Hurricane brand. Our Hurricane franchisees and, by extension, FAT Brands enjoyed an uplift in sales subsequent to our acquisition and throughout 2019 because of the introduction of refreshed and revitalized marketing campaigns. Hurricane ended 2019 with system-wide same-store sales growth of positive 6.4%, while fourth quarter system-wide sales growth was positive 8.3%, and this compares to same-store sales declines of 4% for 2018 when we acquired the brand. This is more than a 10-point swing in the positive direction, and I applaud our team and our franchisees in getting this done. And this is exactly the example we presented to the Ponderosa and Bonanza franchisees, and they bought into it.

During 2019, our franchisees opened 24 new stores worldwide. On the corporate side, we realized the successful acquisition and integration of Elevation Burger, a 44-unit better burger brand, at the end of the second quarter of 2019. The combination of operational performance and the acquisition of Elevation resulted in adjusted EBITDA increasing by over 54% from the 2018 levels. Annualizing the revenue contribution of the Elevation Burger stores as well as the 24 new stores, we would have seen a revenue uplift of an additional $1 million if we had owned Elevation for a full year.

Given our asset-light model and lean operating platform, the vast majority of this revenue uplift would have dropped directly into our income from operations, EBITDA, and adjusted EBITDA. So we felt good about where we were from a business momentum standpoint, starting out in 2020. And looking ahead, with the subsequent completion of the refinancing transaction, we are still poised to ramp our acquisition growth strategy in 2020.

We were very, very fortunate to have completed our refinancing shortly before the severity of the impact of COVID-19 became more apparent. In early March, we announced our $40 million whole business securitization transaction, which significantly lowered our cost of capital. The proceeds were used primarily to repay our expensive term loan, decreasing our annual interest expense by approximately $2 million. Additionally, the structure includes an accordion feature that can be easily accessed in the future as needed to grow our brand portfolio.

On the flip side, March was also the month in which things were turned upside down, particularly for the restaurant industry. As COVID-19 continued to spread, state and local jurisdictions implemented safer-at-home orders, and restaurant traffic plummeted almost overnight.

In compliance with the state and local orders, our franchisees closed dining rooms and were forced to rely solely on the off-premise channel: delivery and to-go. In that regard, we were fortunate to already have a strong to-go and delivery business across many of our brands and subsequently have experienced significant increases in these low-contact modes over the last 6 weeks.

As you'd likely expect, our burger brands, which account for roughly half our revenues on a normalized non-COVID-19 basis, have held up better, off only approximately 28% on a comparable basis and 40% in absolute dollars as compared to our casual dining brands, which were off 65%. But now subject to reopening in a number of states, we think things will improve rapidly.

Across the system, approximately 150 of our 375 restaurants are temporarily closed or shut down, primarily across the steakhouse concepts as well as some Fatburger restaurants located inside casinos, which are themselves closed. During these unprecedented times, our top priority remains the health and safety of our franchise partners, their restaurant teams and their guests. To that end, we are committed to supporting our partners in doing everything we can to ensure their well-being in both the near- and long-term.

The actions we are taking include helping franchisees to acquire personal protective equipment for their staff and developing enhanced cleaning and social distancing procedures in the restaurants, so that franchisees can continue to safely serve their communities. We are helping them optimize their off-premise business through improved packaging and curated menus. In addition, we are coaching franchise partners on how to access funds available through the CARES Act PPP program and the SBA economic injury disaster loan program. And we're walking them through the process to negotiate rent deferrals from their landlords, and we have secured extended terms from distributors like US Foods and Sysco and PFG and food suppliers on their behalf.

As I mentioned earlier, the timing of our whole business transaction, the securitization, was fortunate as it enabled us to enter the crisis with a significantly stronger capital and liquidity position. The closing of the securitization resulted in net proceeds to the company of over $10 million after deal fees and repayment of the term loan and accrued interest. In addition to the significant reduction in quarterly cash interest payment, given the lower cost of capital, the excess proceeds added working capital to our balance sheet.

From the operational perspective, we've taken action at the corporate level to reduce expenditures, including layoffs of certain team members whose roles were related to activities meant to accelerate our growth initiatives in order to mitigate the impact of the reductions in royalty income from our franchisees during this closure time period. This 20% reduction of headcount has not impacted our ability to manage our ongoing operations and to assist our franchisees through the pandemic.

