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, 2021. Overview RCI Hospitality Holdings, Inc. (“RCIHH”) is a holding company. Through our subsidiaries, we engage in a number of activities in the hospitality and related businesses. All services and management operations are conducted by subsidiaries of RCIHH, including RCI Management Services, Inc. Through our subsidiaries, as of December 31, 2021, we operated a total of 58 establishments that offer live adult entertainment and/or restaurant and bar operations. We also operated a leading business communications company serving the multi-billion-dollar adult nightclubs industry. We have two principal reportable segments: Nightclubs and Bombshells. We combine operating segments not included in Nightclubs and Bombshells 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. Ongoing Impact of COVID-19 Pandemic Since the U.S. declaration of the COVID-19 pandemic as a national emergency in March 2020, we have had a major disruption in our business operations that threatened to significantly impact our cash flow. The pandemic resulted in a significant reduction in customer traffic in our clubs and restaurants due to changes in consumer behavior as social distancing practices, dining room closures, and other restrictions that were mandated or encouraged by federal, state, and local governments. 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. 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. We believe that we can borrow capital if needed 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, especially the longer the COVID-19 pandemic lasts. 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. Currently, all Bombshells and club locations are operating at normal business hours. New York is currently mandating vaccines for entry into restaurants, bars, and nightclubs. 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, 2021 filed with the SEC on December 14, 2021. During the three months ended December 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. Results of Operations Highlights of the operating results of the Company during the three months ended December 31, 2021 are as follows: ● Total revenues were $61.8 million compared to $38.4 million during the comparable prior-year period, a 61.0% increase (Nightclubs revenue of $46.8 million compared to $25.2 million, an 85.7% increase; and Bombshells revenue of $14.8 million compared to $13.0 million, a 13.6% increase) ● Consolidated same-store sales increased by 21.8% (Nightclubs increased by 30.6% while Bombshells increased by 7.6%) (refer to the definition of same-store sales in the discussion of revenues below) ● Twelve newly acquired clubs contributed $6.3 million to revenues, while a newly constructed Bombshells contributed $796,000 ● Basic and diluted earnings per share (“EPS”) of $1.12 compared to $1.07 (non-GAAP diluted EPS* of $1.10 compared to $0.39) during the comparable prior-year period ● Net cash provided by operating activities of $16.3 million compared to $6.3 million during the comparable prior-year period, a 159.2% increase (free cash flow* of $15.3 million compared to $5.7 million, a 169.3% increase) * Reconciliation and discussion of non-GAAP financial measures are included in the “Non-GAAP Financial Measures” section below. 22 The following table summarizes our results of operations for the three months ended December 31, 2021 and 2020 (dollars in thousands): For the Three Months Ended December 31, 2021 December 31, 2020 Better (Worse) Amount % of Revenues Amount % of Revenues Amount % Revenues Sales of alcoholic beverages $ 26,431 42.7 % $ 17,360 45.2 % $ 9,071 52.3 % Sales of food and merchandise 10,894 17.6 % 8,609 22.4 % 2,285 26.5 % Service revenues 20,876 33.8 % 10,060 26.2 % 10,816 107.5 % Other 3,635 5.9 % 2,369 6.2 % 1,266 53.4 % Total revenues 61,836 100.0 % 38,398 100.0 % 23,438 61.0 % Operating expenses Cost of goods sold Alcoholic beverages sold 4,834 18.3 % 3,262 18.8 % (1,572 ) (48.2 )% Food and merchandise sold 3,957 36.3 % 2,889 33.6 % (1,068 ) (37.0 )% Service and other 100 0.4 % 53 0.4 % (47 ) (88.7 )% Total cost of goods sold (exclusive of items shown separately below) 8,891 14.4 % 6,204 16.2 % (2,687 ) (43.3 )% Salaries and wages 16,505 26.7 % 11,486 29.9 % (5,019 ) (43.7 )% Selling, general and administrative 18,486 29.9 % 12,152 31.6 % (6,334 ) (52.1 )% Depreciation and amortization 2,194 3.5 % 2,023 5.3 % (171 ) (8.5 )% Other gains, net (151 ) (0.2 )% (50 ) (0.1 )% 101 202.0 % Total operating expenses 45,925 74.3 % 31,815 82.9 % (14,110 ) (44.4 )% Income from operations 15,911 25.7 % 6,583 17.1 % 9,328 141.7 % Other income (expenses) Interest expense (2,604 ) (4.2 )% (2,434 ) (6.3 )% (170 ) (7.0 )% Interest income 106 0.2 % 60 0.2 % 46 76.7 % Non-operating gains, net 84 0.1 % 4,916 12.8 % (4,832 ) (98.3 )% Income before income taxes 13,497 21.8 % 9,125 23.8 % 4,372 47.9 % Income tax expense (benefit) 2,933 4.7 % (384 ) (1.0 )% (3,317 ) (863.8 )% Net income $ 10,564 17.1 % $ 9,509 24.8 % $ 1,055 11.1 % * 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 $23.4 million, or 61.0%, compared to the prior-year quarter due primarily to partial recovery from the COVID-19 pandemic and sales from newly acquired clubs and a new Bombshells opening. Consolidated same-store sales increased by 21.8%. The 61.0% increase in consolidated revenues was primarily from a 22.9% increase from last year’s COVID-19 closures, a 19.2% increase from the impact of same-store sales growth, an 18.6% increase from new units, with a 0.4% increase from non-core operations. 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 December 31, 2021 2020 Nightclubs $ 46,781 $ 25,197 Bombshells 14,771 13,006 Other 284 195 $ 61,836 $ 38,398 Nightclubs revenues increased by 85.7% for the quarter ended December 31, 2021 compared to the prior-year quarter, where the prior-year first quarter was still heavily impacted by government restrictions related to COVID-19. 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 30.6%. Newly acquired clubs contributed $6.3 million to the total Nightclubs revenue increase of $21.6 million. Bombshells revenues increased by 13.6%, of which 7.6% was for same-store sales increase with the remaining increase caused by one new location. Operating Expenses Total operating expenses, as a percent of revenues, decreased to 74.3% from 82.9% from last year’s first quarter, although there was a $14.1 million increase, or 44.4%, which was mainly caused by significantly higher sales in the current-year quarter. Significant contributors to the changes in operating expenses are explained below. Cost of goods sold increased by $2.7 million, or 43.3%, mainly due to higher sales. As a percent of total revenues, cost of goods sold decreased to 14.4% from 16.2% mainly due to the sales mix of higher-margin service revenues increasing. Salaries and wages increased by $5.0 million, or 43.7%, due to increase in personnel and shifts to accommodate the increase in sales. As a percent of total revenues, salaries and wages were 26.7% from 29.9% mainly due to fixed salaries paid on higher sales. Selling, general and administrative expenses increased by $6.3 million, or 52.1%, primarily due to increased variable expenses related to sales activity during the current-year quarter. Depreciation and amortization increased by $171,000, or 8.5% due to new depreciable assets from newly acquired and constructed units partially offset by fully depreciated and sold assets. Other gains, net increased by $101,000 mainly due to an increase in gain from properties sold, partially offset by a lower gain on insurance. 24 Income (Loss) from Operations For the three months ended December 31, 2021 and 2020, our consolidated operating margin was 25.7% and 17.1%, respectively. The main driver for the increase in operating margin is the leveraging of fixed expenses on higher sales. Segment contribution to income (loss) from operations is presented in the table below (in thousands): For the Three Months Ended December 31, 2021 2020 Nightclubs $ 18,736 $ 8,495 Bombshells 2,802 2,717 Other (43 ) (75 ) General corporate (5,584 ) (4,554 ) $ 15,911 $ 6,583 Nightclubs operating margin was 40.1% and 33.7% for the three months ended December 31, 2021 and 2020, respectively, while operating margin for Bombshells was 19.0% and 20.9%, respectively. The increase in Nightclubs operating margin was mainly due to