Earnings Call Transcript - RICK Q4 2021

Gary Fishman, Investor Relations

Thank you, John. For those of you listening on the phone, you can find our presentation on the RCI website. Click Company and Investor Information under the RCI logo. That will take you to the Company & Investor Information page. Scroll down and you'll find all the necessary links. Please turn to Page 2 of our presentation. I want to remind everybody of our safe harbor statement that is posted at the beginning of our conference call presentation. 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, and we disclaim any obligation to update information disclosed in this call as a result of developments that occur afterward. Please turn to Page 3. I also direct you to the explanation of non-GAAP measurements that we use. And I'd like to invite everyone listening in the New York City area to join us tonight at 6:00 to meet management at Rick's Cabaret New York, Manhattan's number one gentleman's club. You can also tour its sister club, Hoops Cabaret and Sports Bar next door. It's located at 50 West 33rd Street between Fifth Avenue and Broadway, around the corner from the Empire State Building. If you haven't RSVP-ed, ask for Eric Langan or me at the door. Now, I'm pleased to introduce Eric Langan, President and CEO of RCI Hospitality. Eric?

Eric Langan, President and CEO

Thanks, Gary. Thanks for joining us today. I'm here with our CFO, Bradley Chhay. After the market closed, we reported our fourth quarter and year-end numbers. We had another strong performance with record fourth quarter revenues, fiscal year revenues, and cash generation. As always, we thank our loyal customers, dedicated team members, and steadfast investors for their support. We are continuing to work on all aspects of executing our growth plan for fiscal 2022. At the end of the quarter, we closed on our $99 million bank real estate refinancing at better rates and terms. In October and November, we closed on our big acquisition of 11 clubs in six states and The Mansion in Newburgh, New York. Last week, we opened our 11th Bombshells in Arlington, Texas, in the Dallas market, and our first franchise is close to opening its first location in San Antonio. Brad and I will talk more about the growth plans later. Now, here's Bradley to review the financials.

