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, 2020. Overview RCI Hospitality Holdings, Inc. (“RCIHH”) is a holding company. Through our subsidiaries, we engaged in a number of activities in the hospitality and related businesses. All services and management operations are conducted by subsidiaries of RCIHH. Through our subsidiaries, as of March 31, 2021, we operated a total of 48 establishments that offer live adult entertainment and/or restaurant and bar operations, including one club that is being renovated due to hurricane damage. 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. Impact of COVID-19 Pandemic Starting in March 2020, our businesses were heavily impacted by the COVID-19 pandemic through the temporary closure and reopening of a number of our clubs and restaurants in adherence to federal, state and local government mandates. Our total revenues for the three and six months ended March 31, 2021 increased by 9.0% and declined by 7.2%, respectively, versus last year. The increase in the quarter ended March 31, 2021 was mainly caused by Bombshells’ same-store sales increase and revenue from two new units. Though we earned no revenues from our core businesses during the period of closures, we continued to incur expenses. To alleviate our cash flow situation, we instituted the following measures: ● Arranged 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; * ● Temporarily enacted a pay reduction for all remaining salaried and hourly employees and deferred board of director compensation; * ● Deferred or modified certain fixed monthly expenses such as insurance, rent, and taxes, among others; ● Temporarily reduced or 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 date of this report, we have recalled all furloughed employees and reinstated the pay for all salaried and hourly employees. As of the release of this report, we do not know the future extent and duration of the impact of COVID-19 on our businesses. Lower sales, as caused by local, state and national 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. 21 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, 2020 filed with the SEC on December 14, 2020. During the three and six months ended March 31, 2021, 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. We signed our first franchise agreement for Bombshells in December 2020. The financial impact of the franchise agreement was immaterial to the Company’s results of operations and cash flows for the three and six months ended March 31, 2021. Results of Operations Highlights of the Company’s operating results are as follows: Second Quarter 2021 ● Total revenues were $44.1 million compared to $40.4 million during the comparable prior-year period, a 9.0% increase (Nightclubs revenue of $30.8 million compared to $31.4 million, a 1.8% decrease; and Bombshells revenue of $13.1 million compared to $8.8 million, a 49.2% increase) ● Consolidated same-store sales increased by 26.3% (Nightclubs increased by 3.6% while Bombshells increased by 48.7%) (refer to the definition of same-store sales in the discussion of Revenues below) ● Gain on forgiven PPP loans amounted to $380,000 ● Basic and diluted earnings per share (“EPS”) of $0.68 compared to a basic and diluted loss per share of $0.37 (non-GAAP diluted EPS* of $0.75 compared to $0.47) ● Net cash provided by operating activities of $11.0 million compared to $1.7 million during the comparable prior-year period, a 542.4% increase (free cash flow* of $9.0 million compared to $618,000, a 1,354.0% increase) 22 Year-to-Date 2021 ● Total revenues were $82.5 million compared to $88.8 million during the comparable prior-year period, a 7.2% decrease (Nightclubs revenue of $56.0 million compared to $69.2 million, a 19.1% decrease; and Bombshells revenue of $26.1 million compared to $19.2 million, a 36.5% increase) ● Consolidated same-store sales increased by 6.9% (Nightclubs decreased by 4.4% while Bombshells increased by 27.9%) (refer to the definition of same-store sales in the discussion of Revenues below) ● Gain on forgiven PPP loans amounted to $5.3 million ● Basic and diluted EPS of $1.75 compared to $0.24 (non-GAAP diluted EPS* of $1.15 compared to $1.09) ● Net cash provided by operating activities of $17.2 million compared to $12.0 million during the comparable prior-year period, a 43.9% increase (free cash flow* of $14.7 million compared to $9.9 million, a 48.5% increase) * Reconciliation and discussion of non-GAAP financial measures are included in the “Non-GAAP Financial Measures” section below. Three Months Ended March 31, 2021 Compared to Three Months Ended March 31, 2020 The following table summarizes our results