the increase in higher-margin service revenues and the leveraging of fixed operating costs and expenses in relation to higher sales. The decrease in Bombshells operating margin was mainly from pre-opening expenses for the new Bombshells unit. Excluding certain items, non-GAAP operating income (loss) and non-GAAP operating margin are computed in the tables below (dollars in thousands). Refer to the discussion of Non-GAAP Financial Measures on page 26. For the Three Months Ended December 31, 2021 Nightclubs Bombshells Other Corporate Total Income (loss) from operations $ 18,736 $ 2,802 $ (43 ) $ (5,584 ) $ 15,911 Amortization of intangibles 47 3 - - 50 Settlement of lawsuits 177 10 - 5 192 Loss (gain) on sale of businesses and assets 45 13 - (400 ) (342 ) Gain on insurance (1 ) - - - (1 ) Non-GAAP operating income (loss) $ 19,004 $ 2,828 $ (43 ) $ (5,979 ) $ 15,810 GAAP operating margin 40.1 % 19.0 % (15.1 )% (9.0 )% 25.7 % Non-GAAP operating margin 40.6 % 19.1 % (15.1 )% (9.7 )% 25.6 % For the Three Months Ended December 31, 2020 Nightclubs Bombshells Other Corporate Total Income (loss) from operations $ 8,495 $ 2,717 $ (75 ) $ (4,554 ) $ 6,583 Amortization of intangibles 47 4 28 - 79 Settlement of lawsuits 118 34 - - 152 Gain on sale of businesses and assets - - - (5 ) (5 ) Gain on insurance (197 ) - - - (197 ) Non-GAAP operating income (loss) $ 8,463 $ 2,755 $ (47 ) $ (4,559 ) $ 6,612 GAAP operating margin 33.7 % 20.9 % (38.5 )% (11.9 )% 17.1 % Non-GAAP operating margin 33.6 % 21.2 % (24.1 )% (11.9 )% 17.2 % Other Income/Expenses During the quarter ended December 31, 2020, we received notices of forgiveness for the first ten forgiven loans out of twelve of our PPP loans. During the quarter ended December 31, 2021, we received a notice of forgiveness for the last remaining forgiven loan out of twelve of our PPP loans. We recognized gains on debt extinguishment amounting to $85,000 and $4.9 million during the quarters ended December 31, 2021 and 2020, respectively. Interest expense increased by $170,000, or 7.0%, which was mainly caused by higher average debt balance and partially offset by a lower average interest rate. Our total occupancy costs, defined as the sum of operating lease expense and interest expense, were $4.2 million and $3.4 million for the quarters ended December 31, 2021 and 2020, respectively. As a percentage of revenue, total occupancy costs were 6.9% and 8.9% during the quarters ended December 31, 2021 and 2020, respectively, primarily due to the increase in sales base. Income Taxes Income taxes were an expense of $2.9 million during the quarter ended December 31, 2021 compared to a benefit of $384,000 during the quarter ended December 31, 2020. The effective income tax rate was an expense of 21.7% and a benefit of 4.2% for the quarters ended December 31, 2021 and 2020, respectively. Our effective tax rate is affected by 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 prior period, as presented below. For the Three Months Ended December 31, 2021 2020 Computed expected income tax expense/benefit 21.0 % 21.0 % State income taxes, net of federal benefit 2.9 % 3.3 % Permanent differences 0.4 % (8.2 )% Change in valuation allowance - (14.0 )% Tax credit (2.0 )% (6.3 )% Other (0.6 )% 0.0 % Total income tax expense (benefit) 21.7 % (4.2 )% 25 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, and (d) 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) settlement of lawsuits, (f) gain on debt extinguishment, and (g) the income tax effect of the above-described adjustments. Included in the income tax effect of the above adjustments is the net effect of the non-GAAP provision for income taxes, calculated at 22.3% and 19.1% effective tax rate of the pre-tax non-GAAP income before taxes for the three months ended December 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) settlement of lawsuits, and (h) 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. 