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Edited Transcript of GRUB earnings conference call or presentation 29-Oct-19 1:00pm GMT

Q3 2019 GrubHub Inc Earnings Call

Chicago Oct 30, 2019 (Thomson StreetEvents) -- Edited Transcript of GrubHub Inc earnings conference call or presentation Tuesday, October 29, 2019 at 1:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Adam Patnaude

Grubhub Inc. - Head of Corporate Development & IR

* Adam J. DeWitt

Grubhub Inc. - President, CFO & Treasurer

* Matthew M. Maloney

Grubhub Inc. - Founder, CEO & Director

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Conference Call Participants

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* Aaron Michael Kessler

Raymond James & Associates, Inc., Research Division - Senior Internet Analyst

* Bradley D. Erickson

Needham & Company, LLC, Research Division - Senior Analyst

* Brian Thomas Nowak

Morgan Stanley, Research Division - Research Analyst

* Elliot Alper

D.A. Davidson & Co., Research Division - Analyst

* Heath Patrick Terry

Goldman Sachs Group Inc., Research Division - MD

* Jason Stuart Helfstein

Oppenheimer & Co. Inc., Research Division - MD and Senior Internet Analyst

* Ralph Edward Schackart

William Blair & Company L.L.C., Research Division - Partner & Technology Analyst

* Ronald Victor Josey

JMP Securities LLC, Research Division - MD and Senior Research Analyst

* Thomas Steven Champion

Cowen and Company, LLC, Research Division - VP

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Presentation

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Adam Patnaude, Grubhub Inc. - Head of Corporate Development & IR [1]

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Good morning, everyone. Welcome to Grubhub's Third Quarter 2019 Earnings Question-and-Answer Call. I'm Adam Patnaude, Head of Investor Relations. Joining me today to discuss Grubhub's results are Founder and

CEO, Matt Maloney; and our President and CFO, Adam DeWitt.

This conference call is available via webcast on the Investor Relations section of our website at investors.grubhub.com. Today we'll be answering questions about our third quarter results, which are

contained in our press release and also discussed in our shareholder letter. Both the press release and shareholder letter have been attached as exhibits to our current report on Form 8-K filed with the SEC

and are posted on the Investor Relations section of our website.

I'd like to take this opportunity to remind you that during this call, we will make forward-looking statements, including guidance as to our future performance. These forward-looking statements are made in

reliance on the safe harbor provisions of the Securities and Exchange Act of 1934 as amended and are subject to substantial risks and uncertainties that may cause actual results to differ materially from

those in these forward-looking statements.

For additional information concerning factors that could affect our financial results or cause actual results to differ materially, please refer to the cautionary statements included in our filings with the

SEC, including the Risk Factors section of our annual report on Form 10-K for the fiscal year ended December 31, 2018, filed with the SEC on February 28, 2019; and our quarterly report on Form 10-Q for the

quarter ended September 30, 2019, that will be filed with the SEC. Our SEC filings are available electronically on our Investors website at investors.grubhub.com or the EDGAR portion of the SEC's website at

www.sec.gov.

Also, I'd like to remind you that during the course of this call, we will discuss non-GAAP financial measures in talking about our performance. Reconciliations to the most directly comparable GAAP financial

measures are provided in the tables in the press release.

Finally, as a reminder, all of our key business metrics exclude transactions like LevelUp and Tapingo, where Grubhub only provides technology or fulfillment services.

And now we'd like to open the call up for questions. Operator?

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Operator [2]

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And before we go to questions, I'd like to turn the call over to Matt Maloney, Founder and CEO. Go ahead, please, sir.

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Matthew M. Maloney, Grubhub Inc. - Founder, CEO & Director [3]

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Thank you. I just want to say a couple things. Thanks for everyone for digesting the letter that we sent out last night. We switched up the method of communication because I think the story was very complex,

and we wanted to get it out clearly and as succinctly as possible. I think we did a great job of outlining the issues that the industry faces and how we are looking to address those through our strategy.

Through the past like 12, 15 hours, we've fielded a lot of calls and inbounds. There's a few items that I just want to clarify before we get into the Q&A because I think it can be helpful. The first is there

was some misunderstanding whether this was an evaluation of Grubhub's situation, specifically, or if it was industry. This -- we have more experience in this industry than anyone else. This is an explicit

overview of the entire industry, and every team that's executing in this space needs to address their strategy in light of the facts that we outlined in the letter.

The overall growth rate, I just want to be clear, is where we think it is right now. There's not going to be artificial accelerants from any of the supply side innovation that was outlined, and I think we

all need to just address that as it's an industry-wide behavior.

The second is there was some confusion around the promiscuity of cohorts in -- or in the older cohorts versus the newer cohorts. To be clear, a very small fraction of our diners use other platforms in

general, and the newer diners use multiple with a much greater degree of frequency. The older cohorts are definitely more stable, but we think that small parts of those cohorts are testing the waters at

different points, and that's why closing the restaurant gap is so important.

I think the point of the strategy is that we're taking our profitability and reinvesting it back in the business as aggressively and competitively as we can. And we would not do that if we thought the

fundamental profits of the business were at risk.

There was a point in the call last night when somebody brought up the analogy that we have the biggest weapon that is reloaded every single day, and we will never have to beg for ammunition. And I think

that's pretty appropriate in this case.

So I wanted to address those 2 things before we got into the rest of the Q&A, but I'm happy to turn it back to the operator for questions now. Thanks.

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Questions and Answers

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Operator [1]

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(Operator Instructions)

And with that, your first question comes from the line of Ralph Schackart with William Blair.