of operations for the three months ended March 31, 2021 (dollars in thousands): For the Three Months Ended March 31, 2021 March 31, 2020 Better (Worse) Amount % of Revenues Amount % of Revenues Amount % Revenues Sales of alcoholic beverages $ 20,273 46.0 % $ 16,919 41.9 % $ 3,354 19.8 % Sales of food and merchandise 9,538 21.6 % 6,479 16.0 % 3,059 47.2 % Service revenues 11,502 26.1 % 14,348 35.5 % (2,846 ) (19.8 )% Other 2,746 6.2 % 2,680 6.6 % 66 2.5 % Total revenues 44,059 100.0 % 40,426 100.0 % 3,633 9.0 % Operating expenses Cost of goods sold Alcoholic beverages sold 3,730 18.4 % 3,435 20.3 % (295 ) (8.6 )% Food and merchandise sold 3,029 31.8 % 2,271 35.1 % (758 ) (33.4 )% Service and other 43 0.3 % 76 0.4 % 33 43.4 % Total cost of goods sold (exclusive of items shown separately below) 6,802 15.4 % 5,782 14.3 % (1,020 ) (17.6 )% Salaries and wages 11,200 25.4 % 12,222 30.2 % 1,022 8.4 % Selling, general and administrative 12,618 28.6 % 14,450 35.7 % 1,832 12.7 % Depreciation and amortization 2,117 4.8 % 2,257 5.6 % 140 6.2 % Other charges, net 1,481 3.4 % 8,190 20.3 % 6,709 81.9 % Total operating expenses 34,218 77.7 % 42,901 106.1 % 8,683 20.2 % Income (loss) from operations 9,841 22.3 % (2,475 ) (6.1 )% 12,316 497.6 % Other income (expenses) Interest expense (2,364 ) (5.4 )% (2,459 ) (6.1 )% 95 3.9 % Interest income 62 0.1 % 85 0.2 % (23 ) (27.1 )% Non-operating gains (losses), net 431 1.0 % (62 ) (0.2 )% 493 795.2 % Income (loss) before income taxes 7,970 18.1 % (4,911 ) (12.1 )% 12,881 262.3 % Income tax expense (benefit) 1,938 4.4 % (1,418 ) (3.5 )% (3,356 ) (236.7 )% Net income (loss) $ 6,032 13.7 % $ (3,493 ) (8.6 )% $ 9,525 272.7 % * Percentages may not foot due to rounding. Percentage of revenue for individual cost of goods sold items pertains to their respective revenue line. 23 Revenues Consolidated revenues increased by approximately $3.6 million, or 9.0%, due primarily to the timing of closures caused by the COVID-19 pandemic. Consolidated same-store sales increased by 26.3%. The 9.0% increase in consolidated revenues was primarily from the 8.7% impact of the same-store increase and a 2.6% increase from new Bombshells units, partially offset by a 2.0% decrease due to closures from COVID-19 and a 0.3% decline in other revenues. We calculate same-store sales by comparing year-over-year revenues from nightclubs and restaurants/sports bars starting in the first full quarter of operations after at least 12 full months for Nightclubs and at least 18 full months for Bombshells. We consider the first six months of operations of a Bombshells unit to be the “honeymoon period” where sales are significantly higher than normal. We exclude from a particular month’s calculation units previously included in the same-store sales base that have closed temporarily for more than 15 days until its next full month of operations. We also exclude from the same-store sales base units that are being reconcepted or are closed due to renovations or remodels. Acquired units are included in the same-store sales calculation as long as they qualify, based on the definition stated above. Revenues outside of our Nightclubs and Bombshells reportable segments are excluded from same-store sales calculation. Segment contribution to total revenues was as follows (in thousands): For the Three Months Ended March 31, 2021 2020 Nightclubs $ 30,787 $ 31,367 Bombshells 13,135 8,803 Other 137 256 $ 44,059 $ 40,426 Nightclubs revenues decreased by 1.8% for the quarter ended March 31, 2021 compared to the prior-year quarter. For Nightclubs that were open enough days to qualify for same-store sales (refer to the definition of same-store sales in the preceding paragraph), sales increased by 3.6%. The remaining decline in revenues reflects lower sales for clubs in states where the number of days closed did not qualify them for same-store sales. Bombshells revenues increased by 49.2%, of which 37.1% was due to the impact of the same-store sales increase with the remaining 12.1% increase generated by two new locations. Operating Expenses Total operating expenses, as a percent of revenues, decreased to 77.7% from 106.1% from last year’s second quarter, with a $8.7 million decrease, or 20.2%, which is mainly caused by the higher impairment in the prior year. Significant contributors to the changes in operating expenses are explained below. Cost of goods sold increased by $1.0 million, or 17.6%, mainly due to higher sales in the current quarter. As a percent of total revenues, cost of goods sold increased to 15.4% from 14.3% mainly due to the sales mix shifting from higher-margin service revenues. Salaries and wages decreased by $1.0 