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 June 30, 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 nine months ended June 30, 2021 increased by 293.0% and 35.5%, respectively, versus last year due to the impact of the pandemic in fiscal 2020. For illustrative purposes, the current quarter and current year-to-date total revenues increased by 23.0% and 3.3% compared to the corresponding period in pre-pandemic fiscal 2019. To adapt to the situation, we took significant steps to augment an anticipated decline in operating cash flows, including negotiating deferment of some of our debts, reducing the number of our employees and related payroll costs where necessary, and deferring or modifying certain fixed and variable monthly expenses, among others. 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. Closures and operating restrictions, 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. 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 nine months ended June 30, 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 nine months ended June 30, 2021. Results of Operations Highlights of the Company’s operating results are as follows: Third Quarter 2021 ● Total revenues were $57.9 million compared to $14.7 million during the corresponding prior-year quarter, a 293.0% increase (Nightclubs revenue of $41.0 million compared to $6.0 million, a 582.4% increase; and Bombshells revenue of $16.1 million compared to $8.5 million, an 88.5% increase) ● For illustrative purposes, total revenues increased by 23.0% compared to the corresponding period in fiscal 2019 (Nightclubs revenue increased by 8.3% and Bombshells revenue increased by 83.6%) ● No club nor Bombshells location qualified for same-store sales comparisons because of closures in fiscal 2020 in connection with the pandemic ● Basic and diluted earnings per share (“EPS”) of $1.37 compared to a basic and diluted loss per share of $0.60 last year (non-GAAP diluted EPS* of $1.36 compared to a loss of $0.74) ● Net cash provided by operating activities of $15.0 million compared to $166,000 during the comparable prior-year period, an 8,918.7% increase (free cash flow* of $13.0 million compared to $166,000, a 7,703.6% increase) 22 Year-to-Date 2021 ● Total revenues were $140.3 million compared to $103.5 million during the corresponding prior-year period, a 35.5% increase (Nightclubs revenue of $97.0 million compared to $75.2 million, a 28.9% increase; and Bombshells revenue of $42.2 million compared to $27.7 million, a 52.5% increase) ● For illustrative purposes, total revenues increased by 3.3% compared to the corresponding period in fiscal 2019 (Nightclubs revenue decreased by 13.9% and Bombshells revenue increased by 89.4%) ● Basic and diluted EPS of $3.11 compared to a basic and diluted loss per share of $0.36 (non-GAAP diluted EPS* of $2.50 compared to $0.36) ● Net cash provided by operating activities of $32.2 million compared to $12.1 million during the comparable prior-year period, a 165.2% increase (free cash flow* of $27.6 million compared to $10.0 million, a 175.1% increase) * Reconciliation and discussion of non-GAAP financial measures are included in the “Non-GAAP Financial Measures” section below. Three Months Ended June 30, 2021 Compared to Three Months Ended June 30, 2020 The following table summarizes our results of operations for the three months ended June 30, 2021 (dollars in thousands): For the Three Months Ended June 30, 2021 June 30, 2020 Better (Worse) Amount % of Revenues Amount % of Revenues Amount % Revenues Sales of alcoholic beverages $ 25,092 43.4 % $ 7,623 51.8 % $ 17,469 229.2 % Sales of food and merchandise 12,058 20.8 % 3,452 23.4 % 8,606 249.3 % Service revenues 16,880 29.2 % 2,907 19.7 % 13,973 480.7 % Other 3,830 6.6 % 739 5.0 % 3,091 418.3 % Total revenues 57,860 100.0 % 14,721 100.0 % 43,139 293.0 % Operating expenses Cost of goods sold Alcoholic beverages sold 4,621 18.4 % 1,245 16.3 % (3,376 ) (271.2 )% Food and merchandise sold 4,043 33.5 % 1,128 32.7 % (2,915 ) (258.4 )% Service and other 208 1.0 % 17 0.5 % (191 ) (1,123.5 )% Total cost of goods sold (exclusive of items shown separately below) 8,872 15.3 % 2,390 16.2 % (6,482 ) (271.2 )% Salaries and wages 13,870 24.0 % 5,421 