RCI HOSPITALITY HOLDINGS, INC. 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations. The following discussion should be read in conjunction with our unaudited condensed consolidated financial statements and related notes thereto included in this quarterly report, and the audited consolidated financial statements and related notes included in our Annual Report on Form 10-K for the year ended September 30, 2019. Overview RCI Hospitality Holdings, Inc. (“RCIHH”) is a holding company engaged in a number of activities in the hospitality and related businesses. All services and management operations are conducted by subsidiaries of RCIHH, including RCI Management Services, Inc. Through our subsidiaries, as of June 30, 2020, we operated a total of 48 establishments that offer live adult entertainment and/or restaurant and bar operations. We also operated a leading business communications company serving the multi-billion-dollar adult nightclubs industry. We have two principal reportable segments: Nightclubs and Bombshells. We combine other operating segments into “Other.” In the context of club and restaurant/sports bar operations, the terms the “Company,” “we,” “our,” “us” and similar terms used in this report refer to subsidiaries of RCIHH. RCIHH was incorporated in the State of Texas in 1994. Our corporate offices are located in Houston, Texas. Pre-COVID-19 Financial Performance During our first quarter ended December 31, 2019, total revenues were $4.4 million, or 9.9%, higher than the same quarter in the prior year. Consolidated same-store sales were up by 0.7%. During the first two months of the second quarter, our consolidated same-store sales were up by 12.4%, giving us a cumulative five-month same-store sales increase of 5.3%. With the outbreak of the coronavirus and COVID-19 national emergency guidelines put in place, we experienced a significant downturn in sales brought about by the temporary closure of all of our clubs and restaurants as of March 18, 2020. Impact of COVID-19 Pandemic Because of the stay-at-home order and social distancing guidelines put into place, our total revenues for the full nine-month period ended June 30, 2020 declined by 23.8% versus last year. Though we earned no revenues from our core businesses during the period of closures, we continue to incur expenses. To alleviate our cash flow situation, we instituted the following measures: ● Arranged and continue to arrange for deferment of principal and interest payment on certain of our debts; ● Furloughed employees working at our clubs and restaurants, except for a limited number of managers; ● Pay cut for all remaining salaried and hourly employees and deferral of board of director compensation; ● Deferred or modified certain fixed monthly expenses such as insurance, rent, and taxes, among others; ● Canceled certain non-essential expenses such as advertising, cable, pest control, point-of-sale-system support, and investor relations coverage, among others. As of the release of this report, we do not know the extent and duration of the impact of COVID-19 on our businesses due to the uncertainty about the spread of the virus. Lower sales, as caused by social distancing guidelines, could lead to adverse financial results. However, we will continually monitor and evaluate the situation and will determine any further measures to be instituted, including refinancing several of our debt obligations. Also see the risk factor in “Item 1A. Risk Factors” regarding risks and uncertainties associated with the COVID-19 pandemic. 22 Critical Accounting Policies and Estimates The preparation of the unaudited condensed consolidated financial statements requires our management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On a regular basis, we evaluate these estimates. These estimates are based on management’s historical industry experience and on various other assumptions that are believed to be reasonable under the circumstances. Actual results may differ from these estimates. For a description of the accounting policies that, in management’s opinion, involve the most significant application of judgment or involve complex estimation and which could, if different judgment or estimates were made, materially affect our reported financial position, results of operations, or cash flows, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Policies and Estimates” in our Annual Report on Form 10-K for the fiscal year ended September 30, 2019 filed with the SEC on February 13, 2020. We adopted ASC 842, Leases , as of October 1, 2019. Our adoption of ASC 842 resulted in an increase of $27.3 million in our total assets as of the adoption date due to the recognition of operating lease right-of-use assets net of the reclassification of deferred rent liability of $1.2 million and an increase in total liabilities due to the recognition of a $28.6 million operating lease liabilities. During the three and nine months ended June 30, 2020, there were no significant changes in our accounting policies and estimates other than the newly adopted accounting standards that are disclosed in Note 2 to our unaudited condensed consolidated financial statements. Results of Operations Highlights of the operating results of the Company during the three and nine months ended June 30, 2020 are as follows: Third Quarter 2020 ● Total revenues were $14.7 million compared to $47.0 million during the comparable prior-year period, a 68.7% decrease (Nightclubs revenue of $6.0 million compared to $37.9 million, an 84.1% decrease; and Bombshells revenue of $8.5 million compared to $8.8 million, a 2.6% decrease) ● No club nor Bombshells location qualified for same-store sales ● Basic and diluted loss per share of $0.60 compared to basic and diluted earnings per share (“EPS”) of $0.59 (non-GAAP diluted loss per share of $0.74 compared to a non-GAAP diluted EPS* of $0.59) ● Net cash provided by operating activities of $166,000 compared to $7.4 million during the comparable prior-year period, a 97.8% decrease (free cash flow* of $166,000 compared to $6.5 million, a 97.4% decrease) Year-to-Date 2020 ● Total revenues were $103.5 million compared to $135.9 million during the comparable prior-year period, a 23.8% decline (Nightclubs revenue of $75.2 million compared to $112.7 million, a 33.2% decrease; and Bombshells revenue of $27.7 million compared to $22.3 million, a 24.2% increase) ● Basic and diluted loss per share of $0.36 compared to basic and diluted EPS of $1.94 (non-GAAP diluted EPS* of $0.36 compared to $1.83, an 80.3% decrease) ● Net cash provided by operating activities of $12.1 million compared to $28.4 million during the comparable prior-year period, a 57.2% decrease (free cash flow* of $10.0 million compared to $26.3 million, a 61.9% decrease) * Reconciliation and discussion of non-GAAP financial measures are included in the “Non-GAAP Financial Measures” section below. 23 Three Months Ended June 30, 2020 Compared to Three Months Ended June 30, 2019 The following table summarizes our results of operations for the three months ended June 30, 2020 and 2019 (dollars in thousands): For the Three Months Ended June 30, 2020 June 30, 2019 Increase (Decrease) Amount % of Revenues Amount % of Revenues Amount % Revenues Sales of alcoholic beverages $ 7,623 51.8 % $ 19,570 41.6 % $ (11,947 ) (61.0 )% Sales of food and merchandise 3,452 23.4 % 7,046 15.0 % (3,594 ) (51.0 )% Service revenues 2,907 19.7 % 17,299 36.8 % (14,392 ) (83.2 )% Other 739 5.0 % 3,112 6.6 % (2,373 ) (76.3 )% Total revenues 14,721 100.0 % 47,027 100.0 % (32,306 ) (68.7 )% Operating expenses Cost of goods sold Alcoholic beverages sold 1,245 16.3 % 4,015 20.5 % (2,770 ) (69.0 )% Food and merchandise sold 1,125 32.6 % 2,565 36.4 % (1,440 ) (56.1 )% Service and other 20 0.5 % 121 0.6 % (101 ) (83.5 )% Total cost of goods sold (exclusive of items shown separately below) 2,390 16.2 % 6,701 14.2 % (4,311 ) (64.3 )% Salaries and wages 5,421 36.8 % 13,164 28.0 % (7,743 ) (58.8 )% Selling, general and administrative 8,908 60.5 % 14,895 31.7 % (5,987 ) (40.2 )% Depreciation and amortization 2,235 15.2 % 2,465 5.2 % (230 ) (9.3 )% Other charges (gains), net 424 2.9 % (172 ) (0.4 )% 596 346.5 % Total operating expenses 19,378 131.6 % 37,053 78.8 % (17,675 ) (47.7 )% Income (loss) from operations (4,657 ) (31.6 )% 9,974 21.2 % (14,631 ) (146.7 )% Other income (expenses) Interest expense (2,459 ) (16.7 )% (2,543 ) (5.4 )% (84 ) (3.3 )% Interest income 80 0.5 % 92 0.2 % (12 ) (13.0 )% Unrealized gain (loss) on equity securities 31 0.2 % (38 ) (0.1 )% 69 181.6 % Income (loss) before income taxes (7,005 ) (47.6 )% 7,485 15.9 % (14,490 ) (193.6 )% Income tax expense (benefit) (1,437 ) (9.8 )% 1,806 3.8 % (3,243 ) (179.6 )% Net income (loss) $ (5,568 ) (37.8 )% $ 5,679 12.1 % $ (11,247 ) (198.0 )% * Percentages may not foot due to rounding. Percentage of revenue for individual cost of goods sold items pertains to their respective revenue line. 24 Revenues Consolidated revenues decreased by $32.3 million, or 68.7%, due primarily to lost sales caused by the COVID-19 pandemic. No club or Bombshells location qualified for same-store sales since all units exceeded the number of closure days to be considered not comparable to prior year. Segment contribution to total revenues was as follows (in thousands): For the Three Months Ended June 30, 2020 2019 Nightclubs $ 6,013 $ 37,889 Bombshells 8,531 8,755 Other 177 383 $ 14,721 $ 47,027 Changing state and local government restrictions caused by COVID-19 have kept our larger Nightclubs, particularly in Florida and New York, closed for most of the quarter. Although our Texas clubs were able to reopen in May, sales were kept to a minimum due to social distancing and occupancy requirements. Bombshells locations were able to reopen in May 2020, but sales were limited due to indoor dining occupancy restrictions. Operating Expenses Total operating expenses, as a percent of revenues, increased to 131.6% from 78.8% from year-ago, with a $17.7 million decrease, or 47.7%, which is mainly caused by fixed overhead expenses in relation to significantly lower sales. Significant contributors to the changes in operating expenses are explained below. Cost of goods sold decreased by $4.3 million, or 64.3%, mainly due to COVID-19-related closures and indoor dining occupancy restrictions. As a percent of total revenues, cost of goods sold increased to 16.2% from 14.2% mainly due to sales mix. Higher-margin service revenues dropped in sales mix year-over year from 36.8% to 19.7%. Salaries and wages decreased by $7.7 million, or 58.8%. As a percent of total revenues, salaries and wages were 36.8% from 28.0% mainly due to fixed salaries paid on significantly lower sales due to COVID-19. Selling, general and administrative expenses decreased by approximately $6.0 million, or 40.2%, primarily due to decreased sales activity during the quarter partially offset by fixed overhead costs. Our adoption of ASC 842 as of October 1, 2019 did not have an impact in our results of operations and cash flows for the three months ended June 30, 2020. See Note 2 to our unaudited condensed consolidated financial statements. Depreciation and amortization decreased by $230,000, or 9.3% partly due to higher prior-year catch-up depreciation from properties moved out of held-for-sale classification. 