10-K 1 form10-k.htm

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

 

[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the fiscal year ended September 30, 2019

 

[  ] Transition report under Section 13 or 15(d) of the Securities Exchange Act of 1934

 

Commission file number: 001-13992

 

RCI HOSPITALITY HOLDINGS, INC.

(Exact name of registrant as specified in its charter)

 

Texas   76-0458229

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

 

10737 Cutten Road

Houston, Texas 77066

(Address of principal executive offices) (Zip Code)

 

(281) 397-6730

(Registrant’s telephone number, including area code)

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class   Trading Symbol(s)   Name of each exchange on which registered
Common stock, $0.01 par value   RICK   The Nasdaq Global Market

 

Securities registered pursuant to Section 12(g) of the Act: None.

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes [  ] No [X]

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes [  ] No [X]

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [  ] No [X]

 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes [X] No [  ]

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act. Large accelerated filer [  ] Accelerated filer [X] Non-accelerated filer [  ] Smaller reporting company [  ] Emerging growth company [  ]

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act [  ]

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.): Yes [  ] No [X]

 

The aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold as of the last business day of the registrant’s most recently completed second fiscal quarter was $204,593,354.

 

As of February 6, 2020, there were approximately 9,258,000 shares of common stock outstanding.

 

 

 

   
 

 

NOTE ABOUT FORWARD-LOOKING STATEMENTS

 

This Annual Report on Form 10-K contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements include, among other things, statements regarding plans, objectives, goals, strategies, future events or performance and underlying assumptions and other statements, which are other than statements of historical facts. Forward-looking statements may appear throughout this report, including without limitation, the following sections: Item 1 – “Business,” Item 1A – “Risk Factors,” and Item 7 – “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” Forward-looking statements generally can be identified by words such as “anticipates,” “believes,” “estimates,” “expects,” “intends,” “plans,” “predicts,” “projects,” “will be,” “will continue,” “will likely result,” and similar expressions. These forward-looking statements are based on current expectations and assumptions that are subject to risks and uncertainties, which could cause our actual results to differ materially from those reflected in the forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those discussed in this Annual Report on Form 10-K, and, in particular, the risks discussed under the caption “Risk Factors” in Item 1A and those discussed in other documents we file with the Securities and Exchange Commission (“SEC”). Important factors that in our view could cause material adverse effects on our financial condition and results of operations include, but are not limited to, the risks and uncertainties associated with (i) operating and managing an adult business, (ii) the business climates in cities where it operates, (iii) the success or lack thereof in launching and building the company’s businesses, (iv) cyber security, (v) conditions relevant to real estate transactions, (vi) our ability to regain and maintain compliance with the filing requirements of the SEC and the Nasdaq Stock Market, and (vii) numerous other factors such as laws governing the operation of adult entertainment businesses, competition and dependence on key personnel. We undertake no obligation to revise or publicly release the results of any revision to any forward-looking statements, except as required by law. Given these risks and uncertainties, readers are cautioned not to place undue reliance on such forward-looking statements.

 

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TABLE OF CONTENTS

 

    Page No.
PART I    
     
Item 1. Business 4
     
Item 1A. Risk Factors 8
     
Item 1B. Unresolved Staff Comments 16
     
Item 2. Properties 16
     
Item 3. Legal Proceedings 17
     
Item 4. Mine Safety Disclosures 17
     
PART II    
     
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities 18
     
Item 6. Selected Financial Data 20
     
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations 21
     
Item 7A. Quantitative and Qualitative Disclosures About Market Risk 39
     
Item 8. Financial Statements and Supplementary Data 39
     
Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure 86
     
Item 9A. Controls and Procedures 86
     
Item 9B. Other Information 88
     
PART III    
     
Item 10. Directors, Executive Officers and Corporate Governance 90
     
Item 11. Executive Compensation 94
     
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters 100
     
Item 13. Certain Relationships and Related Transactions, and Director Independence 101
     
Item 14. Principal Accounting Fees and Services 102
     
PART IV    
     
Item 15. Exhibits, Financial Statement Schedules 103
     
Item 16. Form 10-K Summary 104
     
  Signatures 105

 

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PART I

 

Item 1. Business.

