RCI Hospitality Holdings, Inc. (NASDAQ:RICK) Q2 2023 Earnings Call Transcript May 10, 2023

RCI Hospitality Holdings, Inc. beats earnings expectations. Reported EPS is $1.3, expectations were $1.22.

Operator: Greetings and welcome to RCI Hospitality Holdings Second Quarter Fiscal 2023 Earnings Call. You can find RCI’s presentation on the company’s website. Click Company and Investor Information under the RCI logo, that will take you to the company and investor info page, scroll down and you’ll find all the necessary links. Please turn with me to Slide 2 of our presentation. I’m Mark Moran, CEO of Equity Animal. I’ll be the host of our call today. I’m here in New York City with Eric Langan, President and CEO of RCI Hospitality; and Bradley, the human calculator [indiscernible], the Chief Financial Officer. Please turn with me to Slide 3. If you aren’t doing so already, it is easy to participate in the call on Twitter Spaces.

On Twitter, go to @RicksCEO and select the space titled $RICK RCI Hospitality Holdings, Inc. 2Q23 Earnings Call. Apologies for the technical difficulties here. Looks like we’re back at it. To ask a question, you will need to join the Twitter Space with a mobile device. To listen-only, you can join the Twitter Space on a personal computer. RCI is also making this call available for listen-only through traditional landline and webcast. At this time, all participants are in a listen-only mode. A question-and-answer session will follow. This conference is being recorded. Please turn with me to Slide 4. I want to remind everybody of our safe harbor statement, you may hear or see forward-looking statements that involve risks and uncertainties, actual results may differ materially from those currently anticipated.

We disclaim any obligation to update information disclosed in this call as a result of developments that occur afterwards. Now, please turn with me to Slide 5. I’d also direct you to the explanation of Rick’s non-GAAP measurements. Finally, I’d like to invite everyone listening in the New York City area to join Eric, Bradley and me tonight at 7 o’clock to meet management at Rick’s Cabaret New York, one of RCI’s top revenue-generating clubs. Rick’s is located at 50 West 33rd between 5th Avenue and Broadway, a little in from Herald Square. If you haven’t RSVP, ask form me or Eric at the door. And now I’m pleased to introduce Eric Langan, President and CEO of RCI Hospitality. Eric, take it away.

Eric Langan: Thanks, Mark. Thanks everyone for joining us today. Please turn to Page 6 for Today’s News. We moved ahead on a number of fronts in the second quarter. Revenue grew to $71.5 million. That’s an increase of 12.3% year-over-year, reflecting both same-store sales and acquisitions. Free cash flow was $14.8 million, up 33%. Adjusted EBITDA was $21.7 million, up 8.8%. [Technical Difficulty] look forward to optimizing their contributions. On a sequential quarter basis, our Bombshells turnaround program has started to produce results. We also advanced many of our projects involving club acquisitions, new club developments, the Rick’s Cabaret Steakhouse and Casino in Colorado and new Bombshells locations. I’ll be back to tell you more and answer questions later. And here’s Bradley to review the financials.

Bradley Chhay: Thanks, Eric, and good afternoon, everybody. Looking at some of the other major numbers in the quarter, EPS was $0.83, this reflects some nonrecurring items. On a non-GAAP basis, EPS was a $1.30, up 9.2% year-over-year. On a — non-cash from operating activities was $16.8 million, up 44.8%. We had 9.3 million weighted average shares outstanding, that’s down 2.4% year-over-year due to prior period repurchases. The 200,000 shares issued as part of the Baby Dolls-Chicas acquisition had minor impact that’s because they were issued late in the quarter. Now, moving on to the income statement. Please turn to Page 8 to review the Nightclubs segment. Revenues totaled $57 million, up 18.4% year-over-year. That was driven by $6.9 million from acquisitions and newly remodeled clubs and 3.7% same store sales growth.

Operating margin was 31.6% and 39.3% non-GAAP. GAAP operating margin include primarily a legal settlement expense and an impairment. Compared to the first quarter from fiscal 2023, revenues increased by 1.3%, driven primarily by acquisitions, while non-GAAP operating margin declined 1.1 percentage points. That reflects the fact that we had two weeks of the Baby Dolls-Chichas Locas acquisition, which did not allow enough time for full optimization. Please turn to Page 9 to review the Bombshells segment. I only have three things to say here. Number one, results improved sequentially, revenues increased 6.6% driven mainly by the acquisition of Bombshells San Antonio and the Grange Food Hall with this new Bombshells kitchen. Non-GAAP operating margin expanded 1.6 percentage points, all this reflects initial progress from our turnaround program.

