Gary Fishman - IR Eric Langan - President and CEO

Frank Camma - Sidoti Marco Rodriguez - Stonegate Capital Partners

Greetings, ladies and gentlemen, and welcome to RCI Hospitality Holdings Fiscal 2018 Second Quarter Conference Call and Webcast. [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. Gary, please go ahead.

Thank you. We've changed our Corporate and Investor Relations Website a little bit to make term insurance easier to find things. If you are looking for today's conference call presentation and don't have it, you can click the Company and Investor Information button just under the RCI logo. That will take you to the company and investor information page. Scroll down a little and you'll find all the necessary links for the second quarter. If you'd please turn to slide two, I want to remind everybody of our safe harbor statement. It's posted at the beginning of our conference call presentation, 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 on this call as a result of developments that occur afterwards. Please turn to slide three. I also direct you to the explanation on non-GAAP measurements that we use and are included in our presentation and news release. Finally, 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 in New York, Manhattan's #1 gentleman's club. You can also tour its sister club, Hoops Cabaret and Sports Bar, next door. Rick's 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-ed, ask for me at the door. Now I'm pleased to introduce Eric Langan, President and CEO of RCI Hospitality. Eric?

Thank you, Gary. Good afternoon everyone. Please turn to Slide 4. After the market closed, we issued our Second Quarter Earnings News Release and filed our 10-Q. We reported another great quarter of strong core results. The new Bombshells in Pearland, a Houston suburb, is doing very well. We now have four new locations in various stages of development that will expand the chain to 10 units by the middle of next year. We also announced we have reactivated discussions to acquire a number of night clubs from several owners. Turning to our results. GAAP EPS for the second quarter was $0.48 a share, up 23% from a year ago. During the quarter, we wrote down the note from the sale of Robust and settled two lawsuits. Excluding those and other small items, non-GAAP EPS came in at $0.65, up 59% from a year ago, and free cash flow increased 9% year-over-year to more than $5 million. Our outlook continues to be favorable for the second half of the fiscal year and we are reiterating our fiscal 2018 cash flow target of $23 million. Please turn to slide five for an analysis of our second quarter operating performance. Total revenue increased more than 19% year-over-year to more than $41 million. 16% of the increase came from new units and 5% from same-store sales. All core revenue lines continued to grow. Beverage was up 22%. Higher margin service revenues were up 14% and food was up 25%. GAAP operating profit increased 10% to more than $8 million. On a non-GAAP basis, you can see the real strength of our business. The nightclub segment maintained a high 35% margin. Margin for Bombshells segment expanded approximately 200 basis points to more than 20% for the first time. Corporate overhead costs fell 17% to about $3 million as a percentage of total revenues. They declined to 7.2% from 11.8% in the preceding first quarter and from 10.3% in the year ago second quarter. All told, non-GAAP operating income increased 38% as margin expanded to 25.7% of total revenue compared to 22.2% in the year ago quarter. Please turn to slide six. A variety of factors drove these revenue and margin gains. In general, there has been an improvement in our Nightclub and Restaurant portfolio. Along with increased operating leverage from higher revenues, we have also seen increased customer counts in both nightclubs and restaurants. As we have previously reported, the quarter also benefited from the strong marketing around the Pro Football Championship in February and the Pro and College Basketball games in March. There were some significant factors that provided a tailwind to our major segment. Nightclubs saw higher spend per customer. Bombshells benefited from continued success of the Houston Rockets and an updated menu featuring new items. Corporate costs were down sharply. On a sequential quarter basis, this reflected in part completion of our extensive fiscal 2017 audit and the transition to our new financial IT system. The second quarter is likely to be a low quarter for these costs. In general, we anticipate overall expenses in absolute dollars will rise going forward. That would be due to the opening of Bombshells in Pearland and on I-10 East and the hiring of vendors to help us develop controls governing our new financial accounting system, and to write reports automating business and financial analysis. There were two other factors that contributed to our second quarter performance. Cost of occupancy, which we calculate as a combination of rent and interest as a percentage of revenues continued to decline. And because of the new federal tax law, our effective tax rate was approximately 30% lower than a year ago. Please turn to slide seven. Same-store and total club and restaurant sales are up now for 8 quarters in a row. This is the longest continuous quarterly uptrend we've had since early fiscal 2013. In the third quarter, we start comparing against year ago increases of 6% plus in same-store sales, and increases in total revenue form the acquisitions of Scarlett's Miami and the club we renamed Scarlett's in St. Louis. And in the first quarter, we begin comparing against Bombshells 290. This is where our new Bombshells Pearland and our Bombshells rollout plan will help to enhance future sales gain, while we pursue the acquisition of new clubs. As for non-GAAP operating margin, we are pleased to see year-over-year growth. The quarter's margin was the highest it has been in the last 2 years. Based on my comments on the previous slide, operating margin is likely to moderate somewhat in the