 

INTRODUCTION

 

RCI Hospitality Holdings, Inc. (sometimes referred to as “RCIHH” herein) is a holding company engaged in a number of activities in the hospitality and related businesses. Through our subsidiaries, as of September 30, 2019, we operate a total of 46 establishments (including one that was temporarily closed due to fire and reopened after year-end) that offer live adult entertainment and/or restaurant and bar operations. We also operate a leading business communications company (the “Media Group”) serving the multibillion-dollar adult nightclubs industry. We have two principal reportable segments—Nightclubs and Bombshells. The terms “Company,” “we,” “our,” “us” and similar terms used in this Form 10-K refer to RCIHH and its subsidiaries. Except for executive officers of RCIHH, any employment referenced in this document is not with RCIHH but solely with one of its subsidiaries. RCIHH was incorporated in the State of Texas in 1994.

 

Our fiscal year ends on September 30. References to years 2019, 2018, and 2017 are for fiscal years ended September 30, 2019, 2018, and 2017, respectively. Our fiscal quarters chronologically end on December 31, March 31, June 30 and September 30.

 

Our corporate website address is www.rcihospitality.com. Upon written request, we make available free of charge our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and all amendments to those reports as soon as reasonably practicable after such material is electronically filed with the SEC under the Securities Exchange Act of 1934, as amended (www.sec.gov). Information contained in the corporate website shall not be construed as part of this Form 10-K.

 

OUR BUSINESS

 

We operate several businesses, which we aggregate for financial reporting into two reportable segments – Nightclubs and Bombshells – and combine other operating segments into “Other.”

 

Nightclubs Segment

 

We operate our adult entertainment nightclubs through several brands that target many different demographics of customers by providing a unique, quality entertainment environment. Our clubs do business as Rick’s Cabaret, Jaguars Club, Tootsie’s Cabaret, XTC Cabaret, Club Onyx, Hoops Cabaret and Sports Bar, Scarlett’s Cabaret, Temptations Adult Cabaret, Foxy’s Cabaret, Vivid Cabaret, Downtown Cabaret, Cabaret East, The Seville, Silver City Cabaret, and Kappa Men’s Club. We also operate dance clubs under the brand name Studio 80.

 

We generate revenue on our nightclubs through the sale of alcoholic beverages, food and merchandise items; service in the form of cover charge, dance fees, and room rentals; and through other related means such as ATM commissions and vending income, among others.

 

During fiscal 2019, our Nightclub segment sales mix was 46% service revenue; 39% alcoholic beverages; and 15% food, merchandise and other. Segment gross margin (revenues less cost of goods sold) was approximately 89%. We grew Nightclubs segment revenue by 6.1% and income from operations by 16.3% from prior year.

 

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In November 2018, we acquired a club in Chicago, Illinois for $10.5 million with $6.0 million cash paid at closing and the $4.5 million in a 6-year seller-financed note with interest at 7%. We have since rebranded the club as Rick’s Cabaret Chicago. It generated $5.0 million in revenues during fiscal 2019 since acquisition date. See Note 15 to our consolidated financial statements for details of the transaction.

 

Also in November 2018, we acquired a club in Pittsburgh, Pennsylvania for $15.0 million with $7.5 million cash paid at closing and two seller notes payable. The first note is a 2-year 7% note for $2.0 million and the second is a 10-year 8% note for 5.5 million. We have since rebranded the club as Rick’s Cabaret Pittsburgh. It generated $4.6 million in revenues during fiscal 2019 since acquisition date. See Note 15 to our consolidated financial statements for details of the transaction.

 

On November 5, 2019, the Company announced that its subsidiaries have signed definitive agreements to acquire the assets and related real estate of a well-established, top gentlemen’s club located in the Northeast Corridor for $15.0 million. As of the filing of this report, closing of this transaction is still pending subject to certain conditions. Under the terms of the agreements, Company subsidiaries will pay $7.2 million for the club and $7.8 million for the real estate using $4.0 million in seller financing at 6.0% for the club with the balance of cash from an anticipated $11.0 million bank loan at a blended rate of 6.25%.