25 Other charges/gains, net of $424,000 in net charge during the current quarter compared to a net gain of $172,000 in the prior-year quarter. The current quarter net charge was mainly from approximately $982,000 in impairment charge, partially offset by net gains of $608,000 on sale of one held-for-sale property and another property held and used. Last year’s quarter’s net gain was from the sale of two real estate properties and an aircraft amounting to $265,000, partially offset by $93,000 in insurance loss. Income (Loss) from Operations For the three months ended June 30, 2020 and 2019, our operating margin was (31.6%) and 21.2%, respectively. The main driver for the decrease in operating margin is the COVID-19-related closures. Segment contribution to income (loss) from operations is presented in the table below (in thousands): For the Three Months Ended June 30, 2020 2019 Nightclubs $ (3,088 ) $ 14,034 Bombshells 1,903 686 Other (95 ) (111 ) General corporate (3,377 ) (4,365 ) $ (4,657 ) $ 9,974 Operating margin for the Nightclubs segment was (51.4%) and 37.0% for the three months ended June 30, 2020 and 2019, respectively, while operating margin for Bombshells was 22.3% and 7.8%, respectively. The decrease in Nightclubs operating margin was mainly due to fixed operating costs and expenses in relation to lower sales from the pandemic plus the impairment charges. The increase in Bombshells operating margin was mainly from pre-opening expenses from several Bombshells openings in the prior-year quarter. Excluding impairment charges, amortization of intangibles, settlement of lawsuits, loss on insurance, and gain on disposal of assets, Nightclubs would have had non-GAAP operating margin of (43.7%) and 36.6% for the three months ended June 30, 2020 and 2019, respectively. Excluding loss on disposal of assets and amortization of intangibles, Bombshells would have had non-GAAP operating margin of 22.5% and 7.8% for the three months ended June 30, 2020 and 2019. Non-Operating Items Interest expense decreased by $84,000, or 3.3%. Our total occupancy costs, defined as the sum of lease expense and interest expense, were $3.5 million in both current-year and prior-year third quarters but due to the significantly lower revenue in the current year, as a percentage of revenue 23.6% and 7.5% during the three months ended June 30, 2020 and 2019, respectively. Income Taxes Income tax benefit was $1.4 million during the current-year third quarter compared to an income tax expense of $1.8 million during the prior-year third quarter. The effective income tax rate was a benefit of 20.5% and an expense of 24.1%, respectively. We revised our annual forecast of pretax book income for fiscal 2020 which revised our annual effective income tax rate, for which impact was recognized in the current-year third quarter. Our effective tax rate for both years is affected by the estimate of pre-tax accounting income (loss) for the year, state taxes, permanent differences, and tax credits, including the FICA tip credit. 26 Nine Months Ended June 30, 2020 Compared to Nine Months Ended June 30, 2019 The following table summarizes our results of operations for the nine months ended June 30, 2020 and 2019 (dollars in thousands): For the Nine Months Ended June 30, 2020 June 30, 2019 Increase (Decrease) Amount % of Revenues Amount % of Revenues Amount % Revenues Sales of alcoholic beverages $ 45,285 43.7 % $ 56,366 41.5 % $ (11,081 ) (19.7 )% Sales of food and merchandise 17,378 16.8 % 19,175 14.1 % (1,797 ) (9.4 )% Service revenues 34,448 33.3 % 51,609 38.0 % (17,161 ) (33.3 )% Other 6,430 6.2 % 8,726 6.4 % (2,296 ) (26.3 )% Total revenues 103,541 100.0 % 135,876 100.0 % (32,335 ) (23.8 )% Operating expenses Cost of goods sold Alcoholic beverages sold 8,826 19.5 % 11,541 20.5 % (2,715 ) (23.5 )% Food and merchandise sold 5,917 34.0 % 6,857 35.8 % (940 ) (13.7 )% Service and other 205 0.5 % 307 0.5 % (102 ) (33.2 )% Total cost of goods sold (exclusive of items shown separately below) 14,948 14.4 % 18,705 13.8 % (3,757 ) (20.1 )% Salaries and wages 30,866 29.8 % 37,168 27.4 % (6,302 ) (17.0 )% Selling, general and administrative 39,889 38.5 % 43,263 31.8 % (3,374 ) (7.8 )% Depreciation and amortization 6,696 6.5 % 6,718 4.9 % (22 ) (0.3 )% Other charges (gains), net 8,588 8.3 % (2,250 ) (1.7 )% 10,838 (481.7 )% Total operating expenses 100,987 97.5 % 103,604 76.2 % (2,617 ) (2.5 )% Income from operations 2,554 2.5 % 32,272 23.8 % (29,718 ) (92.1 )% Other income (expenses) Interest expense (7,403 ) (7.1 )% (7,709 ) (5.7 )% (306 ) (4.0 )% Interest income 263 0.3 % 218 0.2 % 45 20.6 % Unrealized loss on equity securities (103 ) (0.1 )% (408 ) (0.3 )% 305 74.8 % Income (loss) before income taxes (4,689 ) (4.5 )% 24,373 17.9 % (29,062 ) (119.2 )% Income tax expense (benefit) (1,262 ) (1.2 )% 5,547 4.1 % (6,809 ) (122.8 )% Net income (loss) $ (3,427 ) (3.3 )% $ 18,826 13.9 % $ (22,253 ) (118.2 )% * Percentages may not foot due to rounding. Percentage of revenue for individual cost of goods sold items pertains to their respective revenue line. Revenues Consolidated revenues decreased by $32.3 million, or 23.8%, for the nine months ended June 30, 2020 compared to prior year primarily due to the COVID-19 pandemic. Segment contribution to total revenues was as follows (in thousands): For the Nine Months Ended June 30, 2020 2019 Nightclubs $ 75,239 $ 112,664 Bombshells 27,684 22,295 Other 618 917 $ 103,541 $ 135,876 27 Nightclubs total sales for the nine months ended June 30, 2020 declined by 33.2% compared to a year ago because of COVID-19-related closures since March 2020. Bombshells total sales for the nine months ended June 30, 2020 increased by 24.2% compared to a year ago mainly