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, 2022. 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 June 30, 2023, we operated a total of 70 establishments that offer live adult entertainment, including two that are under renovation/remodeling, and/or restaurant and bar operations, including one food hall. 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. Current Operating Environment Our fiscal 2020 was the period hardest hit by the COVID-19 pandemic causing 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 were mandated or encouraged by federal, state and local governments. In fiscal 2021, our businesses started to recover from the initial effects of the pandemic when government restrictions eased. Stimulus money also flowed to the economy at that time which prompted increased discretionary spending. In fiscal 2022, several coronavirus variants threatened to bring back tight restrictions. Along with the pandemic, geopolitical and macroeconomic events started to affect the U.S. economy in general, with global inflation and supply chain disruptions impacting our businesses. Toward the end of fiscal 2022 and continuing to the current fiscal year, geopolitical and macroeconomic events have impacted our operating results and cash flows by causing inflation on wages and other operating expenses. In the event global inflation leads to a major economic downturn, our business operations and cash flow could be significantly affected. 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, 2022 filed with the SEC on December 14, 2022. During the three and nine months ended June 30, 2023, there were no significant changes in our accounting policies and estimates. Results of Operations Highlights of the Company's operating results are as follows: Third Quarter 2023 • Total revenues were $77.1 million compared to $70.7 million during the comparable prior-year quarter, a 9.0% increase (Nightclubs revenue of $62.4 million compared to $54.7 million, a 14.2% increase; and Bombshells revenue of $14.4 million compared to $15.8 million, an 8.8% decrease) 26 Table of Contents • Consolidated same-store sales decreased by 9.6% (Nightclubs decreased by 7.3% while Bombshells decreased by 18.2%) (refer to the definition of same-store sales in the discussion of revenues below) • Basic and diluted earnings per share (“EPS”) of $0.96 compared to $1.48 (non-GAAP diluted EPS* of $1.30 compared to $1.60) during the comparable prior-year quarter • Net cash provided by operating activities of $15.3 million compared to $18.9 million during the comparable prior-year quarter, a 18.9% decrease (free cash flow* of $14.3 million compared to $18.0 million, a 20.9% decrease) Year-to-Date 2023 • Total revenues were approximately $218.5 million compared to $196.2 million during the comparable prior-year year-to-date period, a 11.4% increase (Nightclubs revenue of $175.8 million compared to $149.6 million, a 17.5% increase; and Bombshells revenue of $42.1 million compared to $45.9 million, an 8.2% decrease) • Consolidated same-store sales decreased by 4.3% (Nightclubs decreased by 1.1% while Bombshells decreased by 14.8%) (refer to the definition of same-store sales in the discussion of revenues below) • Basic and diluted EPS of $2.91 compared to $3.76 (non-GAAP diluted EPS of $3.80 compared to $3.89) during the comparable prior-year year-to-date period • Net cash provided by operating activities of $47.0 million compared to $46.8 million during the comparable prior-year year-to-date period, a 0.5% increase (free cash flow* of $42.1 million compared to $44.4 million, a 5.2% decrease) * Reconciliation and discussion of non-GAAP financial measures are included in the “Non-GAAP Financial Measures” section below. 