million, or 8.4%. As a percent of total revenues, salaries and wages were lower at 25.4% from 30.2% mainly due to fixed salaries paid on lower sales during the prior-year quarter. Selling, general and administrative expenses decreased by $1.8 million, or 12.7%, primarily due to decreased audit and legal fees from prior year’s SEC matters and controlled advertising and marketing expenses due to uncertainty brought about by the pandemic. As a percent of total revenues, selling, general and administrative expenses decreased to 28.6% from 35.7% due to the lower expenses from the above-cited reasons leveraged on higher sales in the current quarter. Our total occupancy costs, defined as the sum of lease expense and interest expense (see below), were $3.3 million and $3.5 million for the quarter ended March 31, 2021 and 2020, respectively. As a percentage of revenue, total occupancy costs were 7.6% and 8.6% during the quarter ended March 31, 2021 and 2020, respectively, primarily due to higher sales base in the current quarter. Depreciation and amortization decreased by $140,000, or 6.2% partly due to fully depreciated real estate and software assets. Other charges, net decreased to $1.5 million from $8.2 million, which was primarily caused by impairment charges of $1.4 million and $8.2 million during the quarter ended March 31, 2021 and 2020, respectively. 24 Income (Loss) from Operations For the three months ended March 31, 2021 and 2020, our consolidated operating margin was 22.3% and (6.1)%, respectively. The main drivers for the increase in operating margin are the current quarter’s higher sales and the impairment charges in both quarters. Segment contribution to income (loss) from operations is presented in the table below (in thousands): For the Three Months Ended March 31, 2021 2020 Nightclubs $ 10,468 $ 2,284 Bombshells 3,142 688 Other (139 ) (146 ) General corporate (3,630 ) (5,301 ) $ 9,841 $ (2,475 ) Operating margin for the Nightclubs segment was 34.0% and 7.3% for the three months ended March 31, 2021 and 2020, respectively, while operating margin for Bombshells was 23.9% and 7.8%, respectively. The increase in Nightclubs operating margin was mainly due to last year’s impairment charges as triggered by the pandemic. The increase in Bombshells operating margin was mainly from higher sales and a decrease in pre-opening expenses from several Bombshells openings in prior periods. 25 Excluding certain items, non-GAAP operating income (loss) and non-GAAP operating margin are computed in the table below (dollars in thousands). See further discussion in the “Non-GAAP Financial Measures” section below. For the Three Months Ended March 31, 2021 For the Three Months Ended March 31, 2020 Nightclubs Bombshells Other Corporate Total Nightclubs Bombshells Other Corporate Total Income (loss) from operations $ 10,468 $ 3,142 $ (139 ) $ (3,630 ) $ 9,841 $ 2,284 $ 688 $ (146 ) $ (5,301 ) $ (2,475 ) Amortization of intangibles 47 3 29 - 79 57 4 96 - 157 Settlement of lawsuits (4 ) - 5 - 1 - - - - - Impairment of assets 1,401 - - - 1,401 7,965 245 - - 8,210 Loss (gain) on sale of businesses and assets 14 47 - 30 91 (3 ) - - (4 ) (7 ) Loss (gain) on insurance 32 - - (44 ) (12 ) - - - (13 ) (13 ) Non-GAAP operating income (loss) $ 11,958 $ 3,192 $ (105 ) $ (3,644 ) $ 11,401 $ 10,303 $ 937 $ (50 ) $ (5,318 ) $ 5,872 GAAP operating margin 34.0 % 23.9 % (101.5 )% (8.2 )% 22.3 % 7.3 % 7.8 % (57.0 )% (13.1 )% (6.1 )% Non-GAAP operating margin 38.8 % 24.3 % (76.6 )% (8.3 )% 25.9 % 32.8 % 10.6 % (19.5 )% (13.2 )% 14.5 % Non-Operating Items During the quarter ended March 31, 2021, we received one notice of forgiveness for one PPP loan, which forgave 100% of the PPP loan’s principal and interest amounting to $380,000. Interest expense decreased by $95,000, or 3.9%. Income Taxes Income taxes were an expense of $1.9 million during the quarter ended March 31, 2021 compared to a benefit of $1.4 million during the quarter ended March 31, 2020. The effective income tax rate was an expense of 24.3% and a benefit of 28.9% for the quarter ended March 31, 2021 and 2020, respectively. Our effective tax rate is affected by the statutory federal income tax rate, state taxes, permanent differences, and tax credits, including the FICA tip credit, for both years, and the impact of the forgiveness of the PPP loans in the current period, as presented below. For the Three Months Ended March 31, 2021 2020 Statutory federal income tax rate 21.0 % 21.0 % State income taxes, net of federal benefit 7.0 % 4.2 % Permanent differences (5.9 )% 1.3 % Tax credits 2.2 % 2.3 % Effective income tax rate 24.3 % 28.9 % 26 Six Months Ended March 31, 2021 Compared to