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Ralph Edward Schackart, William Blair & Company L.L.C., Research Division - Partner & Technology Analyst [2]

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Matt, thanks for the initial comments and for all the good detail on the shareholder letter last night. Maybe if you could just give a little bit more color and share perspective on what's working with

Grubhub's current strategy. And as you see it, what's needed with the new strategy and the gaps you sort of talked about in the letter? Also maybe just share some perspective on what led you to decide this

was the right time for Grubhub to invest in these specific areas. And then just a quick follow-on, how much of the strategy shift do you view as offensive versus defensive in nature?

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Matthew M. Maloney, Grubhub Inc. - Founder, CEO & Director [3]

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Yes, Ralph, great question. So let me start out by saying the only thing that matters now is diner-side differentiation. We're not seeing any of the acceleration from the supply side innovations. There are 3

scaled-out national players, and so our initiatives are focused on creating the most compelling platform for diners so they don't need to look anywhere else for what they want.

If you think about the industry historically, third-party delivery unlocked new pockets of growth over the past few years. But with all the major players, at least expanded across the whole U.S., delivery

coverage has now been commoditized. And we've said stuff like this before. We all have roughly the same algorithms, same driver interactions, the same ETAs. Five-minute difference in delivery time is

negligible for diners. Effectively, delivery as a function is commoditized. And now with non-partnered restaurant inventory becoming more prevalent, the supply side is soon going to be commoditized as well.

So I mean, first and foremost, we need to clearly close this restaurant gap. We're already on our way. We're scaling aggressively. We have tens of thousands of non-partnered restaurants already listed. We've

been piloting for a while. We have already made the call to scale this out, we're just announcing it right now.

This is 1 of the 2 letters -- or areas that we highlighted in the letter, where we need to improve our consumer value proposition. I would say this part is the more defensive side. As diners are starting to

sample multiple platforms, we want to make sure that there's no reason for a diner to slip back to a previous platform once we've effectively stolen that diner from a competitor.

And so for restaurant inventory, we'll start there. We plan to expand our unpartnered restaurant inventory and grow our sales staff to add more partnered restaurant inventory.

We tested this, call it place and pay. We've -- in the past, we've shared with you before it's a bad experience for diners, it's a bad experience for drivers, it's a bad experience for restaurants. But our

peers have shown real growth; not profits, but they've shown growth using the tactic. And we think there's a benefit to having a larger restaurant network from finding new diners and not giving, again,

diners any reason to go elsewhere.

So it's more expensive for the diner because the restaurant isn't paying, and there are higher fulfillment and care costs. And we don't make a lot of money on these orders since the diner pays full freight,

and there's definitely a mixing cost associated with these orders in addition to the initial start-up costs. And because of all that, we plan to increase our restaurant sales staff aggressively. We still

firmly believe that partnering with restaurants is the right path forward in this industry. So we plan to bring a lot more employees on to help get restaurants across the country signed up for marketplace

immediately when we start to see success in the place and pay.

So with that backdrop, the commoditization of the delivery and the restaurant supply, which I think has happened more -- or it's happened faster than I think we thought it would happen. But with that as a

backdrop, the winner in this space clearly has to have a differentiated experience for diners.

We believe we have 2 core advantages in the space, and this is where the offense starts to come in. First, we have a huge advantage of pricing. We have the largest partnered independent restaurant network

available. This independent restaurant network supports 80% of our order volume now. As we go into 2020, we'll have over 100,000 SMB independent restaurants on our platform. And it's a network that's taken

us 2 decades to build. But with the significant scale in these independents who are willing to pay for demand generation, that's the key, we can offer the lowest prices to consumers because we don't have to

seek profit and aggressive consumer fees.

Many of you have done pricing surveys. And it's consistently supported that we have lowest prices, and it's extremely difficult to offer our pricing if the majority of our volume came from the largest

enterprise brands, because they only pay us for delivery and they don't need us for demand generation. So first, we have a core pricing advantage; and second, we're immediately increasing our already

aggressive investment in restaurant loyalty programs.

The Perks program, which we talked a lot about last earnings call, is already very exciting. Over 20% of our diners are redeeming loyalty rewards right now. Restaurants have given away over $70 million so

far this year on our platform to diners. And the restaurants have seen that free food increases their competitiveness on our platform, which is rewarded by accelerated growth for them.

So we'll be spending a lot of money in the next 12 months, priming the pump for restaurant loyalty programs to show them the immediate ROI to generate that long-term investment from restaurant groups on our

platform. We think that loyalty can be a unique differentiator, a unique long-term differentiator, because of our LevelUp infrastructure. LevelUp has been evolving restaurant loyalty tools for years now.

We also share our customer data with our closest partners to help them build an asset over time, and we have our in-house POS integrations. And the in-house POS integrations, they allow us an unprecedented

level of flexibility and sophistication to build and manage the business rules for loyalty programs. We have real-time access to inventory, real-time access to prices. And so our loyalty programs will always

be better than anyone else's loyalty programs who go through a third-party integrator for POS integrations.

We know that diner loyalty programs drive growth for restaurants. We've seen this for independent and enterprise partners, and we know that restaurants are willing to fund these rewards over the long term as

long as they show positive ROI.

We also know that our competition diners are placing more and more orders on our platform, so we want to retain as many of these diners as possible. Our goal is to build extremely engaging experiences for

diners that reward usage with economic and emotional incentives.