Bradley Chhay, CFO

Thanks, Eric, and good afternoon to all those who are listening. During the fourth quarter, we reported total revenues of $54.9 million. That is up 91% from a year ago quarter but also up 22% from the pre-pandemic fourth quarter in fiscal 2019. GAAP EPS was $0.26 and non-GAAP EPS was $1.58. GAAP EPS was impacted by a non-cash impairment charge of $11.9 million. Most clubs rebounded significantly through the year on a favorable trajectory. However, for the full year contribution from the clubs in certain locations which had more stringent COVID-19 restrictions did not recover as fast as previously projected. Net cash from operating activities was $9.8 million, and free cash flow was $8.5 million for the fourth quarter. Net income was $2.3 million, and adjusted EBITDA was $17.6 million. For the full year fiscal 2021, we reported total revenues of $195.3 million. That is up 48% from a year ago quarter but also up 8% from fiscal 2019. GAAP EPS was $3.37 and non-GAAP EPS was $4.08. GAAP EPS was impacted by a non-cash impairment charge of $13.6 million for the full year. The net cash from operating activities was $42 million, and the free cash flow was $36.1 million. We ended the year with $35.7 million in cash and cash equivalents. Now, if you'll turn to Page 5. Nightclubs segment revenues, operating margin, and income from operations were all up significantly year-over-year. As a result, revenue rose to $40.3 million, which is great for our seasonally slower fourth quarter. GAAP operating margin was 16.1%, and non-GAAP operating margin was a whopping 43.2%. GAAP income from operations increased to $6.5 million, and non-GAAP was $17.4 million. Our Florida clubs did particularly well, and our high-margin service revenues, mainly from our Northern states clubs, grew sequentially year-over-year. Looking at results compared to the pre-COVID fourth quarter of 2019, revenues were up 12%. Income from operations increased 4% on a GAAP basis and 58% on a non-GAAP basis, which excludes impairments. Now, if you'll please turn to Page 6. Bombshells had a great quarter with revenues of $14.4 million, GAAP operating margin of 20.8%, and income from operations of $3 million. Revenues were below the third quarter and the unusually strong year-ago fourth quarter. But they were 11% of the first and second quarters of this fiscal year 2021 and 68% higher on 25% more units compared to the pre-COVID fourth quarter of 2019. Operating margin was lower sequentially; there was less in the way of operating leverage. During the fourth quarter, we experienced and were heavily impacted by food and labor inflation costs. We also had preopening expenses related to Bombshells in Arlington which opened earlier this month. Please turn to Page 7. Still, fiscal year 2021 was a record year for Bombshells. I'd like to spend a moment reviewing our progress. Now over the last five years, we've grown from 5 to 10 locations. We've seen a 200% increase in revenues and an increase of 7 percentage points in GAAP operating margin. Our fiscal '21 average unit volume compares very nicely to some of the biggest and best brands in the business. We believe there are several factors that are driving the success: number one, our Bombshells team, led by restaurant pro, David Simmons. Number two, we believe that Bombshells is a great concept, and we've done a really fine job at refining it. And lastly, our site selection has resulted in better locations and higher average sales per location. Now, please turn to Page 8 to review our fourth quarter consolidated statement of operations. Sales were higher, and expenses were lower. There's a CFO analysis right there. Improvement in the margins of cost of goods sold, salaries and wages, and SG&A were all attributable to higher Nightclub revenues during the quarter. In part, that's due to high-margin service revenues, growing from 23% of the total in a year-ago quarter to 31% this year. Certain costs overall in general, such as insurance and legal, were significantly lower. As a result, GAAP operating margin was 6.6%, and non-GAAP operating margin was 28.4%. Our interest expense also declined as a percentage of revenue. I'll talk about more of this later when I get to the debt analysis slides. Now, if you'll please turn to Page 9. As I also mentioned earlier, we ended the quarter with $35.7 million of cash on hand, while our total debt fell $2.4 million to a two-year low of $125.2 million. The debt decline reflected scheduled paydowns and a $1.2 million paydown related to a sole property. Free cash flow was $8.5 million for the quarter and a record $36.1 million for the year. As you know, we pay a lot of bills in the fourth quarter. This affects our net cash from operating activities and our free cash flow for the period. While many of our locations bounced back over the course of fiscal 2021, they were not open to their full capacity as they are now. Adjusted EBITDA for the quarter was $17.6 million and $60.2 million for the year. Now back to the debt; the next three slides show our debt as a result of the September refinance and then the new debt that we took on related to our October and November acquisitions. Let's start with our 9/30/21 debt pie chart on Page 10. Real estate debt increased $18.6 million from June 30 to $102.3 million September 30. Then using the cash that we pulled out from our real estate, we paid down $7 million in higher-rate seller financing and $12.4 million in higher-rate unsecured interest debt. Please turn to Page 11 to review the 9/30 debt manageability. Our occupancy costs continue to trend in the right direction and are well below our target range of 8% to 12%. As a percentage of revenue, they were 6% in the fourth quarter compared to 11.8% in the year-ago quarter and 7.6% in the fourth quarter of 2019. This was primarily due to higher sales in the current quarter and the decline in interest expense. We've continued to reduce our weighted average interest rate. Over the last five years, it has come down from 7.23% in the fourth quarter of fiscal 2016 to 5.64% in the fourth quarter of this fiscal year. Our 9/30 weighted average interest rate was 104 basis points lower than the 6/30, primarily due to refinancing and paying down the higher-rate interest debt. As we've discussed, our periodic refinancings, like the one we just did in September, enable us to convert higher-rate seller financing and other unsecured financing used in the club acquisitions into lower-rate commercial real estate bank debt. Our periodic refinancing also enables us to smooth out our debt maturity schedule. In this case, the September refi enabled us to eliminate $4 million in balloon payments due in fiscal year 2022. Refi also enabled us to reduce principal amortization by more than $2 million annually. Now, if you'll please turn to Page 12 to look at our 11/30 debt pie chart. During October and November, we were able to take on $39.2 million of new debt. This was in the form of seller financing and unsecured debt used for our recent acquisition of clubs and real estate. I would also like to highlight that we have completed our SBA loan through forgiveness and have a small amount of repayment remaining. We are also approaching the conclusion of the Texas Comptroller Settlement. Now, let me hand the call back over to Eric, and thank you.

Eric Langan, President and CEO

Thanks, Bradley. If you'll turn to Slide 13. We've continued to talk with 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. He studied companies that focused on generating cash per share and allocating that cash effectively to generate more cash. We have been applying these strategies since fiscal 2016 with three different actions, subject, of course, to whether there's other strategic rationale to do otherwise. One is mergers and acquisitions, specifically buying the right clubs in the right markets. We like to buy good, solid, cash-flowing clubs at 3x to 5x adjusted EBITDA, use some seller financing, and acquire the real estate at market value. Another strategy is using cash to grow 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 the yield on our free cash flow per share is more than 10%. Currently, we believe the yield is within our buy range. However, we are seeing some great opportunities to expand Bombshells as well as additional club purchases with opportunities to earn cash-on-cash returns of 25% to 50%. We have been letting our cash build. Once cash gets to a point beyond what we feel we can deploy quickly at these great returns, our plan is to use excess cash to buy stock in the open market if the stock price continues to stay in the current range of $60 to $65 per share. And we would be more aggressive the better the yield becomes, under $60 per share. For our growth initiatives, please turn to Page 14. Here is an update on our current growth initiatives. We have a lot going on. We are making important progress with the 11 clubs that we acquired in October. This is a COVID-rebuilding effort similar to what we did with our own clubs in fiscal '20 in the first half of fiscal '21. The new clubs are back up to about 80% of their pre-COVID run rate. We are continuing to staff them with the right people. As this happens, we expect to make continued progress over the next two quarters. Our other acquisition, The Mansion, is doing well, and our new Bombshells in Arlington is off to a terrific start with a record single-week sales for Bombshells. Our first franchise location in San Antonio should open in the March quarter which is our second fiscal quarter. Also during that quarter, we expect to reopen our remodeled club in Louisiana and the club we are reformatting and rebranding in San Antonio. We are in the process of obtaining our credit card processor for admireme.com. The site is also scheduled for beta testing in the second quarter. We have two access properties under contract for sale. And as we announced last week, we are under contract for purchasing land for two new Bombshells in Dallas. This would give us four locations in that market. We are also under contract for purchasing land in Stafford, Texas, which would give us nine Bombshells in the Houston market. As always, we continue to talk to owners about acquiring their clubs, and we continue to look for new Bombshells locations and franchisees. Sales for our first quarter are doing well. With our acquisitions, we should have another great quarter. As always, a big thanks goes out to our teams, nightclubs, Bombshells, and corporate for all your hard work and dedication. Thank you, all, and Merry Christmas. With that, let's open the lines for questions, operator.