Number two, while operating margin target remains 18% to 21%, the segment’s performance at 15.4% non-GAAP was right in the middle of many well-known publicly traded restaurant chains that have recently reported their results. And lastly, number three, [indiscernible] segment was profitable, generating $1.8 million GAAP and $2.2 million non-GAAP. Please turn to Page 10 with me to review our consolidated statement of operations. Note, that all comps are at a percentage of revenues. Cost of goods sold declined year-over-year, reflecting increased service revenues. Salaries and wages were higher year-over-year and quarter-over-quarter. This was due to minimum wage increases in many states, where we have clubs on January 1st. It also reflects the higher labor costs at newly acquired clubs.

SG&A was higher year-over-year but declined quarter-over-quarter. Year-over-year reflected newer acquisitions that are not fully optimized, and quarter-over-quarter reflected the absence of year-end audit expenses. Depreciation and amortization were higher year-over-year and quarter-over-quarter. The second quarter of 2023 included a one-time accelerated amortization of Grange Food Hall leases. Other charges and gains reflected $3.1 million in legal settlement expense and $662,000 of non-cash impairment. Operating margin was lower year-over-year and quarter-over-quarter, but on a non-GAAP basis, was approximately level with the year ago quarter and expanded 1 percentage basis point from the first quarter. Interest expense was higher year-over-year [Technical Difficulty] but quarter-over-quarter.

Second quarter 2023 include initial cost of new debt at [Technical Difficulty]. Please turn to Page 11. [Technical Difficulty] keep in mind that this was after paying $18.4 million for the cash portion of acquisitions. Free cash flow was 20.6% of revenues and adjusted EBITDA was 30.3%, both increased sequentially or in line with our 20% and 30% targets respectively, as a percentage of revenue. To wrap up discussion of the income statement, please turn to Page 12 for an update of our geographic focus. In the second quarter of 2023, our regional revenue breakdown was Texas at 41%, Florida at 25%, New York, Colorado and Illinois are 8% 7% and 6%, respectively and the other eight states combined for 13%. This demonstrates our geographic diversification, our exposure to growth states like Texas, Florida, Colorado and how we develop our business clusters in key areas.

Turning to [Technical Difficulty] to review our debt metrics. Net of loan costs [Technical Difficulty] ($45.8) (ph) million as of March 31st, that’s an increase of $35 million from December 31st. The increase primarily reflected financing for the five club Baby Dolls-Chicas Locas acquisition, primarily offset by scheduled pay downs of other debts. Our weighted average interest rate was 6.52%. This compares to 6.14% a year ago and 6.6% five years ago. Excluding balloons, our amortization schedule is now in the $12 million to $15.7 million annual range, which is very manageable with our higher level of debt — our cash flow — higher level of cash flow. Please turn to Page 15 to review some of our other debt related metrics. [Technical Difficulty] as of March 31st below are comfort level of around three.

Please note that this reflects our new debt related to Baby Dolls-Chicas Locas acquisition, but only two weeks of contribution. Occupancy cost was 7.6% of revenues. This continues to be well within the 6% to 9% range we’ve averaged when sales were dramatically impacted by COVID. Now please turn to Page 16 to look at our March 31st debt pie chart. Our debt now consists of 54.9% secured by real estate, 30.4% seller financing secured by respective clubs and/or the real estate, which it applies to, 6.6% of unsecured debt, 4.1% of debt secured by other assets, and lastly 4% that relates to new bank line of credit that was used in the Baby Dolls-Chicas Locas acquisition that was also secured. Now, let me turn the call over back to Eric.

Eric Langan: Thank you, Bradley. For this quarter, we added a third section to our presentation. We call it Our Take and are using it to explain the underlying thinking to where we’re going. I want to remind everybody of our safe harbor statement. You may hear or see forward-looking statements that involve risks and uncertainties, actual results may differ materially from those currently anticipated. We disclaim any obligation to update information disclosed in this call as a result of developments that occur afterwards. Please turn to Slide 18. Everything we do is about our capital allocation strategy, which is similar to those outlined in the book, The Outsiders by William Thorndike. First and foremost, the goal of our strategy is to drive shareholder value by increasing free cash flow per share by at least 10% to 15% on a compound annual basis.

We have been implementing this strategy since the end of fiscal 2015 with three different actions subject to whether there is strategic rationale to do otherwise. One is mergers and acquisitions, specifically buying the right clubs in the right markets. We like to buy solid cash-flowing clubs at three to five times adjusted EBITDA, using seller financing and acquire the real estate at market value. Another strategy is growing organically, specifically expanding Bombshells to develop critical mass, market awareness, and sell franchises. Our goal in both M&A and organic growth is to generate annual cash on cash returns of at least 25% to 33%. The third action is buying back shares when yield on flow per share is more than 10%. As a result of these efforts, we have exceeded our primary goal.

