Gary Fishman - IR Eric Langan - Chairman, President and CEO Phillip Marshall - CFO

Andrew Desilva - Merriman Capital Adam Mikkelsen - Cooper Capital John Rolfe - Argand Capital Chris Brown - Aristides Capital

Greetings and welcome to RCI Hospitality Holdings Fiscal 2016 Second Quarter Conference Call and Webcast. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce Gary Fishman who handles Investor Relations for RCI.

Please turn to Slide 2. Thank you, everybody and thank you Denise. I wanted to remind everybody of our Safe Harbor statement; it’s posted at the beginning of our conference call presentation. It reminds you that you may hear or see forward-looking statements that involve a number of risks and uncertainties. I urge you to read it. 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 which occur afterwards. Please turn to Slide 3. I also direct you to the explanation of non-GAAP and adjusted EBITDA measurements that we use and that are included in our presentation and news release. Finally, I’d like to invite everyone in the New York City Area to join us at Rick's Cabaret in New York tonight at 6 o’clock to meet management to get a firsthand look at one of our flagship clubs. Rick's Cabaret New York is located at 50 West 33rd Street between Fifth Avenue and Broadway, around the corner from the Empire State Building. If you haven’t RSVP ready, ask for me at the door. Now I am pleased to introduce Eric Langan, President and CEO of RCI Hospitality.