36.8 % (8,449 ) (155.9 )% Selling, general and administrative 14,697 25.4 % 8,908 60.5 % (5,789 ) (65.0 )% Depreciation and amortization 2,057 3.6 % 2,235 15.2 % 178 8.0 % Other charges (gains), net (143 ) (0.2 )% 424 2.9 % 567 133.7 % Total operating expenses 39,353 68.0 % 19,378 131.6 % (19,975 ) (103.1 )% Income (loss) from operations 18,507 32.0 % (4,657 ) (31.6 )% 23,164 497.4 % Other income (expenses) Interest expense (2,281 ) (3.9 )% (2,459 ) (16.7 )% 178 7.2 % Interest income 72 0.1 % 80 0.5 % (8 ) (10.0 )% Non-operating gains, net 9 0.0 % 31 0.2 % (22 ) (71.0 )% Income (loss) before income taxes 16,307 28.2 % (7,005 ) (47.6 )% 23,312 332.8 % Income tax expense (benefit) 3,986 6.9 % (1,437 ) (9.8 )% (5,423 ) (377.4 )% Net income (loss) $ 12,321 21.3 % $ (5,568 ) (37.8 )% $ 17,889 321.3 % * 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 $43.1 million, or 293.0%, due primarily to last year’s impact of closures 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 in the prior year to be considered not comparable. For illustrative purposes, we are including a comparison to the corresponding quarter of fiscal 2019 in the revenue discussion below. Segment contribution to total revenues was as follows (in thousands): For the Three Months Ended June 30, 2021 2020 2019 Nightclubs Sales of alcoholic beverages $ 16,130 $ 1,777 $ 14,597 Sales of food and merchandise 5,062 774 3,312 Service revenues 16,772 2,906 17,257 Other revenues 3,067 556 2,723 41,031 6,013 37,889 Bombshells Sales of alcoholic beverages 8,962 5,846 4,973 Sales of food and merchandise 6,996 2,678 3,734 Service revenues 108 1 42 Other revenues 11 6 6 16,077 8,531 8,755 Other Other revenues 752 177 383 $ 57,860 $ 14,721 $ 47,027 Nightclubs revenues increased by 582.4% for the quarter ended June 30, 2021 compared to the prior-year quarter mainly due to the closure of all clubs in April 2020. Compared to pre-pandemic third quarter of 2019, current quarter Nightclubs revenues increased by 8.3% due to alcoholic beverages sales and food and merchandise sales increases of 10.5% and 52.8%, respectively, from higher traffic partially offset by a service revenue decrease of 2.8% due to social distancing restrictions. Bombshells revenues increased by 88.5% compared to last year mainly due to closures in April 2020, while also up 83.6% compared to the 2019 quarter primarily due to two new locations. Operating Expenses Total operating expenses, as a percent of revenues, for the third quarter ended June 30, 2021 decreased to 68.0% from 131.6% from last year’s third quarter, with a $20.0 million decrease, or 103.1%, which is mainly caused by the overall impact of last year’s pandemic closures. Significant contributors to the changes in operating expenses for the quarter are explained below. Cost of goods sold increased by $6.5 million, or 271.2%, mainly due to higher sales in the current quarter. As a percent of total revenues, cost of goods sold decreased to 15.3% from 16.2% mainly due to the sales mix shifting to higher-margin service revenues. Salaries and wages increased by $8.4 million, or 155.9%, due to the closures last year. As a percent of total revenues, salaries and wages were lower at 24.0% from 36.8% mainly due to fixed salaries paid on lower sales during the prior-year quarter. Selling, general and administrative expenses increased by $5.8 million, or 65.0%, primarily due to the increase in most of the variable expenses as caused by higher sales in the current year. As a percent of total revenues, selling, general and administrative expenses decreased to 25.4% from 60.5% due to last year’s fixed expenses on significantly lower sales. 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 June 30, 2021 and 2020, respectively. As a percentage of revenue, total occupancy costs were 5.7% and 23.6% during the quarter ended June 30, 2021 and 2020, respectively, primarily due to the lower sales base in last year’s quarter. Depreciation and amortization decreased by $178,000, or 8.0% partly due to fully depreciated real estate and software assets. Other charges (gains), net was a net gain of $143,000 from a net charge of $424,000, which was primarily due to the current quarter’s lower impairment charges. 