 

A list of our nightclub locations is in Item 2— “Properties.”

 

Bombshells Segment

 

As of September 30, 2019, we operated eight Bombshells, all in Texas with one in Dallas, one in Austin, and six in the Greater Houston area. The restaurant concept sets itself apart with décor that pays homage to all branches of the U.S. military. Locations feature local DJs, large outdoor patios, and more than 75 state-of-the-art flat screen TVs for watching your favorite sports. All food and drink menu items have military names. Bombshell Girls, with their military-inspired uniforms, are a key attraction. Their mission, in addition to waitressing, is to interact with guests and generate a fun atmosphere. Bombshells is also open to franchising under our subsidiary, BMB Franchising Services, Inc., which has been approved to sell franchises in all 50 states.

 

During fiscal 2019, Bombshells sales mix was 58% alcoholic beverages and 42% food, merchandise and other. Segment gross margin (revenues less cost of goods sold) was approximately 75%. We grew Bombshells segment revenue by 27.9% and income from operations by 13.1% from prior year.

 

We opened the first Bombshells in March 2013 in Dallas, quickly becoming one of the most popular restaurant destinations in the area. Within six years, eight more opened in the Austin and Houston, Texas areas, including two that were opened in the current fiscal 2019. In September 2016, we closed one Bombshells location in Webster, Texas. In the current fiscal 2019, we opened one Bombshells on Interstate 10 (BMB I-10), east of Houston in December 2018, and another one on State Highway 249 (BMB 249), northwest of Houston in March 2019. BMB I-10 and BMB 249 generated revenues of $4.3 million and $2.3 million, respectively, during fiscal 2019. Of the eight active Bombshells as of September 30, 2019, six are freestanding pad sites and two are inline locations.

 

Subsequent to fiscal year 2019, we opened two new Bombshells units, one in October 2019 (BMB Katy) and another in January 2020 (BMB 59).

 

For a list of our Bombshells locations, refer to Item 2—“Properties.”

 

Other Segment

 

We group together all operating segments other than Nightclubs and Bombshells as Other reportable segment. This is made up of several wholly-owned subsidiaries composed primarily of our Media Group and Drink Robust. Our Media Group is the leading business communications company serving the multibillion-dollar adult nightclubs industry and the adult retail products industry. It owns a national industry convention and tradeshow; two national industry trade publications; two national industry award shows; and more than a dozen industry and social media websites. Included in the Media Group is ED Publications, publishers of the bimonthly ED Club Bulletin, the only national business magazine serving the 2,200-plus adult nightclubs in North America, which collectively have annual revenues in excess of $5 billion, according to the Association of Club Executives. ED Publications, founded in 1991, also publishes the Annual VIP Guide of adult nightclubs, touring entertainers and industry vendors; produces the Annual Gentlemen’s Club Owners EXPO, a national convention and tradeshow; and offers the exclusive ED VIP Club Card, honored at more than 850 adult nightclubs. The Media Group produces two nationally recognized industry award shows for the readers of both ED Club Bulletin and StorErotica magazines, and maintains a number of B-to-B and consumer websites for both industries. Drink Robust is licensed to sell Robust Energy Drink in the United States.

 

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OUR STRATEGY

 

Our overall objective is to create value for our shareholders by developing and operating profitable businesses in the hospitality and related space. We strive to achieve that by providing an attractive price-value entertainment and dining experience; by attracting and retaining quality personnel; and by focusing on unit-level operating performance. Aside from our operating strategy, we employ a capital allocation strategy.

 

Capital Allocation Strategy

 

Our capital allocation strategy provides us with disciplined guidelines on how we should use our free cash flows; provided however, that we may deviate from this strategy if the circumstances warrant. We calculate free cash flow as net cash flows from operating activities minus maintenance capital expenditures. Using the after-tax yield of buying our own stock as baseline, management believes that we are able to make better investment decisions.