Thank you. Good afternoon, everyone. Please turn to Slide 4. We're pleased the company closed its fiscal second quarter results better than our original expectations. We are in $0.54 per share on a GAAP basis. That contained a $1.75 million benefit from tax credits. On a non-GAAP basis, excluding non-recurring items we are in $0.40 per share. That compares to $0.30 in the prior quarter. We're comparing results on a sequential basis in some places of our presentation today. As most of you know the second quarter of 2015 was a record in terms of revenues and profits on a non-GAAP basis after that performance declined. As you see from this quarter's results however, we are back on track and clearly moving in the right direction. Turning to free cash flow, that came in at a strong $6.4 million for the quarter, our second best quarter ever for free cash flow. For the first six months of this fiscal year free cash flow was $10.3 million. We are also pleased to announce the latest results of our share buyback program. We continue to buy back stock in the second quarter and in April. As of the end of April, we bought back more than 284,000 shares since the end of the first quarter and this week we announced the Board authorized an additional $5 million for buying back shares. Please turn to Slide 5. To use our free cash flow most effectively we're committed to capital allocation policy. We’ve updated this slide for our current slightly lower share count and the reduction of convertible debt. Our strategy is providing good guidance on whether to buy shares, buy a new club, open a new restaurant or pay down debt. In recent years we have consistently generated annual free cash flow of at least $15 million. Using that as a base, we’ve calculated that our after-tax yield of buying back our own shares. For example at $10 per share where the stock has traded recently, buying back shares generates an after-tax yield on free cash flow of 15%. We consider this yield pretty much risk free since we are buying our own assets, which we know very well. Based on that calculation to adjust for risk, we require return of about twice that should we decide the buyer open a new unit. For example at $10 per share if we decide the buyer open a new unit we would want to have return of at least 30%. To be clear this doesn’t mean we will now buy clubs or open new restaurants, but at this time the opportunity has to be exceptional and fit our capital allocation model. The same argument applies to paying down higher cost debt. Only at $17 as it makes sense to pay down 13% debt at an accelerated rate assuming no prepayment penalty. This doesn’t mean we wouldn’t do so at this time, but again it would have to be a compelling reason to do so. Please turn to Slide 6. This slide gives you a status report on our share buyback program. To date this fiscal year we have spent $5.4 million. We now have $6.2 million authorized in buy back shares. That’s a combination of the new $5 million the Board just approved and the $1.2 million left from our existing authorization at the end of April. So far this year we’ve retired more than 560,000 shares. That's more than twice the number we purchase for all of last year. Our share count now includes 75,000 shares from a conversion of debt to equity. The Board also declared the regular quarterly dividend of $0.03 per share for fiscal '16's third quarter. The declared dividend for the fiscal '16 third quarter is payable on June 27, 2016, to holders of record on June 10, 2016. The third quarter dividend is part of RCI’s $0.12 per share annual cash dividend. At $10 per share, that equates to a yield of 1.2%. At $12, the yield is still 1% a comparative return in the current environment. Some funds require $100 million market cap or 1% yield in order to invest in Micro Cap stock. With our dividend we should always meet one of those two requirements allowing from broader institutional ownership. Please turn to Slide 7. Revenues are growing at $34.4 million to increase 2.8% or $900,000 from the first quarter. This is especially encouraging since two clubs were closed in the second quarter of 2016 for reformatting, remodeling. Nonetheless, club and restaurant sales grew sequentially month to month during the second quarter. Looking at some of the more important revenue lines, high margin service revenues were up 4.5% from the first quarter. Customers began to spend to spend more per visit and new marketing strategies are proving to be effective. Food sales increased 6.3% due to Bombshells' growing business and alcohol sales remained strong. Looking at same-store sales, they were only down 0.9% year-over-year. Again this is encouraging considering the year ago quarter was a record. But it also represents a significant increase from same-store sales from the previous two quarters. Turning to Slide 8, operating income and margins are also moving in the right direction. Non-GAAP operating income was $7.9 million, that’s up from $6.6 million in the first quarter. As a percent of revenues non-GAAP operating margin was 23.1% of revenues, that’s up from 19.7% in the first quarter. The improvement large reflects two factors, the increase in sales in particular high margin service revenues and reduced cost as a percentage of revenues. I mentioned earlier how net income benefited from a $1.75 million tax credit. To maximize our profitability and cash flow, we have instituted a practice of periodically reviewing different aspects of our business. As one of the first results, we found we could claim certain additional FICA credits for prior years. This amount was deducted from our income tax expense in the quarter. Otherwise we would have paid an effective tax rate of 36.6%. Please turn to Slide 9. As anticipated occupancy cost began to come down in the second quarter. Occupancy cost are one of our largest fixed cost. During the second quarter, they declined 8.2% of revenues, as compared to 8.5% in the first quarter and the year ago quarter. This was primarily due to a partial quarter net benefit of the acquisition in mid January of Rick’s Cabaret's New York real estate. The loan used to finance the acquisition increased interest cost as a percent of revenue, but the savings and rent were even greater. Occupancy cost as a percent of revenue should decline moving forward. Starting in the third quarter of 2016 we have a full quarter benefit of the Rick’s real estate acquisition. In addition, anticipated refinancing should help reduce interest as a percent of revenues. Since occupancy cost are largely fixed as revenues grow these costs should continue to decline on a relative basis. Please turn to Slide 10. Our cash generating power is moving in the right direction. We look at two metrics in this regard. One is adjusted EBITDA. As you can see at $9.7 million, we continue to generate a fairly high level this quarter. Second is free cash flow. We calculate this as operating cash flow less maintenance CapEx. This translated into $6.4 million in the second quarter compared to about $4 million in the first quarter. As a result, we're raising our fiscal '16 free cash flow target to $16 million to $19 million from the original $15 million to $18 million. Please turn to Slide 11. Here are Night Club segment results. Sales of $29.1 million were just a little under the year ago quarter, with 36 units in operation compared to 40. Non-GAAP operating income was $9.8 million compared to $9.5 million in the year ago quarter. As a result, non-GAAP operating margins expanded to 33.7% of revenues compared to 33.7% in the year ago quarter. We believe this demonstrates the improved model we've been working on to expand margins that should benefit us as sales continue to grow. Please turn to Slide 12. Here are Bombshell segment results. Sales of $4.6 million increased 4.1% compared to a year ago quarter with five units in operations in both periods. Operating income