Operator, Operator

Thank you. The first question is from Anthony Lebiedzinski from Sidoti & Company. Your line is live.

Anthony Lebiedzinski, Analyst

Yes, good afternoon, and thank you for taking the questions. Certainly, a terrific quarter and a terrific year as well. So just looking at the segment margins, obviously, very strong performance for both the quarter and the year. So as we think about the rise in food costs and labor costs, how should we think about segment operating margins going forward?

Eric Langan, President and CEO

I believe we have successfully passed most of those costs on to consumers. However, if costs continue to increase and we can't transfer those expenses, our margins might be affected. We incurred significant preopening costs for Bombshells, which we will see again this quarter. The Arlington store will also contribute nearly four weeks of revenue, which will help balance some of that out. I expect Bombshells margins to remain within our target range of 18% to 22%. Regarding the Nightclubs, we are observing an increase in service revenues in our Northern markets as people are returning. We need to monitor how the new variant impacts this and the recent mask mandates in New York may also play a role. We will keep an eye on this development, but there's not much to gauge at this time. Overall, I think our other markets are performing very well, and I anticipate that club margins will either maintain or improve from their current levels.

Anthony Lebiedzinski, Analyst

Got it, okay. And then, as far as just a follow-up on that. As far as the preopening costs, do you have those numbers, what that was for the quarter? And what should we expect for the first fiscal quarter for preopening?

Eric Langan, President and CEO

We don't have a detailed breakdown because we train at our current locations. I can tell you that our labor costs have increased this quarter, primarily due to training. While some of it is due to cost inflation, we've managed to pass most of that on through price increases. Therefore, I'm not overly concerned about margins being impacted at this time. I believe that margins at some of our existing stores will return to more typical labor margins as we progress, particularly since all employees are now working at the new store in Arlington. The training we've been conducting over the past six months, which has been distributed among various stores, will soon come to an end.

Anthony Lebiedzinski, Analyst

Understood. And then you mentioned that the Q1 to date, the trends are pretty good. So is that just mostly traffic-driven? Or are you seeing also increases in average ticket as well?

Eric Langan, President and CEO

We're observing increased spending from VIP customers, which indicates that service revenues will likely continue to rise slightly as a percentage. Currently, we're in a solid position, but I don't have a complete breakdown of our 12 new locations at this moment. I've been monitoring the overall numbers rather than the specific details yet. By the end of this quarter and into the next one, we'll have a clearer understanding of those specifics. These locations are primarily focused on recovering from COVID, with some just having reopened fully in October after operating with restricted hours. Previous owners did not operate during all their normal business hours, so we're now working on extending those hours and ensuring each location is fully staffed. I believe we could reach pre-pandemic activity levels by March, or at the latest, May, and then we can evaluate the growth potential for those locations.

Anthony Lebiedzinski, Analyst

Got it. Okay. Well, thank you and best of luck going forward.

Eric Langan, President and CEO

All right, thank you.

Operator, Operator

Okay. The next question is coming from Adam Wyden from AW Capital. Your line is live.

Adam Wyden, Analyst

Eric, can you hear me all right?

Eric Langan, President and CEO

Yes.

Adam Wyden, Analyst

I wanted to share some analysis regarding the fourth fiscal quarter, which is typically slower and impacted by preopening costs. If I annualize that quarter, it suggests an EBITDA of around $70 million, and possibly a run rate of $75 million or $80 million when taking seasonality into account. Adding in Lowrie, which was generating about $14 million or $15 million before they were fully operational, it looks like the business could be approaching nearly $100 million of EBITDA, not including the new Bombshells locations. With a market cap around $564 million and about $100 million of EBITDA, the valuation is quite attractive compared to many restaurant or hospitality companies. What strategies are you considering to address the cost of capital and help the market recognize this value? Perhaps buying back shares at current prices could be more beneficial than pursuing M&A. At a multiple of 3x EBITDA, that might make sense, but at 5.5x, it's a significant challenge.