We've seen in the data that we're able to steal share, that diners are sampling across platforms, especially in the newer markets that we've entered in the last year. We want to capitalize on each of those

opportunities. We want to make sure that the diners, when they sample our platform, see all the restaurants they want to order from and see as much economic incentive in terms of lower base price as well as

loyalty rewards to be as sticky as possible.

In order to emulate our pricing advantage, our competitors will have to dramatically expand their independent partnerships, which they're trying right now, but this takes a lot of time and it's very

difficult. In order to emulate our loyalty advantage, the competition will have to give away a tremendous amount of money, which is a very challenging problem when they're each losing over $1 billion a year.

And thanks to WeWork recently, there's a lot of pressure to achieve profitability. So when you're asking me about the timing, there's definitely a timing element to this. Everyone knows that there's extreme

pressure on profits right now. And so this is the time that we should be leveraging our advantages to create a differentiation that to replicate will be extraordinarily expensive, especially to our

competitors' bottom line.

In the longer term, we're at least 2 years ahead of the industry in terms of our loyalty technology and tools. And I think that we have a long runway to execute on this strategy very effectively.

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Operator [4]

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Your next question comes from the line of Tom Champion with Cowen.

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Thomas Steven Champion, Cowen and Company, LLC, Research Division - VP [5]

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Can you provide any more granularity around the order trends that emerged in August? The letter talks about this. Did they continue to deteriorate? Or has this sort of stabilized? And can you just talk --

you discussed it a little bit, but can you just describe why this is an industry-wide phenomenon? Or if it's more specific to Grub?

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Adam J. DeWitt, Grubhub Inc. - President, CFO & Treasurer [6]

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Yes. I'll talk about the -- Tom, it's Adam. I'll jump on the order trends, and I'll let Matt talk about the industry comments. But the -- in terms of the trends that we saw, I think we try to lay it out

fairly clearly in the letter. We noticed in August that growth had deviated noticeably from where we thought it was going to be, and it caused us to take a closer look at the causes.

And you see kind of the results in the letter, which is we saw that the newer cohorts in our newest markets, as Matt said, were not maturing at the same level of frequency as we had expected or we would have

forecasted based on prior cohorts' behavior. And when we dug in further, we noticed that a lot of those diners were coming to us already customers of other platforms. And so by nature, some of them would be

ordering on multiple platforms forever. Some of them may stay with Grubhub, but the maturation of frequencies was a little bit lower, and it jumped out in August when we looked at the data.

In terms of stabilization, I think the comments I'll give there is we're 1/3 of the way into the fourth quarter. And obviously, our month -- our quarter-to-date performance is baked into our guidance. And

what I'd say there in terms of order growth, it's -- we're currently viewing it as slightly lower than the third quarter but not another leg down. And most of that is just from having 3 full months of weaker

order behavior versus the 2 that we had in the third quarter. So hopefully, that's helpful.

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Matthew M. Maloney, Grubhub Inc. - Founder, CEO & Director [7]

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Yes. And Tom, in terms of industry versus Grub, there's a few data points that we're triangulating to make that statement. And the first is the third-party data, and I've railed against the accuracy many

times. But if you look at it and all of the data shows everyone down turning consecutively, there's definitely something in that data.

The second thing is it's structural. I think we did a really good job of evaluating the historical growth patterns in the industry. If you look at our growth prior to what we labeled as supply side

innovations, you could see that, by nature, consumers in this offline-to-online transition, they do not run en masse to the online platform. It is slow and steady long-term growth. It's been a hallmark of

this industry until 2017 when you saw the first innovation, and then 2018 when you saw the second. And expectations that the industry would maintain at that growth rate, I think were exaggerated.

Now we're back down to a place where all of the competitors are effectively in all of the markets with commoditized delivery as well as supply. There's not an obvious way that anyone has an edge outside of

the strategy we're outlining here. And so we are all going to be held within the aggregate growth rate of the industry, whatever that ends up being.

A third point that we're looking at is all of this came about because we realized we were stealing share in markets we were not expecting to steal share. So it was kind of a surprise to us as well, an

interesting opportunity is how we're looking at it right now. We had the incumbent mindset, concerned about where we were going to be losing share. And here we are in the most aggressive markets where we

told all of you guys a year ago, we were going to grow as fast as we could. Here we are stealing share, and the share that we were stealing was less valuable than we expected it to be, but that's because

these weren't fresh, clean, brand-new cohorts. These were stolen diners who had a history of ordering on other platforms, and we didn't have the same restaurant network in many of these communities that they

were expected to. And so the fact that they're performing a little bit less, I think is pretty logical. We have to fix that because we hope to see those cohorts perform at or above what we were hoping.

And then finally, many of our competitors are private companies that are raising money right now. And so we're talking to the same investors that they are, and we're hearing their stories that they're not

growing as fast by any stretch. And so there's a lot of dancing around that fact. And I think there's a lot of investments you'd expect if you were trying to hide the fact that your fundamental acceleration

has gone around international investments or acquisitions that I think are just trying to avoid the reality of what we outlined in the shareholder letter. So we chose the fact to be straightforward and

transparent with exactly what we're seeing and address that reality in our strategy and discuss that with all of you now.

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Operator [8]

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Your next question comes from the line of Ron Josey with JMP.

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Ronald Victor Josey, JMP Securities LLC, Research Division - MD and Senior Research Analyst [9]

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I wanted to drill down a little bit more on just the lowered 4Q guidance specifically and just trying to understand the delta or maybe difference between demand softness that potentially you're seeing. Or

maybe on the revenue side, just the ramp in contra revenue that led to that sort of decline in guidance for 4Q revenue. Any bridge there would be helpful.