was $643,000 compared to $457,000 in the year ago quarter. Operating margin was up strongly to 13.9% compared to 10.3%. As we had anticipated, we’re seeing the benefit of growing sales from our new units after they have work through the typical fall-off from their grand opening honeymoon periods. As a result, not only our sales growing, but margins are as well. Since our last call we’ve been getting ready to roll out our franchise marketing program. Our franchise has received legal approval in all 50 states. Later this week we’ll be making our first trade show appearance at the franchise expo in Dallas, May 14 and 15. Please turn to Slide 13. We want to give you an update on what we're doing with our debt. During the second quarter we continued to significantly reduce our convertible debt. This has an average weighted rate of 8.6%. We paid off $716,000 as scheduled. One of our lenders converted $750,000 in debt and exchange for share is at $10 each. We plan to pay off $1.9 million of the remaining convertible debt as scheduled in the fourth quarter of fiscal 2016 and the first quarter of fiscal '17. This will eliminate almost all possible dilution from these issues. The only new debt was that previously announced $10 million commercial bank mortgage to buy the Rick’s Cabaret real estate in New York City and a little less than $1 million related to our new corporate office, which I’ll talk about in a minute. Looking ahead, we anticipate refinancing two commercial mortgages as part of a transaction that would roll over commercial mortgages of $6.2 million currently financed at 7.2% and pay off unsecured loan of $4 million at 13% and on a combined basis, meaningfully reduce our interest expense. We also have some real estate that is no longer needed and hope to complete those sales in fiscal 2017. Proceeds would be used to buy back stock, finance growth, or pay down debt. Please turn to Slide 14. We also want to tell you about our new corporate headquarters. Our plan is to move in buy the end of fiscal 2016. We have more than outgrown our existing facility, which was built about 12 years ago. At the time, we had six in-house employees. Today we've grown to almost seven times that amount. The new building will significantly enhance operating efficiency. It will be more than four times as big with more office and more warehouse space. The warehouse is for the club and restaurant inventory as well as safety, corporate and subsidiary documents. As per financing we bought the land which is across the street from our current offices for $700,000 in 2014. In October of last year, we obtained a bank construction loan for $4.9 million at 5.25%. When we move out, we will lease or sell our old building. We expect the class of owning the new building to be more efficient than leasing. Keep in mind for accounting purposes, in two years there is not going to be much of a difference between owning or leasing. New accounting rules will require publically trading companies to capitalize leases on their balance sheet as debt. As part of our new office project we will implement a major accounting technology upgrade. This new technology will automatically connect our accounting, POS and banking systems. This will result in major monetization and far greater scalability. After the transition, it should also pave the way for a major reduction in overtime and related cost. Please turn to Slide 15. Here we've updated our long term debt slide, which we first showed you last quarter. There are few things that I’d like to point out. Long term debt increased about $7 million from December 31, that’s primarily the result of Rick’s Cabaret in New York real estate acquisition, partially offset by the reduction of convertible and amortizing debt. The percentage of long term debt backed by real estate is now 69% versus 64% making our debt position even more secure. And the average weighted rate on our long-term debt has fallen to 7.58%. Please turn Slide 16. Here we have updated our debt maturity slide. As we explained last quarter, this is intended to show that a good portion of our debt maturing over the next five years are real estate amortizations or real estate balloons. We plan to refinance all non amortized debt. Any non-reality balloons will be paid out of cash flow or otherwise refinanced. For example the new refinancing I talked about on Slide 13. If you please turn to Slide 17. Looking ahead we have four clubs and restaurants that will start contributing the revenues. In May, we reopened the two clubs we had closed in the second quarter for remodeling and reformatting. One held it's grand opening last week which did very well. The other will be holding a grand opening later this month. Then in our fiscal 2016 fourth quarter, we plan to open a third club in New York City. It will be a sport's named gentlemen's club in Madison Square Garden Area and the first of its kind in Manhattan. Our current time table cost with opening of the sixth Bombshells in the first quarter of fiscal 2017 it will be in Houston. The demographics and type of location are very similar to those are the biggest revenue generating Bombshells. In line with our current capital allocation policy, we believe the risk adjusted after-tax return for these new units should be better than buying back our shares. As per fiscal 2017 itself we believe we’ll also benefit from a very strong sports lineup. In the first quarter the Minnesota Vikings will be returning to the new stadium in Downtown Minneapolis where we have three major clubs. In the second quarter, the Super Bowl will be in Houston where we have seven locations both clubs and Bombshells and the NBA All-Star game will be in Charlotte where we have a very large club. In addition Mixed Martial Arts events are coming to Madison Square Garden for the first time, now that they've been approved by the New York State Legislator. These events based on their location, could have significant incremental high margin sales. Please turn to Slide 18. To wrap up on the last quarter call, I told you we were off to a good start with our plans for margin and EPS growth and free cash flow generation this year. During the second quarter you can clearly see we are moving in the right direction. In the second half our model will take further shape. This should enable us to post year-over-year favorable comparisons including or excluding of course things like the third quarter of 2015, onetime $8.2 million pretax gain. As a result I believe we are on track to achieve or in one case exceed our fiscal 2016 goals. For revenues, that means the second half up slightly making up for the first half being down slightly for a flattish year. For margins, that means improvement for the year and an increase in GAAP EPS for the year. For free cash flow, that means reaching our new $16 million to $19 million target. Looking further ahead into fiscal 2017 we're very encouraged. We'll have the full year benefit of the reopen clubs, the new club in New York as well as a new Bombshell in Northwest Houston. In addition we expect to benefit from a strong sports lineup I just mentioned. With our capital allocation policy, improved operating performance, continued share buybacks, new dividend and contributions from our investment banking and Investor Relations teams, we hope to see further recognition of our shares in the market. The stock is up more than 30% from our last call. We believe that's a good indication that our strategy is working. We had a very productive meeting with institutional investors at a Study Conference in New York on March 31 and in April in Boston. But in no way are we satisfied. There's still more work to do and we're dedicated to making this happen. Speaking on behalf of all of RCIs Management and that our subsidiaries, I'd like to thank our loyal shareholders for their support. With that, let's open the line for questions. Operator?