Six Months Ended March 31, 2020 The following table summarizes our results of operations for the six months ended March 31, 2021 (dollars in thousands): For the Six Months Ended March 31, 2021 March 31, 2020 Better (Worse) Amount % of Revenues Amount % of Revenues Amount % Revenues Sales of alcoholic beverages $ 37,633 45.6 % $ 37,662 42.4 % $ (29 ) (0.1 )% Sales of food and merchandise 18,147 22.0 % 13,926 15.7 % 4,221 30.3 % Service revenues 21,562 26.1 % 31,541 35.5 % (9,979 ) (31.6 )% Other 5,115 6.2 % 5,691 6.4 % (576 ) (10.1 )% Total revenues 82,457 100.0 % 88,820 100.0 % (6,363 ) (7.2 )% Operating expenses Cost of goods sold Alcoholic beverages sold 6,992 18.6 % 7,581 20.1 % 589 7.8 % Food and merchandise sold 5,918 32.6 % 4,846 34.8 % (1,072 ) (22.1 )% Service and other 96 0.4 % 131 0.4 % 35 26.7 % Total cost of goods sold (exclusive of items shown separately below) 13,006 15.8 % 12,558 14.1 % (448 ) (3.6 )% Salaries and wages 22,686 27.5 % 25,445 28.6 % 2,759 10.8 % Selling, general and administrative 24,770 30.0 % 30,981 34.9 % 6,211 20.0 % Depreciation and amortization 4,140 5.0 % 4,461 5.0 % 321 7.2 % Other charges, net 1,431 1.7 % 8,164 9.2 % 6,733 82.5 % Total operating expenses 66,033 80.1 % 81,609 91.9 % 15,576 19.1 % Income from operations 16,424 19.9 % 7,211 8.1 % 9,213 127.8 % Other income (expenses) Interest expense (4,798 ) (5.8 )% (4,944 ) (5.6 )% 146 3.0 % Interest income 122 0.1 % 183 0.2 % (61 ) (33.3 )% Non-operating gains (losses), net 5,347 6.5 % (134 ) (0.2 )% 5,481 4,090.3 % Income before income taxes 17,095 20.7 % 2,316 2.6 % 14,779 638.1 % Income tax expense 1,554 1.9 % 175 0.2 % (1,379 ) (788.0 )% Net income $ 15,541 18.8 % $ 2,141 2.4 % $ 13,400 625.9 % * Percentages may not foot due to rounding. Percentage of revenue for individual cost of goods sold items pertains to their respective revenue line. 27 Revenues Consolidated revenues decreased by approximately $6.4 million, or 7.2%, due primarily to the closures caused by the COVID-19 pandemic. Consolidated same-store sales increased by 6.9%. The 7.2% decrease in consolidated revenues was primarily from the 13.5% decrease due to closures from COVID-19 and a 0.1% decline in other revenues, partially offset by the 3.4% impact of the same-store increase and a 3.0% increase from new Bombshells units. We calculate same-store sales by comparing year-over-year revenues from nightclubs and restaurants/sports bars starting in the first full quarter of operations after at least 12 full months for Nightclubs and at least 18 full months for Bombshells. We consider the first six months of operations of a Bombshells unit to be the “honeymoon period” where sales are significantly higher than normal. We exclude from a particular month’s calculation units previously included in the same-store sales base that have closed temporarily for more than 15 days until its next full month of operations. We also exclude from the same-store sales base units that are being reconcepted or are closed due to renovations or remodels. Acquired units are included in the same-store sales calculation as long as they qualify, based on the definition stated above. Revenues outside of our Nightclubs and Bombshells reportable segments are excluded from same-store sales calculation. Segment contribution to total revenues was as follows (in thousands): For the Six Months Ended March 31, 2021 2020 Nightclubs $ 55,984 $ 69,226 Bombshells 26,141 19,153 Other 332 441 $ 82,457 $ 88,820 Nightclubs revenues decreased by 19.1% for the six-month period ended March 31, 2021 compared to the prior-year period. For Nightclubs that were open enough days to qualify for same-store sales (refer to the definition of same-store sales in the preceding paragraph), sales decreased by 4.4%. The remaining decline in revenues reflects lower sales for clubs in states where the number of days closed did not qualify them for same-store sales. Bombshells revenues increased by 36.5%, of which 22.5% was due to the impact of the same-store sales increase with the remaining 14.0% increase generated by two new locations. 