24 Income (Loss) from Operations For the three months ended June 30, 2021 and 2020, our consolidated operating margin was 32.0% and (31.6)%, respectively. The main driver for the increase in operating margin is the current quarter’s higher sales. Segment contribution to income (loss) from operations is presented in the table below (in thousands): For the Three Months Ended June 30, 2021 2020 Nightclubs $ 18,350 $ (3,038 ) Bombshells 4,404 1,850 Other 321 (92 ) General corporate (4,568 ) (3,377 ) $ 18,507 $ (4,657 ) Operating margin for the Nightclubs segment was 44.7% and (50.5)% for the three months ended June 30, 2021 and 2020, respectively, while operating margin for Bombshells was 27.4% and 21.7%, respectively. The increase in Nightclubs operating margin was mainly due to last year’s closures caused 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 June 30, 2021 For the Three Months Ended June 30, 2020 Nightclubs Bombshells Other Corporate Total Nightclubs Bombshells Other Corporate Total Income (loss) from operations $ 18,350 $ 4,404 $ 321 $ (4,568 ) $ 18,507 $ (3,038 ) $ 1,850 $ (92 ) $ (3,377 ) $ (4,657 ) Amortization of intangibles 47 4 - - 51 49 3 96 - 148 Settlement of lawsuits 123 4 - - 127 50 - - - 50 Impairment of assets 271 - - - 271 982 - - - 982 Loss (gain) on sale of businesses and assets (512 ) 9 - (38 ) (541 ) (619 ) 16 - (4 ) (607 ) Loss (gain) on insurance - - - - - - - - - - Non-GAAP operating income (loss) $ 18,279 $ 4,421 $ 321 $ (4,606 ) $ 18,415 $ (2,576 ) $ 1,869 $ 4 $ (3,381 ) $ (4,084 ) GAAP operating margin 44.7 % 27.4 % 42.7 % (7.9 )% 32.0 % (50.5 )% 21.7 % (52.0 )% (22.9 )% (31.6 )% Non-GAAP operating margin 44.5 % 27.5 % 42.7 % (8.0 )% 31.8 % (42.8 )% 21.9 % 2.3 % (23.0 )% (27.7 )% Non-Operating Items Interest expense decreased by $178,000, or 7.2%. Income Taxes Income taxes were an expense of $4.0 million during the quarter ended June 30, 2021 compared to a benefit of $1.4 million during the quarter ended June 30, 2020. The effective income tax rate was an expense of 24.4% and a benefit of 20.5% for the quarter ended June 30, 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, as presented below. For the Three Months Ended June 30, 2021 2020 Statutory federal income tax rate 21.0 % 21.0 % State income taxes, net of federal benefit 4.8 % 3.4 % Permanent differences (0.1 )% (0.1 )% Tax credits (1.2 )% (3.7 )% Effective income tax rate 24.4 % 20.5 % 26 Nine Months Ended June 30, 2021 Compared to Nine Months Ended June 30, 2020 The following table summarizes our results of operations for the nine months ended June 30, 2021 (dollars in thousands): For the Nine Months Ended June 30, 2021 June 30, 2020 Better (Worse) Amount % of Revenues Amount % of Revenues Amount % Revenues Sales of alcoholic beverages $ 62,725 44.7 % $ 45,285 43.7 % $ 17,440 38.5 % Sales of food and merchandise 30,205 21.5 % 17,378 16.8 % 12,827 73.8 % Service revenues 38,442 27.4 % 34,448 33.3 % 3,994 11.6 % Other 8,945 6.4 % 6,430 6.2 % 2,515 39.1 % Total revenues 140,317 100.0 % 103,541 100.0 % 36,776 35.5 % Operating expenses Cost of goods sold Alcoholic beverages sold 11,613 18.5 % 8,826 19.5 % (2,787 ) (31.6 )% Food and merchandise sold 9,961 33.0 % 5,974 34.4 % (3,987 ) (66.7 )% Service and other 304 0.6 % 148 0.4 % (156 ) (105.4 )% Total cost of goods sold (exclusive of items shown separately below) 21,878 15.6 % 14,948 14.4 % (6,930 ) (46.4 )% Salaries and wages 36,556 26.1 % 30,866 29.8 % (5,690 ) (18.4 )% Selling, general and administrative 39,467 28.1 % 39,889 38.5 % 422 1.1 % Depreciation and amortization 6,197 4.4 % 6,696 6.5 % 499 7.5 % Other charges, net 1,288 0.9 % 8,588 8.3 % 7,300 85.0 % Total operating expenses 105,386 75.1 % 100,987 97.5 % (4,399 ) (4.4 )% Income from operations 34,931 24.9 % 2,554 2.5 % 32,377 1,267.7 % Other income (expenses) Interest expense (7,079 ) (5.0 )% (7,403 ) (7.1 )% 324 4.4 % Interest income 194 0.1 % 263 0.3 % (69 ) (26.2 )% Non-operating gains (losses), net 5,356 3.8 % (103 ) (0.1 )% 5,459 5,300.0 % Income (loss) before income taxes 33,402 23.8 % (4,689 ) (4.5 )% 38,091 812.3 % Income tax expense (benefit) 5,540 3.9 % (1,262 ) (1.2 )% (6,802 ) (539.0 )% Net income (loss) $ 27,862 19.9 % $ (3,427 ) (3.3 )% $ 31,289 913.0 % * 