27 Table of Contents The following table summarizes our results of operations as a percentage of revenue: Three Months Ended June 30, Nine Months Ended June 30, 2023 2022 2023 2022 Revenues Sales of alcoholic beverages 44.3 % 42.1 % 43.0 % 42.6 % Sales of food and merchandise 14.8 % 16.4 % 15.0 % 17.1 % Service revenues 34.6 % 36.0 % 35.7 % 34.6 % Other 6.3 % 5.6 % 6.4 % 5.8 % Total revenues 100.0 % 100.0 % 100.0 % 100.0 % Operating expenses Cost of goods sold Alcoholic beverages sold 18.7 % 17.4 % 18.2 % 17.9 % Food and merchandise sold 36.0 % 34.2 % 34.9 % 35.0 % Service and other 0.1 % 0.2 % 0.1 % 0.2 % Total cost of goods sold (exclusive of items shown separately below) 13.7 % 13.0 % 13.1 % 13.7 % Salaries and wages 26.7 % 24.6 % 26.9 % 25.7 % Selling, general and administrative 30.9 % 27.7 % 31.4 % 28.8 % Depreciation and amortization 5.2 % 3.6 % 5.1 % 3.9 % Other charges, net 3.4 % 2.1 % 2.6 % 0.7 % Total operating expenses 79.9 % 71.0 % 79.0 % 72.7 % Income from operations 20.1 % 29.0 % 21.0 % 27.3 % Other income (expenses) Interest expense (5.6) % (4.3) % (5.3) % (4.3) % Interest income 0.1 % 0.1 % 0.1 % 0.2 % Non-operating gains, net — % 0.2 % — % 0.1 % Income before income taxes 14.6 % 25.0 % 15.8 % 23.2 % Income tax expense 2.9 % 5.3 % 3.4 % 5.1 % Net income 11.7 % 19.7 % 12.3 % 18.1 % * Percentages may not foot due to rounding. Percentage of revenue for individual cost of goods sold items pertains to their respective revenue line. Revenues Consolidated revenues for the third quarter increased by $6.3 million, or 9.0%, versus the comparable prior-year quarter due primarily to an 18.5% increase in sales from newly acquired clubs and new Bombshells openings. Consolidated revenues for the year-to-date period increased by $22.3 million, or 11.4%, compared to the prior-year year-to-date period mainly due to an increase in sales from newly acquired clubs and new Bombshells openings partially offset by the impact of consolidated same-store sales decline. Consolidated same-store sales decreased by 9.6% for the quarter and decreased by 4.3% for the year-to-date period. 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 until its next full quarter 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. 28 Table of Contents Segment contribution to total revenues was as follows (in thousands, except percentages): Three Months Ended June 30, 2023 Mix Three Months Ended June 30, 2022 Mix Inc (Dec) $ Inc (Dec) % Nightclubs Sales of alcoholic beverages $ 26,144 41.9 % $ 21,061 38.5 % $ 5,083 24.1 % Sales of food and merchandise 5,288 8.5 % 4,639 8.5 % 649 14.0 % Service revenues 26,497 42.4 % 25,287 46.2 % 1,210 4.8 % Other revenues 4,520 7.2 % 3,697 6.8 % 823 22.3 % 62,449 100.0 % 54,684 100.0 % 7,765 14.2 % Bombshells Sales of alcoholic beverages 8,007 55.6 % 8,677 55.0 % (670) (7.7) % Sales of food and merchandise 6,117 42.5 % 6,935 43.9 % (818) (11.8) % Service revenues 166 1.2 % 157 1.0 % 9 5.7 % Other revenues 107 0.7 % 20 0.1 % 87 435.0 % 14,397 100.0 % 15,789 100.0 % (1,392) (8.8) % Other Other revenues 209 100.0 % 241 100.0 % (32) (13.3) % $ 77,055 $ 70,714 $ 6,341 9.0 % Nine Months Ended June 30, 2023 Mix Nine Months Ended June 30, 2022 Mix Inc (Dec) $ Inc (Dec) % Nightclubs Sales of alcoholic beverages $ 70,433 40.1 % $ 57,901 38.7 % $ 12,532 21.6 % Sales of food and merchandise 14,705 8.4 % 13,726 9.2 % 979 7.1 % Service revenues 77,716 44.2 % 67,472 45.1 % 10,244 15.2 % Other revenues 12,951 7.4 % 10,540 7.0 % 2,411 22.9 % 175,805 100.0 % 149,639 100.0 % 26,166 17.5 % Bombshells Sales of alcoholic beverages 23,504 55.8 % 25,603 55.8 % (2,099) (8.2) % Sales of food and merchandise 18,052 42.8 % 19,902 43.4 % (1,850) (9.3) % Service revenues 200 0.5 % 349 0.8 % (149) (42.7) % Other revenues 387 0.9 % 39 0.1 % 348 892.3 % 42,143 100.0 % 45,893 100.0 % (3,750) (8.2) % Other Other revenues 592 100.0 % 710 100.0 % (118) (16.6) % $ 218,540 $ 196,242 $ 22,298 11.4 % Nightclubs revenues increased by 14.2% for the quarter ended June 30, 2023 compared to the prior-year quarter primarily due to the contribution of newly acquired clubs and the impact of the increase in same-store sales. 