Eric Langan, President and CEO

I agree, and that's why I believe we are currently within a good buying range. We are exploring all available opportunities. You mentioned our activities, and we plan to attend the Noble conference in April and the IRC and Sidoti conferences in January. I'm also considering a possible conference in March. We intend to share our story and continue focusing on building free cash flow, aiming for $100 million in EBITDA and growing from there. Although we might be slightly below that run rate at the moment, I anticipate that from March to May, with the Lowrie clubs becoming operational, we will see the benefits of our efforts, typically growing these locations by 15% to 20%. We recently saw a record week at the new Bombshells in Arlington, which is a fantastic location. We are progressing with the Rowlett property and had a development meeting this afternoon, and it looks promising for us to close on that property by late January or early February, after which we will begin work there. We have also submitted all necessary documentation for the Grapevine location, which is about a 42-day process that commenced on December 6. We expect to start construction there shortly thereafter. Additionally, we are in the early stages of developing a new location in Houston and exploring multiple other properties with letters of intent out for negotiation to continue expanding Bombshells. I aim to secure the eight locations we previously discussed and move them all into construction. We're meeting with a couple of franchisees to advance those discussions. Our current franchisee is eager to open in January or early February, aiming for a pre-Super Bowl launch. They initially wanted to open in December, but based on our experience with such projects, we anticipate a mid-January completion, which should allow for a February opening. Once this franchisee starts sharing their results, I believe it will highlight the value of franchising Bombshells, leading to further interest and growth in the concept.

Adam Wyden, Analyst

The economics of the Bombshells franchise are excellent. Clearly, royalty revenue provides a full return on invested capital. If you examine the cash-on-cash returns for Bombshells, they are around 50% to 60% on a leveraged basis. It’s surprising that we are trading at 5.5 times EBITDA when this segment has such a strong return profile. Meanwhile, companies like Chipotle are trading at 40 times EBITDA and Wingstop at 100 times EBITDA. Although Wingstop is franchised, Chipotle is fully company-owned with leases, while we have owned real estate that arguably delivers better cash-on-cash returns. You reported a strong quarter, and in pre-COVID times, you were at $50 EBITDA or so. Now you are exiting 2021 with double that, which is very impressive. Any initiatives to expand your audience and optimize your cost of capital will be beneficial. The company is performing well, but we aren’t seeing the corresponding appreciation in the public market.

Eric Langan, President and CEO

I believe we'll achieve our goals. We need to keep sharing information. Currently, the market is somewhat weaker, and there appears to be initial fear regarding the new variant. However, this fear seems to be diminishing as reports indicate it's not causing significant illness, and it hasn't impacted our business. Last week was excellent for us, and I anticipate this week will be strong as well. Our operational weeks run from the 1st to the 7th, 8th through the 14th, and 15th through the 21st. As we progress through December, I expect a very robust month, leading to a strong quarter. Moving into January, February, and March, I foresee continued improvement, which aligns with what we've been observing.

Adam Wyden, Analyst

Yes. Well, then maybe my $100 million of EBITDA is getting a little bit light but...

Eric Langan, President and CEO

Well, that's what I'm working for, like making the under me for a change.

Adam Wyden, Analyst

Oh my goodness, wouldn't that be nice. All right, guys, I have to jump off for a Zoom but keep up the good work. Thank you.

Eric Langan, President and CEO

All right, have a good one.

Operator, Operator

Okay. The next question is coming from Joe Gomes from Noble Capital Markets. Your line is live.

Joshua Zoepfel, Analyst

Hi guys, this is Joshua Zoepfel filling in for Joe Gomes. My first question is just based on the acquisition pipeline you guys are going on. I know you guys are just finalizing those 11 clubs. But just how is it looking? And I noticed that there are like four new exposure markets that you guys are dealing with? Is it kind of like a trend you're seeing sort of a new strategy for those acquisitions?

Eric Langan, President and CEO

I believe we have become more aggressive. Previously, we typically paid three times or less for most of our acquisitions. The recent acquisition we completed was at five times EBITDA for some excellent locations, including four new markets where we have a strong presence, and in some cases, these are the only locations in those markets. We're very enthusiastic about this development. This has prompted other owners with quality clubs to approach us, saying they were unaware that we would pay five times; they thought we were limited to three times. I mentioned that we are open to examining their clubs, and in certain markets, I would consider paying between three to four times. For what I refer to as supermarkets and select clubs, I am prepared to pay a higher multiple. I am currently receiving calls from some of these owners as we discuss where their clubs fall within that three to five times range to see if we can reach mutually beneficial agreements. There are numerous clubs under consideration largely due to the significant cash reserves we have. Looking back to 2019, securing $8 million or $10 million in cash was a considerable amount for us. For this deal, we invested $36 million in cash upfront, enabling us to pursue much larger deals, which is obviously more appealing to the sellers than receiving gradual payments over time. However, I am also in discussions with a few owners who are looking for 20-year annuities. They indicate they need consistent monthly cash, as they are 68 years old and anticipate living another 20 years, hence they desire guaranteed monthly payments. We are actively negotiating some deals of this nature with various owners. There are certainly plenty of exciting opportunities available right now.

Joshua Zoepfel, Analyst

I just kind of want to switch over to the Bombshells portion. I want to see how the franchising is going. I know you alluded to Arizona as a state you're looking at outside of Texas. Is there like maybe a possibility of other states that you're looking at?