28 Operating Expenses Total operating expenses, as a percent of revenues, decreased to 80.1% from 91.9% from the comparable period last year, with a $15.6 million decrease, or 19.1%, which is mainly caused by the higher impairment in the prior year, a $6.2 million decrease in selling, general and administrative expenses, and a $2.8 million decrease in salaries and wages. Significant contributors to the changes in operating expenses are explained below. Cost of goods sold increased by $448,000, or 3.6%, mainly due to a shift in sales mix from higher-margin service revenues to alcohol and food sales in the current six-month period. As a percent of total revenues, cost of goods sold increased to 15.8% from 14.1% mainly due to the shift in sales mix. Salaries and wages decreased by $2.8 million, or 10.8%, mainly due to COVID-19-related closures. As a percent of total revenues, salaries and wages were lower at 27.5% from 28.6% mainly due to fixed salaries paid on lower sales during the prior-year period. Selling, general and administrative expenses decreased by $6.2 million, or 20.0%, primarily due to decreased audit and legal fees from prior year’s SEC matters, controlled advertising and marketing expenses due to uncertainty brought about by the pandemic, and lower taxes and permits and charge card fees due to lower sales. As a percent of total revenues, selling, general and administrative expenses decreased to 30.0% from 34.9% due to legal and accounting fees and advertising and marketing expenses. Our total occupancy costs, defined as the sum of lease expense and interest expense (see below), were $6.7 million and $7.0 million for the six months ended March 31, 2021 and 2020, respectively. As a percentage of revenue, total occupancy costs were 8.2% and 7.9% during the six months ended March 31, 2021 and 2020, respectively, primarily due to lower sales base in the current six-month period. Depreciation and amortization decreased by $321,000, or 7.2% partly due to fully depreciated real estate and software assets. Other charges, net decreased to $1.4 million from $8.2 million, which was primarily caused by impairment charges of $1.4 million and $8.2 million during the six months ended March 31, 2021 and 2020, respectively. Income from Operations For the six months ended March 31, 2021 and 2020, our consolidated operating margin was 19.9% and 8.1%, respectively. The main drivers for the increase in operating margin are the current period’s lower sales and gain on debt extinguishment, and the prior-year period’s higher impairment charges. Segment contribution to income (loss) from operations is presented in the table below (in thousands): For the Six Months Ended March 31, 2021 2020 Nightclubs $ 18,963 $ 16,040 Bombshells 5,859 2,259 Other (214 ) (331 ) General corporate (8,184 ) (10,757 ) $ 16,424 $ 7,211 Operating margin for the Nightclubs segment was 33.9% and 23.2% for the six months ended March 31, 2021 and 2020, respectively, while operating margin for Bombshells was 22.4% and 11.8%, respectively. The increase in Nightclubs operating margin was mainly due to last year’s impairment charges as triggered by the pandemic. The increase in Bombshells operating margin was mainly from higher sales and a decrease in pre-opening expenses from several Bombshells openings in prior periods. 29 Excluding certain items, non-GAAP operating income (loss) and non-GAAP operating margin are computed in the table below (dollars in thousands). See further discussion in the “Non-GAAP Financial Measures” section below. For the Six Months Ended March 31, 2021 For the Six Months Ended March 31, 2020 Nightclubs Bombshells Other Corporate Total Nightclubs Bombshells Other Corporate Total Income (loss) from operations $ 18,963 $ 5,859 $ (214 ) $ (8,184 ) $ 16,424 $ 16,040 $ 2,259 $ (331 ) $ (10,757 ) $ 7,211 Amortization of intangibles 94 7 57 - 158 114 8 191 - 313 Settlement of lawsuits 114 34 5 - 153 24 - - - 24 Impairment of assets 1,401 - - - 1,401 7,965 245 - - 8,210 Loss (gain) on sale of businesses and assets 14 47 - 25 86 - - - (37 ) (37 ) Gain on insurance (165 ) - - (44 ) (209 ) (20 ) - - (13 ) (33 ) Non-GAAP operating income (loss) $ 20,421 $ 5,947 $ (152 ) $ (8,203 ) $ 18,013 $ 24,123 $ 2,512 $ (140 ) $ (10,807 ) $ 15,688 GAAP operating margin 33.9 % 22.4 % (64.5 )% (9.9 )% 19.9 % 23.2 % 11.8 % (75.1 )% (12.1 )% 8.1 % Non-GAAP operating margin 36.5 % 22.7 % (45.8 )% (9.9 )% 21.8 % 34.8 % 13.1 % (31.7 )% (12.2 )% 17. 7 % Non-Operating Items During the six months ended March 31, 2021, we received 11 notices of forgiveness for a PPP loan, which forgave 100% of the PPP loans’ principal and interest amounting to $5.3 million. Interest expense decreased by $146,000, or 3.0%. Income Taxes Income tax expense was $1.6 million during the six months ended March 31, 2021 compared to $175,000 during the six months ended March 31, 2020. The effective income tax rate was 9.1% and 7.6% for the six months ended March 31, 2021 and 2020, respectively. Our effective tax rate is affected by the statutory federal income tax rate, state taxes, permanent differences, and tax credits, including the FICA tip credit, for both years, and the change in the deferred tax asset valuation allowance and the impact of the forgiveness of the PPP loans in the current period, as presented below. For the Six Months Ended March 31, 2021 2020 Statutory federal income tax rate 21.0 % 21.0 % State income taxes, net of federal benefit 5.0 % 4.5 % Permanent differences (7.1 )% 0.3 % Change in valuation allowance (7.5 )% - Tax credits (2.3 )% (18.3 )% Effective income tax rate 9.1 % 7.6 % 30 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) impairment of assets, and (e) settlement of lawsuits. 