And then to that end, talking about overall rationalization and just the $100 million in EBITDA or at least $100 million next year into 2020. Can you just talk to us about where these costs might be coming

from? Understood restaurant sales, but anything on the tech side? And I ask only because you talk about the $2 per order; assuming everything would be steady state, are you focused on cash flow? So if you

take that $2 and then you get the $100 million, it's a meaningful amount of investment. So any revenue bridge would be helpful and then any insights on where you're investing next year would be great.

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Adam J. DeWitt, Grubhub Inc. - President, CFO & Treasurer [10]

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Yes. Thanks, Ron. So in terms of the fourth quarter, I'm glad you asked the follow-up there. So obviously, I just had some comments about the growth rate in the fourth quarter. But both EBITDA and revenue,

we're taking down about $60 million. And what I'd say there is rough -- kind of rough brackets, about half of that is due to the -- is due to volume and half of that is going to be -- on the revenue side is

going to be due to revenue per order, as you said, contra revenue.

I do want to highlight -- dig into that a little bit deeper because it's not -- what we're not doing is ramping up on promotions. What we're doing is -- are the things that we outlined in the letter. One is

supporting kind of these free delivery campaigns with some of the larger enterprise brands, McDonald's, KFC, Taco Bell, Panera. We found that these are really good ways to seed -- get our diners to -- first,

get the awareness that those enterprises are on our platform, helps attract new diners, helps retain diners, et cetera.

And then we're also using pricing levers to work on, Matt talked about differentiation in the platform. So loyalty, working on new diner conversion and testing into kind of optimal pricing for non-partnered,

the loyalty programs, et cetera. And so when you look at that $60 million that we took down on the revenue side, that's how it breaks down. But be it from a growth perspective, we're not anticipating another

big step-down at this point from DAG growth.

We're looking at 2020, I think that the first thing you have to realize is we are not giving 2020 guidance right now. I think the purpose of putting that number out there was to say -- is kind of underline,

we firmly believe we will be generating significant profit next year while we're investing, and our platform gives us the ability to do this and lean in on these opportunities. And so that's not formal

guidance.

But if you want to think about it in broad strokes, we can do it from the -- I'll do it from the $2 an order or you can think about it more broadly from The Street. The $2 number is really saying, "Hey, this

is if we're managing the business to lower volume and trying to extract as much cash flow as possible." And to your point, there's a lot of investment applied in there. But we're operating the business as

though we're supporting a much higher growth rate, right. If we wanted to get to $2 -- I'll do it both ways. If we wanted to get to $2 an order, what we would do is take down our advertising by a bunch and

then take a bunch of costs out of overhead and -- instead of investing behind initiatives.

If you want to do it the other way, which is kind of think about where The Street was versus where -- versus that $100 million, I think that's probably a little easier to think about. Obviously, that -- The

Street number is not our number. But in broad strokes, what I would say is about half of that is volume-related based on current trends, and then half of that is investing behind these initiatives.

And so at the end of the day, the reality is we are investing, right, all of that, right. If we're keeping the business at the same size at a lower volume, the implication is that we're investing. So we're

investing a lot more than the explicit amount that we're putting into these initiatives. But for all the reasons Matt outlined, we have a lot of confidence that it's going to drive long-term growth and put

us in a better spot in the long term.

I do want to -- the last thing there is when we're thinking about the spend behind the initiatives, and I gave you some real high-level brackets as to what that -- what we think that spend is going to be,

you got to remember that that's all discretionary, right. So we have the ability to ratchet that down if it's not working or move out of it over time.

And so it's not the same as like, let's say, when we launched delivery in 2015 and we had all of this expense out there, and it would've been hard to unravel. A lot of this is testing pricing levers, trying

to accelerate restaurant sign-ups and things that we have a lot of control of. So I hope that helps give a little bit more color to both the 4Q guide. In broad strokes for the fourth quarter, roughly half of

that decline is the initiatives. And so for both 4Q and 2020, it's about 50-50 in terms of the volume decline and then the initiatives.

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Operator [11]

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Your next question comes from the line of Brian Nowak with Morgan Stanley.

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Brian Thomas Nowak, Morgan Stanley, Research Division - Research Analyst [12]

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I have 2, please. So the first one, just on the comment about the low double-digit growth rate and the way to think about the industry. And I guess there's third-party data out. We're probably going to hear

from another food delivery company pretty soon over the course of the earnings season who may refute that. So I guess I'd be curious to sort of hear what mathematical analyses or what gives you confidence

that it's actually the industry that's slowing low double digits and not a Grub-specific problem?

And then the second one, I think in the letter you say a common fallacy in the business is that an avalanche of volume, food or otherwise are going to drive logistics costs down. I guess in your previous

slides, you laid out how self-delivery and the marketplace can sort of get to the roughly same profit per order. What changes now that you think the previous analyses were incorrect as you think about the

long-term profitability of delivery? And what is the right way to think about long-term profitability of a delivery order now?

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Matthew M. Maloney, Grubhub Inc. - Founder, CEO & Director [13]

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Brian, let me address your first point and maybe give a quick pass at the second, and then Adam can follow up with the specifics on what you're asking about. I mean the industry-wide versus Grub-specific, I

kind of just answered that question. When you look at the third-party data available, when all of the data is pointing in the same direction, it's hard to argue that it's completely wrong.