due to sales from two new Bombshells location, partially offset by closures due to the COVID-19 pandemic. Operating Expenses Total operating expenses, as a percent of revenues, increased to 97.5% from 76.2% from year-ago, with a $2.6 million decrease, or 2.5%. Significant contributors to the changes in operating expenses are explained below. Cost of goods sold decreased by $3.8 million, or 20.1%, mainly due to COVID-19-related closures. As a percent of total revenues, cost of goods sold increased to 14.4% from 13.8% mainly due to perishable inventory spoilage and sales mix. Higher-margin service revenues dropped in sales mix year-over year from 38.0% to 33.3%. Salaries and wages decreased by $6.3 million, or 17.0%. As a percent of total revenues, salaries and wages were 29.8% from 27.4% mainly due to fixed salaries paid on significantly lower sales due to COVID-19. Selling, general and administrative expenses decreased by $3.4 million, or 7.8%, primarily due to decreased sales activity during the nine-month period partially offset by fixed overhead costs. Our adoption of ASC 842 as of October 1, 2019 did not have an impact in our results of operations and cash flows for the nine months ended June 30, 2020. See Note 2 to our unaudited condensed consolidated financial statements. Other charges/gains, net of $8.6 million in net charge in the current year compared to a net gain of $2.3 million in the prior year. The current year net charge was mainly from approximately $9.2 million in impairment charges, partially offset by $645,000 of net gains in the sale of real estate properties. Last year benefited from the gain on the sale of several real estate properties amounting to $2.5 million. Income from Operations For the nine months ended June 30, 2020 and 2019, our operating margin was 2.5% and 23.8%, respectively. The main driver for the decrease in operating margin is the COVID-19-related closures. Segment contribution to income from operations is presented in the table below (in thousands): For the Nine Months Ended June 30, 2020 2019 Nightclubs $ 13,002 $ 44,499 Bombshells 4,166 1,543 Other (480 ) (406 ) General corporate (14,134 ) (13,364 ) $ 2,554 $ 32,272 28 Operating margin for the Nightclubs segment was 17.3% and 39.5% for the nine months ended June 30, 2020 and 2019, respectively, while operating margin for Bombshells was 15.0% and 6.9%, respectively. The decrease in Nightclubs operating margin was mainly due to fixed operating costs and expenses in relation to lower sales from the pandemic plus the impairment charges. The increase in Bombshells operating margin was caused by early gains from reduction in pre-opening expenses partially offset by COVID-19-related closures plus the impairment charges. Excluding impairment charges, amortization of intangibles, gain on disposal of assets, gain on insurance and settlement of lawsuits, Nightclubs would have had non-GAAP operating margin of 28.6% and 37.6% for the nine months ended June 30, 2020 and 2019, respectively. Excluding impairment charges, amortization of intangibles, settlement of lawsuits and loss on sale of assets, Bombshells would have had non-GAAP operating margin of 16.0% and 6.9% for the nine months ended June 30, 2020 and 2019, respectively. Non-Operating Items Interest expense decreased by $306,000, or 4.0%. Our total occupancy costs, defined as the sum of lease expense and interest expense, decreased to $10.5 million from $10.7 million in the prior year, but due to the significantly lower revenue in the current year, our total occupancy cost as a percentage of revenue increased to 10.1% from 7.8%. Income Taxes Income tax benefit was $1.3 million during the current nine-month period compared to an income tax expense of $5.5 million during the prior year. The effective income tax rate was a benefit of 26.9% and an expense of 22.8%, respectively. We revised our annual forecast of pretax book income for fiscal 2020 due to the forecasted financial impact of the COVID-19 pandemic, which revised our annual effective income tax rate. Our effective tax rate for both years is affected by the estimate of pre-tax accounting income (loss) for the year, state taxes, permanent differences, and tax credits, including the FICA tip credit. Non-GAAP Financial Measures In addition to our financial information presented in accordance with GAAP, management uses certain non-GAAP financial measures, within the meaning of the SEC Regulation G, to clarify and enhance understanding of past performance and prospects for the future. Generally, a non-GAAP financial measure is a numerical measure of a company’s operating performance, financial position or cash flows that excludes or includes amounts that are included in or excluded from the most directly comparable measure calculated and presented in accordance with GAAP. We monitor non-GAAP financial measures because it describes the operating performance of the Company and helps management and investors gauge our ability to generate cash flow, excluding (or including) some items that management believes are not representative of the ongoing business operations of the Company, but are included in (or excluded from) the most directly comparable measures calculated and presented in accordance with GAAP. Relative to each of the non-GAAP financial measures, we further set forth our rationale as follows: Non-GAAP Operating Income and Non-GAAP Operating Margin. We calculate non-GAAP operating income and non-GAAP operating margin by excluding the following items from income from operations and operating margin: (a) amortization of intangibles, (b) gains or losses on sale of businesses and assets, (c) gains or losses on