While the duration and severity of the ultimate impact from COVID-19 on the industry remains uncertain, we are excited about our future and our platform. We are continuing to make progress on our third-party delivery initiative. While some of our brands were well ahead of the curve, as they had been offering delivery through services such as Uber Eats, GrubHub and Postmates for years now, while others are much earlier in that process as well -- in conjunction with them, we are continuing to roll out our ghost kitchens, adding a location in Chicago last week. Our ghost kitchens not only drive third-party delivery business, but allow guests to access our brand's delicious food even in markets where the brands don't have a brick-and-mortar presence.

Our development pipeline is active, and we anticipate opening between 25 and 40 new locations in 2020. We've opened 11 already this year. There are 3 more stores ready to open, and they've been fully built and are just waiting for local authorities to permit the openings. Construction is continuing in many locations, though we do not expect delays in new store openings, and new development deals are being signed both domestically and internationally. Furthermore, we have many opportunities for brand acquisitions. Though, as always, we'll evaluate them methodically and proceed deliberately, adding only the very best to the FAT Brands platform.

Before we open the call for your questions, I'd like to extend my heartfelt thanks to all of our team members, franchise partners and their employees. The industry is facing difficulties of the like we have never experienced before, and this group has done an incredible job rising to meet the challenge.

With that, I'm going to ask the operator to open the line for questions. And I'm going to remind you that we're not going to make projections for 2019 or give guidance -- for 2020 and give guidance for 2020, given the uncertainty as to when different markets will open. But you can talk about that as you ask questions, just don't expect a specific answer. Operator?

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from the line of [Gregory Fortunoff], a private investor.

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Unidentified Participant [2]

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Andy, so my first question was going to be, are we going to make it through this, but I -- after reading the press release and hearing your comments, I know that isn't an issue. But I guess the question is, what are we going to look like? Do you expect to lose many franchisees? And what does it look like from where you're sitting, as best you can tell?

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Andrew A. Wiederhorn, FAT Brands Inc. - President, CEO & Director [3]

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Understood the question. Thank you. Look, we are certainly going to make it through this as a company. We've done every stress test imaginable, and if necessary, could ride this out in the current disastrous state for a year. So we're very comfortable that we have adequate liquidity now to survive this. But the real question is, when are we allowed to reopen? Is there any kind of a relapse? How do we plan for that? How do we ensure that we get as much momentum as possible at each brand level?

We will lose some stores. Everyone will lose some stores. I don't think it's going to be a huge number. If we have 400 stores by the end of the year or 375 stores now, we could lose 5 or 10 stores for sure. Probably a few steakhouses; not sure that we have any Fatburgers or Buffalo's Cafe or Hurricanes or -- we might lose an Elevation. Not tons of stores. It's a small number. And generally, if we lose any units, they were probably the -- they were lower contributors in terms of high average volumes and high royalties. That's not that group. So if a store is closing, it probably wasn't doing that well to start with, and just didn't have the staying power here, but I don't expect to lose a lot.

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Unidentified Participant [4]

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Okay. Second question, internationally. You were starting to get some momentum internationally. I'm assuming that's going to slow a little bit. Is that the case? Or am I wrong?

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Andrew A. Wiederhorn, FAT Brands Inc. - President, CEO & Director [5]

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Well, internationally, there's a lot going on that's positive. We have some deals in China to roll out more of the burger businesses. We'll announce those hopefully very soon for a large development deal across China. And Canada is continuing to build stores, although they'll probably be a little bit slower than they originally planned this year. I think they had planned 10 stores; now, though, they will have a few less. We've already opened a couple. And the Singapore is working on new stores right now, and they're at some pretty high average unit volumes.

So I don't think international is dead in the water. And with the momentum we have in China, I expect that that's going to -- that's really going to pick up the pieces. And those are not really in our projections for the 25 to 40 stores this year. And I think there are -- of course, domestically, we have a bunch of stores coming out as well. So I feel pretty good about development actually, about new store openings.

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Unidentified Participant [6]

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Okay. Last question, and I'll let someone else ask. So I was pleasantly surprised to hear that you are still talking about doing deals. I mean, I would assume that the environment is ripe for deals as people are struggling. Can you talk about your strategy? I mean, when should we look to expect -- in the last call, you were talking about a deal sort of imminently in the first quarter. Obviously, that's delayed. Can you give us an idea of when we could be looking for a deal and what your criteria are?

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Andrew A. Wiederhorn, FAT Brands Inc. - President, CEO & Director [7]

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Yes. Thanks for teeing that up. So the existing financing facility is expandable and is structured to add in more brands. We have some targets identified. We've had extensive negotiations. There are no binding deals yet, but there could be soon. I'm hopeful that we complete 1 or more acquisitions before the end of the quarter. And I think that we'll see the opportunity to acquire 2 or 3 brands for the entire year.