Secondly, looking at the other food app that is going to be talking about this and potentially refuting it, their innovation is outlined in our paper as well and it justifies their significant growth at a

point of time. And I don't think we have seen that growth rate consistently executed on since then. And so I think that if you look at the fact pattern over the past few years, it supports the analysis that

we put forward last night. And we're stealing share in specific markets.

So we're looking at markets where, for example, it's only 1 competitor. We're launching in that market successfully, both on a logistics and an advertising diner perspective. We're evaluating those diners

and seeing that we are attracting consumers that have consistently ordered on other platforms. So even in these smaller very new markets, we're seeing we're butting up head-to-head against the competition.

And so I don't think there's a question of if this is just us or if this is industry-wide. I guess only time will tell. But I think that our argument is concise and accurate.

The fallacy around a lot of activity will make your delivery network more efficient, that -- we put that in there because we're hearing a lot of noise around corner store delivery, Walmart delivery, various

exercises that your delivery team can execute on and the justification that there is kind of this asymptotic decline of incremental expense to 0. And that's just not true.

So we kind of laid it out in clear terms. It takes about 0.5 hour to do something, to go pick something up, to take it somewhere and to drop it off. Clearly, there's a bundling opportunity, which we've

talked about before, and everyone's trying to crack that code. But you're not going to get to a place where it costs $1 to deliver something even if you deliver everything that needs to be delivered across

the entire country.

So I think we were just poking a hole in that thought bubble around, "Hey, we're going to really make our ICs extremely busy, and we're going to see the incremental costs go to 0, and this is going to be

full-on profit." I think there's a lot of bogus arguments floating around our industry when you're trying to justify incremental jolts of capital. And so we're just trying to pop those fallacies when we see

them.

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Adam J. DeWitt, Grubhub Inc. - President, CFO & Treasurer [14]

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Brian, just to follow up real quick. In terms of the industry going to low double-digit growth, our comment is that it's going there. It may not be there next month or the month after, but it's trending

there quickly. I mean you don't have -- you know how growth rates work, where you just have this pent-up amount and you're comping different periods and things like that. But the growth is -- from our

perspective and the data that we're looking at, the growth is slowing quickly. And we think that, long term, this industry can support low double-digit growth.

There's a lot of opportunity left. But it's -- as Matt said, there's not a lot of magic tricks where you can just throw 100,000 new restaurants on a platform and give delivery or give options to people that

don't have it before. And so it's going to be a ground battle where we're competing on, as Matt said, on diner differentiation.

And just a couple extra thoughts on the cost of delivery. I think the comments were meant not to counter what we've said historically on delivery, which we still believe is absolutely true, where for an SMB

where we're sharing the cost of delivery, we can deliver the food economically at a price that's reasonable to a diner. I think it's meant to underscore some of the challenges of working on the extremes of

the model where you're working with, for example, a QSR. Even if you're partnered with a QSR, I think we've talked about this before, that if the AOV is lower and the tip is lower and the amount that you're

getting paid is lower, it's a lot more challenging to make the economics work. And so you have to pass that on to the diner. And just by adding a ton more volume of QSRs, you're not going to be able to drive

that price down or the cost to Grubhub down dramatically. And that equation is even more dramatic when you think about QSR -- a non-partnered relationship, where we're bearing 100% of the cost.

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Operator [15]

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Your next question comes from the line of Brad Erickson with Needham.

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Bradley D. Erickson, Needham & Company, LLC, Research Division - Senior Analyst [16]

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Just 2 for me. One, given that you mentioned you're not making as much money with the larger QSRs versus independents, SMB restaurants, can you explain the rationale just, I guess around the investment? You

talk about with some of those larger delivery partners. I guess it seemed like those initiatives are leading you right back to sort of the same lower-LTV diners, which have emerged in these newer cohorts. So

still just need some help understanding the strategy in light of needing to remedy what appears to be, I guess a marginally lower diner LTV.

Second, on signing up restaurants where you're not contracted with, just what have you seen in terms of new diner acquisition and where you've started doing that? Or what do you expect out of that? Just

curious if it's as simple as just jump-starting your performance marketing conversion in subscale markets? Or what are your expectations for that new arrangement?

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Matthew M. Maloney, Grubhub Inc. - Founder, CEO & Director [17]

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Brad, I'll talk about the QSR. So yes, 80% of our volume is currently going to the SMBs. It's definitely a higher margin. The restaurants are paying us for the demand generation. It makes the model work. The

challenge around QSR is it's what a lot of the consumers want. And so it's -- I would almost say it's impossible to win the category without QSR. And we've seen over the past few years, especially in the

non-partnered models, when they list the QSRs on a non-partnered basis, they have a tremendous jump-start in their funnel and their new diner marketing.

So I wouldn't think about it in terms of lower-LTV cohorts of consumers. I think about it as definitely, we're not getting paid for demand gen. Demand gen is where we make our profits. Hopefully, we're

getting paid for the delivery, but it makes our marketing more effective. And so you're creating a funnel, and this is what we saw with the Yum! markets over the past 18 months is you have a market that were

completely not executing it. And so we drop a Taco Bell, a KFC, a few Cornerstones from the Yum! network in there. And then we pepper a bunch of SMBs around that, and that creates the initial marketplace for

us.

And what we've seen is that consumers that begin ordering from Taco Bell, because Taco Bell is doing their advertising, they're doing their in-store, they're promoting their channels on Grubhub, you have --

the consumers are introduced to Grub via the brands that they know and love. And then they start to broaden and they order from more and more SMBs. In fact, we've seen a lot of diversification of ordering

from consumers, especially in these early Yum! markets, where that was kind of our bet, that diners would come to the platform from the QSR relationship, and then they would diversify and start to order from

more of the SMBs that would then justify the actual marketplace. And we are seeing just that.