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 7.3%. Newly acquired and remodeled clubs contributed a sales increase of $11.9 million to the total Nightclubs revenue increase of $7.8 million. By type of revenue, service revenue increased by 4.8%, alcoholic beverage sales increased by 24.1%, and food, merchandise and other revenue increased by 17.7%. Bombshells revenues decreased by 8.8%, of which 18.2% was for same-store sales decrease with the offsetting increase caused by two new locations and a food hall. By type of revenue, food and merchandise sales decreased by 11.8% while alcoholic beverage sales decreased by 7.7%. Management believes that the decrease in total Bombshells revenue was mainly from higher customer spending in the prior year caused by government stimulus money. 29 Table of Contents Operating Expenses Total operating expenses, as a percent of revenues, increased to 79.9% from 71.0% from last year’s third quarter, with a $11.3 million increase, or 22.6%, which was mainly caused by costs and expenses directly related to higher sales in the current-year quarter, and stock-based compensation, amortization of SOB licenses, settlement of lawsuits and impairment of goodwill in the current quarter. Compared to last year's nine-month period, the current nine-month period total operating expenses as a percent of revenues increased to 79.0% from 72.7%, with a $30.0 million increase, or 21.0%, due to the same reasons cited above. Significant contributors to the changes in operating expenses are explained below. Cost of goods sold . Cost of goods sold for the third quarter increased by $1.3 million, or 14.7%, mainly due to higher sales. As a percent of total revenues, cost of goods sold increased to 13.7% from 13.0% mainly due to the sales mix increase in service revenue. Service revenue has the highest margin while food and merchandise have the lowest. Nightclubs cost of goods sold increased to 11.7% from 10.0%, while Bombshells cost of goods sold decreased to 22.3% from 23.3%. Cost of goods sold for the nine months increased by $1.8, or 6.8%, mainly due to higher sales. As a percent of total revenues, cost of goods sold decreased to 13.1% from 13.7% mainly due to the sales mix increase in service revenue. Service revenue has the highest margin while food and merchandise have the lowest. Nightclubs cost of goods sold increased to 10.9% from 10.6%, while Bombshells cost of goods sold decreased to 22.5% from 23.5%. Salaries and wages . Salaries and wages increased by $3.2 million, or 18.4%, for the third quarter due to increase in personnel from newly acquired clubs and new Bombshells openings, work shifts to accommodate the increase in sales, and the impact of minimum wage increases in certain states and cities. As a percent of total revenues, salaries and wages increased to 26.7% from 24.6% due to wage inflation. Nightclubs increased to 21.4% from 19.0% and Bombshells increased to 27.0% from 23.6%, while corporate was flat at 4.1%. For the nine-month period, salaries and wages increased by $8.3 million, or 16.4%. As a percent of total revenues, consolidated salaries and wages increased to 26.9% from 25.7%. Nightclubs increased to 21.2% from 19.9%, Bombshells increased to 26.5% from 23.9%, and corporate decreased to 4.5% from 4.7%. Selling, general and administrative expenses . Selling, general and administrative expenses increased by $4.2 million, or 21.6%, primarily due to increased variable expenses related to higher sales during the current-year quarter and stock-based compensation. On a year-to-date period, selling, general and administrative expenses increased by $12.1 million, or 21.4%, due to the same reasons cited above. Dollar amounts in the tables below are in thousands, except percentages. For the Three Months Ended June 30, 2023 For the Three Months Ended June 30, 2022 Better (Worse) Amount % of Revenues Amount % of Revenues Amount % Taxes and permits $ 2,969 3.9 % $ 2,418 3.4 % $ (551) (22.8) % Advertising and marketing 3,284 4.3 % 2,460 3.5 % (824) (33.5) % Supplies and services 2,865 3.7 % 2,068 2.9 % (797) (38.5) % Insurance 2,718 3.5 % 2,481 3.5 % (237) (9.6) % Legal 754 1.0 % 328 0.5 % (426) (129.9) % Lease 1,836 2.4 % 1,736 2.5 % (100) (5.8) % Charge card fees 1,792 2.3 % 1,829 2.6 % 37 2.0 % Utilities 1,443 1.9 % 1,151 1.6 % (292) (25.4) % Security 1,523 2.0 % 1,081 1.5 % (442) (40.9) % Stock-based compensation 470 0.6 % — — % (470) (100.0) % Accounting and professional fees 1,050 1.4 % 818 1.2 % (232) (28.4) % Repairs