Rci Hospitality Holdings, Inc. Q2 FY2023 Earnings Call

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 here in New York City with Eric Langan, President and CEO of RCI Hospitality, and Bradley Chhay, 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 Street between 5th Avenue and Broadway, a little in from Herald Square. If you haven't RSVP'd, ask for 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.

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%. We're looking forward to optimizing our 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.

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 $1.30, up 9.2% year-over-year. 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 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. This 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 includes primarily a legal settlement expense and an impairment. Compared to the first quarter of 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-Chicas 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 the 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, the 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 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 but lower quarter-over-quarter. The second quarter 2023 included initial cost of new debt. Please turn to Page 11. 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. Talking about our debt metrics, net of loan costs we had $45.8 million as of March 31st, that's an increase of $35 million from December 31st. The increase primarily reflected financing for the 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 cash flow. To review some of our other debt-related metrics, we are currently below our 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, 6.6% of unsecured debt, 4.1% of debt secured by other assets, and lastly 4% that relates to a new bank line of credit that was used in the Baby Dolls-Chicas Locas acquisition. Now, let me turn the call back over to Eric.

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 a 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. So what is the current consideration 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 investments. 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 a midpoint of $13 million in year two and $15 million in year three, that total $39 million would represent 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. 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 a total of 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 better financing terms. 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 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. 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 used $18.4 million in cash primarily for the Baby Dolls-Chicas Locas acquisitions, ending the quarter with $22.8 million 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 a range of $46 million to $56 million in projected cash available to use for future investments. 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 shares at an average price of $65.71 to provide $46 million of capital for acquisitions. From our viewpoint, we used shares that we bought at an average of $19.55 and sold them for $65.71, achieving a 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. Before we go into the Q&A, 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 you. Now here's Mark to start the Q&A.

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. 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.

Good afternoon and thank you, Mark. Eric, I'm curious, can you give us an update on where you are in terms of licensing for gaming for the Central City, Colorado location?

Typically, it will take about 12 months. We filed at the end of November 2022, so we're hoping to hear something soon. Typically, you'll get some type of preliminary deal, which allows us to then set up the casino. I'm hoping that we see that in August or September; it could be as late as October. Gaming in Colorado has been a very slow process, not just for us, but for all new licensees. I think there are seven or eight licenses that are now applied for in the State of Colorado, some are much older due to various reasons like funding of the casino, things like that. I believe as a publicly traded company, our funding will be super easy to explain due to cash in bank accounts, so I don't think we're going to have any issues when we reach that point; it's just getting to that point. I know that there's been some shuffling at higher levels in the Colorado gaming development department, and hopefully the new people coming in will speed this process up a little bit. We would definitely like to see our license issued by the end of the year to do a grand opening for New Year's Eve, but worst case, it could be as late as March.

Understood and thank you for that. And I'm just curious if you could give us an update on what you're seeing in the clubs, just given the current environment. I know in the past couple of quarters, there had been some weakness in a few of the blue-collar clubs, but you were kind of more than making up for that in some of the higher-end stuff. So any kind of update there on business would be great.

Yes, I mean, I think right now it's just inconsistencies. I don't see real trends forming up or down. I think we're just seeing kind of more of the same. We have some locations that get down a little bit; we make some adjustments, and then we have another location that's down a little bit; we make some adjustments, and it goes well. So it's just constant right now, like a shell game, where we're just moving pieces around and just overall shooting for a set number each week. If we're hitting that number, we're looking for the weak spots and the strong spots, and we focus on those while everyone else is just kind of in the water right now. Overall, though, revenues have been strong, as you've seen in this quarter. I don't believe that there will be a decline in revenues because we have acquired enough new assets. The question now is whether we can continue to maintain the growth rate at double-digit growth rates. We're looking at other club acquisitions right now that will help that hopefully by the time we reach the fourth quarter or definitely through 2024. Everything has been primed for the pump so to speak for 2024, and I think you'll see a lot of activity as we move into that year.

Great. I appreciate that. And then just lastly, on the acquisition front. First, congrats on the deal closed earlier this year. What are you seeing in terms of pricing when you talk to folks? Any changes there or are people kind of holding steady?