So I wouldn't say we're getting lower LTV cohorts. I wouldn't say that the QSRs are one of the reasons that we're seeing the cohorts not perform where we thought they would. I would say the QSRs are

definitely doing their job in attracting consumers to our platform. And it's our job to then channel that demand to the SMBs to make a higher margin on those consumers.

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Adam J. DeWitt, Grubhub Inc. - President, CFO & Treasurer [18]

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In terms of the non-partnered, as Matt mentioned, we've rolled out a bunch of them in a few markets. And to your point and to our strategy and the way to use them, we think that they do help us acquire new

diners. So if a diner is looking online for a specific restaurant, they can find us in SEM or SEO now as a non-partnered restaurant, whereas before, they couldn't. And so we do find that the percentage of

diners that are ordering from the non-partnered, that are new diners to Grubhub, is higher than the percentage of new diners that order from a typical Grubhub-partnered restaurant.

I will say that we've underlined this a bunch, and we've seen it in practice so far, which is the prices that we have to charge the diner, because they're basically bearing full freight for the cost of the

delivery on the non-partnered, are so high that the conversion on those orders is a fair amount lower. And so even though we're adding tens of thousands of restaurants, I think we said we're going to --

we're likely to double our restaurant supply over the next year. We don't expect the numbers of orders to be similar at all to the partnered restaurants. And I think it's our job over time to make those

restaurants, turn those restaurants into partnered restaurants and drive the cost down so we can drive more volume, more conversion.

But adding them to the platform does help us in a similar way that Matt just walked you through with QSRs, helps us attract some new diners. And also if we have a diner who's a very loyal diner and is

looking for a specific restaurant, it at least gives them the option to order from that restaurant. So we're seeing those things play out so far, but it is early.

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Operator [19]

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Your next question comes from the line of Aaron Kessler with Raymond James.

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Aaron Michael Kessler, Raymond James & Associates, Inc., Research Division - Senior Internet Analyst [20]

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Yes. I mean just a couple of questions. Maybe just quickly back to the initial growth. I think there's some third-party data for September which suggests about 40% growth year-over-year. Just want see your

thoughts on that, or if you think the growth was much lower than that. And second, on the loyalty plans that you talked about, it sounded like you're talking about maybe experimenting with a few different

types of loyalty plans. Should we expect potentially a subscription plan that you would experiment with? And then interested to get your thoughts on service fees as well. Most of your competitors charge

service fees. Even if you guys charge a very nominal service fee of, say, $1, I mean that could generate significant increase to EBITDA revenue for you as well to maybe offset some of these investments.

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Matthew M. Maloney, Grubhub Inc. - Founder, CEO & Director [21]

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Aaron, yes, again I go back and forth on my support of third-party data. I think it's fundamentally inaccurate because it's sampled. However, when you see all the signals trending in the same direction,

there's probably some kernel of truth there. I think that one industry report saying there's 40% growth, I mean I wouldn't be shocked. I wouldn't be talking about if that was accurate, I'm just saying that

it's coming down over time.

We've had tremendous growth, incredible growth in this industry over the past 2 years. So if you take all of the growth of all the players together, that is the growth I'm saying is coming down. Long term,

steady state. We're saying low double digits. I don't think there's magic in that number. We can't control it. The higher, the better. But what we've seen in the past is that this is not an industry that

flocks from offline to online.

I would say 5 years ago, we were all in on television. We were all in on every type of consumer awareness channel that we could think of, and we weren't growing 100% per year. So there's just a fundamental

friction to consumers going from offline to online. The only thing that accelerates that trend is supply side innovations. I don't see any supply side innovations on the horizon right now, at least none that

we're not participating in to equal or more than our competition. So I would say whatever the industry does this year or next year, it's coming down over time if you look at the total.

Loyalty, yes, there's going to be a ton of loyalty testing going on in the next year. As Adam was saying earlier, a huge part of the EBITDA takedown that we're talking about, we don't have specifically

allocated to programs, we have allocated to tests. We know it works. And we see in our current marketplace, Just Salad extended their loyalty program from their branded channels into our marketplace, and we

saw a share shift from other healthy QSR concepts to theirs, especially when they ran specific promotions to drive loyalty rewards. It absolutely works. It makes restaurants more competitive on our platform.

Like I said, we've given away -- restaurants, I'm sorry, have given away over $70 million on our platform so far this year, and it works.

So we're going to continue to iterate around concepts that make restaurants more competitive on our platform to the benefit of consumers because we believe that the more economic incentives we can allocate

to consumers, the higher the stickiness will be. Once we have -- once we've closed the gap on restaurants, there will be no reason for consumers to go elsewhere because we will have all the restaurants and

we will have the lowest pricing, and we will have the highest economic incentives and emotional incentives for restaurants or for consumers to order on our platform.

So I'm not sure what forms that will take. We're definitely going to be testing a subscription program. We already have one that we're playing around with. I think someone asked about it on the last earnings

call called deal pass. It's kind of a pay-it-forward type concept. It's not perfect, but we are on our way there. I think when we launch things, we'll be transparent about them. Because we'll be excited,

we'll be launching it and we see that it is effective.

Service fees. So here's the thing about service fees, and we've done an incredible amount of research on this. It doesn't matter if the cost to consumer is strict delivery fee, strict service fee or a

combination of both. It is the aggregate diner burden that they face that defines conversion. So it -- like sub-$10 diner burden, it's irrelevant how you split it. Consumers are smart. They figure it out.