and maintenance 1,367 1.8 % 960 1.4 % (407) (42.4) % Other 1,732 2.2 % 2,242 3.2 % 510 22.7 % Total selling, general and administrative expenses $ 23,803 30.9 % $ 19,572 27.7 % $ (4,231) (21.6) % 30 Table of Contents For the Nine Months Ended June 30, 2023 For the Nine Months Ended June 30, 2022 Better (Worse) Amount % of Revenues Amount % of Revenues Amount % Taxes and permits $ 8,392 3.8 % $ 7,015 3.6 % $ (1,377) (19.6) % Advertising and marketing 8,685 4.0 % 7,091 3.6 % (1,594) (22.5) % Supplies and services 7,946 3.6 % 6,223 3.2 % (1,723) (27.7) % Insurance 7,538 3.4 % 7,357 3.7 % (181) (2.5) % Legal 3,035 1.4 % 2,286 1.2 % (749) (32.8) % Lease 5,363 2.5 % 4,948 2.5 % (415) (8.4) % Charge card fees 5,372 2.5 % 4,626 2.4 % (746) (16.1) % Utilities 4,067 1.9 % 3,194 1.6 % (873) (27.3) % Security 3,995 1.8 % 3,218 1.6 % (777) (24.1) % Stock-based compensation 2,117 1.0 % — — % (2,117) (100.0) % Accounting and professional fees 3,225 1.5 % 2,786 1.4 % (439) (15.8) % Repairs and maintenance 3,738 1.7 % 2,588 1.3 % (1,150) (44.4) % Other 5,088 2.3 % 5,163 2.6 % 75 1.5 % Total selling, general and administrative expenses $ 68,561 31.4 % $ 56,495 28.8 % $ (12,066) (21.4) % Depreciation and amortization . Depreciation and amortization increased by $1.5 million, or 57.5%, during the third quarter and increased by $3.5 million, or 45.5%, during the year-to-date period due to the amortization of SOB licenses from leased clubs. Other charges, net . Other charges, net for both the third quarter and the year-to-date period increased by $1.1 million and $4.3 million, respectively, due mainly to settlement of lawsuits and impairment charges. We recorded a $2.8 million assessment by the New York State Department of Labor in the second quarter of 2023 and we recorded impairment charges of $662,000 in the second quarter of 2023 and $2.1 million in the third quarter of 2023 versus impairment charges of $1.7 million in the third quarter of 2022. The current year third quarter impairment charge included $2.6 million related to two clubs, one of which has been permanently closed. Income (Loss) from Operations For the three months ended June 30, 2023 and 2022, our consolidated operating margin was 20.1% and 29.0%, respectively, while for the nine months ended June 30, 2023 and 2022, our consolidated operating margin was 21.0% and 27.3%, respectively. The main drivers for the decreases in operating margin are stock-based compensation, amortization of SOB licenses, settlement of lawsuits, and impairment of goodwill, which are only present in the current year partially offset by fixed expenses leveraged from higher sales. Segment contribution to income (loss) from operations is presented in the table below (in thousands): For the Three Months Ended June 30, For the Nine Months Ended June 30, 2023 2022 2023 2022 Nightclubs $ 20,392 $ 22,459 $ 61,127 $ 60,321 Bombshells 1,701 3,065 5,323 9,335 Other (300) (82) (653) (159) Corporate (6,278) (4,935) (19,957) (15,998) $ 15,515 $ 20,507 $ 45,840 $ 53,499 Nightclubs operating margin was 32.7% and 41.1% for the three months ended June 30, 2023 and 2022, respectively, while operating margin for Bombshells was 11.8% and 19.4%, respectively. Nightclubs operating margin was 34.8% and 40.3% for the nine months ended June 30, 2023 and 2022, respectively, while operating margin for Bombshells was 12.6% and 20.3%, respectively. Nightclubs operating margin decreased due to settlement of lawsuits, amortization of SOB licenses, 31 Table of Contents and impairment of goodwill partially offset by fixed expenses leveraged from higher sales. The decrease in Bombshells operating margin was mainly due to fixed expenses deleveraged from lower sales. Excluding certain items, third quarter 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 3 2 . For the Three Months Ended June 30, 2023 Nightclubs Bombshells Other Corporate Total Income (loss) from operations $ 20,392 $ 1,701 $ (300) $ (6,278) $ 15,515 Amortization of intangibles 624 81 208 5 918 Settlement of lawsuits 57 6 — — 63 Impairment of assets 2,631 — — — 2,631 Loss (gain) on sale of businesses and assets (153) 50 — (2) (105) Gain on insurance — — — — — Stock-based compensation — — — 470 470 Non-GAAP operating income (loss) $ 23,551 $ 1,838 $ (92) $ (5,805) $ 19,492 GAAP operating margin 32.7 % 11.8 % (143.5) % (8.1) % 20.1 % Non-GAAP operating margin 37.7 % 12.8 % (44.0) % (7.5) % 25.3 % For the Three Months Ended June 30, 2022 Nightclubs Bombshells Other Corporate Total Income (loss) from operations $ 22,459 $ 3,065 $ (82) $ (4,935) $ 20,507 Amortization of intangibles 23 1 — 1 25 Settlement of lawsuits 124 8 — — 132 Impairment of assets 1,072 650 — — 1,722 Gain on sale of businesses and assets (264) — — (2) (266) Gain on insurance (87) — — — (87) Non-GAAP operating income (loss) $ 23,327 $ 3,724 $ (82) $ (4,936) $ 22,033 GAAP operating margin 41.1 % 19.4 % (34.0) % (7.0) % 29.0 % Non-GAAP operating margin 42.7 % 23.6 % (34.0) % (7.0) % 31.2 % 32 Table of Contents Excluding certain items, year-to-date period non-GAAP operating income (loss) and non-GAAP operating margin are computed in the tables below (dollars in thousands). For the Nine Months Ended June 30, 2023 Nightclubs Bombshells Other Corporate Total Income (loss) from operations $ 61,127 $ 5,323 $ (653) $ (19,957) $ 45,840 Amortization of intangibles 1,880 500 329 13 2,722 Settlement of lawsuits 3,174 9 — — 3,183 Impairment of assets 3,293 — — — 3,293 Loss (gain) on sale of businesses and assets (734) 66 — (24) (692) Gain on insurance (48) — — (43) (91) Stock-based compensation — — — 2,117 2,117 Non-GAAP operating income (loss) $ 68,692 $ 5,898 $ (324) $ (17,894) $ 56,372 GAAP operating margin 34.8 % 12.6 % (110.3) % (9.1) % 21.0 % Non-GAAP operating margin 39.1 % 14.0 % (54.7) % (8.2) % 25.8 % For the Nine Months Ended June 30, 2022 Nightclubs Bombshells Other Corporate Total Income (loss) from operations $ 60,321 $ 9,335 $ (159) $ (15,998) $ 53,499 Amortization of intangibles 117 5 — 2 124 Settlement of lawsuits 578 18 — 113 709 Impairment of assets 1,072 650 — — 1,722 Loss (gain) on sale of businesses and assets (344) 17 — (339) (666) Gain on insurance (408) — — — (408) Non-GAAP operating income (loss) $ 61,336 $ 10,025 $ (159) $ (16,222) $ 54,980 GAAP operating margin 40.3 % 20.3 % (22.4) % (8.2) % 27.3 % Non-GAAP operating margin 41.0 % 21.8 % (22.4) % (8.3) % 28.0 % Other Income/Expenses Interest expense for the third quarter increased by $1.3 million, or 42.5%, primarily caused by a higher average debt balance mostly from seller-financed promissory notes from this and last years' acquisitions. For the nine-month period, interest expense increased by $3.2 million, or 37.5%. Our total occupancy costs for the third quarter, defined as the sum of operating lease expense and interest expense, were $6.2 million and $4.8 million for the quarters ended June 30, 2023 and 2022, respectively. As a percentage of revenue, total occupancy costs were 8.0% and 6.7% during the quarters ended June 30, 2023 and 2022, respectively, primarily due to the interest from higher average debt balance. For the year-to-date period, total occupancy costs amounted to $17.0 million and $13.4 million, respectively, with a percent of revenue of 7.8% and 6.9%, respectively, primarily due to interest from higher average debt balance. These additional debt are mainly related to acquisitions. Income Taxes Income tax expense was $2.3 million and $3.8 million during the three months ended June 30, 2023 and 2022, respectively, and $7.4 million and $10.1 million during the nine months ended June 30, 2023 and 2022, respectively. The effective income tax expense rate was 20.1% and 21.3% for the three months ended June 30, 2023 and 2022, respectively, while for 33 Table of Contents the nine months ended June 30, 2023 and 2022, 21.6% and 22.1%, respectively. Our effective income tax rate is affected by 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, For the Nine Months Ended June 30, 2023 2022 2023 2022 Federal statutory income tax expense 21.0 % 21.0 % 21.0 % 21.0 % State income taxes, net of federal benefit 2.1 % 2.9 % 3.4 % 2.9 % Permanent differences 0.5 % 0.4 % 0.5 % 0.4 % Tax credit (3.7) % (3.2) % (3.4) % (2.8) % Other 0.1 % 0.1 % 0.1 % 0.5 % Total income tax expense 20.1 % 21.3 % 21.6 % 22.1 % 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) impairment of assets, (c) gains or losses on sale of businesses and assets, (d) gains or losses on insurance, (e) settlement of lawsuits, and (f) stock-based compensation. 