Thank you. At this time, we'll be conducting a question-and-answer session. [Operator Instructions] And the first question will be from Andrew Desilva of Merriman Capital. Please go ahead. Q – Andrew Desilva: Good afternoon, everyone. Just a couple quick questions. First off as far as your marketing spend goes, were the full cost reductions that have been discussed on previous calls were they realized in the quarter and then related to that marketing, are you seeing that spend that you transitioned to is translating in a way that is meeting your initial thoughts?

I think that most of it is yes. We may actually have a little marketing increase for the two new clubs that we're opening. But we're very happy with our switch to our new strategy and we're seeing some pretty positive results from it as you can see from the results this quarter. And I think that we'll continue -- we're going to keep monitoring as fairly new, we're starting to push into some other locations and hopefully we will continue to see the growth.

Great. And then as far as big spenders go, have you seen any transition from that from the last quarter. Is that increasing or staying fairly stable on a quarter-over-quarter basis?

It's definitely up in the second quarter from the first quarter. Of course it's too early to really tell. April was very good. It was too early to tell how May is going to play out. Always after income taxes are paid, we see a slight slowdown. Usually we see the bounce back in the second week of May. So this week and coming up will be very critical. We'll be watching and see how things go.

Great. Great. And then as far as legal expense, obviously a lot of the large overhangs they're gone at this point. Is this quarter fairly indicative of what we should expect going forward? And then also have you found out or received any notification on a settlement that's related to the dispute related to the construction of that one Bombshell that you had to close down a few quarters ago?

Right, I’ll answer the Bombshells' question first. That's ongoing litigation. We have not discussed settlement at all in that case. We're basically on a trial schedule. We'll see how that progress. I'm sorry what was the first part of the question.

I know legal expenses fairly are they kind of where you expect them to be on a go-forward basis now that some of the larger issues have passed?

Yeah, I think give or take, for the next couple quarters give or take $100,000 will probably going to be pretty close.

Okay. Fantastic. And then there is last question related to franchising. Has there been any progress that you can discuss. Last time you said you had a potential in San Diego for up to four or five restaurants. Maybe elaborate on that?