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) impairment of assets, (f) settlement of lawsuits, (g) gain on debt extinguishment, and (h) 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 24.2% and 7.6% effective tax rate of the pre-tax non-GAAP income before taxes for the six months ended March 31, 2021 and 2020, 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) impairment of assets, (h) settlement of lawsuits, and (i) gain on debt extinguishment. 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. 31 The following tables present our non-GAAP performance measures for the three and six months ended March 31, 2021 and 2020 (in thousands, except per share amounts and percentages): For the Three Months For the Six Months Ended March 31, Ended March 31, 2021 2020 2021 2020 Reconciliation of GAAP net income (loss) to Adjusted EBITDA Net income (loss) attributable to RCIHH common stockholders $ 6,091 $ (3,452 ) $ 15,734 $ 2,182 Income tax expense (benefit) 1,938 (1,418 ) 1,554 175 Interest expense, net 2,302 2,374 4,676 4,761 Settlement of lawsuits 1 - 153 24 Impairment of assets 1,401 8,210 1,401 8,210 Loss (gain) on sale of businesses and assets 91 (7 ) 86 (37 ) Gain on debt extinguishment (380 ) - (5,329 ) - Unrealized loss on equity securities 34 62 67 134 Gain on insurance (12 ) (13 ) (209 ) (33 ) Depreciation and amortization 2,117 2,257 4,140 4,461 Adjusted EBITDA $ 13,583 $ 8,013 $ 22,273 $ 19,877 Reconciliation of GAAP net income (loss) to non-GAAP net income (loss) Net income (loss) attributable to RCIHH common stockholders $ 6,091 $ (3,452 ) $ 15,734 $ 2,182 Amortization of intangibles 79 157 158 313 Settlement of lawsuits 1 - 153 24 Impairment of assets 1,401 8,210 1,401 8,210 Loss (gain) on sale of businesses and assets 91 (7 ) 86 (37 ) Gain on debt extinguishment (380 ) - (5,329 ) - Unrealized loss on equity securities 34 62 67 134 Gain on insurance (12 ) (13 ) (209 ) (33 ) Net income tax effect (522 ) (633 ) (1,741 ) (659 ) Non-GAAP net income (loss) $ 6,783 $ 4,324 $ 10,320 $ 10,134 Reconciliation of GAAP diluted earnings (loss) per share to non-GAAP diluted earnings (loss) per share Diluted shares 9,000 9,225 9,010 9,274 GAAP diluted earnings (loss) per share $ 0.68 $ (0.37 ) $ 1.75 $ 0.24 Amortization of intangibles 0.01 0.02 0.02 0.03 Settlement of lawsuits 0.00 - 0.02 0.00 Impairment of assets 0.16 0.89 0.16 0.89 Loss (gain) on sale of businesses and assets 0.01 (0.00 ) 0.01 (0.00 ) Gain on debt extinguishment (0.04 ) - (0.59 ) - Unrealized loss on equity securities 0.00 0.01 0.01 0.01 Gain on insurance (0.00 ) (0.00 ) (0.02 ) (0.00 ) Net income tax effect (0.06 ) (0.07 ) (0.19 ) (0.07 ) Non-GAAP diluted earnings per share $ 0.75 $ 0.47 $ 1.15 $ 1.09 Reconciliation of GAAP operating income (loss) to non-GAAP operating income (loss) Income (loss) from operations $ 9,841 $ (2,475 ) $ 16,424 $ 7,211 Amortization of intangibles 79 157 158 313 Settlement of lawsuits 1 - 153 24 Impairment of assets 1,401 8,210 1,401 8,210 Gain on insurance (12 ) (13 ) (209 ) (33 ) Loss (gain) on sale of businesses and assets 91 (7 ) 86 (37 ) Non-GAAP operating income (loss) $ 11,401 $ 5,872 $ 18,013 $ 15,688 Reconciliation of GAAP operating margin to non-GAAP operating margin GAAP operating margin 22.3 % (6.1 )% 19.9 % 8.1 % Amortization of intangibles 0.2 % 0.4 % 0.2 % 0.4 % Settlement of lawsuits 0.0 % - 0.2 % 0.0 % Impairment of assets 3.2 % 20.3 % 1.7 % 9.2 % Gain on insurance (0.0 )% (0.0 )% (0.3 )% 0.0 % Loss (gain) on sale of businesses and assets 0.2 % (0.0 )% 0.1 % 0.0 % Non-GAAP operating margin 25.9 % 14.5 % 21.8 % 17.7 % * 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. 32 Liquidity and Capital Resources At March 31, 2021, our cash and cash equivalents were approximately $20.2 million compared to $15.6 million at September 30, 2020. Because of the large volume of cash we handle, we have very stringent cash controls. As of March 31, 2021, we had positive working capital of $175,000 compared to a negative working capital of $5.9 million as of September 30, 2020, excluding assets held for sale (net of associated liabilities of $3.2 million and $0, respectively) amounting to $4.2 million and $0 as of March 31, 2021 and September 30, 2020, respectively. Although we believe that our ability to generate cash from operating activities is one of our fundamental financial strengths, the temporary closure of our clubs and restaurants caused by the COVID-19 pandemic presented operational challenges. Our strategy was to open locations and operate in accordance with local and state guidelines. Based upon the current state of allowed openings, revenues seem favorable. 