Rci Hospitality Holdings, Inc. Q3 FY2022 Earnings Call

Greetings, and welcome to RCI Hospitality Holdings Third Quarter Earnings Call. You can find RCI's presentation on the company website. Click Company and Investor Information under the RCI logo, that will take you to the company investor info page; scroll down and you'll find all of the necessary links. Please turn with me to slide two of our presentation. I'm Mark Moran, CEO of Equity Animal, and I'll be the host of our call today. I'm here with Eric Langan, President and CEO of RCI Hospitality; and Bradley Chhay, CFO of the company. Please turn with me to slide three. If you aren't doing so already, it's easy to participate in the call on Twitter Spaces. On Twitter, go to RicksCEO and select the Space titled Dollar Sign RICK 3Q22 earnings call. As a reminder, if you want to ask a question, you'll be needing to join Twitter Spaces on a mobile device. If you just want to listen, you can join the Twitter Space on a personal computer. RCI is also making this call available to listeners through a traditional landline and webcasting. At this time, all participants are in a listen-only mode; a Q&A session will follow. This conference is being recorded. Now turn with me to slide four. I want to remind everybody of our Safe Harbor statement. It reminds you that 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 five. I direct you to the explanation of non-GAAP measurements that we use. I'd also like to invite everyone listening in the New York City area to join Eric, Bradley, and myself tonight at 7 o'clock to meet management at Rick's Cabaret, one of RCI's top revenue-generating clubs. Rick is located at 50 West 33rd Street between Fifth Avenue and Broadway, a little in from Harold Square. If you have an RSVP, ask for Eric or me at the door. Now I'm pleased to introduce Eric Langan, President and CEO of RCI Hospitality.

Thank you, Mark. Thanks for joining us today. The third quarter benefited from higher sales, continued rebound in nightclub service revenues, and sequential improvements in Bombshells. Year-over-year, nearly all our key metrics continue to increase on a double-digit basis for both the third quarter and the first nine months. This resulted in particularly strong free cash flow and adjusted EBITDA in the third quarter. Net cash from operating activities and free cash flow were further enhanced by a receipt of a tax refund I've mentioned on previous calls. We continue to execute on our growth plan and capital allocation strategies. During the third quarter, we continued the buyback of shares. We acquired the Playmates Club in South Florida. We also purchased property for the 13th company-owned Bombshells. To date, in the fourth quarter of 2022, we bought a club in Odessa, Texas, that we have rebranded and planned to reopen on August 18th, as well as opening the rebranded Scarlett's Cabaret in San Antonio, Texas, that will also open August 18th. We also bought the well-known Cheetah's Club in South Florida, and we continue to take advantage of market conditions to buy back shares. Now here's Bradley for a review of our financials.