We’re working with those groups that we talked in the past, but we're very excited about going to the national restaurant franchise convention in Dallas this weekend. We'll be there Saturday and Sunday. We actually have a booth set up. All of our stuff spend up. We're ready to go and we're very excited to get out there and actually start talking to some restaurant operators. So hope we'll have a much better update by the next conference call and get some great leads at this convention.

Great. Thank you so much and good luck on the quarter.

Thank you.

[Operator Instructions] Your next question will be from Adam Mikkelsen of Cooper Capital. Please go ahead.

Hey Eric.

Hey Adam. How are you doing?

Good. Good. How are you?

Good.

Just a couple of questions. The proceeds from these real estate sales, how much are you expecting there?

We're working with some of the brokers now just off the top of my head, I haven't really -- like I said, we're just really going through the process of it now; probably somewhere around $7 million to $9 million.

Wow and how many properties do you sell it? A – Eric Langan: Probably four or five, we just sold a smaller lot for one hundred some thousand that we had purchased for additional parking that we don't need any more. We've got another parking lot that we're probably going to look at and some vacant buildings that we own. And we're still discussing whether or not we're going to sell some of our leased properties. We have some properties that we own that we lease to other individuals and we're going to decide if the lease payments meet our capital allocation strategy versus selling the property and redeploying the capital could we do better than the current leases. So there's some work we're still doing on those. So hopefully in the next quarter you'll get a better idea. We should have everything decided in and have changed the status of those assets to our current assets for sale.

And I know you try to wrap this up, this fiscal year?

I'm sorry. I think most of them probably fell at 2017. The brokers we're talking to tell us that typical it's going to take about six to nine months on commercial properties right now.

Okay. Okay.

And we could get lucky on a couple and they get sell quicker. I’m just going by with brokers that we've started to talking to and getting the stuff listed with are telling us.

Okay. Hey and just one more question, with you guys effectively out of the market for buying new clubs, what are you seeing out there in terms of things being often up to you, what’s the market doing and when you back in the market, has things changed over the past couple of years?

I haven’t really heard about a lot of clubs trading hands in the last couple years. I would say we're out of the market. We're just not paying what we’re paying before because it doesn’t meet or capital allocation strategy. What we're looking as something comes up that will fall into the -- fall into our math, we’ll make it happen. Otherwise I think we'll just sit on the sidelines and wait, eventually the prices will come to us or we’ll be able to may be move towards those prices if our stock is performing.

Yeah, okay. Very good. Thanks nice quarter.

Thank you.

[Operator Instructions] And our next question will come from John Rolfe of Argand Capital. Please go ahead.

Hey, good afternoon, guys. Just one quick question, wondering if there has been any progress in terms of distribution for robust? I think it's been a couple of quarters since you gave us an update on that and I think originally you were hoping in the back half of this year to maybe get to the point where you had national distribution on that. So just wanted to see is there has been any movement? Thanks.

Sure. We’re working. We’ve launched in Minnesota now with Southern. We’ve talking with Southern to launch in a few more states. We’ve also picked up some other beer distributors and other distributors now. Right now I think that the second half is really still our best idea to figure out where we’re at with Robust. They bag in a box product is out. It's doing well on its launch. So hopefully in the next few months we'll start seeing increased sales of bag in a box and we'll evaluate from there. We’re going to evaluate Robust as we move forward. Basically I've give him a deadline on our capital allocation strategy. They're going to have to meet our strategy for investment on go forward basis and if we're not there by certain time. Then we'll be able to look at how we're going to adjust the strategy at that point.

Okay. Okay great thanks very much.

And our next question will be from Chris Brown of Aristides Capital. Please go ahead. Mr. Brown your line is open.

Sorry, good afternoon Eric good quarter. I just had a question for you on the employment tax credit that $1.75 million, I am sorry, joining the call I was a bit late, that is -- is that a several years catch-up payments and that is basically a one-time item or is there any chance of you capturing more tax credits subsequently?