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) impairment of assets, (c) gains or losses on sale of businesses and assets, (d) gains or losses on insurance, (e) unrealized gains or losses on equity securities, (f) settlement of lawsuits, (g) gain on debt extinguishment, (h) stock-based compensation, and (i) 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 21.6% and 21.6% effective tax rate of the pre-tax non-GAAP income before taxes for the nine months ended June 30, 2023 and 2022, 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, (i) gain on debt extinguishment, and (j) stock-based compensation. 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. 34 Table of Contents The following tables present our non-GAAP performance measures for the three and nine months ended June 30, 2023 and 2022 (in thousands, except per share, number of shares and percentages): Three Months Ended June 30, Nine Months Ended June 30, 2023 2022 2023 2022 Reconciliation of GAAP net income to Adjusted EBITDA Net income attributable to RCIHH common stockholders $ 9,085 $ 13,902 $ 27,055 $ 35,429 Income tax expense 2,269 3,767 7,447 10,056 Interest expense, net 4,229 2,925 11,412 8,175 Settlement of lawsuits 63 132 3,183 709 Impairment of assets 2,631 1,722 3,293 1,722 Gain on sale of businesses and assets (105) (266) (692) (666) Gain on debt extinguishment — (53) — (138) Unrealized loss on equity securities — — — 1 Gain on insurance — (87) (91) (408) Stock-based compensation 470 — 2,117 — Depreciation and amortization 4,041 2,565 11,108 7,636 Adjusted EBITDA $ 22,683 $ 24,607 $ 64,832 $ 62,516 Reconciliation of GAAP net income to non-GAAP net income Net income attributable to RCIHH common stockholders $ 9,085 $ 13,902 $ 27,055 $ 35,429 Amortization of intangibles 918 25 2,722 124 Settlement of lawsuits 63 132 3,183 709 Impairment of assets 2,631 1,722 3,293 1,722 Gain on sale of businesses and assets (105) (266) (692) (666) Gain on debt extinguishment — (53) — (138) Unrealized loss on equity securities — — — 1 Gain on insurance — (87) (91) (408) Stock-based compensation 470 — 2,117 — Net income tax effect (812) (312) (2,258) (59) Non-GAAP net income $ 12,250 $ 15,063 $ 35,329 $ 36,714 35 Table of Contents Reconciliation of GAAP diluted earnings per share to non-GAAP diluted earnings per share Diluted shares 9,430,225 9,389,675 9,308,624 9,428,461 GAAP diluted earnings per share $ 0.96 $ 1.48 $ 2.91 $ 3.76 Amortization of intangibles 0.10 0.00 0.29 0.01 Settlement of lawsuits 0.01 0.01 0.34 0.08 Impairment of assets 0.28 0.18 0.35 0.18 Gain on sale of businesses and assets (0.01) (0.03) (0.07) (0.07) Gain on debt extinguishment — (0.01) — (0.01) Unrealized loss on equity securities — — — 0.00 Gain on insurance 0.00 (0.01) (0.01) (0.04) Stock-based compensation 0.05 — 0.23 — Net income tax effect (0.09) (0.03) (0.24) (0.01) Non-GAAP diluted earnings per share $ 1.30 $ 1.60 $ 3.80 $ 3.89 Reconciliation of GAAP operating income to non-GAAP operating income Income from operations $ 15,515 $ 20,507 $ 45,840 $ 53,499 Amortization of intangibles 918 25 2,722 124 Settlement of lawsuits 63 132 3,183 709 Impairment of assets 2,631 1,722 3,293 1,722 Gain on sale of businesses and assets (105) (266) (692) (666) Gain on insurance — (87) (91) (408) Stock-based compensation 470 — 2,117 — Non-GAAP operating income $ 19,492 $ 22,033 $ 56,372 $ 54,980 Reconciliation of GAAP operating margin to non-GAAP operating margin Income from operations 20.1 % 29.0 % 21.0 % 27.3 % Amortization of intangibles 1.2 % 0.0 % 1.2 % 0.1 % Settlement of lawsuits 0.1 % 0.2 % 1.5 % 0.4 % Impairment of assets 3.4 % 2.4 % 1.5 % 0.9 % Gain on sale of businesses and assets (0.1) % (0.4) % (0.3) % (0.3) % Gain on insurance 0.0 % (0.1) % 0.0 % (0.2) % Stock-based compensation 0.6 % — % 1.0 % — % Non-GAAP operating margin 25.3 % 31.2 % 25.8 % 28.0 % * 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. 