The -- what's different here is, of course, valuations are lower. Everyone understands that. We're getting more flexibility from sellers who want to get a deal done. Some need to get a deal done. Some just want to get a deal done. It depends on their circumstances. But there's more flexibility in terms of like a seller carryback note or taking preferred stock or something like that to help us get the deal done as well. Because capital is precious. And even though it's available in our securitization, spreads are wider and things like that. So, so far, the sellers that we've been negotiating with still want to make deals happen.

I'm trying to be cautious about valuations and cautious about the mechanism to make an acquisition so that there's a little bit of a formula involved that we're not setting 100% of the price today without some sort of earn-out along the way that could be adjusted. If the brand does better, great. If the brand doesn't do as well, we acquire; then our purchase price is reduced, and therefore, we're not having to take on all that risk. So there's definitely stuff to happen. And I hope that by the end of the quarter, we'll be able to announce at least 1 acquisition.

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Operator [8]

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Our next question comes from the line of Joe Gomes with NOBLE Capital.

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Joseph Anthony Gomes, NOBLE Capital Markets, Inc., Research Division - Senior Generalist Analyst [9]

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I just wanted to go back to the fourth quarter for a quick moment here. I think in the third quarter, you had mentioned that you were expecting EBITDA of $9 million to $11 million for the year. We came in at $7.7 million. Just if you can help me understand what happened in the fourth quarter, especially as you're saying that it was a solid quarter.

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Andrew A. Wiederhorn, FAT Brands Inc. - President, CEO & Director [10]

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Yes. So here's -- there's really 2 things to point to that are relevant. And understand that, again, we didn't -- we only owned Elevation Burger for 6 months. So there's another $1 million of revenue from Elevation Burger and another $250,000 from new franchises that were opened during the year that weren't open the full year.

But with respect to the quarter, our transactions where we call them refranchising affected negatively our quarter, and that's where we have gains from the sale of restaurants to franchisees where we buy them and resell them. We had a transaction fall apart to a buyer who -- of course, our luck would have it -- was from Wuhan, and put a down payment down on buying some restaurants and signed the contract. We had recorded the transaction in Q3 and had to essentially reverse it in Q4, which caused losses. There's substantially less refranchising income. We should have had another $1 million of positive income in Q4 that we expected that didn't happen because that person -- they're stuck in Wuhan, their money is stuck. They couldn't complete the transaction. And now we're not certain that they ever will. So that's a big chunk of it, that's $1 million of it.

There's also an adjustment in -- on the revenue side of things, Joe, of about $400,000, you can see, in negative store opening fees. And that's -- I'm sure you're familiar with ASC 606 and the recognition of income for franchise fees and how you have to amortize them over the life of the franchise agreement, which didn't -- isn't the way it used to be. And there's -- we adopted initially a formula to allocate some of those revenues to the actual costs we incur, and fees that we charge for opening a store; and the balance, we amortize. And while we believe that's the right way to account for it, and we believe that that's what GAAP permits, we just aren't seeing any of our competitors recognize franchise fee income the way that we all used to recognize it. Now, everyone's straight-line amortizing it.

So if you have a -- charge $50,000 for a franchise fee and you have a 15-year franchise agreement, you have to amortize the $50,000 over 15 years. You can't recognize $25,000 of it or whatever the number is to allocate to the actual costs you spent helping that franchisee open the store, training or store design or anything like that. So historically, we've done that, but we decided to take the most conservative view possible and get in line with everybody else. I know that FASB is continuing to review this. Just came out with a new bulletin that said they're reevaluating this, but we decided to go with that drop. So those 2 things account to about $1.4 million or more of a change in revenue from what we forecast at the end of Q3.

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Joseph Anthony Gomes, NOBLE Capital Markets, Inc., Research Division - Senior Generalist Analyst [11]

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Okay. Just wondering if maybe you could kind of just educate me a little bit here. If some of these -- some of the stores you lose, do they go back to you? Are they potentially stores that you would operate and then look to try and resell? Or just a little bit more color and detail how that whole process would work, it would be appreciated.

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Andrew A. Wiederhorn, FAT Brands Inc. - President, CEO & Director [12]

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So again, that falls into that refranchising bucket. And we have, before, stepped up, acquired franchise locations, put them in our portfolio, repositioned them and resold those to new franchisees. So there is an expectation that for some of those stores, we will do that. There's also the chance that we just let some go that are either like a really old location where the new capital expenditure doesn't pencil, where the market may have moved if it's a 30- or 40-year-old location and it was the hotspot at one point, but it's no longer in the hotspot. It may not make sense to acquire that store and refranchise it versus just try to sell a new franchise in that community. So I think there is that chance. We have the liquidity to do it if we need to, but I can't give you any specifics today.