It’s a onetime credit that of amount. We will continue to get a much smaller amount year-over-year. This is, I think we were able to capture five years with this part going back with the current year plus four years back is what we were able to capture and we’ll be able to take that credit on a going forward basis, but it will be obviously about one fifth or less of that amount depending on coming new hirers we have in a year and stuff. I’m not exactly sure 100% how the credit works, but I know what we have to do with basically job creation and part of the tax credit. Like I said I've got -- our accounts are going to figure that out. They notice that when we were doing reviews of all the different possibility and stuff based on hey, I think we've been missing this and let’s see what it is and we started doing the math on it and there was a couple years that were very significant and some of the years were smaller. So all in all, it was a nice overall deal for us and it will be a small amount going forward.

Okay. Great and some of the software in terms of the accounting systems you talked about upgrading, is that -- can you quantify, is that a large materially expense we should be looking at or what the range of extra expense there?

400,000 we've already expended, 300,000 is the actual software training and setup cost and then about $100,000 in actual equipment and servers to operate and run the software and then approximately another $300,000 will go into programming, training our staff and what not. Our goal is go live by January 1 and the reason we chose January instead of the fiscal year October 1 is due to payroll. Payroll is a method in order to change in October would have been probably another couple $100,000 to convert all the payroll data. So it's cheaper and probably smoother and easier if we convert everything in January 1 and so that we'll do. We're not going to really be into our new office building until sometime in September anyway. So we're going to kind of be working between both offices for a little while and so make the transition easier to move and get all the training done. We'll be able to do all the accounting our current office and do all the training at the new office space is the initial plan I believe. Now it's subject to change as we get closer and move forward. We're in a really beginning stages of it, but we're very excited about it because it will link all of our POS systems. It will take basically all the manual entries that we do now that are subject to any kind of human error and require massive amounts of review time where all become automated. All the reconciliation of our banking, all that type of stuff will all be automated. We should be able to do all of our positive pay for all of our checking accounts, which will help with any type of fraud, it's an amazing transition when you go from a lower level of accounting software to be able to step up into a mass, and as far as scalability, we'll be able to add the clubs unlimited basically at this point once we get the new software.

Okay. Great. I know you guys use 35% as your tax rate in our non-GAAP EPS, which historically I guess has been pretty close to your actual tax rate. For the back half of this year, do you anticipate kind of a normalized 35% GAAP tax rate or are there any special tax items you think will swing that one way or the other?

Phil, that's a question for you. What do you think?

Well, the tax credit will help. It will help lower that rate somewhat. I don't know exactly what it will be, but we'll have it calculated, but it will lower.

But roughly I think 35% is a good approximate number for modeling.

I would say for modeling we're talking lower than -- that the net tax credits we're talking will be at least -- the net will be at least $350,000.

Okay. Okay. So maybe some more tailwind in Q3 and Q4 to look forward to. Fantastic, all right. Thanks a lot.

You're welcome. Thank you.

[Operator Instructions] And at this time, I am showing no additional questions. I would like to hand the conference back to Gary Fishman for his closing remarks.

Thank you, everybody for listening. Thank you, Eric. Please turn to Slide 19. Here is our reporting calendar for the rest of fiscal 2016. Tonight as I mentioned earlier we have Meet Management at Ricks Cabaret New York from 6 to 8 o’clock. Tomorrow we have a series of 101 meetings with institutional investors in the New York City. The week of June 6, we'll be meeting with institutional investors in Dallas. Anybody interested please give us a call. In July, we report our third quarter club and restaurant sales and we're now looking at August 4 as a possible day for announcing third quarter results before the 23rd Annual Gentlemen's Club Expo that's being held in New Orleans. There is couple of more items in the calendar, but I don't think that's relevant. On behalf of Eric, the company and our subsidiaries, thank you and good night and as always please visit one of our clubs or restaurants. Thank you.

Ladies and gentlemen, this concludes today’s teleconference. You may disconnect your lines at this time. Thank you for your participation.