 

Based on our current capital allocation strategy:

 

  We consider buying back our own stock if the after-tax yield on free cash flow is above 10%;
     
  We consider disposing of underperforming units to free up capital for more productive use;
     
  We consider acquiring or developing our own clubs or restaurants that we believe have the potential to provide a minimum cash on cash return of 25%-33%, absent an otherwise strategic rationale;
     
  We consider paying down our most expensive debt if it makes sense on a tax-adjusted basis, or there is an otherwise strategic rationale.

 

COMPETITION

 

The adult entertainment and the restaurant/sports bar businesses are highly competitive with respect to price, service and location. All of our nightclubs compete with a number of locally owned adult clubs, some of whose brands may have name recognition that equals that of ours. The names “Rick’s” and “Rick’s Cabaret,” “Tootsie’s Cabaret,” “XTC Cabaret,” “Scarlett’s,” “Silver City,” “Club Onyx,” “Downtown Cabaret,” “Temptations,” “The Seville,” “Jaguars,” “Hoops Cabaret,” and “Foxy’s Cabaret” are proprietary. In the restaurant/sports bar business, “Bombshells” is also proprietary. We believe that the combination of our existing brand name recognition and the distinctive entertainment environment that we have created allows us to compete effectively in the industry and within the cities where we operate. Although we believe that we are well positioned to compete successfully, there can be no assurance that we will be able to maintain our high level of name recognition and prestige within the marketplace.

 

GOVERNMENTAL REGULATIONS

 

We are subject to various federal, state and local laws affecting our business activities. Particularly in Texas, the authority to issue a permit to sell alcoholic beverages is governed by the Texas Alcoholic Beverage Commission (“TABC”), which has the authority, in its discretion, to issue the appropriate permits. We presently hold a Mixed Beverage Permit and a Late Hour Permit at numerous Texas locations. Minnesota, North Carolina, Louisiana, Arizona, Pennsylvania, Florida, New York, and Illinois have similar laws that may limit the availability of a permit to sell alcoholic beverages or that may provide for suspension or revocation of a permit to sell alcoholic beverages in certain circumstances. It is our policy, prior to expanding into any new market, to take steps to ensure compliance with all licensing and regulatory requirements for the sale of alcoholic beverages, as well as the sale of food.

 

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In addition to various regulatory requirements affecting the sale of alcoholic beverages, in many cities where we operate, the location of an adult entertainment cabaret is subject to restriction by city, county or other governmental ordinance. The prohibitions deal generally with distance from schools, churches and other sexually oriented businesses, and contain restrictions based on the percentage of residences within the immediate vicinity of the sexually oriented business. The granting of a sexually oriented business permit is not subject to discretion; the permit must be granted if the proposed operation satisfies the requirements of the ordinance. In all states where we operate, management believes we are in compliance with applicable city, county, state or other local laws governing the sale of alcohol and sexually oriented businesses.

 

TRADEMARKS

 

Our rights to the trade names “RCI Hospitality Holdings, Inc.,” “Rick’s,” “Rick’s Cabaret,” “Tootsie’s Cabaret,” “Club Onyx,” “XTC Cabaret,” “Temptations,” “Jaguars,” “Downtown Cabaret,” “Cabaret East,” Bombshells Restaurant and Bar,” and “Vee Lounge” are established under common law, based upon our substantial and continuous use of these trade names in interstate commerce, some of which have been in use at least as early as 1987. We have registered our service mark, “RICK’S AND STARS DESIGN,” and the “BOMBSHELLS RESTAURANT & BAR” logo design with the United States Patent and Trademark Office. We have also obtained service mark registrations from the Patent and Trademark Office for “RICK’S AND STARS DESIGN” logo, “RCI HOSPITALITY HOLDINGS, INC.,” “RICK’S,” “RICK’S CABARET,” “CLUB ONYX,” “XTC CABARET,” “SCARLETT’S CABARET,” “SILVER CITY CABARET,” “BOMBSHELLS RESTAURANT AND BAR”, “THE SEVILLE CLUB”, “DOWN IN TEXAS SALOON”, “CLUB DULCE”, “THE BLACK ORCHID”, “HOOPS CABARET”, “VEE LOUNGE,” “STUDIO 80”, “FOXY’S CABARET,” and “EXOTIC DANCER” are registered through service mark registrations issued by the United States Patent and Trademark Office. As of this date, we have pending registration applications for the names “TOOTSIES CABARET”, “Toys for Tatas”, “In The Biz”, “Better Flight, Better Price!” and “Bombshells Officer’s Club”. We also own the rights to numerous trade names associated with our media division. There can be no assurance that these steps we have taken to protect our service marks will be adequate to deter misappropriation of our protected intellectual property rights.