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 increased by approximately $36.8 million, or 35.5%, due primarily to reopenings after the closures caused by the COVID-19 pandemic. For illustrative purposes, we are including a comparison to the corresponding quarter of fiscal 2019 in the revenue discussion below. Segment contribution to total revenues was as follows (in thousands): For the Nine Months Ended June 30, 2021 2020 2019 Nightclubs Sales of alcoholic beverages $ 38,398 $ 28,321 $ 43,547 Sales of food and merchandise 12,567 6,837 9,812 Service revenues 38,216 34,290 51,513 Other revenues 7,834 5,791 7,792 97,015 75,239 112,664 Bombshells Sales of alcoholic beverages 24,327 16,964 12,819 Sales of food and merchandise 17,638 10,541 9,363 Service revenues 226 158 96 Other revenues 27 21 17 42,218 27,684 22,295 Other Other revenues 1,084 618 917 $ 140,317 $ 103,541 $ 135,876 Nightclubs revenues increased by 28.9% for the nine-month period ended June 30, 2021 compared to the comparable prior-year period mainly due to pandemic restrictions in 2020. Compared to pre-pandemic nine-month period of fiscal 2019, current year Nightclubs revenues decreased by 13.9% due to alcoholic beverages sales and service revenue decreases of 11.8% and 25.8%, respectively, caused by stricter pandemic restriction at the early part of fiscal 2021 partially offset by food and merchandise sales increase of 28.1% due to customer spending shift. Bombshells revenues increased by 52.5% compared to last year mainly due to closures in April 2020, and increased by 89.4% compared to the 2019 nine-month period primarily due to two new locations. 28 Operating Expenses Total operating expenses, as a percent of revenues, for the nine months ended June 30, 2021 decreased to 75.1% from 97.5% from the comparable period last year, with a $4.4 million increase, or 4.4%, which is mainly caused by a $6.9 million increase in cost of goods sold and a $5.7 million increase in salaries and wages, partially offset by a higher impairment in the prior year. Significant contributors to the changes in operating expenses for the year-to-date period are explained below. Cost of goods sold increased by $6.9 million, or 46.4%, mainly due the increase in sales. As a percent of total revenues, cost of goods sold increased to 15.6% from 14.4% mainly due to the shift in sales mix. Salaries and wages increased by $5.7 million, or 18.4%, mainly due to increased staffing for reopenings after COVID-19-related closures. As a percent of total revenues, salaries and wages were lower at 26.1% from 29.8% mainly due to fixed salaries paid on lower sales during the prior-year period. Selling, general and administrative expenses decreased by $422,000, or 1.1%, 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 28.1% from 38.5% 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 $10.0 million and $10.5 million for the nine months ended June 30, 2021 and 2020, respectively. As a percentage of revenue, total occupancy costs were 7.1% and 10.1% during the nine months ended June 30, 2021 and 2020, respectively, primarily due to lower sales base in the prior-year nine-month period. Depreciation and amortization decreased by $499,000, or 7.5% partly due to fully depreciated real estate and software assets. Other charges, net decreased to $1.3 million from $8.6 million, which was primarily caused by impairment charges of $1.7 million and $9.2 million during the nine months ended June 30, 2021 and 2020, respectively. Income from Operations For the nine months ended June 30, 2021 and 2020, our consolidated operating margin was 24.9% and 2.5%, respectively. The main drivers for the increase in operating margin are the current period’s higher 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 Nine Months Ended June 30, 2021 2020 Nightclubs $ 37,313 $ 13,002 Bombshells 10,263 4,109 Other 107 (423 ) General corporate (12,752 ) (14,134 ) $ 34,931 $ 2,554 Operating margin for the Nightclubs segment was 38.5% and 17.3% for the nine months ended June 30, 2021 and 2020, respectively, while operating margin for Bombshells was 24.3% and 14.8%, respectively. The increase in Nightclubs operating margin was mainly due to this year’s higher sales and last year’s impairment