second half. Please see slide eight. Cash generation continued to do well. Adjusted EBITDA was up 35% to more than $12 million. This too is the highest quarterly level in the last two years. As for the six months, adjusted EBITDA was up 37% at close to $24 million. As for cash itself, we have $12.5 million on March 31. Even with all of our expansion activity, cash increased nearly 5% from December 31 and has grown 26% from the start of the fiscal year. As for free cash flow, we are now up 28% for the first 6 months to just under $13 million. That gives us even greater confidence of hitting our target for the year. Please turn to slide nine. Debt continues to be very manageable. It is up approximately $1 million from December 31. Weighted average interest rate is down 7 basis points with declines in all categories. Our real estate debt now includes $10 million related to Bombshells properties. As we've discussed in previous calls, when possible, we are using bank financing to purchase Bombshells real estate and finance construction, fixtures, and furniture to enhance our cash-on-cash returns. Please turn to slide 10. Regarding debt maturities, in the second quarter we refinanced the Bombshells $1.9 million realty balloon into a construction loan and began construction on Bombshells I-10 East. In May, we refinanced $3 million in the Scarlett's Miami seller-financed non-realty balloon. It now balloons in May of 2019. The only major balloon in the next five years is $5.4 million related to the Scarlett's acquisition. We believe we can extend that if needed or we can refinance it before the balloon is due. Even though total debt has increased slightly, with our higher revenues and declining interest rate, cost of occupancy has continued to fall. In the second quarter, it was 7.4% of total revenues, down from 7.7% in the first quarter and down from 8.3% for all of last fiscal year. Please turn to slide 11. On April 11, we opened our sixth and largest Bombshells in the fast growing Houston suburb of Pearland. For the first three weeks, sales have averaged more than $160,000 per week, making it our most successful Bombshells launch to date. We now have four locations in various stages of development in greater Houston. I-10 East Houston under construction and scheduled to open in September of this year. U.S. 59 in Southwest Houston is under construction. That unit is scheduled to open in December. We recently closed on a property in U.S. 249 in Tomball, north of Houston, and that unit should be open in March of 2019. And we are finalizing site selection for a location in Katy, Texas, a fast growing West Houston suburb. That location should be open by the end of June 2019. Over the last year, we have assembled a strong group of architects, contractors, and vendors for the creation of 290 in Pearland. Based on this experience, we're hopeful barring unforeseen delays of being able to deliver new Bombshells on a regular schedule. The new units will bring the chain up to 10 Bombshells by the middle of next year and based on recent results, the average Bombshells is now running at $4.5 million annually in revenues with an operating margin of 20%. Doing the simple math, we are looking at having a Bombshells business by the end of fiscal year with an annualized run rate of $40 million to $50 million in addition to operating leverage to continue to expand segment operating margin. Our next target market for Bombshells are in San Antonio and Miami. Please turn to slide 12. We continue to apply the lessons learned from the past and apply the formula we have developed to almost all of our decision making involving capital investment. We look at our free cash flow relative to our market cap. With an estimated free cash flow of $23 this fiscal year and the current market cap of more than $280 million, we currently have an after-tax yield in the low 8% range on our equity. That is what we consider to be our risk free return for buying back our own assets in the open market. At that yield, we are more likely to use capital for clubs acquisitions, or to open Bombshells as we are doing. To compensate for the added risk, our hurdle rate has to be at least 25% to 33% cash-on-cash return unless there is a significant strategic rationale to do otherwise. If an existing club or restaurant is not generating a significant return, we are more likely to dispose of it, free up the capital, and use that money for more productive purposes. Should free cash flow rise or our stock price ease to the point where that yield is in double-digit percentage range, we would look at buying back shares again. For the longest time, we have been saying the stock would have to be trading at a significantly higher price for us to consider accelerated paydown of our most expensive 12% debt assuming no onerous penalties. The new tax law changes that dynamic. With the estimated tax rate of 23%, the after-tax yield of paying down 12% debt is more than 9% and that's far more attractive. To wrap up, please turn to Slide 13 for a review of our 3 to 5 year financial goals. Our objective is to grow free cash flow by more than 50% from our fiscal 2017 level to approximately $30 million a year. On a per share basis, we'd like to grow that on an average of 10% to 15% a year. We have three strategies to achieve that. One, acquire more great clubs in right markets. On average, we have made more than one club acquisition per year and last year, we acquired 2. Two, continue to expand the number of company owned Bombshells. Our target is 3 per year. And three is strict adherence to our capital allocation strategy. While we are in growth mode, we will not be pressured into deals that we don't like for the sake of growth. Our aim is to make sure that each new acquisition or restaurant is right for us. If we can't find the right acquisition or Bombshells location, we will sit and wait and let our capital build. And if our stock price doesn't adequately reflect our cash generating power, we'd be happy buying back shares. Now, let's open the call for questions.