 

EMPLOYEES AND INDEPENDENT CONTRACTORS

 

As of September 30, 2019, we had approximately 2,200 employees, of which approximately 280 are in management positions, including corporate and administrative operations, and approximately 1,920 are engaged in entertainment, food and beverage service, including bartenders, waitresses, and certain entertainers. None of our employees are represented by a union. We consider our employee relations to be good. Additionally, as of September 30, 2019, we had independent contractor entertainers, who are self-employed and conduct business at our locations on a non-exclusive basis. Our entertainers at Rick’s Cabaret in Minneapolis, Minnesota and at Jaguars Club in Phoenix, Arizona act as commissioned employees. All employees and independent contractors sign arbitration non-class-action participation agreements where allowed by federal and state laws.

 

We believe that the adult entertainment industry standard of treating entertainers as independent contractors provides us with safe harbor protection to preclude payroll tax assessment. We have prepared plans that we believe will protect our profitability in the event that the sexually oriented business industry is required in all states to convert entertainers, who are now independent contractors, into employees. See related discussion in “Risk Factors” below.

 

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Item 1A. Risk Factors.

 

An investment in our common stock involves a high degree of risk. You should carefully consider the risks described below before deciding to purchase shares of our common stock. If any of the events, contingencies, circumstances or conditions described in the risks below actually occurs, our business, financial condition or results of operations could be seriously harmed. The trading price of our common stock could, in turn, decline and you could lose all or part of your investment.

 

Our business operations are subject to regulatory uncertainties which may affect our ability to continue operations of existing nightclubs, acquire additional nightclubs, or be profitable.

 

Adult entertainment nightclubs are subject to local, state and federal regulations. Our business is regulated by local zoning, local and state liquor licensing, local ordinances, and state and federal time place and manner restrictions. The adult entertainment provided by our nightclubs has elements of speech and expression and, therefore, enjoys some protection under the First Amendment to the United States Constitution. However, the protection is limited to the expression, and not the conduct of an entertainer. While our nightclubs are generally well established in their respective markets, there can be no assurance that local, state and/or federal licensing and other regulations will permit our nightclubs to remain in operation or profitable in the future.

 

We have recorded impairment charges in past periods and may record additional impairment charges in future periods.

 

Our nightclubs are often acquired with a purchase price based on historical EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization). This results in certain nightclubs carrying a substantial amount of intangible asset value, mostly allocated to licenses and goodwill. Generally accepted accounting principles require an annual impairment review of these indefinite-lived intangible assets. As a result of our annual impairment review, we recorded impairment charges of $6.0 million in 2019 (representing $4.2 million property and equipment impairment on two clubs, $1.6 million goodwill impairment on four clubs, and $178,000 of license impairment on one club); $5.6 million in 2018 (representing a $1.6 million of property and equipment impairment on one club and one Bombshells, $834,000 goodwill impairment on two clubs, and $3.1 million of license impairment on three clubs); and $7.6 million in 2017 (including $4.7 million of goodwill impairment on three operating clubs and one property held for sale, $385,000 of property and equipment impairment on one operating club, $1.4 million of license impairment on two clubs, and $1.2 million of other-than-temporary impairment recognized on our cost method investment in Robust). If difficult market and economic conditions materialize over the next year and/or we experience a decrease in revenue at one or more nightclubs or restaurants, we could incur a decline in fair value of one or more of our nightclubs or restaurants. This could result in future impairment charges of up to the total value of our intangible assets, including goodwill. We actively monitor our clubs and restaurants for any indication of impairment.