They see $6 here, $4 there, it's still $10. Once you exceed a $10 burden, things get a little squirrely, but you're also in very low conversion area where it kind of doesn't matter that much.

So we are absolutely testing service fees. We're absolutely trying to figure out a way to maximize conversion with a given diner burden, and we have been for months. Whatever we have on our platform right

now is what we believe the current best practice is, and that's justified by exhaustive A/B testing. That will change over time. We will continue to optimize. We will continue to try to increase conversion

for given cost constructs. And I believe that over time, you'll see all of our competition doing the same thing. But the reality is, it's very hard to trick a consumer to pay more than they want to pay.

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Operator [22]

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Your next question comes from the line of Heath Terry with Goldman Sachs.

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Heath Patrick Terry, Goldman Sachs Group Inc., Research Division - MD [23]

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Great. Matt, just to follow up on that last part, the part about it's very hard to trick consumers to pay more than they want to. I mean it would seem, just given we've now got sort of 5 years or so of this,

that there's at least some evidence that -- I guess, whether or not you want to consider 5 years long term or short term, that there's at least some segment, and maybe it's to fool some of the people, some

of the time part of the segment that it does work or has worked for some of those competitors out there. And I guess to some extent, I guess the question is, is there a sense in your mind that you

simply have to play along with this as long as that part is going to work for that segment of the audience?

And then back to the discussion about what may have happened in August specifically, is there a sense that, that focus on profitability that you seem to see coming from some of the privately funded

competitors out there that are maybe now a little bit more aware of the need to get to profitability is also driving that significant slowdown in the broader market. Are you seeing a change in behavior

around consumer subsidies, driver subsidies that would have led to that sharp falloff in industry volumes because consumers are reacting to that kind of pricing environment?

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Matthew M. Maloney, Grubhub Inc. - Founder, CEO & Director [24]

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Sure. To your first point, I think that shell games around pricing, they do make tiny trenches. It's not that it doesn't work, but it's not going to move the needle. I mean you'll see like a fraction of a

percent increase or decrease in conversion as you play around. And I think it is more impactful, for sure, in the pricing-sensitive segments.

So you have consumers that they don't really care what it costs and they're just going to order it anyway. I think you've seen a lot of that over the past few years, especially in communities where you

didn't have the option to do any delivery historically. And all of a sudden, you can have anything delivered. And sure it costs a lot, but like you can get it delivered. And I think you've seen a lot of

that.

As we equalize the supply available on different platforms, I think you're going to see consumers make a different choice because they realize that -- we were actually laughing internally a couple days ago

because McDonald's is on multiple platforms. And McDonald's is a really smart operation and they know the demand triggers for the different prices of their items. And so they held strict requirements around

what the fee structure is for consumers, both menu price, which they define; as well as services, which they define as well.

And we are poking around some competitor sites and we noticed a $5.99 Big Mac meal available for like $10.70, all-in fees, and it was ridiculous. And it's completely outside of the rule set that McDonald's

has put forward, but that's the kind of sleight of hand you're seeing in our marketplace, and it's ridiculous.

So I think that in -- the #1 thing that matters to consumers is restaurants. So I think they're willing to pay more if they're able to get restaurants that they're only able to get from the expensive

platform. But once the restaurants have equalized, they're not going to continue paying those fees. They're incredibly price-sensitive is what we see over and over again in our tests. Like I said, it doesn't

matter if it's delivery fee or service fee or a combination of both. It doesn't matter if you hide the fees or if you put them front and center on their ticket. They understand what they're paying. They're

not going to pay 2x for food and bev and a delivery/service fee in order to get it delivered, unless that's the only way they can get it delivered.

So the amount of restaurants, I think is paramount, then the price sensitivity kicks in. And I don't think that the tactics that have been used in this industry are sustainable once a solid competitor with

all available restaurants is an option for consumers.

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Adam J. DeWitt, Grubhub Inc. - President, CFO & Treasurer [25]

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And Heath, on your question related to August and the competition. I don't think we've seen anything -- any dramatic sea change in spend. It's possible that that's happening, but we haven't seen it, whether

it's in -- on the diner acquisition side, on the restaurant side or even the driver supply, driver cost side.

I think one thing that we haven't mentioned, which I think is worth mentioning about our thoughts related to the fourth quarter in 2020 of next year and the shift in strategy, we're operating under the

assumption that behavior doesn't change. And so when we talk about investing behind these initiatives and kind of our baseline expectation for next year, that's all assuming that the competitive environment

continues to be very engaged and very complex and doesn't change. So if it does change, we think that there's upside. I would actually -- if competitors are spending less money, I think it'll be easier for

us to acquire and retain diners and drive frequency. So I think that would be a positive for us, not a -- not necessarily a negative.

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Operator [26]

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Your next question comes from the line of Jason Helfstein from Oppenheimer.

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Jason Stuart Helfstein, Oppenheimer & Co. Inc., Research Division - MD and Senior Internet Analyst [27]

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And it's worth putting out because we're going to keep talking about this for a while, Amazon just announced today that they're making grocery delivery service free for all Prime members in the United

States. And I think there's still a whole lot of questions about how anyone makes money on grocery delivery.

But onto you guys, so you discussed in the letter some of the reasons why consumers are going to competing platforms and steps you're going to take in the fourth quarter next year to make Grub more

compelling for diners. I know you don't -- you're not giving guidance for next year, but can you help us bridge the financial impact between, I think prior consensus for next year was like 3 40. You're

saying EBITDA next year will be more than $100 million at the low end, so maybe help us understand how much of this is revenue, how much is the expenses. I think you said in the fourth quarter, it's half and

half.