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. To augment an expected decline in operating cash flows caused by the COVID-19 pandemic, we instituted the following measures: ● Arranged 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; * ● Temporarily enacted a pay reduction for all remaining salaried and hourly employees and deferred board of director compensation; * ● Deferred or modified certain fixed monthly expenses such as insurance, rent, and taxes, among others; ● Temporarily reduced or 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 date of this report, we have recalled all furloughed employees and reinstated the pay for all salaried and hourly employees. 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. The Company believes it used the entire loan amount for qualifying expenses. Under the terms of the PPP, certain amounts of the loan may be forgiven if they are used for qualifying expenses as described in the CARES Act. The Company utilized all of the PPP funds and submitted its forgiveness applications. During the three and six months ended March 31, 2021, we received 1 and 11 Notices of PPP Forgiveness Payment (“Notice”), respectively, from the Small Business Administration out of the 12 of our PPP loans granted. All of the notices received forgave 100% of each of the ten PPP loans totaling the amount of $380,000 and $5.3 million in principal and interest during the three and six months ended March 31, 2021, respectively, and were included in non-operating gains (losses), net in our unaudited condensed consolidated statement of operations. No assurance can be provided that the Company will in fact obtain forgiveness of the one remaining PPP loan in whole or in part. As of the release of this report, we do not know the future extent and duration of the impact of COVID-19 on our businesses. Lower sales, as caused by local, state and national 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 a number of our locations depending on changing government mandates, including operating hour and limited occupancy restrictions. 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. 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 Six Months Ended March 31, 2021 2020 Operating activities $ 17,246 $ 11,981 Investing activities (6,355 ) (3,870 ) Financing activities (6,340 ) (12,383 ) Net increase (decrease) in cash and cash equivalents $ 4,551 $ (4,272 ) Cash Flows from Operating Activities Following are our summarized cash flows from operating activities (in thousands): For the Six Months Ended March 31, 2021 2020 Net income $ 15,541 $ 2,141 Depreciation and amortization 4,140 4,461 Deferred income tax benefit - (1,155 ) Gain on debt extinguishment (5,298 ) - Impairment of assets 1,401 8,210 Net change in operating assets and liabilities 712 (2,695 ) Other 750 1,019 Net cash provided by operating activities $ 17,246 $ 11,981 Net cash provided by operating activities increased from year to year due primarily to higher income from operations and lower income taxes paid, partially offset by higher interest expense paid. 33 Cash Flows from Investing Activities Following are our cash flows from investing activities (in thousands): For the Six Months Ended March 31, 2021 2020 Payments for property and equipment and intangible assets $ (6,718 ) $ (5,323 ) Proceeds from sale of businesses and assets 8 105 Proceeds from insurance 294 945 Proceeds from note receivable 61 403 Net cash used in investing activities $ (6,355 ) $ (3,870 ) Following is a breakdown of our payments for property and equipment and intangible assets for the six months ended March 31, 2021 and 2020 (in thousands): For the Six Months Ended March 31, 2021 2020 New facilities, equipment and intangible assets $ 4,127 $ 3,212 Maintenance capital expenditures 2,591 2,111 Total capital expenditures $ 6,718 $ 5,323 Capital expenditures for new facilities during the six months ended March 31, 2021 were composed primarily of real estate and construction of one new Bombshells location, a newly renovated club that was damaged by hurricane, and a liquor license purchase. Capital expenditures for new facilities during the six months ended March 31, 2020 were composed primarily of construction and development costs for two new Bombshells locations that opened in the first and second quarters of fiscal 2020. 