Thanks, Eric, and good afternoon to all those listening. All of our comparisons in this call will be to the year-ago third quarter unless otherwise noted. It is important to note that this was the first period since the first quarter of fiscal 2020 that was not affected by COVID restrictions. Looking at the numbers, we generated record total revenues of $70.7 million, up 22.2%. EPS increased 8% to $1.48. Non-GAAP EPS increased 18% to $1.60. Net cash from operating activities was $18.9 million, an increase of 26.2%. Free cash flow totaled $18 million, which is up 39.1%. Net income attributed to RCI common stockholders was $13.9 million, up 13%. Adjusted EBITDA totaled $24.6 million, which was up 20.6%. Please turn to page seven. Our Nightclub segment had an excellent third quarter. Revenues totaled $54.7 million, an increase of 33.3%. Operating margin was 41.1% and 42.7% non-GAAP. Operating income was $22.5 million GAAP and $23.3 million non-GAAP. Highlights included the $11.8 million in sales from fiscal 2022 acquisitions and a 50.8% increase in our higher margin service revenues. On a sequential quarter basis, revenues increased 13.5%. Non-GAAP operating margin expanded 321 basis points and Non-GAAP operating margin increased 22.7%. Please turn to page eight. We created this slide to show the strong progress we've made in the Nightclub segment since the pre-COVID first quarter of 2020. Nightclub revenues as a percentage of consolidated revenues have returned to just under where they were. As you can see, Nightclub revenues are closely linked to service revenues. Both of these trends reflect the combination of the rebound and growth of existing clubs and the addition of club acquisitions against the growth of Bombshells revenue. Please turn to page nine. Bombshells also had a great third quarter. Revenues declined 1.8%, which was due to a tough year-over-year comparison against an unusually strong third quarter in fiscal 2021. This was our record highest revenue quarter for Bombshells ever. Operating margin came in at 19.4% GAAP and 23.6% non-GAAP. On a sequential quarter basis, revenue increased 3%. GAAP operating margin expanded 94 basis points and non-GAAP operating income increased 7.2%. Overall, we think that we're effectively managing food and labor inflation. Please turn to page 10 to review our consolidated quarter unless otherwise noted. Cash and cash equivalents were $37.5 million on June 30th. I'd like to point out that this was after utilizing more than $12 million for share buybacks during the nine months, cash portion of the Playmates acquisition, and the down payment for our Bombshells location in Rowlett, Texas. Free cash flow for the third quarter totaled $18 million or 25.5% of consolidated revenues. Our refinancing enables us to smooth out our debt maturity schedule. Our amortization continues in the $7 million to $8 million annual range for the next four years, which is manageable with our cash flow. And to pay off our loans, periodic refinancing enables us to convert higher rate seller financing into lower rate commercial real estate bank debt. We currently have multiple unencumbered properties in our portfolio. Should we need additional capital, we can borrow against them. Our occupancy costs were 6.7% of revenues. This continues to be well within the 6% to 9% range that we averaged when sales weren't dramatically impacted by COVID. Thank you.

Thank you, Bradley. We continue to talk to new investors, so I'd like to review our capital allocation strategy. Our goal is to drive shareholder value by increasing free cash flow per share 10% to 15% on a compound annual basis. Our strategy is similar to those outlined in the book, The Outsiders by William Thorndike. We have been applying these strategies since fiscal 2016 with three different actions subject, of course, to their 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 real estate at market value. So far this fiscal year, we have deployed $141.8 million in capital. Another strategy is growing organically, specifically expanding Bombshells to develop critical mass and 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%. Sorry, the third action is buying back shares when the yield on free cash flow per share is more than 10%. As of last Friday, we deployed $14.3 million in cash to buy back 255,962 shares this fiscal year at an average of $55.91. The momentum is strong and we are confident in continuing to pursue these strategies. Thank you.

Hey, congratulations about the quarter. Can you discuss the plan for Fort Worth when you think that might be closed and then estimates for opening and if you're going to look at Utah and then rebranding the facility.

Sure. We're definitely going to be remodeling and rebranding the facility. We're waiting on the plat. It's at the county level. Unfortunately, there's not much we can do to speed the process up. However, we have talked with the owners; they've given us keys. We have the architects in; we're starting to draw remodel plans and get that ready. I suspect, we'll probably open within three months of actually closing on the property. I believe the liquor license is in place. The adult entertainment licenses are already in place. So, basically, it's just a matter of remodel, rebranding, and, of course, getting this plat done so that we can get a title permit from the title policy.

Thank you. And then just shifting gears, can you talk about real estate pricing in this environment? Has it backed off at all? Is it helping you in terms of Bombshells location?

I am not certain if the prices have significantly decreased. We recently made an offer on a property in Austin, Texas for Bombshells, which was accepted yesterday. We had been interested in this property for a while, but the initial price was very high. They finally agreed to our offer and reached out to us, so we are moving forward with that. It's possible we could partner with someone or bring in a franchisee at that location, but it's still early to determine how that will play out since we just got it under contract yesterday. Additionally, we are exploring multiple other sites at this time.

Great. And then I'll ask one last question then I'll circle back into queue. But can you just discuss the general contractor pricing trends you're seeing? Has it had any impact in terms of building out Bombshells locations, or just in general, what you're seeing in there?