[Operator Instructions] And your first question comes from the line of Frank Camma with Sidoti.

Eric, obviously good quarter. I wonder, consumer confidence, small business confidence, stock market, everything is positive here and not to be sort of playing the other side I guess, if you will. But I guess how strong - I'm not asking you to be an economist - but at what point does it become harder and harder to comp to lapse? It seems like to me how good can it get. It's really directed towards two different sides here. I mean I think it effects your restaurant business differently than - and you can tell me if I'm wrong - than your adult side. Meaning I think your restaurants can have a long runway but maybe not so on the adult side. So maybe you can address that first.

We haven't seen an end to it yet. April was decent for us. The first week of May has been good. Right now, I think that we're going against very strong comps. I don' think we'll be in the positive territory as high as we maybe were this quarter and the last quarter because we did have 6% growth for this last year. But I'm very optimistic at this point in the quarter. Obviously, we're only five weeks in but like I said, very optimistic that this is still going to be a positive quarter year-over-year, which would give us 9 in a row.

Let's talk about pricing then. Obviously, there's really no pricing per se in the adult side. But do you get any pricing on the restaurant side given that commodity, we're seeing some compression?

With the new menus, we did raise certain menu item prices to bring the cost back in line. You'll see that a little bit in the food cost, in our cost of goods sold. I think you'll see it a little bit better this quarter because we did it in mid-February. So it's only about half the quarter that that was but it's minor. But basically, for March, it brought our food cost back down from 34% back down to about 30% for the restaurant, which is very good for us. And we also were able to go in - we reviewed in this last quarter a lot of our clubs and made some small changes to some pricing. We finally passed on some of the liquor cost increases and some of the beer cost increases to the consumers by raising drink prices a quarter here and a quarter there. Nothing significant, but just enough to get our cost - we want to keep our cost in certain margins and they were getting a little above those. So I think that will help especially in this next quarter of keeping those costs down. I think we will see salary and wage costs increase in the next quarter a little bit, especially with the new stores opening. And I think that some of our other G&A will go up a little bit due to the hiring of the new internal audit firm that's going to help us write everything and set everything up so that we have all of our financial controls proper with our new ERP system, and hopefully get a much better, clean bill of health from BDO this year in our audit. So we're working towards those things. The new ERP system has definitely helped our overtime, especially in this last quarter was very, very low, which is good. That helps lower cost tremendously and of course, we didn't have as much of the cost of the audits and those types of things in that quarter. So like I said, I'm optimistic. I do think, like I said, those costs will raise a little bit in real dollars and we'll just have to see where, as far as percentage wise, where the revenues come in at, whether we continue the same-store sales growth and keep pushing the numbers up.

I think I remember when I was down visiting one of your restaurants that you mentioned that you were one of the largest purchasers of Budweiser. I could have that wrong - or beer. Are you getting any benefit now that you're opening up more and more restaurants on a volume discount? Or can you explain how that works for general alcohol?

We were for a while. Anheuser-Busch has had some management changes and some of the things are changing there. So it hasn't been as lucrative as we would have liked, but we are working with their people and we're working with some other beer suppliers as well. So next quarter, I'll have a better idea of where we're going to be with that. Our national beverage director is working on a few issues to try to bring our costs down even more.

Last question from me and then I'll hop off is just seen a lot of restaurants talking about how they - I know you talk about the ERP system - but how they engage and use technology for the customer. And what I mean by that is - and I don't know if you already do this, but as far as apps that people can order ahead for takeout. Can you talk about that and do you have much of a takeout business already at Bombshells?

Bombshells isn't really a takeout place. It's come, stay, eat, and play type place. So I mean, while we probably have some take out, it's not something we market or push for sure. Our food is better hot. So it doesn't - it's not like pizza where it travels well. So like I said, it's not something we push. We are in the process, as we've expanded Bombshells, of looking for maybe a social media director, maybe looking for a brand director or something along those lines. We're kind of negotiating those things now amongst ourselves and talking amongst ourselves to really kind of solidify the brand so we can take it to the next level. Especially as we move, right now with most of the stores in Texas and really, the majority of the stores in Houston and everybody is really close together, it's kind of easy to keep everything the same. And so we are worried about that as we move towards the Miami market, making sure that we have all of those things set up right and basically, the formula mastered.

You all have the value of the brand when you move to Miami initially, or the brand awareness as you open each incremental one in Houston.