Through the end of fiscal 2022, we have increased free cash flow by 22% on a compound annual basis, while reducing shares by 1.5% on a compound annual basis. Please turn to Slide 19. So what is the current [Technical Difficulty] point between whether we should buy shares or invest in buying or opening new locations. Using a possible range of $68 million to $78 million for fiscal 2024 against 9.43 million shares, the 10% yield point for buying back shares comes in at $72 to $83 per share, subject to whether we can make better investment. Please turn to Slide 20. Let’s take a look at our most recent club acquisition. We used $15 million in cash, $16 million in stock, and $35.5 million in debt to acquire five Baby Dolls-Chicas Locas clubs and their real estate.

We estimate the acquisition will generate $11 million in adjusted EBITDA in the first full year after closing. After that with remodeling and some expansions, we estimate it will generate $14 million to $16 million in adjusted EBITDA. We assume conservatively we go from $11 million in year one to midpoint $13 million in year two and $15 million in year three, that total $39 million would represent [Technical Difficulty] more than 50% on the $15 million that we put down on this acquisition. If you turn to Page 21, let’s take a look at our planned Rick’s Cabaret Steakhouse and Casino in Central City, Colorado. We bought the building and real estate for only $2.4 million. We anticipate it will take us about $8 million to complete, which would include 200 slot machines.

Excluding the casino, a similar-sized RCI club generates between $8 million and $10 million of revenue. Slot machines at existing Central City casinos average $129 per day, that’s another $9.4 million in annual revenue. So the combined estimated revenue of $18.4 million at a 40% average club margin will generate $7.4 million operating profit. Let’s assume conservatively that we only do $3.7 million in year one and in year two we build to $7.4 million, that’s a total of $11.1 million that would represent an average annual cash-on-cash return of more than 50% on the $10.4 million invested. Keep in mind, this does not include any table games or sports betting revenues. Please turn to Slide 22, I’m sorry Slide 23. We also believe we have the opportunity to add even more locations.

For example, it took 28 years for the company to go from one location to 21 locations. In the following seven years, we added 19 more, and in the next five-and-a-half years, we added another six, so total 56 clubs, which represent only a small portion of the market we want to consolidate. As our company expanded in size, we believe we can continue to potentially accelerate our rate of growth. This is due to a variety of factors, including increased economies of scale, enhanced market penetration, and greater access to [indiscernible]. With a larger company footprint, we may be better positioned to capitalize on opportunities, take advantage of the synergies and achieve operational efficiencies that can both — that can help us drive growth.

Therefore we believe as we continue to grow as a company, we can potentially experience faster rates of growth and achieve greater levels of success. Turning to Page — Slide 23, I’m sorry. We believe we have the cash to do this. Let’s take a — let’s look at what happened in the second quarter, at December 31st, we had $34.1 million, we made an acquisition of $7.1 million in net new cash and we made an additional $7.1 million in net new cash and we used $18.4 million in cash, primarily for the Baby Dolls-Chicas Locas acquisitions, ending the quarter with [Technical Difficulty] in cash. Now, let’s look at what could happen in the next fiscal year. Using the range of $68 million to $78 million in free cash flow, that’s $21.7 million in debt maturities gives us with a range of $46 million to $56 million in projected cash available to use for future investments.

Turning to Slide 24. We also have shares we can use to finance acquisitions, provided we continue to do it carefully, judiciously and in an accretive manner. To that end, we believe we have demonstrated a strong track record. Since the implementation of our capital allocation strategy, we have acquired more than 2 million shares at an average price of $19.55 per share. We have issued 700,000 of shares at an average price of $65.71 to provide $46 million of capital for acquisitions. From our viewpoint, we use shares that we bought at an average of $19.55 and sold them for $65.71 or at 236% cash-on-cash return. To sum up, we have a long list of investment opportunities with the potential to generate significantly compelling returns, when combined with our strong, disciplined and proven track record to make it happen.

Please turn to Slide 25. Before we go into the Q&A [indiscernible] we’ll be holding our 30th Anniversary Gentlemen’s Club Expo Convention, August 20th to 23rd at the Paris Hotel in Las Vegas. For more information, go to the website listed on the slide. Thank you to our loyal and dedicated teams for all their hard work and effort. We can’t do it without now here’s Mark to start the Q&A

A – Mark Moran: Thank you, Eric and Bradley. Before we move on, I’d like to congratulate you both on the one-year anniversary of our first Twitter Spaces, the first ever earnings call on Twitter Spaces [Operator Instructions] Before we start things off, I’d like to give a special shout out to Kellen Curry, a listener in the audience and former equity research analyst at JPMorgan, who will be challenging George Santos next year for New York’s third Congressional District. Thank you for joining us. Let’s go ahead and start this show. We’d like to take questions from Rick’s equity research analysts and some of its largest shareholders first. To begin, we’ll have Scott Buck of HC Wainwright. Scott, please take it away.