Rci Hospitality Holdings, Inc. Q4 FY2023 Earnings Call

Greetings and welcome to RCI Hospitality Holdings Fourth Quarter and Year-End Fiscal 2023 Earnings Call. You can find the company's presentation on RCI's website. Click Company and Investor Information under the RCI logo. That will take you to the company and investor info page. Please turn 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 with Eric Langan, President and CEO of RCI Hospitality. CFO, Bradley Chhay is coming to us from Houston. Please turn to Slide 3. If you aren't doing so already, it is easy to participate in the call on Twitter Spaces. Go to @RicksCEO and select a space titled Rick RCI Hospitality Holdings Inc 4Q '23 Earnings Call. 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. This conference call is being recorded. Please turn 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. Please turn to Slide 5. I also direct you to the explanation of Rick's non-GAAP financial measures. Finally, I'd like to invite everyone listening in the New York City area to join Eric and me tonight at 7 o'clock to meet management at Rick's Cabaret, New York, one of RCI's top generating clubs. Rick's is located at 50 West 33rd Street between 5th Ave and Broadway, a little in from Herald Square. If you haven't RSVPed, ask for us at the door. Now, I'm pleased to introduce Eric Langan, President and CEO of RCI Hospitality. Eric, take it away.

Thank you for joining us today. Please turn to Slide 6. I think our fourth quarter results are generally in line with what everyone was expecting. We generated revenue of $75.3 million, a 5.4% increase compared to the year-ago quarter, mainly due to acquisitions. This increase more than offset the decline in same-store sales of 10.5%. However, margins were negatively impacted as a percentage of sales. Because of the same-store sales decline, results were also affected by higher noncash impairments. As a result, we earned $0.23 per share. But on a non-GAAP basis, we were solidly profitable, earning $1.11 per share. We are operating in a unique and complex macroeconomic environment. In addition, last year's second half saw the highest operating leverage we've had in the past 5 years. Fiscal '22 free cash flow also benefited from a $2.2 million tax refund in the third quarter. I am proud of our efforts and the dedication of our teams as well as the strength and resiliency of our business model. In fiscal 2023, our same-store sales were up 9% compared to pre-COVID fiscal 2019, with Nightclubs up 8.3% and Bombshells up 12.6%. We also saw the second-highest levels of free cash flow and adjusted EBITDA in the company's history, eclipsed only by the unique dynamics of fiscal 2022. Please turn to Slide 7. We are pleased to report that during and subsequent to the quarter, we have made significant progress toward our key growth initiatives. These should begin to yield results this fiscal year and next. We have also implemented some changes to improve operations. Our capital allocation strategy has continued to provide strong long-term results. Since its adoption at the year-end fiscal 2015, free cash flow has increased on a compound annual basis of 17.2%. After the fourth quarter, we continued to buy back more shares. We believe we have significant cash resources to implement our strategies and plans. Please turn to Slide 8. I'd like to take a moment to go into more detail on the progress of our 3 major growth initiatives. First, we are excited about our 2 Central City, Colorado casinos, Rick's Cabaret Steakhouse & Casino and our Bombshells Sports Casino. We are awaiting the conclusion of the state's gaming licensing process. At the very beginning of this effort, we estimated it would take 12 to 18 months, based on past Colorado history. We remain in line with that timetable. All indications suggest the process is proceeding well. No other applicant has received a gaming license ahead of us. We are also awaiting liquor licenses for both casinos and a building permit for the Bombshells Casino. We have begun to form our organization by retaining a Director of Casino Operations, who has extensive experience in the Colorado market. During the first quarter, we received a building permit for our Rick's Cabaret Steakhouse & Casino. Interior demolition has been completed, and construction has