I have definitely slowed down on our plans. We received the initial bid for the Stafford location and have completed the demolition, but we haven't started construction yet. I am currently working with two different general contractors. Although steel and lumber prices have decreased, the main issue we're facing is that subcontractors are so busy with high demand that they are charging exorbitant prices. I've decided to hold off for now. We will avoid overspending just to proceed quickly; instead, we will take our time. We will be patient and wait for costs to stabilize, particularly roofing costs, and find a roofer who can offer a satisfactory price. For instance, during the tear-out phase, we found a contractor who provided a bid significantly lower than others because they were eager for work. We will take a similar approach and wait for the right opportunity to build. Our final zoning hearings are scheduled for early September, and we have progressed with the plans, which should allow us to apply for building permits once the zoning issues are resolved. If all goes well, we expect to start construction in December or early January, which is our current plan.

Thanks so much, Rob, for the questions. Now, I would like to take the opportunity to hear from other analysts on the call.

Gotcha. Okay. And in terms of the acquisitions, since you closed the quarter, you announced the Cheetah Gentlemen's Club as well as the Odessa Club. Just can you help us perhaps to think about those as to how we should think about the revenue and EBITDA run rates or contributions from those?

Sure. Cheetah is about $10 million. We expect EBITDA to be around $4 million. We could see some slight improvements on that. We're just going to have to get a few quarters in to figure out where we're at, but I think that's kind of where we're at right now. The Odessa Club, I'm going to guess is similar to the Rick type location, probably $1.8 million in revenue, which would put us around $600,000 a year in EBITDA on that one.

Got it. So, to go back to your question, can we expect to see sequential improvement in your segment operating margins? I understand the business is seasonal, but if you could provide some insights on that, I would appreciate it.

I would say not in the next quarter, for sure. Our goal is 30% EBITDA and 20% free cash flow on revenues; that's our target. We might exceed that occasionally and fall short at other times. However, over the course of a year, I believe we will be very close to those figures. This quarter, July through September, is typically our seasonal period where we return to a more normal state, which is encouraging because it suggests that as people adopt a more regular lifestyle, we can expect significant increases in October, November, and December, extending through May. I anticipate that our first quarter of fiscal 2023 will set a record for us, especially as New York City increases its office occupancy from 45% to 85% in October and November.

That's great to hear. Well, thank you and best of luck.

Yeah. Thank you.

Thanks much for the questions. Next, we have Josh of Noble Capital Markets. Josh, take it away.

Hi. Good afternoon, everybody. Thanks for taking my questions.

Hi, Josh.

Hey. So, I just kind of want to start off with some Bombshells. I know that you're talking to a few franchising groups. Can you talk about just kind of how those talks are progressing as one group kind of further along than others?

Yeah. There's definitely all in different stages. The farthest along group has three sites picked out for us. On the way back from Vegas, I'm going to stop in with David Simmons. We're going to fly back from Vegas together, and stop in, and they've got three sites picked out. We're going to look at those locations and give them approvals or declines on our opinions on those three locations. If we approve a location, we'll probably get the contract, the franchisee contract done. All franchise contracts have to be tied to a specific location on the first one before we can create the franchise agreement. So, hopefully, we find one of their three locations we can approve and get them signed up, which will give us our third franchise. At this time, I know the San Antonio group is looking for their second location right now as well. So, hopefully, we'll have some more information as we progress through the quarter on franchisees for Bombshells.

Perfect. It kind of led me to my next question, obviously recessionary fears are out there, at least amongst some people, just the general public. And kind of that leads me to question of like, are you seeing a drop in visits to your clubs just due to this economic environment we're in?

I mean, our typical summer slowdown. I wouldn't call it drops in visits. I don't think the customer spend has changed hugely at this point. Our VIP spend has been fantastic. I've talked with the different club managers and our upper management guys. They say the VIP spend is still fairly strong. The biggest thing we're hearing is that people are on vacations. And so, that's interfering with their normal flow schedules to the clubs and whatnot, but not in a huge way. We're monitoring this closely. I think overall we'll be in great shape, and we can manage any slippage with acquisitions if needed.

Yeah. That's fantastic. And just have one last one before I go back in the queue. I kind of want to give just an update on AdmireMe. Obviously, you guys were having talks at a soft launch last quarter. I just want to hear if there's anything, just related to traffic on it. If it's been going as you guys expected or it's been surpassing you guys' expectations. Thanks.