Eric Langan, President and CEO

For Arizona, we're focusing on the Phoenix market for company-owned stores. We are also in discussions with franchise groups in about three other states. One of these states faced an issue with the Department of Transportation regarding a curb cut needed for the property. Without this curb cut, they would need to construct an additional road, which resulted in insufficient land for the project. Consequently, they would have lost around 45 parking spots, making the site impractical. Now, they are searching for another location, and we hope they find one soon so we can move forward. Our current franchisees are already discussing their second location and are eager to get started on it. Additionally, we are vetting several other potential franchisee candidates and exploring the markets they are interested in. Our company is still keen on opportunities in Florida; we would love to establish a presence in the Miami area, but we are also considering Jacksonville and Orlando, as well as the West Coast of Florida, from Tampa down to Naples, for potential expansion of company-owned stores in those regions.

Joshua Zoepfel, Analyst

Great. And then one more question, if I may. I saw that in one of the slides that your Florida clubs are doing particularly well. Is there like any kind of reason for that, like increased traffic, just better cost initiatives going into those?

Eric Langan, President and CEO

Well, I think all of our New York customers moved to Florida. I mean I just think the growth in, especially the Miami, Fort Lauderdale area alone is phenomenal. The state of Florida has been very business friendly. And I think that's helped with the recovery in that market tremendously. I'm not big on politics, but I do believe that it's definitely helping the clubs down there. I mean Tootsie's is doing record numbers week after week after week after week. And that's a site that was already doing $26 million as our best year ever. This last year, we did almost $33 million, and our current run rate is probably $36 million plus at that location. So you're talking about a 50% increase post-COVID at Tootsie's. Scarlett's is up 40%. So as always, I say, the numbers don't lie. I mean, the math is there, the numbers are great. And as our northern clubs are coming online now, we're starting to see an even bigger influx and I think we're going to see as the new acquisitions, as we get past the COVID restraints, I can't kind of call them restraints, right? We have these restraints put on us. And when you first take off the restraints, you haven't used your muscle in a while, it's sort of little weak. And so now we're building up. We're going to the gym every day and we're building up, and those locations, I believe, will be very, very strong as we move into March and definitely through May.

Joshua Zoepfel, Analyst

Great, thank you for the color on that. That would be all for me. But congrats on the quarter and the year. Look forward to more.

Eric Langan, President and CEO

We are too.

Operator, Operator

Okay. The next question is coming from Jason Scheurer from Orchard Wealth. Your line is live.

Jason Scheurer, Analyst

Hey guys, congratulations. Thought the fourth quarter was excellent, considering it was your slowest, makes some of your other quarters look pitiful; it's unbelievable how much business you guys are doing. A question for you about sales from the new locations. What do you think they're going to add in sales to the balance sheet, let's say, for the next 12 months?

Eric Langan, President and CEO

If you had asked me three months ago, I would have expected us to reach a run rate of around $14 million to $15 million. Currently, we're at about 80% of that or approximately $40 million in revenue, which translates to around $14 million in EBITDA. So we're at roughly 32% of our projected run rate. However, we’ve only been operating the new locations for about eight or nine weeks, making it a bit too early to draw conclusions. It's challenging because we aren't getting enough open hours, and in some markets, hiring has been quite difficult. Consequently, we are in the process of relocating staff and training new employees, which is taking longer than it would if the locations were fully operational with complete staffing. Therefore, it will be a gradual process, one day at a time.

Jason Scheurer, Analyst

On the earnings call earlier, you mentioned that your Bombshells operating margins are projected to be in the range of 18% to 22%. What do you anticipate for the operating margins for the clubs?

Eric Langan, President and CEO

We have been operating between 40% and 55%, which really depends on several factors. Sporting events significantly influence our performance. Different locations also play a key role, depending on the sporting events in those areas and the performance of local teams. For instance, in New York, if the Knicks were contenders for the NBA finals, our New York club's revenue during that 2-month period, leading up to the finals and playoffs, could be around 25% higher than usual, mainly because of proximity to The Garden. The high-profile executives attend these games rather than general ticket holders. Our customer turnout also varies; for example, when the Rangers go on a winning streak, we tend to see a surge of hockey fans after games. Overall, our performance fluctuates by market and time, making it challenging to predict. However, I estimate we can expect a low end of 40% and a high end of 55%.

Jason Scheurer, Analyst

Okay. And then, the question I have is with the OnlyFans rollout that you guys are going to be doing, is this going to be something that every one of the dancers is going to be encouraged to do this and you're going to give them like a free site or something along those lines? What's your plan with that?

Eric Langan, President and CEO

We will definitely encourage promotions in our clubs to help them attract customers and enhance their online business. This will be particularly effective in our business clubs where business travelers frequent. Typically, these individuals visit multiple times a year, allowing for relationships to develop. Each time they return to town, they'll be more inclined to visit the club, and when they're away, they can maintain contact online to foster what I refer to as the fancy relationship.

Jason Scheurer, Analyst

Yes, I'm very pleased with the results. For what is typically a slow quarter, I was anticipating lower figures, but you all surpassed my expectations. Congratulations.

Eric Langan, President and CEO

Yes, we sometimes question if this is real, but we understand.

Operator, Operator

The next question is coming from Andrew Hollingworth from Holland Advisors. Your line is live.