begun. Based on all this, we continue to anticipate opening both casinos in fiscal 2024. Using simple math, we believe this represents a significant free cash flow opportunity. Our plan is for a total of 400 slot machines and 9 to 12 table games, as well as sports betting. Looking at the slots, they have been averaging $133 adjusted gross proceeds per day in Central City and $307 per day in nearby Black Hawk. Black Hawk is higher mainly because they operate on a 24/7 basis, which we plan to do also. We have assembled additional properties on Main Street for further casino development as well. Please turn to Slide 9. The Baby Dolls-Chicas Locas acquisition continues to perform well. Sales have improved every quarter since the March acquisition. And we finished remodeling the 5th location in June, which is contributing to that growth. Labor and direct operating expenses as a percentage of revenue have decreased, and we are analyzing more ways to improve those margins. We plan to open 3 more clubs in fiscal '24 using existing club assets that we own. They will be branded Baby Dolls, helping us turn that into a major Texas chain. The third club is the replacement club that we previously discussed in Lubbock, Texas. Construction is underway. As we reported, we named Dean Reardon and Shaun Kevlin as Director and Assistant Director of nightclub operations for RCI Management Services. This should enable Ed Anakar, President and Director of RCI Management Services, to focus more time on acquisitions and development of new clubs. We are moving full steam ahead with regard to acquisitions, but we will not overpay for the sake of buying more clubs. We continue to be actively engaged in discussions with numerous club owners. 2023 was a very challenging year for us. I've talked to many smaller operators, and they didn't have the reserves that we've had. They've faced additional slowdowns compared to what we are experiencing. I expect many acquisitions over the next 12 to 18 months to come to our attention and be on very favorable terms. So, I am very excited about that. If you'll please turn to Slide 10 to review our Bombshells development program. In September, we announced a major expansion of the food offerings at our food hall in Greenwood Village, a suburb of Denver, to add to our successful Bombshells kitchen there. We later relaunched that location as Cherry Creek Food Hall. In November, we opened the first Bombshells post-COVID. This is located in Stafford, Texas, a suburb of Houston. It is off to a fantastic start. Regarding other new Bombshells, construction is continuing on Rowlett and the Lubbock locations, and remodeling should begin soon for our Downtown Denver site. All 3 are expected to open in fiscal '24. In other developments, we hired a new Assistant Director of Operations with over 20 years of multi-unit restaurant experience. For Bombshells, I am currently exploring with private equity groups, partial sales of the concept, partnerships, or mergers, basically, all strategic opportunities available that we can use to maximize the value of this asset and accelerate our growth. I believe the concept can be highly successful. We need to expand to 80 to 100 units, which we believe we can achieve. I'd like to pursue this with capital outside the company's own resources because I think we have too many acquisition opportunities coming up, alongside the expansion of the casinos, and I'd prefer to keep our capital more focused on those operations rather than expanding Bombshells. Please turn to Slide 11. Acting upon our confidence in our capital allocation strategy, strong free cash flow profile, and valuation, we continue to take advantage of our low stock price in the first quarter of fiscal '24 to buy back more shares. As of December 8, we had repurchased 37,954 common shares for approximately $2.1 million or an average price of about $54.59 per share in Q1 '24. We currently have $14.6 million in remaining stock purchase authorization. While we continue to prioritize high cash on cash returns and developing our new casinos, clubs, and restaurants, we also continue to opportunistically and aggressively repurchase shares when they trade materially below our view of fair value. Now here’s Bradley to detail more of our results, and I'll be happy to take Q&A at the end of this session.