And then on the expense side, I guess you've made a decision to invest a lot of money. Why not partner with other companies who have some of the attributes you're looking for? Just kind of -- I think a lot

of people think these are pretty extreme decisions you've made. And maybe talk about why you think this was the necessary decision. So 2 questions.

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Adam J. DeWitt, Grubhub Inc. - President, CFO & Treasurer [28]

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Jason, on the first question, I tried to answer that with Ron earlier. But the -- obviously, The Street number of 3 40 is not our number. But if you're thinking in broad strokes, how to get from there to the

$100 million number that we gave, again, just a step back on what the $100 million is, right. We wanted to -- we're not giving guidance right now. We just wanted to underscore that we can make an aggressive

strategy change to lean in because of the base profitability and talk about how we are still going to make a lot of money next year even with these initiatives, right. So the $100 million number is just a

baseline to give you guys an idea of how we're thinking about what this means for us in 2020.

That said, if you're trying to build a bridge, what I'd say is it's roughly half lower volume and roughly half explicit spend on initiatives. And obviously, the lower volume reduction in EBITDA implies

investment. And I talked -- we talked in the letter about how we could make a different decision, retrench and make a lot more money, in which case our infrastructure would probably be a lot smaller. But

instead, our plan is to grow into that infrastructure over time and lean in with the spend. So it's about half and half. I didn't really break it into revenue and expense, but at least that gives you an idea

how to get from The Street to the $100 million.

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Matthew M. Maloney, Grubhub Inc. - Founder, CEO & Director [29]

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And Jason, I didn't -- I hadn't heard about Amazon's decision about grocery, but I think they're seeing the same thing we are, in that there is weakness in the private markets. There is a push for

profitability. I think some of these companies are finally going to be held accountable for a lot of their investments. And we see an opportunity as the only profitable player in this space that has

incredible TAM ahead of us.

So we're going to go after that with everything we have. We're going to take the profitability. Like Adam said, we're still going to make a lot of money next year. We're not going to break even. We're not

losing money next year, like our competitors. We're going to take a tremendous amount of our profit, and we're going to channel right back into our industry to be as competitive as possible with the

restaurant network when we see the opportunity where we are stealing share from competitors. And on top of that, we're going to leverage our internal assets around loyalty programs that we've been building

for years to try to make the platform as sticky as possible.

We're creating a scenario where, to replicate our consumer-facing differentiation, our competitors are going to have to spend an incredible amount of money exactly at the time that their shareholders and

Boards are forcing them into more profitable investments. So I think this is exactly the right time. I don't know who we partner with to win our space. But this is our opportunity to take share, to win and

to reestablish ourselves as the leader and the innovator in the space.

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Adam J. DeWitt, Grubhub Inc. - President, CFO & Treasurer [30]

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And Jason, just one last thought on the economics of why delivery economics are so -- or the logistics economics are so challenging in our space is the low AOV, right. There's just not a lot of room in the

transaction if you're talking about $30 and lower. And we've always said that in order to drive the most demand in this business, you want the AOV to be closer to 20%. And it's just not going to go there if

you have to charge the diner $10 to pay for the cost of delivery.

So that's -- when you think about delivery in our business versus other businesses and also the nature of it having to be on the minute on demand as opposed to a group of hours makes it also significantly

more challenging. So as you're thinking about logistics related to food delivery or on-demand food delivery versus other industries, I think there's a couple unique factors that make this business

particularly complex.

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Operator [31]

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And our final question comes from the line of Elliot Alper with D.A. Davidson.

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Elliot Alper, D.A. Davidson & Co., Research Division - Analyst [32]

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Great. So as you're pushing into the sales efforts of converting non-partnered restaurants to partnerships, what are you planning on doing differently compared to how you sold your product suite before? And

what are some of the reasons you're seeing restaurants that would want to create this new partnered relationship?

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Matthew M. Maloney, Grubhub Inc. - Founder, CEO & Director [33]

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Yes. Elliot, that's a great question, actually. The difference between a non-partnered relationship on the platform and a partnered relationship, why would a restaurant choose to partner when they have a

non-partner option, is because the diner experience sucks. The volume is going to be way lower. It's not going to be as accurate. I appreciate that. There's no way to fix the issues. It's less accurate

delivery time. They're not going to have promotion on our platform. And we know this because conversion is way lower on the non-partnered, and the AOV is way higher. So I mean people don't want to pay 12%

for delivery or service or whatever you're going to call it.

And it's going to be tough, but it hasn't been a noticeable problem. We've been piloting this for months. We've seen it. And the reality is non-partnered restaurants are on the platform for the consumers

that specifically want that non-partnered. We're obviously going to try to route diners who want a burger to a different partnered burger option. But if they want that specific restaurant that has no

partner, that doesn't have a partner with us and a relationship, we're going to allow that to happen. But we're going to do whatever we can to route demand to partnered restaurants where the economics are

not so miserable and the experience is way better.

And so when -- what we're going to show them is this is what life looks like as a partner and this is what it costs to be a partner, and this is how we're going to grow your business as a partner versus as a

non-partner. But that's -- it is absolutely trickier, and we're already gearing up the teams and they're already executing on that strategy.

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Operator [34]

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And with that, ladies and gentlemen, today's conference call has concluded. We do thank you for your participation, and you may now disconnect.