Andrew Hollingworth, Analyst

Hi, thanks very much. I'm just making sure you can hear me, because I'm calling from the U.K.

Eric Langan, President and CEO

Yes, we can hear you.

Andrew Hollingworth, Analyst

Great, thanks for taking the question. Again, like everyone else, it was a fantastic reporting period. I have a couple of questions. I wanted to ask about the segmental margin. To clarify, I'm curious about the structural increase we've seen in margin — how much of that comes from revenue due to good trading, and how much is due to the structural changes made to the cost base over the last two years? You've somewhat addressed this by indicating that the current run rate of the clubs' margin seems to be on the low end of the range. I just want to confirm that the 40% to 55% you mentioned is comparable to what is shown on Slide 5. That's my first question.

Eric Langan, President and CEO

Yes, some of the margin improvements come from our upgraded accounting systems over the past five years and the efficiencies we've implemented. When COVID hit, our revenue dropped sharply, prompting us to make significant cuts to reduce excess costs in the company. Over the long term, as a business grows, certain inefficiencies tend to accumulate. We began addressing these in 2016 with our application strategy and believed we had eliminated a substantial amount by 2018 and 2019. However, with revenue falling to zero, it became evident that there were still inefficiencies present. We managed to cut even more and have been diligent about not reinstating those costs, maintaining tight controls, and focusing on our margins. While some of the margin is influenced by customers, our VIP expenditure is currently low in certain markets, but we are starting to see it rebound. As those significant customers return, the margins will improve. This explains the variation in margins I mentioned, where a 15% difference can be substantial, but it largely hinges on the level of VIP spending. If that spending returns strongly, we will reach that target range.

Andrew Hollingworth, Analyst

Okay. I think it's very difficult just to talk about...

Eric Langan, President and CEO

I'm sorry, you're cutting out a little bit now. I'm sorry.

Andrew Hollingworth, Analyst

Okay. Just a second. In previous periods of time, you talked about sort of six to eight quarters of having sort of good trading and then it can slow down for a while. So in terms of that margin range, you had a wonderful period of trading for six to eight quarters, then it ended up in that range and sort of a slower period. Do you think now a slower period is probably 40%, not to say in this quarter or next quarter or but years from now, that's what you're telling us is that the bottom end of the range could be 40% whereas the bottom end of the range used to be obviously much lower than that?

Eric Langan, President and CEO

I believe we've made significant progress. Looking back long-term, especially before 2016, we had many legacy clubs that we had owned for a long time, as well as properties with considerable carrying costs. We operated some clubs that weren't profitable, but we focused heavily on top-line revenue and neglected return on investment. Since 2016, we have started paying closer attention to this and eliminated those unprofitable clubs in 2016 and 2017. This accounts for the lower margins during that period; when times were tough, our margin of 40% included a 6% drag from those losing clubs, bringing it down to 34%. That 6% drag is no longer an issue and won't return. Now, if we have underperforming locations, we will sell them or relocate them and reinvest that capital into higher margin assets.

Andrew Hollingworth, Analyst

That's very clear and helpful. May I ask one final question? Based on the presentations you've made in previous calls and with some assistance from Adam, the outlook for the business looks impressive and appealing, and your capital allocation is very well articulated. I commend you for that. As a shareholder in the fund I manage, the main question I have regarding this company is about potential risks. I would appreciate your insights on this matter, especially in light of the recent developments involving Visa and Mastercard over the past six months. It seems that some businesses thrive while others face challenges, particularly when governments appear to be against certain companies. Could you elaborate on the impact of societal attitudes or political factors?

Eric Langan, President and CEO

Well, the beauty of the government...

Andrew Hollingworth, Analyst

What can you do to appease that?

Eric Langan, President and CEO

The government changes every few years, which means we constantly have to adapt. We navigate these changes, and when necessary, we rely on the courts. We can hold things up until a new administration or city council comes in, and then we can work things out. We have reached settlements and are moving forward. Most of the litigation is settled, but there are still a few cities that don’t grasp the protections in place and occasionally try to challenge us, like what happened in San Antonio. However, we have reached a good compromise there, and our stores will reopen soon since we passed the inspections. I view this as background noise; there's always some legal matter happening somewhere. As we grow, we manage our legal needs like any large company does. Occasionally, we may lose a case, but we usually win because we strive to do the right thing. Sometimes, we do have to make settlement payments, which we disclose. We don’t publicize our wins, but we focus on the battles that matter. We aim for cost-effective resolutions when possible, but we don't waste money on frivolous lawsuits. We invest in our legal representation, resulting in higher legal costs, but we have a strong relationship with our insurance company, which helps manage those costs. Overall, the main challenges we face are occasional disputes. We have overcome tough times, like the downturn in 2008-2009 and the pandemic, demonstrating our resilience. Each challenge we face only makes us stronger, and we aim to keep that momentum going.

Andrew Hollingworth, Analyst

I think if you are as successful as you appear to be in consolidating the industry in Miami and beyond, you could become a significantly larger company. You are on the verge of making that leap. I'm curious about the impact on your reputation.