Thanks, Eric. Please turn to Slide 12 to review our Nightclubs segment. Fourth quarter revenues increased by $4.3 million year-over-year. This was primarily due to $9.2 million from new acquisitions more than offsetting the $5.1 million decline in same-store sales. By revenue type, alcoholic beverages increased 17.2%; food, 15.9%; and other, 8.1%. Service revenue declined by 2%. The different growth rates reflected a higher alcohol and food sales mix from the newly acquired Heartbreakers, Baby Dolls, and Chicas Locas clubs this year. They also reflect the lower same-store sales and the summer slump in service revenues. Service revenue was 42% of Nightclubs sales this quarter, versus 46% a year ago. Had the sales mix remained the same, we would have realized $2.4 million in service revenue, most of which would have benefited free cash flow. The post-acquisition of Heartbreakers, Baby Dolls, and Chicas Locas shows our quarterly sales demonstrating steady improvement, coinciding with a marked decline in labor costs and a corresponding dip in direct operating expenses as a percentage of revenue. Fourth quarter results included $8.4 million more in items typically excluded from non-GAAP calculations, mainly due to non-cash impairments. Consequently, GAAP operating income was $12.1 million or 19.8% of revenues, while non-GAAP operating income and margin were significantly higher at $21.6 million and 35.4% of revenues, respectively. Even amid the macroeconomic challenges we've faced, our strategies have enabled Nightclub non-GAAP operating income to remain within the $22 million to $24 million range per quarter since the second quarter of '22. Please turn to Slide 13 to review our Bombshells segment. Fourth quarter revenues declined by $452,000. Lower same-store sales were partially offset by the $1.6 million from newly acquired locations, namely Bombshells San Antonio and the renamed Cherry Creek Food Hall featuring its Bombshells kitchen. GAAP operating income showed a profit of $1.2 million or 8.2% of revenues, while non-GAAP was a profit of $1.4 million or 10.4%. Please turn to Slide 14. In our other segment, revenues remained approximately level at $727,000. Operating income was a loss of $793,000 compared to a profit of $216,000 from the previous year. This variance was largely attributable to a $908,000 increase in items generally excluded from non-GAAP calculations, again, primarily due to impairments. Corporate expenses were $6.8 million, nearly level with last year. On a non-GAAP basis, they were $1.7 million higher, reflecting about $500,000 more in salaries and wages in the fiscal '23 fourth quarter, with the subsequent offset of a $1 million legal insurance payment in the previous year's fourth quarter. I also want to mention the effective tax rate for the year was 19% compared to 23.4% last year. This fiscal '23 effective tax rate reflects higher federal tax credits that more than offset the larger portion of income subject to state income taxes. Please turn to Slide 15. Here, you can observe 3 significant spikes in the operating margin we experienced in the third quarter of fiscal '21 and the third and fourth quarters of fiscal '22 as we emerged from the COVID area. Please turn to Slide 16. We have a couple of slides that will discuss free cash flow and adjusted EBITDA, which are non-GAAP measurements. In advance of that, we wanted to present you with the closest GAAP equivalents on this slide, which are operating and net income. Please turn to Slide 17 to look at some of our other key metrics. We ended the year with cash and cash equivalents totaling $21 million. During the fourth quarter, we utilized $2.1 million to repurchase shares. We also concluded the year with $9.8 million in accounts receivable. This represented a 16% increase from a year ago quarter, as September 30 fell on a Saturday, causing us to carry credit card sales from Thursday to Saturday at the end of the quarter. Fourth quarter free cash flow totaled $11.1 million or 15% of revenues. Adjusted EBITDA was $20.2 million or 27% of revenues. Our recent free cash flow and adjusted EBITDA conversion rates reflect a lower percentage of service revenues. Please turn to Slide 18 to review some of our debt metrics. Our debt as of September 30 declined by $4 million from June 30 due to scheduled paydowns. The weighted average interest rate was 6.64%, consistent with what we have been paying. Total occupancy costs inched up slightly on a sequential quarter basis to 8.1%, but still fall within our comfort range of 6% to 9%. The increase from the third quarter of fiscal '22 primarily relates to new club acquisition debt. Our debt to trailing 12-month adjusted EBITDA remained relatively stable at 2.8x, September 30 compared to June 30. This metric remains aligned with our comfort level of being below 3x. We adjusted our September 30 debt maturity tables to reflect the previously announced October modifications to our 12% unsecured debt. As observed, our maturities continue to remain reasonable and manageable. Alongside our cash position and our October restructuring of our 12% unsecured debt, we possess an estimated $30 million of unencumbered real estate, allowing us additional leverage options if necessary. Please turn to Slide 19 for our debt pie chart. Our debt composition is akin to the third quarter. And that concludes my section. I will now turn the presentation back to Eric.