36 Table of Contents Liquidity and Capital Resources At June 30, 2023, our cash and cash equivalents were approximately $23.6 million compared to $36.0 million at September 30, 2022. Because of the large volume of cash we handle, we have very stringent cash controls. As of June 30, 2023, we had negative working capital of $11.4 million compared to working capital of $18.6 million as of September 30, 2022, excluding net assets held for sale amounting to $0 and $1.0 million as of June 30, 2023 and September 30, 2022, respectively. The negative working capital at June 30, 2023 was caused by borrowings, of which a large portion have current maturities, and which were used to fund business acquisitions. Since the pandemic hard hit fiscal 2020, we have since recovered and have seen a more normal stream of operations in 2021 and 2022. Toward the end of fiscal 2022 and continuing to the current fiscal year, geopolitical and macroeconomic events have impacted our operating results and cash flows by causing inflation on wages and other operating expenses. In the event global inflation leads to a major economic downturn, our business operations and cash flow could be significantly affected. 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. We have not recently raised capital through the issuance of equity securities although we have used equity recently in our acquisitions. Instead, we use debt financing to lower our overall cost of capital and increase our return on stockholders’ equity, but we are monitoring our total debt service cost as interest rates continue to increase. 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 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, 2023 2022 Operating activities $ 47,004 $ 46,754 Investing activities (57,047) (56,222) Financing activities (2,353) 11,282 Net increase (decrease) in cash and cash equivalents $ (12,396) $ 1,814 Cash Flows from Operating Activities Following are our summarized cash flows from operating activities (in thousands): For the Nine Months Ended June 30, 2023 2022 Net income $ 26,981 $ 35,479 Depreciation and amortization 11,108 7,636 Deferred income tax benefit (790) (409) Impairment of assets 3,293 1,722 Stock-based compensation 2,117 — Gain on debt extinguishment — (83) Net change in operating assets and liabilities 2,579 1,421 Other 1,716 988 Net cash provided by operating activities $ 47,004 $ 46,754 37 Table of Contents Net cash provided by operating activities increased from year to year primarily due to higher sales, partially offset by higher interest expense and lower income tax refund. Cash Flows from Investing Activities Following are our cash flows from investing activities (in thousands): For the Nine Months Ended June 30, 2023 2022 Payments for property and equipment and intangible assets $ (29,919) $ (17,173) Acquisition of businesses (30,200) (44,302) Proceeds from sale of businesses and assets 2,811 4,611 Proceeds from insurance 91 515 Proceeds from notes receivable 170 127 Net cash used in investing activities $ (57,047) $ (56,222) Following is a breakdown of our payments for property and equipment and intangible assets for the nine months ended June 30, 2023 and 2022 (in thousands): For the Nine Months Ended June 30, 2023 2022 New facilities, equipment, and intangible assets $ 24,970 $ 14,788 Maintenance capital expenditures 4,949 2,385 Total capital expenditures $ 29,919 $ 17,173 The capital expenditures during the nine months ended June 30, 2023 and 2022 were composed primarily of real estate and new equipment and furniture purchases for the newly acquired clubs. 