insurance, (d) settlement of lawsuits, and (e) impairment of assets. We believe that excluding these items assists investors in evaluating period-over-period changes in our operating income and operating margin without the impact of items that are not a result of our day-to-day business and operations. Non-GAAP Net Income and Non-GAAP Net Income per Diluted Share . We calculate non-GAAP net income and non-GAAP net income per diluted share by excluding or including certain items to net income attributable to RCIHH common stockholders and diluted earnings per share. Adjustment items are: (a) amortization of intangibles, (b) gains or losses on sale of businesses and assets, (c) gains or losses on insurance, (d) unrealized gains or losses on equity securities, (e) settlement of lawsuits, (f) impairment of assets, and (g) the income tax effect of the above described adjustments. Included in the income tax effect of the above adjustments is the net effect of the non-GAAP provision for income taxes, calculated at 26.9% and 22.8% effective tax rate of the pre-tax non-GAAP income before taxes for the nine months ended June 30, 2020 and 2019, respectively, and the GAAP income tax expense (benefit). We believe that excluding and including such items help management and investors better understand our operating activities. Adjusted EBITDA . We calculate adjusted EBITDA by excluding the following items from net income attributable to RCIHH common stockholders: (a) depreciation and amortization, (b) income tax expense (benefit), (c) net interest expense, (d) gains or losses on sale of businesses and assets, (e) gains or losses on insurance, (f) unrealized gains or losses on equity securities, (g) settlement of lawsuits, and (h) impairment of assets. We believe that adjusting for such items helps management and investors better understand our operating activities. Adjusted EBITDA provides a core operational performance measurement that compares results without the need to adjust for federal, state and local taxes which have considerable variation between domestic jurisdictions. The results are, therefore, without consideration of financing alternatives of capital employed. We use adjusted EBITDA as one guideline to assess our unleveraged performance return on our investments. Adjusted EBITDA is also the target benchmark for our acquisitions of nightclubs. We also use certain non-GAAP cash flow measures such as free cash flow. See “Liquidity and Capital Resources” section for further discussion. 29 The following tables present our non-GAAP performance measures for the three and nine months ended June 30, 2020 and 2019 (in thousands, except per share amounts and percentages): For the Three Months For the Nine Months Ended June 30, Ended June 30, 2020 2019 2020 2019 Reconciliation of GAAP net income (loss) to Adjusted EBITDA Net income (loss) attributable to RCIHH common stockholders $ (5,474 ) $ 5,638 $ (3,292 ) $ 18,717 Income tax expense (benefit) (1,437 ) 1,806 (1,262 ) 5,547 Interest expense, net 2,379 2,451 7,140 7,491 Settlement of lawsuits 50 - 74 144 Impairment of assets 982 - 9,192 - Gain on sale of businesses and assets (608 ) (265 ) (645 ) (2,487 ) Unrealized loss (gain) on equity securities (31 ) 38 103 408 Loss (gain) on insurance - 93 (33 ) 93 Depreciation and amortization 2,235 2,465 6,696 6,718 Adjusted EBITDA $ (1,904 ) $ 12,226 $ 17,973 $ 36,631 Reconciliation of GAAP net income (loss) to non-GAAP net income (loss) Net income (loss) attributable to RCIHH common stockholders $ (5,474 ) $ 5,638 $ (3,292 ) $ 18,717 Amortization of intangibles 149 165 462 474 Settlement of lawsuits 50 - 74 144 Impairment of assets 982 - 9,192 - Gain on sale of businesses and assets (608 ) (265 ) (645 ) (2,487 ) Unrealized loss (gain) on equity securities (31 ) 38 103 408 Loss (gain) on insurance - 93 (33 ) 93 Net income tax effect (1,840 ) (6 ) (2,499 ) 327 Non-GAAP net income (loss) $ (6,772 ) $ 5,663 $ 3,362 $ 17,676 Reconciliation of GAAP diluted earnings (loss) per share to non-GAAP diluted earnings (loss) per share Diluted shares 9,125 9,620 9,224 9,671 GAAP diluted earnings (loss) per share $ (0.60 ) $ 0.59 $ (0.36 ) $ 1.94 Amortization of intangibles 0.02 0.02 0.05 0.05 Settlement of lawsuits 0.01 - 0.01 0.01 Impairment of assets 0.11 - 1.00 - Gain on sale of businesses and assets (0.07 ) (0.03 ) (0.07 ) (0.26 ) Unrealized loss (gain) on equity securities (0.00 ) 0.00 0.01 0.04 Loss (gain) on insurance - 0.01 (0.00 ) 0.01 Net income tax effect (0.20 ) (0.00 ) (0.27 ) 0.03 Non-GAAP diluted earnings (loss) per share $ (0.74 ) $ 0.59 $ 0.36 $ 1.83 Reconciliation of GAAP operating income (loss) to non-GAAP operating income (loss) Income (loss) from operations $ (4,657 ) $ 9,974 $ 2,554 $ 32,272 Amortization of intangibles 149 165 462 474 Settlement of lawsuits 50 - 74 144 Impairment of assets 982 - 9,192 - Loss (gain) on insurance - 93 (33 ) 93 Gain on sale of businesses and assets (608 ) (265 ) (645 ) (2,487 ) Non-GAAP operating income (loss) $ (4,084 ) $ 9,967 $ 11,604 $ 30,496 Reconciliation of GAAP operating margin to non-GAAP operating margin GAAP operating margin (31.6 )% 21.2 % 2.5 % 23.8 % Amortization of intangibles 1.0 % 0.4 % 0.4 % 0.3 % Settlement of lawsuits 0.3 % - 0.1 % 0.1 % Impairment of assets 6.7 % - 8.9 % - Loss (gain) on insurance - 0.2 % (0.0 )% 0.1 % Gain on sale of businesses and assets (4.1 )% (0.6 )% (0.6 )% (1.8 )% Non-GAAP operating margin (27.7 )% 21.2 % 11.2 % 22.4 % * Per share amounts and percentages may not foot due to rounding. The adjustments to reconcile net income attributable to RCIHH common stockholders to non-GAAP net income exclude the impact of adjustments related to noncontrolling interests, which is immaterial. 