Eric Langan, President and CEO

When you figure statistically, it’s the compounded growth, it's going to grow pretty quick because we've gotten to that critical mass. That's what you needed to do.

Andrew Hollingworth, Analyst

My question is just more a question of what happened to Visa and Mastercard. More than about lawsuits, it was just about somebody made it stink, and then ultimately, they were forced to react. And I'm just sort of trying to put myself in a position of years to come, and is the business more sort of more in the public perception, and therefore, is there issues that work is right? So I just want to know how you think about that as an organization in terms of what could go wrong with it?

Eric Langan, President and CEO

We certainly value our reputation and strive to manage it. It's impossible to keep everyone satisfied all the time, and we've realized that. As we grow, particularly with Bombshells and in more mainstream markets, traditional strip clubs are not as prominent anymore; there are very few left. Unlike the 1980s and '90s with hundreds of clubs in cities like Dallas and Fort Worth, most of those low-end establishments have diminished. Today, these establishments are often multimillion-dollar enterprises. While smaller clubs have largely vanished, we are seeing some rogue operators emerging in specific markets who do not comply with regulations and operate as bikini bars, but they typically do not succeed in the long run. They either face tax issues or other problems and eventually go out of business, while we continue to operate responsibly. The focus for us is to be a good neighbor and to do our best in our operations. We aim to minimize negative press, although it's impossible for any business to avoid it entirely, as there will always be critics. Nevertheless, we will keep presenting our perspective and the reasoning behind our operations, and as long as we maintain this approach, we expect to thrive.

Andrew Hollingworth, Analyst

Good enough. I appreciate the way you take the questions; I appreciate your answer. Thank you for taking the time.

Eric Langan, President and CEO

Okay, thank you.

Operator, Operator

The next question is coming from Craig Smith, a private investor. Your line is live.

Unidentified Analyst, Analyst

Hi, so I just had one question on the $11.9 million impairment. So was that in any particular market area? Or what's triggered that now with COVID-19 sort of 18 months on?

Eric Langan, President and CEO

Sure. I'll explain it simply. There are multiple markets involved. Primarily, it's some of our college towns in Texas where the colleges have not fully reopened yet, along with our Northern clubs in New York and other markets that opened late in the year. When assessing impairments on a 12-month basis, the numbers just don't add up, and GAAP doesn't allow for a COVID exception. We faced material weaknesses because management based our projections on a non-COVID period, excluding about six to nine months of growth during the COVID rebuild phase. This is what we intended to present as our actual situation. However, the auditors insisted that GAAP requires us to include the COVID numbers, which led to some impairments in certain markets. We believe in the long-term viability of those markets, but as I mentioned, GAAP doesn't permit any COVID exceptions, so we adhered to the guidelines.

Unidentified Analyst, Analyst

Okay. So do you see sort of part of that maybe reversing in the future if demand...

Eric Langan, President and CEO

Once you write it off, it's gone, and you can't reverse it. There’s no increase in value once that happens. If we could, Tootsie's would probably have to be valued higher by about $50 million based on their current numbers. However, once it's written off, you never recover that value; it remains a write-off in book value. We don't really consider book value as a measure of our company's worth; instead, we focus on our free cash flow, cash generation, EBITDA, and non-GAAP metrics to assess the company and understand our future cash generation potential. So, book value is not very significant to us; it's just another figure.

Unidentified Analyst, Analyst

And just one other, not related to this. But so on your new debt financing, is that a fixed rate loan or is that floating?

Eric Langan, President and CEO

It's a fixed rate for five years with one adjustment at the end of that period. I can't recall if there was a ceiling included. Essentially, it's a one-time adjustment that lasts for another five years, after which it becomes ballooned at the end of ten years, but it's based on a 20-year amortization schedule.

Unidentified Analyst, Analyst

Okay. So if tomorrow rates increase, that's not really impacting you guys?

Eric Langan, President and CEO

It won't impact us for five years.

Unidentified Analyst, Analyst

Okay, thank you.

Eric Langan, President and CEO

Then it could have a small impact in five years from now.

Operator, Operator

Okay. The next question is coming from Jason Scheurer from Orchard Wealth. Your line is live.

Jason Scheurer, Analyst

Hey, sorry, guys. I just wanted to get a little more clarification on stock buybacks. I'm under the impression again because you gave away part of the deal was the 0.5 million shares at $60 a share. Anything under $60, you guys are going to be crazy buying back because that's just printing money, right?