Thanks, Bradley. Please turn to Slide 20. Everything we do is centered around our capital allocation strategy. We employ 3 different approaches, subject to whether there's compelling rationale to act otherwise: mergers and acquisitions, organic growth, and stock buybacks when our yield on free cash flow per share exceeds 10%. All of this is executed with the ultimate goal of driving shareholder value by increasing free cash flow per share by at least 10% to 15% on a compounded annual basis. Please turn to Slide 21. We have adhered strictly to our capital allocation strategy since the end of fiscal 2015. It has proven to be successful, generating compound annual growth rates of 10.2% for total revenues, 12.1% for adjusted EBITDA, and 17.2% for free cash flow. Simultaneously, we have reduced our fully diluted share count by 1.3% on a compounded annual basis, which includes shares utilized for acquisitions. Additionally, I would like to note that we ended fiscal '23 with over $200 million in retained earnings for the first time. The first Rick's Cabaret opened 40 years ago. I believe we will be here for the next 40 years. The future is bright for RCI. There continues to be a strong demand for what we do. We believe the actions we are taking are positioning us for many years of financial success to come. Every piece of the puzzle has its place. We just need to stick to our plan. I would like to express special thanks to our loyal and dedicated teams for their hard work, and to all the shareholders who believe in us and make our success possible. We can't do this without you. Now here's Mark.

To start things off, we'd like to take questions from Rick's analysts and then some of its larger shareholders. Our 3 analysts are Scott Buck of H.C. Wainwright, Anthony of Sidoti, and Rob from Granite Research. Scott, you're up first. Take it away.

Eric, could you give us a little bit more color on what kind of traffic and spending trends you're seeing in the clubs today? Curious if some of those softer trends in the fourth quarter have persisted into the first quarter.

Well, I mean, we've seen some of the drags, especially among blue-collar patrons, still influencing this first quarter. The comp challenges are easing, not ideal for us yet, but becoming less cumbersome. It's challenging to pinpoint trends. I've noted this as a psychological recession, where spending behaviors have become unpredictable. I've observed that consumers, particularly within the last 60 to 90 days, seem to be loosening up, although there's still a level of cautious spending; people remain uncertain. We're witnessing numerous tech layoffs, impacting higher-end spending, hence they are more discerning about their expenditures, wanting to ensure they receive good value for their experiences. Our leading clubs are outperforming, particularly in markets where we hold the #2 or #3 spots, or where we own all clubs. The top clubs are thriving; however, others still show some signs of decline. This seems to be indicative of the current market situational nuances. In terms of trends, I haven't noted any prolonged patterns. The longest trend I've identified in the last 7 months has been approximately 3 weeks before things shift again, often erratically week by week. It's an unusual climate compared to my past observations. However, we're seeing enough resilience that I feel very optimistic moving ahead. The low sales weeks seem to be behind us, and the holiday parties have started to pick up this week. I've seen some promising figures. Just last weekend in Miami, the clubs were thriving, particularly Tootsie's, which was packed all weekend long. We experienced immense traffic and anticipation with the home game against Miami on Monday night, which always bodes well for business. Football is gaining momentum for us, and basketball's beginning to heat up as well. I think that 2024 is going to be a fantastic year for us, even if things remain somewhat sluggish.

Great. I appreciate that insight. I'm also curious about Bombshells. How far along are you with some of these strategic conversations? And can you give us any sense of timing on when something could potentially be announced?

We're in talks with several parties currently. About 60 days ago, we reached out to a couple of groups regarding potential partnerships and have received some requests for data, which we're currently compiling for different groups exploring various options—be it a strategic partnership, partial buyouts, or direct asset sales. We're carefully weighing all of these possibilities based on what aligns best with our long-term goals for RCI. In terms of timing, we've been working diligently on the case. Bradley has been involved in this as well. We aim to have the data put together and shared by January to the groups we're in discussions with. Following this, we expect more groups to reach out and more opportunities for exploration. We will ensure we find the best route to leverage our assets for increased cash flow while advancing our growth strategy without deploying too much of our own capital, especially with the evolving acquisition landscape.