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 Nine Months Ended June 30, 2023 2022 Proceeds from debt obligations $ 11,595 $ 35,820 Payments on debt obligations (11,431) (10,714) Purchase of treasury stock (98) (12,057) Payment of dividends (1,580) (1,322) Payment of loan origination costs (239) (445) Share in return of investment by noncontrolling partner (600) — Net cash provided by financing activities $ (2,353) $ 11,282 We purchased 1,500 shares of our common stock at an average price of $65.02 during the nine months ended June 30, 2023, while we purchased 213,712 shares of our common stock at an average price of $56.42 during the nine months ended June 30, 2022. As of June 30, 2023, we have approximately $18.8 million authorization remaining to purchase additional shares. Subsequent to the balance sheet date through August 4, 2023, we repurchased 10,440 shares of our common stock at an average price of $69.48. Prior to the second quarter of fiscal 2022, we have been paying $0.04 per share in quarterly dividends. From the second quarter of fiscal 2022 until the first quarter of fiscal 2023, we have paid $0.05 per share, and starting in the second quarter of fiscal 2023, we have paid $0.06 per share in quarterly dividends. 38 Table of Contents See Note 7 to our unaudited condensed consolidated financial statements for future maturities of our debt obligations. We have paid all our debts on time and have not defaulted nor requested forbearance on any of our debts during the nine months ended June 30, 2023 and 2022. 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 Nine Months Ended June 30, 2023 2022 Net cash provided by operating activities $ 47,004 $ 46,754 Less: Maintenance capital expenditures 4,949 2,385 Free cash flow $ 42,055 $ 44,369 Our free cash flow for the nine-month period decreased by 5.2% compared to the comparable prior-year period primarily due to higher interest expense, lower income tax refund, and higher maintenance capital expenditures from renovations and remodeling of several of our clubs, partially offset by higher sales. We do not include capital expenditures related to new facilities construction, equipment and intangible assets 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 ongoing impact of the COVID-19 pandemic, the current geopolitical and macroeconomic events happening globally, and the notes payable financing described above, we are not aware of any event or trend that would adversely impact our 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 downturns. 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. The following table presents a summary of such indicators for the nine months ended June 30 (in thousands, except percentages): 2023 Increase (Decrease) 2022 Increase (Decrease) 2021 Sales of alcoholic beverages $ 93,937 12.5 % $ 83,504 33.1 % $ 62,725 Sales of food and merchandise 32,757 (2.6) % 33,628 11.3 % 30,205 Service revenues 77,916 14.9 % 67,821 76.4 % 38,442 Other 13,930 23.4 % 11,289 26.2 % 8,945 Total revenues $ 218,540 11.4 % $ 196,242 39.9 % $ 140,317 Net income attributable to RCIHH common stockholders $ 27,055 (23.6) % $ 35,429 26.4 % $ 28,036 Net cash provided by operating activities $ 47,004 0.5 % $ 46,754 45.1 % $ 32,217 Adjusted EBITDA* $ 64,832 3.7 % $ 62,516 46.5 % $ 42,675 Free cash flow* $ 42,055 (5.2) % $ 44,369 60.7 % $ 27,609 Debt (end of period) $ 243,823 29.7 % $ 187,965 47.3 % $ 127,603 * See definition and calculation of Adjusted EBITDA and Free Cash Flow above in the Non-GAAP Financial Measures subsection of Results of Operations. 39 Table of Contents 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. 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 we can continue to grow organically and through careful entry into markets with high growth potential. Our growth strategy includes acquiring existing units, opening new units after market analysis, developing new club concepts that are consistent with our management and marketing skills, franchising our Bombshells brand, and developing and opening our Bombshells concept as our capital and manpower allow. All twelve of the existing Bombshells as of June 30, 2023 were located in Texas, including the former franchisee location that we acquired in February 2023 (see Note 4 to our unaudited condensed consolidated financial statements). 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 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. 40 Table of Contents Item 3. Quantitative and Qualitative Disclosures About Market Risk. As of June 30, 2023, 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, 2022.