26 The following tables present our non-GAAP performance measures for the three months ended December 31, 2021 and 2020 (in thousands, except per share, number of shares and percentages): For the Three Months Ended December 31, 2021 2020 Reconciliation of GAAP net income to Adjusted EBITDA Net income attributable to RCIHH common stockholders $ 10,575 $ 9,643 Income tax expense (benefit) 2,933 (384 ) Interest expense, net 2,498 2,374 Settlement of lawsuits 192 152 Gain on sale of businesses and assets (342 ) (5 ) Gain on debt extinguishment (85 ) (4,949 ) Unrealized loss on equity securities 1 33 Gain on insurance (1 ) (197 ) Depreciation and amortization 2,194 2,023 Adjusted EBITDA $ 17,965 $ 8,690 Reconciliation of GAAP net income to non-GAAP net income Net income attributable to RCIHH common stockholders $ 10,575 $ 9,643 Amortization of intangibles 50 79 Settlement of lawsuits 192 152 Gain on sale of businesses and assets (342 ) (5 ) Gain on debt extinguishment (85 ) (4,949 ) Unrealized loss on equity securities 1 33 Gain on insurance (1 ) (197 ) Net income tax effect (38 ) (1,219 ) Non-GAAP net income $ 10,352 $ 3,537 Reconciliation of GAAP diluted earnings per share to non-GAAP diluted earnings per share Diluted shares 9,407,519 9,019,088 GAAP diluted earnings per share $ 1.12 $ 1.07 Amortization of intangibles 0.01 0.01 Settlement of lawsuits 0.02 0.02 Gain on sale of businesses and assets (0.04 ) (0.00 ) Gain on debt extinguishment (0.01 ) (0.55 ) Unrealized loss on equity securities 0.00 0.00 Gain on insurance (0.00 ) (0.02 ) Net income tax effect (0.00 ) (0.14 ) Non-GAAP diluted earnings per share $ 1.10 $ 0.39 Reconciliation of GAAP operating income to non-GAAP operating income Income from operations $ 15,911 $ 6,583 Amortization of intangibles 50 79 Settlement of lawsuits 192 152 Gain on sale of businesses and assets (342 ) (5 ) Gain on insurance (1 ) (197 ) Non-GAAP operating income $ 15,810 $ 6,612 Reconciliation of GAAP operating margin to non-GAAP operating margin Income from operations 25.7 % 17.1 % Amortization of intangibles 0.01 % 0.2 % Settlement of lawsuits 0.3 % 0.4 % Gain on sale of businesses and assets (0.06 )% (0.0 )% Gain on insurance (0.00 )% (0.5 )% Non-GAAP operating margin 25.6 % 17.2 % * 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. 27 Liquidity and Capital Resources At December 31, 2021, our cash and cash equivalents were approximately $18.0 million compared to $35.7 million at September 30, 2021. Because of the large volume of cash we handle, we have very stringent cash controls. As of December 31, 2021, we had working capital of $1.3 million compared to working capital of $26.1 million as of September 30, 2021, excluding net assets held for sale (net of associated liabilities of $800,000 and $1.1 million, respectively) amounting to $2.3 million and $3.8 million as of December 31, 2021 and September 30, 2021, 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. Revenues seem favorable now that all our locations are not under pandemic-related closure mandates. However, some locations do have certain restrictions still in place. We believe that we can borrow capital if needed 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. In fiscal 2020, 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 year ended September 30, 2021, we received 11 Notices of PPP Forgiveness Payment 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 $5.3 million in principal and interest during the period and were included in non-operating gains (losses), net in our consolidated statement of operations. In November 2021, we received a partial forgiveness of the remaining $124,000 PPP loan for $85,000 in principal and interest. The remaining unforgiven portion of approximately $41,000 in principal will be repaid as debt plus accrued interest. 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 although we have recently issued shares of our common stock to partly pay for an acquisition (see next paragraph). 