Great. I appreciate that. Lastly, can you guide us on OpEx for next year, especially once you start layering in some new revenue from those growth initiatives? Will there be significant spending needed, or should we see notable operating leverage in the business?

Are you referring to CapEx spend or maintenance CapEx? I'm sorry.

I'm referring to back office support roles, staff additions, that sort of thing.

I don’t foresee significant increases in staff. Our payroll levels have remained somewhat flat. While we did have some additional payroll expenses, that was largely due to acquisitions. I think growth overall will outpace any growth in that department significantly.

Thank you very much for your questions, Scott. Next up we have Anthony of Sidoti. Anthony, take it away.

So first, just a follow-up on the previous question regarding the weakness among blue-collar clubs. I recall Eric mentioned this a year ago. Is it the same group of blue-collar clubs showing weakness, and what percentage of your clubs would you categorize as blue-collar?

I'd have to review our records. Out of 70 locations, I consider the working crowd—like the pickup truck crowd—as blue-collar. Although gas prices have come down, energy costs remain high, leading to challenges for this demographic. The slight uncertainty in the market is contributing to their hesitance in spending. However, as I observe the Bombshells and overall sales for the company improving modestly from November to December, I feel optimistic—we may have seen the bottom already. Predicting human behavior post-COVID is tricky, and I don't foresee a return to the free-spending habits of 2022. However, I believe we will return to our standard growth rates of about 3% to 5% for existing clubs over time while normalizing labor costs.

Understood. Are you noticing any geographical differences in your same-store sales for both the recent quarter and the current quarter, or is it fairly consistent across the board?

It's inconsistent across various regions. For instance, in New York, we see significant sales one month and declines in the next. Miami has remained fairly stable, although we saw a dip across our 4 clubs there. Reflecting on last year's impressive figures—like Tootsie's generating $39 million in revenue—our current figures are still positive compared to pre-pandemic levels. This week, for instance, Tootsie's is performing exceptionally well, buoyed by a surge in cryptocurrency transactions. We've processed considerable amounts in bitcoin this week alone. We are exploring the option of accepting bitcoin in our New York and possibly Chicago locations. If bitcoin stays strong, that could positively impact sales. I'm optimistic that this summer will be much improved, particularly as it seems many vacationers spread their trips out over the summer months, avoiding the busy crowding seen last June that affected our VIP spend.

Got it. You mentioned changes in operations to improve performance. Can you share some examples of what you've implemented and what we can expect moving forward?

Of course. We've promoted Dean Reardon and Shaun Kevlin, enabling Ed to dedicate more time toward acquisitions and new club developments. We've made modifications in management approaches and enhanced our regional management oversight. We also appointed an Assistant Director of Operations for Bombshells with over 20 years of multi-restaurant experience—a change that seems to be positively influencing results in specific markets. I believe our recent adjustments will help rediscover our operational excellence in a landscape where prior managers may have gotten complacent due to the easy money era of 2021 and 2022. We are returning to our foundational principles, emphasizing customer service, engagement, and consistently exceeding guest expectations.

I see. You noted a decrease in labor costs as well?

Yes, it's gradually becoming more manageable. Our kitchen staff availability is improving, and overtime hours are decreasing. However, we have been pushing our best employees hard to cover for absences, leading to imbalances in their work-life balance that we need to rectify.

Do you see opportunities to reach historical operational margins again, maybe not the peak levels from last year, but can margins get back to the high 20s over time?

I believe we can attain the high 20s on free cash flow conversion. Our adjusted EBITDA may settle closer to 30%. There may be slight dips in the interim, but returning to normalized free cash flow margins in the 20s and adjusted EBITDA at 30% is feasible and remains our goal.

All right, that seems promising. Best of luck and happy holidays to all.

Thank you.

Thank you very much, Anthony. Next up, we have Rob McGuire from Granite Research. Rob, the floor is yours.

Regarding the Nightclubs, could you elaborate on the Baby Dolls locations? You spoke about 2 new locations already using the assets you own. Are these part of club expansions? Can you provide more details?