Eric Langan, President and CEO

That's the way we see it. I believe we're taking a more aggressive approach. Currently, we have a lot on our plate, and I'm focused on navigating through the holiday season while allowing our cash reserves to grow. We recently made a significant acquisition, costing us $36 million in cash, of which we borrowed a portion. I estimate that we currently have about $24 million in cash on hand. I'm not sure how we will wrap up this quarter. We are in the process of arranging debt financing for all the real estate related to the new acquisition, the Arlington location, and several other properties we own outright that weren’t included in the first loan. We're putting together a small financing package that could provide us with additional cash. If we can finalize this by the end of the quarter, we might end with around $45 million. I believe we're generating free cash after debt service of about $750,000 to $1 million a week right now. We’ve been navigating through this transition, completing the K report, and finalizing the acquisition. I have a lot of work to do as we approach the end of this quarter and enter January and February. After the New Year, I plan to thoroughly analyze our free cash flow run rate. We're confident that it's strong, but we've been busy, so we haven't completely documented everything. I hope that by May, we can present a clearer picture of our run rate and free cash flow. We used to share those details regularly before COVID, including when we would buy back stock and at what prices, and I would like to restore that practice. However, the current situation makes it challenging to predict. I don't know if a city will impose restrictions overnight next week, but I believe our southern markets are doing very well. I also don’t foresee significant shutdowns in the north, as public sentiment seems to favor keeping businesses open. Recent elections indicated a strong desire for that, such as in Minnesota where several council members were voted out due to strict restrictions. People want to resume normal activities, including dining out, rather than staying home. I think this sentiment is beneficial for us. By the end of March, we should have a much clearer understanding of our position, and I hope to share that in our May presentations.

Jason Scheurer, Analyst

Well, you also have the good numbers coming from the 11 clubs being told that...

Eric Langan, President and CEO

Yes, because they are so new, that's part of the challenge. We currently have eight or nine weeks of data, and while we are observing growth trajectories, we haven't returned to 2019 levels at all of our clubs yet, though I believe we will soon. As we approach that point, the next step will be determining how to grow. I have a clearer understanding of our current status, which is what I want to know today. I want to establish where we are right now so I can assess our situation, considering seasonality and other factors, to project our future. Once we return to our free cash flow projections, we can use them to decide when to buy stock, as calculating the yield based on the stock price is straightforward.

Jason Scheurer, Analyst

Yes, anything around $60 is a complete deal. Thank you very much.

Eric Langan, President and CEO

Yes, and we're buying it. We're definitely buying it. If it's under $60, we'd buy it. It's getting close; so let's see what happens tomorrow.

Operator, Operator

Okay. We have a question from Michael Juradio, an individual investor. Your line is live.

Unidentified Analyst, Analyst

Hello, everyone. Thank you for taking my last-minute question. I have a question about the dividend. I recall that a few quarters ago, you mentioned you were considering raising it slightly. I'm curious if you could provide any guidance on that. I appreciate cash distributions, but at the same time, I know you can deploy that cash and integrate into businesses with strong economic characteristics that I can't access in the stock market. I'm not firmly set on either side of the issue, so feel free to respond.

Eric Langan, President and CEO

I don't expect to see a significant increase, but we discuss this during Board meetings. This could be the year to assess our growth rates for our annual targets. To qualify for certain dividend metrics, we need to maintain a specific growth rate. We will be reviewing this before the March dividend is distributed to ensure we stay on track with our growth. Currently, our dividend is $0.16 per year, and I can see us potentially increasing it to $0.18, possibly with two quarters at $0.05 and two at $0.04. Alternatively, we might consider raising it to $0.20, paying $0.05 each quarter. However, that approach isn't the most tax-efficient use of our capital and doesn't align perfectly with our capital allocation strategy. Nonetheless, as you mentioned, it does create positive sentiment among investors and opens the door for more investors to buy and hold our stock longer. Personally, I appreciate that aspect of the dividend, and as a large shareholder, I'm also in favor of those quarterly payments.

Unidentified Analyst, Analyst

I have a question as a follow-up on that. Is the acquisition pipeline a factor in your decision-making? If so, how significant is it? Or is it not really impacting your thought process at all?

Eric Langan, President and CEO

Regarding the dividend, we did have one. If we increase it by $0.04, it amounts to around $400,000 a year, which is quite minimal compared to the $36 million in cash we generated. In the grand scheme, $400,000 barely makes an impact. Our focus is on growth, and this dividend adjustment doesn’t significantly influence our thinking. Even though our current dividend yield is just 0.5%, it represents a tiny fraction of our overall cash. It's more about the positive sentiment it provides; knowing that cash is coming in quarterly can appeal to certain shareholders and enhance their experience of owning the stock. These factors are considerations during our Board meetings and will continue to influence our decisions. Maintaining our growth trajectory is crucial, as it helps us appear in more searches and stock screenings, which is also important.

Unidentified Analyst, Analyst

Thank you.

Gary Fishman, Investor Relations

Thank you, John and thank you, Eric and Bradley. Just to reiterate what Eric had mentioned, we've been invited to a number of investment conferences the first half of calendar 2022. We'll be at the ICR conference in Orlando, January 10 to the 12. We'll be participating in the Sidoti Virtual Small Cap Conference, January 19 and 20 and we'll be at the Noble Capital Markets Small Cap Conference in Hollywood, Florida, April '19 through the '21. And on behalf of Eric, Bradley, the company and our subsidiaries, thank you and good night. Stay safe, stay healthy. And as always, please visit one of our clubs or restaurants. Thank you.

Operator, Operator

Thank you, ladies and gentlemen. This does conclude today's conference call. You may disconnect your phone lines at this time and have a wonderful day. Thank you for your participation.