charges 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 Nine Months Ended June 30, 2021 For the Nine Months Ended June 30, 2020 Nightclubs Bombshells Other Corporate Total Nightclubs Bombshells Other Corporate Total Income (loss) from operations $ 37,313 $ 10,263 $ 107 $ (12,752 ) $ 34,931 $ 13,002 $ 4,109 $ (423 ) $ (14,134 ) $ 2,554 Amortization of intangibles 141 11 57 - 209 163 11 287 - 461 Settlement of lawsuits 237 38 5 - 280 74 - - - 74 Impairment of assets 1,672 - - - 1,672 8,947 245 - - 9,192 Loss (gain) on sale of businesses and assets (498 ) 56 - (13 ) (455 ) (619 ) 16 - (41 ) (644 ) Gain on insurance (165 ) - - (44 ) (209 ) (20 ) - - (13 ) (33 ) Non-GAAP operating income (loss) $ 38,700 $ 10,368 $ 169 $ (12,809 ) $ 36,428 $ 21,547 $ 4,381 $ (136 ) $ (14,188 ) $ 11,604 GAAP operating margin 38.5 % 24.3 % 9.9 % (9.1 )% 24.9 % 17.3 % 14.8 % (68.4 )% (13.7 )% 2.5 % Non-GAAP operating margin 39.9 % 24.6 % 15.6 % (9.1 )% 26.0 % 28.6 % 15.8 % (22.0 )% (13.7 )% 11.2 % Non-Operating Items During the nine months ended June 30, 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 $324,000, or 4.4%. Income Taxes Income taxes were an expense of $5.5 million during the nine months ended June 30, 2021 compared to a benefit of $1.3 million during the nine months ended June 30, 2020. The effective income tax rate was an expense of 16.6% and a benefit of 26.9% for the nine months ended June 30, 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 Nine Months Ended June 30, 2021 2020 Statutory federal income tax rate 21.0 % 21.0 % State income taxes, net of federal benefit 4.9 % 2.8 % Permanent differences (3.7 )% (0.4 )% Change in valuation allowance (3.8 )% - Tax credits (1.8 )% 3.5 % Effective income tax rate 16.6 % 26.9 % 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 24.3% and 26.9% effective tax rate of the pre-tax non-GAAP income before taxes for the nine months ended June 30, 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 nine months ended June 30, 2021 and 2020 (in thousands, except per share amounts and percentages): For the Three Months For the Nine Months Ended June 30, Ended June 30, 2021 2020 2021 2020 Reconciliation of GAAP net income (loss) to Adjusted EBITDA Net income (loss) attributable to RCIHH common stockholders $ 12,302 $ (5,474 ) $ 28,036 $ (3,292 ) Income tax expense (benefit) 3,986 (1,437 ) 5,540 (1,262 ) Interest expense, net 2,209 2,379 6,885 7,140 Settlement of lawsuits 127 50 280 74 Impairment of assets 271 982 1,672 9,192 Gain on sale of businesses and assets (541 ) (608 ) (455 ) (645 ) Gain on debt extinguishment - - (5,329 ) - Unrealized loss (gain) on equity securities (9 ) (31 ) 58 103 Gain on insurance - - (209 ) (33 ) Depreciation and amortization 2,057 2,235 6,197 6,696 Adjusted EBITDA $ 20,402 $ (1,904 ) $ 42,675 $ 17,973 Reconciliation of GAAP net income (loss) to non-GAAP net income (loss) Net income (loss) attributable to RCIHH common stockholders $ 12,302 $ (5,474 ) $ 28,036 $ (3,292 ) Amortization of intangibles 51 149 209 462 Settlement of lawsuits 127 50 280 74 Impairment of assets 271 982 1,672 9,192 Gain on sale of businesses and assets (541 ) (608 ) (455 ) (645 ) Gain on debt extinguishment - - (5,329 ) - Unrealized loss (gain) on equity securities (9 ) (31 ) 58 103 Gain on insurance - - (209 ) (33 ) Net income tax effect 39 (1,840 ) (1,702 ) (2,499 ) Non-GAAP net income (loss) $ 12,240 $ (6,772 ) $ 22,560 $ 3,362 Reconciliation of GAAP diluted earnings (loss) per share to non-GAAP diluted earnings (loss) per share Diluted shares 9,000 9,125 9,006 9,224 GAAP diluted earnings (loss) per share $ 1.37 $ (0.60 ) $ 3.11 $ (0.36 ) Amortization of intangibles 0.01 0.02 0.02 0.05 Settlement of lawsuits 0.01 0.01 0.03 0.01 Impairment of assets 0.03 0.11 0.19 1.00 Gain on sale of businesses and assets (0.06 ) (0.07 ) (0.05 ) (0.07 ) Gain on debt extinguishment - - (0.59 ) - Unrealized loss (gain) on equity securities (0.00 ) (0.00 ) 0.01 0.01 Gain on insurance - - (0.02 ) (0.00 ) Net income tax effect 0.00 (0.20 ) (0.19 ) (0.27 ) Non-GAAP diluted earnings per share $ 1.36 $ (0.74 ) $ 2.50 $ 0.36 Reconciliation of GAAP operating income (loss) to non-GAAP operating income (loss) Income (loss) from operations $ 18,507 $ (4,657 ) $ 34,931 $ 2,554 Amortization of intangibles 51 149 209 462 Settlement of lawsuits 127 50 280 74 Impairment of assets 271 982 1,672 9,192 Gain on insurance - - (209 ) (33 ) Gain on sale of businesses and assets (541 ) (608 ) (455 ) (645 ) Non-GAAP operating income (loss) $ 18,415 $ (4,084 ) $ 36,428 $ 11,604 Reconciliation of GAAP operating margin to non-GAAP operating margin GAAP operating margin 32.0 % (31.6 )% 24.9 % 2.5 % Amortization of intangibles 0.1 % 1.0 % 0.1 % 0.4 % Settlement of lawsuits 0.2 % 0.3 % 0.2 % 0.1 % Impairment of assets 0.5 % 6.7 % 1.2 % 8.9 % Gain on insurance - - (0.1 )% (0.0 )% Gain on sale of businesses and assets (0.9 )% (4.1 )% (0.3 )% (0.6 )% Non-GAAP operating margin 31.8 % (27.7 )% 26.0 % 11.2 % * 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 June 30, 2021, our cash and cash equivalents were approximately $29.1 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 June 30, 2021, we had positive working capital of $7.3 million 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 $1.1 million and $0, respectively) amounting to $3.8 million and $0 as of June 30, 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 is to open locations and operate in accordance with local and state guidelines. Revenues seem favorable now that all our locations are not under pandemic-related closure mandates. We believe that we can borrow capital if need be but currently we do not have unused credit facilities so there can be no guarantee that additional liquidity will be readily available or available on favorable terms. To adapt to the situation, we took significant steps to augment an anticipated decline in operating cash flows, including negotiating deferment of some of our debts, reducing the number of our employees and related payroll costs where necessary, and deferring or modifying certain fixed and variable monthly expenses, 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. 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 nine months ended June 30, 2021, we received 0 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 11 PPP loans totaling the amount of $0 and $5.3 million in principal and interest during the three and nine months ended June 30, 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 $124,000 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. Closures and operating restrictions, 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. 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, where applicable. Currently, all of our locations are open except two clubs that are being renovated and/or remodeled. 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 Nine Months Ended June 30, 2021 2020 Operating activities $ 32,217 $ 12,147 Investing activities (7,186 ) (1,024 ) Financing activities (11,568 ) (10,425 ) Net increase in cash and cash equivalents $ 13,463 $ 698 Cash Flows from Operating Activities Following are our summarized cash flows from operating activities (in thousands): For the Nine Months Ended June 30, 2021 2020 Net income (loss) $ 27,862 $ (3,427 ) Depreciation and amortization 6,197 6,696 Deferred income tax benefit (430 ) (1,517 ) Gain on debt extinguishment (5,298 ) - Impairment of assets 1,672 9,192 Net change in operating assets and liabilities 1,656 (51 ) Other 558 1,254 Net cash provided by operating activities $ 32,217 $ 12,147 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 Nine Months Ended June 30, 2021 2020 Payments for property and equipment and intangible assets $ (10,788 ) $ (5,565 ) Proceeds from sale of businesses and assets 3,213 2,041 Proceeds from insurance 294 945 Proceeds from note receivable 95 1,555 Net cash used in investing activities $ (7,186 ) $ (1,024 ) Following is a breakdown of our payments for property and equipment and intangible assets for the nine months ended June 30, 2021 and 2020 (in thousands): For the Nine Months Ended June 30, 2021 2020 New facilities, equipment and intangible assets $ 6,180 $ 3,454 Maintenance capital expenditures 4,608 2,111 Total capital expenditures $ 10,788 $ 5,565 Capital expenditures for new facilities during the nine months ended June 30, 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 nine months ended June 30, 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 and the rehabilitation of a club that was damaged by fire. 