Yes, we are working collaboratively to convert an older Jaguar’s location into a Baby Dolls in the City of Tye near Abilene, Texas. We also plan to expand the original Baby Dolls West – permits are being secured for that project. In Lubbock, we are on track to open a location soon, following our acquisition process and necessary land negotiations. This new location is nearing completion; we're simply waiting for a few final approvals. These are the 3 clubs we are concurrently developing.

I appreciate that, Eric. I’m also curious about your plans regarding the Chicas — two of the Chicas Locas locations—is there still a development plan in place, or is this a 2024 undertaking?

It might be more of a 2024 initiative. At present, we've promoted individuals to free up Ed’s schedule to focus on these various prospects more effectively. With these 3 projects actively moving forward, we’re yet to finalize our strategy for the Dallas market—where we have another Chicas location. Recently, we assessed potential expansions for current clubs. Interestingly, I visited Houston last Wednesday and was impressed by the bustling traffic there, so there's definitely high demand fueling discussions about enhancing the current club capacities. We will convene again early next year to evaluate potential action steps.

On Central City, once you obtain a license, theoretically, how long will it take to ramp up and staff those facilities for an operational opening?

Approximately six weeks—it's not just about staffing; we also have to set up and complete a testing phase. After acquiring the license, we will need enough time to get everything installed and tested. Our newly appointed Director of Casino Operations is experienced in this area, having successfully opened several locations in Colorado. We have our plans established to ensure rapid deployment once we obtain the necessary approvals, but theoretically, if we were to secure a license today, I suspect we wouldn’t be open for business until late March or early April due to construction timelines.

Do you have plans to apply for a license to expand your third property in Central City? Can you discuss the timeline for that?

Yes, we have submitted our application for the gaming license for that third property. We've also purchased additional contiguous property to better position ourselves for potential development opportunities. We are working methodically to manage existing tenants, ensuring we maintain engagement with them while simultaneously moving forward with the preparations for the new casinos. We'll prioritize getting the two new casinos operational before we decide on this property's future; however, controlling this property is critical as it allows us to manage future competition effectively.

Are there plans by any third parties to establish casinos in Central City? What are some other operators considering?

We are hopeful for that. There are several sites that could accommodate significant resorts with casinos attached. These developments could help draw substantial traffic. We've heard from various developers actively considering the prospects for development, and I sincerely believe that progress in this area could improve the overall gaming market you mentioned.

Thank you very much, Rob. We're opening up the floor again for any remaining questions from the audience.

As we circle back to your earlier point about navigating these economic challenges, could you share some insight into the strategies you've employed to tighten margins? While we expect comp improvements over time, is there ongoing cost rationalization taking place, especially as higher-margin casino revenue begins to contribute more to the revenue mix?

Indeed, margin performance will fluctuate based on future acquisitions. When discussing margins returning to the 20% range, we were at approximately 15% free cash flow margins this quarter. Annually, we were roughly at 18%. One quarter's performance shouldn't be dismissed as representative. Seasonality is an important factor. I hope that 2024 can normalize our trends, allowing us to return to growth as early as the June quarter.

Noting the various land acquisitions this year, your cash has been directed toward investments rather than debt reduction or share buybacks. Could this lead to a higher debt load or increased interest expense without corresponding revenues?

Yes, I'd estimate that our carrying costs in 2023 were between $4 million and $6 million; opening additional casino revenues could decrease that significantly in 2024 as we reduce expenses while also enhancing revenue. Thus, I would likely see margins returning closer to 20% and could achieve those levels sooner than expected.

Supposing both Bombshells and casinos open simultaneously, could there be a scenario where you can use them to effectively cash flow the overall project?

Yes, once we're operational and generating revenue, we can explore financing options against the actual earnings, a stark contrast to our strip club operations. This is a more favorable environment for raising capital, enabling us to continue expanding even in uncertain landscapes. I acknowledge the demand for your ideas and recommendations moving forward.

Fantastic discussion! If there are any additional inquiries from the attendees, please raise your hand for our audiences and we’ll accommodate you. Thank you all for participating in today's earnings call.