30 Liquidity and Capital Resources At June 30, 2020, our cash and cash equivalents were approximately $14.8 million compared to $14.1 million at September 30, 2019. Because of the large volume of cash we handle, we have very stringent cash controls. As of June 30, 2020, we had negative working capital of $6.7 million compared to a negative working capital of $2.3 million as of September 30, 2019, excluding net assets held for sale of $2.0 million and $2.9 million as of June 30, 2020 and September 30, 2019, respectively. Although we believe that our ability to generate cash from operating activities is one of our fundamental financial strengths, the closure of our clubs and restaurants caused by the COVID-19 pandemic has presented operational challenges. Our strategy is to open locations in accordance with local and state guidelines and it is too early to know when and if they will generate positive cash flows for us. Depending on the timing and number of locations we get open, and their ability to generate positive cash flow, we may need to borrow funds to meet our obligations or consider selling certain assets. Based upon the small sampling of early openings in Texas, revenues seem favorable. We are hopeful that we can become profitable within a relatively short period of time after a majority of our locations have reopened, assuming these results can be sustained and the other locations, once opened, follow these early results. But if the business interruptions and occupancy limitations caused by COVID-19 last longer than we expect, we may need to seek other sources of liquidity. The COVID-19 pandemic is adversely affecting the availability of liquidity generally in the credit markets, and there can be no guarantee that additional liquidity will be readily available or available on favorable terms, especially the longer the COVID-19 pandemic lasts. We now currently forecast our cash flows to fall significantly lower than the levels that we initially targeted. To augment an expected decline in operating cash flows caused by the COVID-19 pandemic, we instituted the following measures: ● Arranged and continue to arrange for deferment of principal and interest payment on certain of our debts; ● Furloughed employees working at our clubs and restaurants, except for a limited number of managers; ● Pay cut for all remaining salaried and hourly employees and deferral of board of director compensation; ● Deferred or modified certain fixed monthly expenses such as insurance, rent, and taxes, among others; ● Canceled certain non-essential expenses such as advertising, cable, pest control, point-of-sale system support, and investor relations coverage, among others. On May 8, 2020, the Company received approval and funding under the Paycheck Protection Program of the CARES Act for its restaurants, shared service entity and lounge. Ten of our restaurant subsidiaries received amounts ranging from $271,000 to $579,000 for an aggregate amount of $4.2 million; our shared-services subsidiary received $1.1 million; and one of our lounges received $124,000. None of our adult nightclub and other non-core business subsidiaries received funding under the PPP. As of the release of this report, we do not know the extent and duration of the impact of COVID-19 on our businesses due to the uncertainty about the spread of the virus. Lower sales, as caused by social distancing guidelines, could lead to adverse financial results. However, we will continually monitor and evaluate our cash flow situation and will determine any further measures to be instituted, including refinancing several of our debt obligations. We continue to adhere to state and local government mandates regarding the pandemic and, since March 2020, have closed and reopened several of our locations depending on changing government mandates. As of the release of this report, we have reopened many of our club and Bombshells locations with limited occupancy but some of our bigger clubs are still closed. We have not recently raised capital through the issuance of equity securities. Instead, we use debt financing to lower our overall cost of capital and increase our return on stockholders’ equity. We have a history of borrowing funds in private transactions and from sellers in acquisition transactions and have secured traditional bank financing on our new development projects and refinancing of our existing notes payable, but with the significant global impact of the COVID-19 pandemic, there can be no assurance that any of these financing options would be presently available on favorable terms, if at all. We also have historically utilized these cash flows to invest in property and equipment, adult nightclubs and restaurants/sports bars. Though our cash flows are not as we expected at the beginning of the year, the near-term outlook for our business remains strong, and we expect to generate adequate cash flows from operations for the next 12 months from the issuance of this report. The following table presents a summary of our cash flows from operating, investing, and financing activities (in thousands): For the Nine Months Ended June 30, 2020 2019 Operating activities $ 12,147 $ 28,414 Investing activities (1,024 ) (25,608 ) Financing activities (10,425 ) (9,576 ) Net increase (decrease) in cash and cash equivalents $ 698 $ (6,770 ) Cash Flows from Operating Activities Following are our summarized cash flows from operating activities (in thousands): For the Nine Months Ended June 30, 2020 2019 Net income (loss) $ (3,427 ) $ 18,826 Depreciation and amortization 6,696 6,718 Deferred income tax expense (benefit) (1,517 ) 1,237 Impairment of