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. On July 23, 2021, we and certain of our subsidiaries entered into definitive agreements (the “Agreements”) to acquire eleven gentlemen’s clubs, nine of which are controlled by club entrepreneur Troy Lowrie of Lakewood, Colorado, six related real estate properties, and associated intellectual property for a total acquisition price of $88.0 million (the “Acquisition”).The Agreements for the eleven clubs being purchased include ten Asset Purchase Agreements and one Stock Purchase Agreement. The sellers collectively own and operate adult entertainment clubs in six states, four of which we do not currently have a presence. Closing of the Acquisition is subject to transfer of all necessary permits, licenses, and other authorizations; closing on the bank financing; and other customary closing conditions. See our current report on Form 8-K filed on July 28, 2021 for more information regarding this transaction. We have not completed our valuation analysis and related calculations in sufficient detail necessary to arrive at the fair values of the assets acquired, along with the determination of any goodwill or gain on the transaction. Since the initial accounting of the acquisition is incomplete, we also could not provide supplemental pro forma information of the combined entities as of this time. As of the filing of this report, we are in negotiations with our bank lender to refinance most of our existing real estate debt and to partially finance the real estate purchases related to the Acquisition. Cash Flows from Financing Activities Following are our cash flows from financing activities (in thousands): For the Nine Months Ended June 30, 2021 2020 Proceeds from debt obligations $ 2,176 $ 6,503 Payments on debt obligations (10,845 ) (7,489 ) Purchase of treasury stock (1,794 ) (8,488 ) Payment of dividends (1,080 ) (920 ) Payment of loan origination costs (25 ) - Distribution to noncontrolling interests - (31 ) Net cash used in financing activities $ (11,568 ) $ (10,425 ) We purchased 74,659 shares of our common stock at an average price of $24.03 during the nine months ended June 30, 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 nine months ended June 30, 2021 compared to $0.03 per share in the first and third quarters and $0.04 in the second quarter of 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 $32.2 million and $12.1 million during the nine months ended June 30, 2021 and 2020, respectively. Maintenance capital expenditures were $4.6 million and $2.1 million during the nine months ended June 30, 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 Nine Months Ended June 30, 2021 2020 Net cash provided by operating activities $ 32,217 $ 12,147 Less: Maintenance capital expenditures 4,608 2,111 Free cash flow $ 27,609 $ 10,036 Our free cash flow for the current nine-month period increased by 175.1% 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 nine months ended June 30 (in thousands, except percentages): Increase Increase 2021 (Decrease) 2020 (Decrease) 2019 Sales of alcoholic beverages $ 62,725 38.5 % $ 45,285 (19.7 )% $ 56,366 Sales of food and merchandise 30,205 73.8 % 17,378 (9.4 )% 19,175 Service revenues 38,442 11.6 % 34,448 (33.3 )% 51,609 Other 8,945 39.1 % 6,430 (26.3 )% 8,726 Total revenues 140,317 35.5 % 103,541 (23.8 )% 135,876 Net cash provided by operating activities $ 32,217 165.2 % $ 12,147 (57.2 )% $ 28,414 Adjusted EBITDA* $ 42,675 137.4 % $ 17,973 (50.9 )% $ 36,631 Free cash flow* $ 27,609 175.1 % $ 10,036 (61.9 )% $ 26,342 Debt (end of period) $ 127,603 (10.6 )% $ 142,736 (2.6 )% $ 146,579 * 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 nine months ended June 30, 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 June 30, 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 June 30, 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 signed our first franchisee for Bombshells restaurants in the San Antonio, Texas area in December 2020. 36 Item 3. Quantitative and Qualitative Disclosures About Market Risk. As of June 30, 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.