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. Cash Flows from Financing Activities Following are our cash flows from financing activities (in thousands): For the Six Months Ended March 31, 2021 2020 Proceeds from debt obligations $ 2,176 $ 880 Payments on debt obligations (5,977 ) (4,097 ) Purchase of treasury stock (1,794 ) (8,488 ) Payment of dividends (720 ) (647 ) Payment of loan origination costs (25 ) - Distribution to noncontrolling interests - (31 ) Net cash used in financing activities $ (6,340 ) $ (12,383 ) We purchased 74,659 shares of our common stock at an average price of $24.03 during the six months ended March 31, 2021, while we purchased 465,390 shares of our common stock at an average price of $18.24 during the same period last year. We paid quarterly dividends of $0.04 per share during the six months ended March 31, 2021 compared to $0.03 per share in the first quarter and $0.04 in the second quarter during the prior year. 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 $17.2 million and $12.0 million during the six months ended March 31, 2021 and 2020, respectively. Maintenance capital expenditures were $2.6 million and $2.1 million during the six months ended March 31, 2021 and 2020, 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 Six Months Ended March 31, 2021 2020 Net cash provided by operating activities $ 17,246 $ 11,981 Less: Maintenance capital expenditures 2,591 2,111 Free cash flow $ 14,655 $ 9,870 Our free cash flow for the current six-month period increased by 48.5% compared to the comparable prior-year period primarily due to higher income from operations and lower income taxes paid, partially offset by higher interest expense paid and higher maintenance capital expenditures. 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. 34 The following table presents a summary of such indicators for the six months ended March 31 (in thousands, except percentages): Increase Increase 2021 (Decrease) 2020 (Decrease) 2019 Sales of alcoholic beverages $ 37,633 (0.1 )% $ 37,662 2.4 % $ 36,796 Sales of food and merchandise 18,147 30.3 % 13,926 14.8 % 12,129 Service revenues 21,562 (31.6 )% 31,541 (8.1 )% 34,310 Other 5,115 (10.1 )% 5,691 1.4 % 5,614 Total revenues 82,457 (7.2 )% 88,820 (0.0 )% 88,849 Net cash provided by operating activities $ 17,246 43.9 % $ 11,981 (42.9 )% $ 20,971 Adjusted EBITDA* $ 22,273 12.1 % $ 19,877 (18.6 )% $ 24,405 Free cash flow* $ 14,655 48.5 % $ 9,870 (50.3 )% $ 19,854 Debt (end of period) $ 132,412 (5.7 )% $ 140,440 (6.3 )% $ 149,818 * 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 74,659 shares of our common stock at an average price of $24.03 during the six months ended March 31, 2021, while we purchased 465,390 shares of our common stock at an average price of $18.24 during the same period last year. As of March 31, 2021, we have approximately $9.0 million remaining to purchase additional shares. 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. 35 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 Bombshells 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 other strategic rationale warrants. 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 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 disposing of underperforming units to free up capital for more productive use; ● We consider buying back our own stock if the after-tax yield on free cash flow is above 10%; ● 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 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. Nightclubs We believe that our nightclub operations can continue to grow organically and through careful entry into markets and demographic segments with high growth potential. 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. Bombshells 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 March 31, 2021 are located in Texas. Part of our growth strategy is to continue to appeal to men, women, families, friends, singles, couples, and millennials through better quality of food, service and experience that is more upscale than a traditional sports bar. We continue to search for suitable markets where we can open new Bombshells and are currently in the process of development in several of these locations. We have also increased our efforts on Bombshells franchising and have recently signed our first franchisee for Bombshells restaurants in the San Antonio, Texas area. 36 Item 3. Quantitative and Qualitative Disclosures About Market Risk. As of March 31, 2021, 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, 2020.