assets 9,192 - Net change in operating assets and liabilities (51 ) 3,324 Other 1,254 (1,691 ) Net cash provided by operating activities $ 12,147 $ 28,414 Net cash provided by operating activities decreased from year to year due primarily to the impact of the COVID-19 pandemic and higher income taxes paid partially offset by lower interest expense paid. 31 Cash Flows from Investing Activities Following are our cash flows from investing activities (in thousands): For the Nine Months Ended June 30, 2020 2019 Payments for property and equipment and intangible assets $ (5,565 ) $ (16,901 ) Acquisition of businesses, net of cash acquired - (13,500 ) Proceeds from sale of businesses and assets 2,041 5,106 Proceeds from insurance 945 - Proceeds from notes receivable 1,555 107 Issuance of note receivable - (420 ) Net cash used in investing activities $ (1,024 ) $ (25,608 ) Following is a breakdown of our payments for property and equipment and intangible assets for the nine months ended June 30, 2020 and 2019 (in thousands): For the Nine Months Ended June30, 2020 2019 New facilities, equipment and software $ 3,454 $ 14,829 Maintenance capital expenditures 2,111 2,072 Total capital expenditures $ 5,565 $ 16,901 The capital expenditures during the nine months ended June 30, 2020 were composed primarily of construction and development costs for two new Bombshells locations and the rehabilitation of a club that was damaged by fire, while the capital expenditures during the nine months ended June 30, 2019 were composed primarily of construction and development costs for four new Bombshells locations. Maintenance capital expenditures refer mainly to capitalized replacement of productive assets in already existing locations. Variances in capital expenditures are primarily due to the number and timing of new, remodeled, or reconcepted locations under construction. Prior year acquisitions of $13.5 million relate to $7.5 million cash paid on the Pittsburgh club acquisition and the $6.0 million cash paid on the Chicago club acquisition. Cash Flows from Financing Activities Following are our cash flows from financing activities (in thousands): For the Nine Months Ended June 30, 2020 2019 Proceeds from debt obligations $ 6,503 $ 12,330 Payments on debt obligations (7,489 ) (18,634 ) Purchase of treasury stock (8,488 ) (2,364 ) Payment of dividends (920 ) (867 ) Payment of loan origination costs - (20 ) Distribution to noncontrolling interests (31 ) (21 ) Net cash used in financing activities $ (10,425 ) $ (9,576 ) Included in the $6.5 million proceeds from debt obligations for the nine months ended June 30, 2020 are $5.4 million in PPP loans as provided by the CARES Act. We purchased 465,390 shares of our common stock at an average price of $18.24 during the nine months ended June 30, 2020, while we purchased 102,113 shares of our common stock at an average price of $23.15 during the same period last year. We paid quarterly dividends of $0.03 per share during each of the current- and prior-year quarters, except in the second quarter of 2020 where we paid $0.04 per share. Management also uses certain non-GAAP cash flow measures such as free cash flow. We calculate free cash flow as net cash provided by operating activities less maintenance capital expenditures. Net cash provided by operating activities was $166,000 and $12.1 million during the three and nine months ended June 30, 2020, respectively, and $7.4 million and $28.4 million during the three and nine months ended June 30, 2019, respectively. Maintenance capital expenditures were $0 and $2.1 million during the three and nine months ended June 30, 2020, respectively, and $955,000 and $2.1 million during the three and nine months ended June 30, 2019, respectively. We use free cash flow as the baseline for the implementation of our capital allocation strategy. Below is a table reconciling free cash flow to its most directly comparable GAAP measure (in thousands): For the Nine Months Ended June 30, 2020 2019 Net cash provided by operating activities $ 12,147 $ 28,414 Less: Maintenance capital expenditures 2,111 2,072 Free cash flow $ 10,036 $ 26,342 Our free cash flow for the current year decreased by 61.9% compared to the comparable prior-year period primarily due to the impact of the COVID-19 pandemic and capital expenditures on remodeling of an older Bombshells unit and on upgrades in our Miami clubs in preparation for the pro football championship. Other than the potentially prolonged effect of the COVID-19 pandemic and the notes payable financing described above, we are not aware of any event or trend that would potentially significantly affect liquidity. In our opinion, working capital is not a true indicator of our financial status. Typically, businesses in our industry carry current liabilities in excess of current assets because businesses in our industry receive substantially immediate payment for sales, with nominal receivables, while inventories and other current liabilities normally carry longer payment terms. Vendors and purveyors often remain flexible with payment terms, providing businesses in our industry with opportunities to adjust to short-term business down turns. We consider the primary indicators of financial status to be the long-term trend of revenue growth, the mix of sales revenues, overall cash flow, profitability from operations and the level of long-term debt. 32 The following table presents a summary of such indicators for the nine months ended June 30 (in thousands, except percentages): Increase Increase 2020 (Decrease) 2019 (Decrease) 2018 Sales of alcoholic beverages $ 45,285 (19.7 )% $ 56,366 6.7 % $ 52,835 Sales of food and merchandise 