It's always been three to five times. We've basically set the market. Other operators looking to expand typically lack the capital or cash that we can bring into a transaction. They also don't have the track record or public records, so I think we'll stick to our current plan. Our focus is on adjusted EBITDA; if we notice trends where their numbers are declining, we'll adjust our forecast based on those trend numbers and make an offer accordingly. Conversely, if their numbers are improving, we'll base our offer on that. We closely monitor the situation in our markets and theirs, and it has been relatively straightforward math for us; we don't anticipate many changes.

Thank you very much, Scott. And to further highlight your question on spending, I'd like to add that my spending at Rick's establishments has stayed consistent. Next up, we're going to bring Anthony of Sidoti and Company.

Yes. Good afternoon and thank you for taking the questions. So just a follow up, Eric, you mentioned that you are making some adjustments to some of the clubs that have seen softness, so can you just talk about some of these adjustments?

Yes, I mean basically what we'll do is increase social media marketing, ensure that the venues are well promoted. We may run some bottle service specials on slower nights; we will do whatever we need to do to create better value for the customers and guests visiting the location. That involves onsite promotions, and we've had huge marketing teams out for various events. It's simply about being more promotional. We've become more proactive. If our main floor isn't full, we try to fill it up and if the VIP area is empty, we'll try to run some specials there. We may also implement more special promotions, so just strategies designed to put more people through the door.

Got it. Understood. Yeah. Thanks for that insight. And then just in terms of the second quarter here. You also cited higher labor costs at the newly acquired clubs. Do you expect to bring those costs down as a percentage of revenue now that you've had a few weeks under your belt?

Yes, certainly. When we first take over clubs, they are typically overstaffed. We put some extra labor in there as needed, but we sort through moving people around, and if there's dead weight, we must prune those resources to get the numbers where they need to be. Typically, it's a three to six month process to stabilize things, like we saw in Denver, which took a lot longer to normalize. This particular location will be much faster for us due to its location in Texas.

Got it. Okay. And then it was good to see Bombshells margins up sequentially. Do you still expect over the long term to get to your target range of 18% to 22% segment margins for that piece of the business?

Absolutely. We didn't raise prices through most of March; we raised most of the prices needed at the end of the March period, so you didn't see any of those price increases reflected in that quarter. You'll see the effects of these price increases in April, May, and June. We've also had a couple of major events in April and the first week of May that have significantly boosted traffic. Overall, I think we have a lot of potential in this segment, especially as we move into the upcoming season.

Thank you, Anthony. Next up we have Lynne Collier of Water Tower Research. Lynne, please take it away.

Thank you and congratulations on a great quarter. I had a couple of questions around your growth opportunity in Central City. The first question is, are there any zoning issues that prevent Central City from being built out like Black Hawk?

There are no reasons Central City cannot build out like Black Hawk, aside from its Historic District limitations, which may restrict it to some extent. However, there are other gaming areas down the Gulf, where larger hotels can be built. Black Hawk has a much more business-friendly leadership in the city that has helped them grow faster. The gaming laws changed in September 2021, allowing Central City to grow. Central City is the next growth area for gaming in Colorado, with much charm and more entertainment options than Black Hawk. As both towns grow closer, I believe they will share some customers and develop toward a unified gaming area over the next few years.

That sounds great. Thank you. I just have one follow-up question about Bombshells and the initiatives you've put in that seem to resonate with consumers. Besides pricing, what other initiatives have you implemented there lately?

The pricing changes were made at the end of the quarter, so none of that reflected in the previous results. A lot of it is just returning to basic principles. Teams may become complacent, so we need to reinforce getting back on social media, promoting events, and ensuring excellent customer service. The managers need to be involved in customer interactions to create a memorable experience leading to repeat business. We are emphasizing proactive marketing steps to attract more guests.

Congratulations on the quarter. I just have a couple of questions here. First off on Bombshells; can you give us the Bombshells margins back to 18% if the Arlington on-ramp, off-ramp has not yet reopened?

I believe we can.

Okay, great. And since the price increases went into effect this quarter, can you give us an idea of how those have been performing?

It's too early; I don't have the numbers from that period yet.

All right. Can you just talk about where cash is today? What you intend to do with it?

I think we ended the quarter with $22.8 million, and we haven't disclosed anything after that publicly, but it has been increasing.

Very good. And then could you just talk about the wages? They're a little higher in terms of wages as a percentage of overall revenues. Is that something we can expect going forward?

I think we will continue to be in that 25% range. We're mostly aiming for that target. I don't worry about any specific quarter as various factors like overtime can skew costs.