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Operator [13]

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Our next question comes from the line of Richard Ehrlich with JH Darbie & Co.

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Richard Ehrlich, JH Darbie & Co. Inc. - Investment Manager [14]

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Could you explain how your ghost kitchen expansion -- because you announced it today, some news on that -- can you explain how that does not negatively impact like physical locations that possibly may open up in that area?

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Andrew A. Wiederhorn, FAT Brands Inc. - President, CEO & Director [15]

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Yes. So we made a decision with the ghost kitchen operator who is committing to open 10 ghost kitchens, 3 this year, to let them try it in some markets where we don't have an active franchise base and don't have any next 12-month or 24-month plans by franchisees to develop stores. So it's another way to get a presence in a market, and we'll have to see how it performs and see what kind of volumes they get and how successful they are. We had franchises in Chicago, years and years ago. We haven't had a lot of franchise interest in that market in recent years and decided that let's try to sell our products through delivery and to-go -- what better time to do it than now -- and see if we get some traction. And if it works, then we'll reevaluate.

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Richard Ehrlich, JH Darbie & Co. Inc. - Investment Manager [16]

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Okay. I do have 1 more question, though. I'd have to imagine there are some restaurant companies, corporations, that for future growth for yourself to purchase, they could possibly steal some names, where you may not be able to make acquisitions on the exact quantity you'd like. But as far as getting the name and maybe doing some real building, you'll have to do about to rebuild these restaurants, but I imagine you can really steal some names out there for almost no cost.

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Andrew A. Wiederhorn, FAT Brands Inc. - President, CEO & Director [17]

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It's a delicate -- yes, there's a delicate balance here, right? For sure, there's an opportunity to make acquisitions. There are buyers that we're -- sellers that we're negotiating with who, like I said, need to make a deal, and some who just want to make a deal. No one wants to make a deal if they feel they're getting picked off, horribly so, unless they're in absolute desperation. So we're going to look at those things. But we want to buy brands that are -- brands we can really move the needle with.

So there's only so many hours in a day and heavy lifting -- we have enough heavy lifting to do on our own. So trying to be thoughtful about, if we're going to buy a brand, what does that mean to us? We've been shown an awful lot of deals over the last 6 weeks. A number of them had a high concentration of company-owned stores, definitely not what we want to do. If we're going to buy a brand that has some company on source because not every brand is going to be 100% franchised, we have to have a plan. We think we can actually [get] on to refranchise those stores.

I think there's also some brands that are more ethnic than others like Korean barbecue or sushi or something like that, where it may or may not make sense for us to try to integrate it -- that into our platform. Right now, burgers, chicken -- we're not going to buy any more steakhouses at this point. But the burgers and the wing space are very good for us. So I think there'll be opportunities there.

We don't have a pizza chain yet. We don't have a salad chain or coffee and dessert, sandwiches, like I've said before. Those will all make sense, but I feel like in this environment, we know what to do with the brands we have. And brands that are similar like that will be the better acquisition candidates than just buying anything that comes along.

Capital is very valuable today. We want to really make it work. That doesn't mean that I'm not listening to you or hearing your comment, as I've heard from many others, that this should be a really good time to make acquisitions. We think so. The platform is well positioned to make acquisitions. That's the whole point of getting this platform to this scale, and now financing is in place to do that. So this is our time, for sure.

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Richard Ehrlich, JH Darbie & Co. Inc. - Investment Manager [18]

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Great. Good luck. And I'm confident if there's a chance in 2 quarters from now, you'll be actually bigger than you are now. So I think that's very lifting.

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Andrew A. Wiederhorn, FAT Brands Inc. - President, CEO & Director [19]

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Yes. I think that's a very -- that's the right way to look at it. This platform at this size needs to get bigger.

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Operator [20]

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There are no other questions in the queue. I'd like to hand the call back over to Andy Wiederhorn for closing remarks.

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Andrew A. Wiederhorn, FAT Brands Inc. - President, CEO & Director [21]

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Thank you, operator. I want to thank everyone again for joining today's call. Please look at our earnings supplement that's on the IR website. Stay safe and have a great night, and look forward to updating you with Q1 around the end of May.

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Operator [22]

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Ladies and gentlemen, this does conclude today's teleconference. Thank you for your participation. You may disconnect your lines at this time, and have a wonderful day.