Right. Houston has been great. Opening Pearland, everybody already knew who we were. Everybody was excited we were coming. Of course, the hurricane put us 4 months behind so we had an extra 4 months to push and market. They see the building sitting there for an extra 4 months, which probably didn't hurt people wanting to know what was inside. But now, hopefully, these new stores are going to open on time. But yes, in Houston, we differently have a strong brand recognition in that market now. So as we move to Miami, we want to make sure that since we're going to be recreating it there that we create it in the exact image of what we've done in Houston.

Our next question comes from the line of Marco Rodriguez with Stonegate Capital Partners.

I'm wondering if you can talk a little bit more about the Bombshells expansion plans here. Just first off, the table in your presentation with the different target opening dates. Should we be thinking of those particular dates being the revenue generation start time or is that maybe the opening of the end of the quarter and then revenue starts the prior quarter?

We're thinking the last two weeks of the quarter, based on the way our flow is working right now. Unless construction speeds up a couple weeks or they gain a few weeks here or there. And unfortunately, with construction, it's always give or take a month with these guys. But I think we've got it down to give or take two weeks now. So either we could open two weeks earlier if we open it up the first of - say the next one is going to open in June, it could open the 1st of June or it could open the 30th of June - August - September, I'm sorry, September. So the 30th of September, we're targeting around mid-September. Maybe we get lucky. I'm hoping. We are getting to the point now where, because we have 4 stores lined up with our suppliers, they now know they're going to have a year's worth of business from us. So we are getting some priority treatment on long lead items, which will help if something comes up and we can get open 2 weeks earlier because everything else is done, we won't be waiting for any type of equipment or decor or anything. All of that, we secured pretty well now. So basically, it's just how quick they can get the construction done and get the inspections, and how much it rains, those types of things that they can't pour (inaudible) for two weeks because it's muddy, they can't do this or that. So that's really kind of where we're at. So basically, I would plan on the real revenue starting the quarter after. So we say we're going to open in September, so the real revenue would start in the October first quarter. You'll get a little bit but it won't be significant in that first quarter, in the quarter of opening.

And then in terms of the new Bombshells, the Pearland location, I believe in your press release you guys mentioned that this was one of the most successful launches that you've had here. Was there anything special you did in terms of perhaps marketing? Or was this maybe what you were alluding to earlier before on one of the questions as far as pent up demand given the shift that you saw and the opening from the hurricanes?

I think some of it was pent up demand. The marketing we do is I call guerilla marketing. What we do is when we do all the training - after all the training session, when the new wait staff is first being trained, then we take them on promotion runs where we'll run out to all the car dealerships and pass out stuff. So it's really more - we don't really do television, radio, that type of marketing stuff. It's really more guerilla, more we use the wait staff to go out and market, and promote the business. And there is definitely pent up demand in Pearland. We bought six acres there and we built it with 196 parking spots. And we use 196 parking spots and a whole additional four acres of developable land where people were parking in grass. It is a very, very busy location for us.

And then can you talk a little bit about the new target markets you're looking for, for Bombshells, San Antonio, Miami? Are you going to target one area before the other and maybe if you could just talk a little bit as far as why those particular 2 markets?

The demographics are perfect in San Antonio. We like Miami. It's got decent demographics. Definitely alto of money and a lot of great restaurant row type areas in Miami. The weather will be great for our patios and we definitely want to make this concept work in another market to help with franchising down the road. I think as we move into other markets and build the brand awareness that it will make our franchising areas. And we know Miami and we have a couple clubs there. We have staff and people there, as far as office type staff that will help with accounting. So we just think it's an easier market for us to grow in than trying to go to, say, Phoenix-Scottsdale right now, which is another market we're considering heavily.

And is there a sort of target date when you anticipate starting to move into those markets?

I'm hoping that the location after our Katy location would be our next location, which would put us in the basically looking more at the September-December quarter of 2019 for the actual opening. We're actually looking now so depending on how quickly we can secure the real estate and get the plans developed, and get through there. We've got to learn the building and the building permit processes in those markets, get the right contractors and that type of stuff in those markets. So while we do have a lot of experience with the clubs, this is new build construction. It will be a little different for us. So it will be a little learning process for us. Basically, it takes us about from the time I find a location and put it under an L&I, it takes us about 12 months to get open. So if we can find something, say, by the end of June because we're basically looking in that market now in Miami, and get it under contract by June, we could push for a June-September opening basically.

And last quick question and I'll jump back in the queue, just kind of shifting gears here to the nightclubs. I believe in your prepared remarks, you mentioned acquisitions. You're in the midst of talking to, I guess, quite a few potentials out there. Can you kind of give us a sense as far as that backlog, if you will? Do you have any very large type acquisitions or are these more kind of tuck-in? Any kind of color there.

A little bit of both.

This concludes today's conference call. You may disconnect your lines. Thank you for participating and have a pleasant day.