Okay, I appreciate that. And lastly, can you talk a little bit about the softness in nightclubs? Has the trend of softness been limited to blue-collar establishments?

In the past, yes, it has been pretty based on blue-collar locations. It’s tough to assess April because we had Easter this year, which negatively impacted our weekend traffic compared to last year. There's no definitive trend in weakness or strength. As long as we continue to monitor our weekly numbers and adapt as necessary at our best and weakest locations, we should be fine.

Thank you so much, Rob. Before we bring up our next questioner, I'd like to encourage everyone to re-tweet and share this Space. Next up, we have Joe Gomes of Noble Capital Markets. Joe, please take it away.

Congrats on the quarter and thanks for taking my questions. Eric, service revenues continue to perform nicely; I'm wondering, do you think this can just continue or might they start to level out?

They will find a peak at some point, but I think they will remain within these ranges. Our highest peak was around 42% or 43% service revenue margins, so we are still below those peaks. However, there are more Bombshells locations now and they may provide room for ongoing trends. We just have to keep an eye on market conditions. Certain areas perform better during controlled local events, which drives demand.

At the end of the first quarter, you mentioned the reopening of the Galveston, Heartbreakers, and Jaguars in San Antonio. How have these been performing?

Both have continued to improve, and Heartbreakers just had a couple of record weeks, so we're very excited about how that location is performing. The real challenge now is getting Baby Dolls in Fort Worth reopened, which should happen by mid-June. We could have opened earlier, but we wanted to ensure everything was right. We encountered some electrical and HVAC issues, so we had to add some extra power to the building. That's taking some extra time but necessary for long-term success.

I know you had a $200 million goal of investment for the year. I think at the end of the first quarter, we were around $110 million. Are you still confident you'll hit that $90 million target in this fiscal year?

We're certainly going to try. We have to find the right deals. We are in the process of four bank loans right now for various construction and properties. We're getting rates between 6.8% to 7.25%, so rates aren't awful. We're looking to lock in what we can and get these projects going. Some construction projects we're funding with cash, such as the Jaguars in Lubbock, which is all cash, and we've paid for the construction of the Stafford location with cash as well.

Thank you, Joe, for those questions. Before we bring up our next questioner, I'd like to encourage everyone to share this Space. Next up, we have Orchid Wealth. The mic is all yours.

Good quarter. I wanted to get some clarity on it. As you keep acquiring real estate in prime areas like Texas, Florida, and Colorado, do you know how much the underlying property values you've been buying have appreciated year after year?

Real estate properties cannot be stepped up under GAAP accounting regulations. I’d estimate somewhere in certain markets, we've been approached with significant verbal offers for properties like Tootsie's; we bought that property for $15 million and recently received an offer for $24 million; I laughed at it, indicating they need to add a zero for a real discussion. Real estate and acquisitions remain critical for our operational strategy.

What percentage of your entire business do you own versus lease?

About 85% owned and 15% leased. We've seen that percentage change as we acquire new properties. New locations, like the ones we're anticipating in Fort Worth, will increase the percentage of owned properties more favorably going forward.

Are there any other clubs in the area where you plan to open your new casino location?

There are five clubs within a 45 minute radius. We'll be the only option for late-night dining when a casino guest decides to leave a table. Our goal is to create an entertainment zone that encourages guests to enjoy multiple offerings, which should ultimately enhance revenue streams.

What is your strategy when acquiring clubs in terms of maximizing their value?

Our target is generally about a 20% increase in revenue and EBITDA after acquisition. We've historically seen a 17.4% increase in the trailing 12 months, so we believe 20% is a reasonable expectation post-acquisition.

What percentage of the clubs in the industry are owned by multi-club owners?

I believe there are a lot of multi-club owners. Many owners have between four and ten clubs, while there are a few who run more than 25. There are hidden opportunities for acquisitions, as we continue to look for growth in markets where we can effectively manage operations.

Thank you, everyone, for those questions. Next our Q&A will conclude, but we want to encourage everyone to keep sharing their thoughts. As we end this segment of our meeting, I want to express my gratitude to Eric and Bradley for their leadership and for this wonderful quarter. Goodbye for now, and we'll see you in the next earnings call.

Thank you, everyone, for your time today. I look forward to another great quarter as we move forward and hope to talk to everyone again soon.