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. On October 18, 2021, we and certain of our subsidiaries completed our acquisition of eleven gentlemen’s clubs, six related real estate properties, and associated intellectual property for a total agreed acquisition price of $88.0 million (with a total consideration preliminary fair value of $88.4 million based on the Company’s stock price at acquisition date and discounted due to the lock-up period). The acquisition gives the Company presence in six additional states. We paid for the acquisition with $36.8 million in cash, $21.2 million in four seller-financed notes, and 500,000 shares of our common stock with a fair value of $30.4 million at issuance. On January 25, 2022, the Company borrowed $18.7 million from a bank lender for working capital purposes by executing a 10-year promissory note with an initial interest rate of 5.25% per annum to be adjusted after five years to a rate equal to the weekly average yield on U.S. Treasury securities plus 3.98% with a floor of 5.25%. The note is payable in monthly payments of $126,265 in principal and interest to be adjusted after five years. The promissory note is secured by eleven real estate properties. After the 10-year term, the remaining balance of principal and interest are payable at maturity date. There are certain financial covenants with which the Company is to be in compliance related to this loan, among which to maintain a debt service coverage of not less than 1.4 times, reviewed annually. 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 Three Months Ended December 31, 2021 2020 Operating activities $ 16,264 $ 6,274 Investing activities (48,130 ) (1,013 ) Financing activities 14,134 (3,899 ) Net increase (decrease) in cash and cash equivalents $ (17,732 ) $ 1,362 Cash Flows from Operating Activities Following are our summarized cash flows from operating activities (in thousands): For the Three Months Ended December 31, 2021 2020 Net income $ 10,564 $ 9,509 Depreciation and amortization 2,194 2,023 Gain on debt extinguishment (83 ) (4,920 ) Net change in operating assets and liabilities 3,414 (495 ) Other 175 157 Net cash provided by operating activities $ 16,264 $ 6,274 Net cash provided by operating activities increased from year to year primarily driven by the impact of higher sales and lower interest expense paid partially offset by lower income tax refund in the current quarter. 28 Cash Flows from Investing Activities Following are our cash flows from investing activities (in thousands): For the Three Months Ended December 31, 2021 2020 Payments for property and equipment and intangible assets $ (9,850 ) $ (1,289 ) Acquisition for businesses (39,302 ) - Proceeds from sale of businesses and assets 803 - Proceeds from insurance 185 250 Proceeds from note receivable 34 26 Net cash used in investing activities $ (48,130 ) $ (1,013 ) Following is a breakdown of our payments for property and equipment and intangible assets for the three months ended December 31, 2021 and 2020 (in thousands): For the Three Months Ended December 31, 2021 2020 New facilities, equipment and intangible assets $ 8,852 $ 684 Maintenance capital expenditures 998 605 Total capital expenditures $ 9,850 $ 1,289 The capital expenditures during the three months ended December 31, 2021 were composed of primarily of real estate and new equipment and furniture purchases for the newly acquired clubs. The capital expenditures during the three months ended December 31, 2020 were composed of primarily of real estate and liquor license purchases. 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 Three Months Ended December 31, 2021 2020 Proceeds from debt obligations $ 17,002 $ - Payments on debt obligations (2,488 ) (1,745 ) Purchase of treasury stock - (1,794 ) Payment of dividends (380 ) (360 ) Net cash provided by (used in) financing activities $ 14,134 $ (3,899 ) We purchased 74,659 shares of our common stock at an average price of $24.03 during the three months ended December 31, 2020, while we did not purchase shares of our common stock during the three months ended December 31, 2021. We paid quarterly dividends of $0.04 per share in both the current- and prior-year first quarter. See Note 7 to our consolidated financial statements for future maturities of our debt obligations. 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. 