RCI Hospitality Holdings, Inc. — Form 10-Q Summary
Reporting period: First quarter of fiscal 2019, the three months ended December 31, 2018. Unaudited results; financial amounts below are in U.S. dollars unless noted. The company operates adult nightclubs and Bombshells restaurants and bars, with Nightclubs and Bombshells as its principal reportable segments.
Key financial results
| Metric | Q1 FY2019 | Q1 FY2018 | Change |
|---|---|---|---|
| Revenue | $44.0 million | $41.2 million | Up 6.8% |
| Operating income | $11.1 million | $9.1 million | Up 21.8% |
| Operating margin | 25.3% | 22.2% | Up 3.1 percentage points |
| Net income attributable to RCIHH shareholders | $6.3 million | $14.3 million | Down 55.7% |
| Diluted EPS | $0.65 | $1.47 | Down 55.8% |
| Operating cash flow | $11.5 million | $8.1 million | Up 40.6% |
| Free cash flow (non-GAAP) | $11.1 million | $7.5 million | Up 47.0% |
| Adjusted EBITDA (non-GAAP) | $12.0 million | $11.1 million | Up 8.4% |
- Revenue mix and comparable sales: Nightclubs generated $37.7 million, up 7.1%; Bombshells generated $6.0 million, up 3.2%. Consolidated same-store sales rose 0.7%, comprising a 4.3% increase for Nightclubs and a 20.5% decrease for Bombshells.
- Margins and expenses: Cost of goods sold fell to 13.2% of revenue from 14.3%, while SG&A rose 9.5% to $14.0 million, partly due to legal and marketing costs. Nightclubs’ operating margin increased to 40.8%; Bombshells’ fell to 2.0% from 15.3%.
- Cash and liquidity: Cash was $9.4 million at December 31, down from $17.7 million at September 30, 2018. Management reported negative working capital of $6.5 million excluding assets held for sale, versus positive working capital of $55,000 at September 30.
- Debt: Total debt was $153.1 million at December 31, 2018, including $14.9 million current and $138.2 million long-term, compared with $140.6 million at September 30, 2018. The filing reports covenant compliance at quarter-end.
- Investment and financing: Investing cash outflow was $19.5 million, including $13.5 million cash paid for acquisitions and $7.3 million in property and equipment additions. Financing cash outflow was $0.3 million. The company paid a $0.03-per-share dividend and repurchased 14,111 shares for approximately $355,000.
Changes, unusual items, and management commentary
- GAAP net income and EPS declined sharply in part because the prior-year quarter included an $8.2 million income tax benefit, driven mainly by a $9.7 million deferred-tax-liability reduction related to the Tax Act. Current-quarter income tax expense was $1.8 million, at a 22.0% effective rate.
- Current-quarter operating results included a net $1.1 million gain in “other charges (gains),” primarily from selling the Philadelphia club and two assets held for sale. The company also recorded a $447,000 unrealized loss on equity securities. Management’s non-GAAP diluted EPS was $0.61 versus $0.53 a year earlier; these measures exclude or adjust for specified items and are not GAAP results.
- The company acquired clubs in Chicago for $10.5 million and Pittsburgh for approximately $15.0 million, using cash and seller-financed notes. It also purchased an aircraft for $2.8 million, financing $2.2 million of the cost. Long-term debt was higher year over year, which management attributed to growth and financing activity.
- Management said the near-term outlook remained strong and expected substantial operating cash flow for fiscal 2019, but provided no specific numerical full-year earnings or revenue guidance in this filing. It planned to open four Bombshells in fiscal 2019, including one opened in December 2018, and continued to evaluate nightclub acquisitions. Management noted nightclub seasonality, with historically stronger results from October through March.
- The board authorized an additional $10 million for share repurchases in January 2019; $2.8 million remained under the existing program at December 31.
- An $834,000 goodwill impairment-analysis error relating to fiscal 2018 was identified and treated as an immaterial revision to prior-period statements. The company attributed the error to incorrect tax-rate assumptions and omitted debt-service payments in impairment testing.
- The company adopted revenue-recognition guidance on October 1, 2018, with no material reported impact. It expected the forthcoming lease-accounting standard to materially affect the balance sheet through recognition of operating-lease assets and liabilities; the ultimate materiality was still being evaluated.
Risks, contingencies, and controls
- Management concluded that disclosure controls and procedures were not effective at December 31, 2018, due to previously identified material weaknesses in internal control over financial reporting. Weaknesses included revenue controls and cash counts, complex accounting and estimates, financial close and reporting, IT access controls, and segregation of duties. Remediation efforts were ongoing and had not yet been completed and tested as effective.
- Legal exposures include a Houston landlord dispute in which an adverse judgment was entered in January 2019 but remained modifiable, and an Arizona dram-shop case in which the appellate court vacated the jury verdict and remanded the matter. The company said the financial effect of the Houston case was uncertain.
- Two unresolved claims remained from 71 claims involving former insurer IIC, which is in liquidation; the company is funding litigation costs and cannot assure recovery. A Texas Patron Tax dispute also remained partly unresolved, although a court invalidated a key part of the challenged administrative rule.
- Other disclosed risks include regulation of adult entertainment businesses, competition, dependence on key personnel, real-estate conditions, cybersecurity, financing availability, and potential changes to entertainer worker classification. The company reported ongoing tax examinations and a $165,000 uncertain-tax-position liability.
Important facts for investors to verify
- Whether Bombshells’ same-store sales and operating margin recover after the reported declines, and whether planned openings meet management’s targets.
- How much reported operating income and cash generation depend on asset-sale gains, and how comparable results look excluding those gains and other adjustments.
- Whether acquisition economics, seller financing, capital spending, and the higher debt balance produce the returns management expects while preserving liquidity.
- Progress in remediating and independently testing the disclosed material weaknesses in financial reporting controls.
- Developments and potential financial effects in the Houston landlord case, Arizona dram-shop litigation, Texas Patron Tax matter, and unresolved IIC claims.