17,378 (9.4 )% 19,175 13.4 % 16,906 Service revenues 34,448 (33.3 )% 51,609 6.8 % 48,338 Other 6,430 (26.3 )% 8,726 24.8 % 6,993 Total revenues 103,541 (23.8 )% 135,876 8.6 % 125,072 Net cash provided by operating activities $ 12,147 (57.2 )% $ 28,414 26.8 % $ 22,411 Adjusted EBITDA* $ 17,973 (50.9 )% $ 36,631 3.4 % $ 35,432 Free cash flow* $ 10,036 (61.9 )% $ 26,342 28.1 % $ 20,564 Long-term debt (end of period) $ 142,736 (4.7 )% $ 146,579 11.7 % $ 131,255 * See definition and calculation of Adjusted EBITDA and Free Cash Flow above in the Non-GAAP Financial Measures subsection of Results of Operations. Share Repurchase We purchased 465,390 shares of our common stock at an average price of $18.24 during the nine months ended June 30, 2020, while we purchased 102,113 shares of our common stock at an average price of $23.15 during the same period last year. In February 2020, the Company’s Board of Directors authorized an additional $10.0 million to repurchase the Company’s common stock. As of June 30, 2020, we have $11.8 million remaining to purchase additional shares under our share repurchase program. Impact of Inflation We have not experienced a material overall impact from inflation in our operations during the past several years. To the extent permitted by competition, we have managed to recover increased costs through price increases and may continue to do so. However, there can be no assurance that we will be able to do so in the future. 33 Seasonality Our nightclub operations are affected by seasonal factors. Historically, we have experienced reduced revenues from April through September (our fiscal third and fourth quarters) with the strongest operating results occurring during October through March (our fiscal first and second quarters). Our revenues in certain markets are also affected by sporting events that cause unusual changes in sales from year to year. Capital Allocation Strategy Our capital allocation strategy provides us with disciplined guidelines on how we should use our free cash flows; provided however, that we may deviate from this strategy if the circumstances warrant. We calculate free cash flow as net cash flows from operating activities minus maintenance capital expenditures. Using the after-tax yield of buying our own stock as baseline, management believes that we are able to make better investment decisions. Based on our current capital allocation strategy: ● We consider buying back our own stock if the after-tax yield on free cash flow is above 10%; ● We consider disposing of underperforming units to free up capital for more productive use; ● We consider acquiring or developing our own clubs or restaurants that we believe have the potential to provide a minimum cash on cash return of 25%-33%, absent an otherwise strategic rationale; ● We consider paying down our most expensive debt if it makes sense on a tax adjusted basis, or there is an otherwise strategic rationale. Growth Strategy We believe that our nightclub operations can continue to grow organically and through careful entry into markets and demographic segments with high growth potential. Our growth strategy involves the following: (i) to acquire existing units in locations that are consistent with our growth and income targets and which appear receptive to the upscale club formula we have developed; (ii) to open new units after market analysis; (iii) to franchise our Bombshells brand; (iv) to form joint ventures or partnerships to reduce start-up and operating costs, with us contributing equity in the form of our brand name and management expertise; (v) to develop new club concepts that are consistent with our management and marketing skills; (vi) to develop and open our restaurant concepts as our capital and manpower allow; and (vii) to control the real estate in connection with club operations, although some units may be in leased premises. We believe that Bombshells can grow organically and through careful entry into markets and demographic segments with high growth potential. All ten of the existing Bombshells as of June 30, 2020 are located in Texas. Our growth strategy is to diversify our operations with these units which do not require SOB licenses, which are sometimes difficult to obtain. While we are searching for adult nightclubs to acquire, we are able to also search for restaurant/sports bar locations that are consistent with our income targets. We opened two new Bombshells units during the current year, one during the first quarter ended December 31, 2019, and another during the second quarter ended March 31, 2020. On November 5, 2019, we announced that our subsidiaries have signed definitive agreements to acquire the assets and related real estate of a well-established, top gentlemen’s club located in the Northeast Corridor for $15.0 million. The agreements terminated prior to closing. We provided the sellers notice of the termination in April 2020. We continue to evaluate opportunities to acquire new nightclubs and anticipate acquiring new locations that fit our business model as we have done in the past. The acquisition of additional clubs may require us to take on additional debt or issue our common stock, or both. There can be no assurance that we will be able to obtain additional financing on reasonable terms in the future, if at all, should the need arise. An inability to obtain such additional financing could have an adverse effect on our growth strategy. 34 Item 3. Quantitative and Qualitative Disclosures About Market Risk. As of June 30, 2020, there were no material changes to the information provided in Item 7A of the Company’s Annual Report on Form 10-K for fiscal year ended September 30, 2019.