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 Three Months Ended December 31, 2021 2020 Net cash provided by operating activities $ 16,264 $ 6,274 Less: Maintenance capital expenditures 998 605 Free cash flow $ 15,266 $ 5,669 Our free cash flow for the current quarter increased by 169.3% compared to the comparable prior-year period primarily due to higher sales, net of related expense payments, and lower interest expense payments, partially offset by income tax refunds in the prior year and higher maintenance capital expenditures. We do not include total capital expenditures as a reduction from net cash flow from operating activities to arrive at free cash flow. This is because, based on our capital allocation strategy, acquisitions and development of our own clubs and restaurants are our primary uses of free cash flow. 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. 29 The following table presents a summary of such indicators for the three months ended December 31 (in thousands, except percentages): Increase Increase 2021 (Decrease) 2020 (Decrease) 2019 Sales of alcoholic beverages $ 26,431 52.3 % $ 17,360 (16.3 )% $ 20,743 Sales of food and merchandise 10,894 26.5 % 8,609 15.6 % 7,447 Service revenues 20,876 107.5 % 10,060 (41.5 )% 17,193 Other 3,635 53.4 % 2,369 (21.3 )% 3,011 Total revenues 61,836 61.0 % 38,398 (20.7 )% 48,394 Net cash provided by operating activities $ 16,264 159.2 % $ 6,274 (38.9 )% $ 10,273 Adjusted EBITDA* $ 17,965 106.7 % $ 8,690 (26.8 )% $ 11,864 Free cash flow* $ 15,266 169.3 % $ 5,669 (38.7 )% $ 9,252 Debt (end of period) $ 161,850 20.0 % $ 134,821 (4.9 )% $ 141,826 * 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 three months ended December 31, 2020, while we did not purchase shares of our common stock during the three months ended December 31, 2021. As of December 31, 2021, we have approximately $9.0 million remaining to purchase additional shares. Impact of Inflation 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. 30 Seasonality Our nightclub operations are affected by seasonal factors. Historically, we have experienced reduced revenues from April through September (our fiscal third and fourth quarters) with the strongest operating results occurring during October through March (our fiscal first and second quarters). Our revenues in certain markets are also affected by sporting events that cause unusual changes in sales from year to year. Capital Allocation Strategy Our capital allocation strategy provides us with disciplined guidelines on how we should use our free cash flows; provided however, that we may deviate from this strategy if 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 We believe that our nightclub operations can continue to grow organically and through careful entry into markets and demographic segments with high growth potential. Our growth strategy involves the following: (i) to acquire existing units in locations that are consistent with our growth and income targets and which appear receptive to the upscale club formula we have developed; (ii) to open new units after market analysis; (iii) to franchise our Bombshells brand; (iv) to form joint ventures or partnerships to reduce start-up and operating costs, with us contributing equity in the form of our brand name and management expertise; (v) to develop new club concepts that are consistent with our management and marketing skills; (vi) to develop and open our restaurant concepts as our capital and manpower allow; and (vii) to control the real estate in connection with club operations, although some units may be in leased premises. We believe that Bombshells can grow organically and through careful entry into markets and demographic segments with high growth potential. All eleven of the existing Bombshells as of December 31, 2021 are located in Texas. Our growth strategy is to diversify our operations with these units which do not require SOB licenses, which are sometimes difficult to obtain. While we are searching for adult nightclubs to acquire, we are able to also search for restaurant/sports bar locations that are consistent with our income targets. We are currently in the process of site selection for new Bombshells locations and our first franchisee for Bombshells restaurants in the San Antonio, Texas area is scheduled to open in February 2022. 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. 31 Item 3. Quantitative and Qualitative Disclosures About Market Risk. As of December 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, 2021.