Right now, we're not focused on it too much. We're trying to get it working correctly, and getting a couple of bug fixes out right now in the next update. We're finally getting the referral program put together. We've realized the more we learn, the more we do. The beta was good because it helped us get the operational bugs worked out. But as we talked to influencers and some larger people on OnlyFans, we realized some of the things we have to set certain things up. Those are almost all programmed in and should be completed by the end of August. Then we'll start our launch.

That is perfect. Thank you so much, Eric, for answering so clearly and concisely. I think, doing what you guys are doing, Mark and yourself, and coming to Twitter where you can interact with shareholders and have this open dialogue regard to the future of the company is, not only very transparent, but also I think it's just extremely bullish because you're just opening yourself up to that many more potential investors. So, again, I really appreciate it. I appreciate your time. And letting me up to ask a question.

You're welcome and thanks. And I love it because it puts me in a position where I feel like I'm operating the nightclubs again. One of the things I loved about the nightclub business was I threw the party every day. I was talking to people every single day, and as I moved into corporate world, I kind of lost that. And Twitter, for me, especially in the last three or four months, has just gotten so fun. I get to interact with end users. I get to interact with investors. As you've seen on some of my Twitter feeds, I'll spontaneously go, I'm going to the club tonight, come see me. And it's great because seven, 10, 15 people show up, we have some drinks, we'll talk, and I get direct feedback of exactly where we're at, what we're doing right, what we're doing wrong. I get to get the ideas. So, it's been very exciting. Thank you so much for the question. Next up, we're going to be bringing Eric Roderick to speak. Eric, take it away.

Hey. Thanks, Mark, and thanks Eric for taking my questions today. Just wanted to get some clarity on the Cheetah acquisitions so we can kind of understand exactly how these acquisitions are valued. I know in the press release that you said that you expected $4 million of adjusted EBITDA for the club with a $25 million total purchase price for both the club and the real estate. So that's a bit over a six X multiple. I don't know if the club is being valued at three to five and there's some rent paid to the building or something else going on there, or maybe it's $4 million now, but you expect a higher run rate. But just help understand the underwriting of that acquisition would be really helpful.

Sure. So, let me give you the basics. What I looked at is this: We have a 10-year, six promissory note at $15 million. If you take that and divide it out, you get the payments. So, there's a couple of things to consider. It's basically our cash on cash returns going to be about 33%. Maybe it's a little less, depending on how much savings we get. I know we're going to save on their insurance; their insurance costs were much higher than ours. We look at a couple other things where we think we can shave a few points off a cost of goods; hopefully overall, that $4 million becomes $5 million, $4.8 million, something like that. You pay out the two something. Basically, we need to make a little over $3.3 million a year to get that 33% return. I think we'll do that. The rest is basically managed to own, right? We're going to take owner financing. We're going to pay the owner 60% of his free cash flow or 40% of his free cash flow. Then we're going to take the rest, give him cash for, and earn that cash back. We think it's a win-win transaction all the way around.

Okay. Thanks. Appreciate that. Eric, can I clarify something for a moment? You mentioned a 6% to 12% equity cost of capital, but if your shares are priced at $60 and you're generating $9 per share in free cash flow, it seems your equity cost of capital would be closer to 16%. I agree with your general perspective on how Warren Buffett values securities. He assesses the free cash flow yield and organic earnings growth. In this case, there's a 16% free cash flow yield and your earnings growth is likely at least 15% for now, as you'll see growth in volumes and prices, possibly even introduce some new products. Given these factors, you should be trading at a multiple of 16 or 15 times your current free cash flow, aligning your multiple with your organic free cash flow growth without factoring in any credit for mergers and acquisitions or capital allocation.

I mean, you're always like 15 steps ahead of me. I have to sit down and write it down and do the math, get back to you. As we were talking the other day, it's all fifth-grade simple math. I agree with you that I think we are trading much lower, but I think the market's going to have to set the reward system; the market rewards us for performance.

Appreciate it. Those are my thoughts. Thank you.

Thanks so much for the question and to everyone who participated in today's call. I hope to see you at Rick's tonight. Have a great day!