 

We may deviate from our present capital allocation strategy.

 

We believe that our present capital allocation strategy will provide us with optimized returns. However, implementation of our capital allocation strategy depends on the interplay of several factors such as our stock price, our outstanding common shares, the interest rates on our debt, and the rate of return on available investments. If these factors are not conducive to implementing our present capital allocation strategy, or we determine that adopting a different capital allocation strategy is in the best interest of shareholders, we reserve the right to deviate from this approach. There can be no assurance that we will not deviate from or adopt an alternative capital allocation strategy moving forward.

 

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We may need additional financing, or our business expansion plans may be significantly limited.

 

If cash generated from our operations is insufficient to satisfy our working capital and capital expenditure requirements, we will need to raise additional funds through the public or private sale of our equity or debt securities. The timing and amount of our capital requirements will depend on a number of factors, including cash flow and cash requirements for nightclub acquisitions and new restaurant development. If additional funds are raised through the issuance of equity or convertible debt securities, the ownership percentage of our then-existing shareholders will be reduced. We cannot ensure that additional financing will be available on terms favorable to us, if at all. Any future equity financing, if available, may result in dilution to existing shareholders; and debt financing, if available, may include restrictive covenants. Any failure by us to procure timely additional financing, if needed, will have material adverse consequences on our business operations.

 

There is substantial competition in the nightclub entertainment industry, which may affect our ability to operate profitably or acquire additional clubs.

 

Our nightclubs face substantial competition. Some of our competitors may have greater financial and management resources than we do. Additionally, the industry is subject to unpredictable competitive trends and competition for general entertainment dollars. There can be no assurance that we will be able to remain profitable in this competitive industry.

 

The adult entertainment industry standard is to classify adult entertainers as independent contractors, not employees. If federal or state law mandates that they be classified as employees, our business could be adversely impacted.

 

The adult entertainment industry standard is to classify adult entertainers as independent contractors, not employees. The Internal Revenue Service regulations and applicable state law guidelines regarding independent contractor classification are subject to judicial and agency interpretation, and it could be determined that the independent contractor classification is inapplicable. Further, if legal standards for classification of independent contractors change, it may be necessary to modify our compensation structure for these adult entertainers, including by paying additional compensation or reimbursing expenses. While we take steps to ensure that our adult entertainers are deemed independent contractors, if our adult entertainers are determined to have been misclassified as independent contractors, we would incur additional exposure under federal and state law, workers’ compensation, unemployment benefits, labor, employment and tort laws, including for prior periods, as well as potential liability for employee benefits and tax withholdings. Any of these outcomes could result in substantial costs to us, could significantly impair our financial condition and our ability to conduct our business as we choose, and could damage our ability to attract and retain other personnel.

 

The adult entertainment industry is extremely volatile.

 

Historically, the adult entertainment, restaurant and bar industry has been an extremely volatile industry. The industry tends to be extremely sensitive to the general local economy, in that when economic conditions are prosperous, adult entertainment industry revenues increase, and when economic conditions are unfavorable, entertainment industry revenues decline. Coupled with this economic sensitivity are the trendy personal preferences of the customers who frequent adult cabarets. We continuously monitor trends in our customers’ tastes and entertainment preferences so that, if necessary, we can make appropriate changes which will allow us to remain one of the premiere adult cabarets. However, any significant decline in general corporate conditions or uncertainties regarding future economic prospects that affect consumer spending could have a material adverse effect on our business. In addition, we have historically catered to a clientele base from the upper end of the market. Accordingly, further reductions in the amounts of entertainment expenses allowed as deductions from income under the Internal Revenue Code of 1954, as amended, could adversely affect sales to customers dependent upon corporate expense accounts.

 

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Private advocacy group actions targeted at the kind of adult entertainment we offer could result in limitations and our inability to operate in certain locations and negatively impact our business.

 

Our ability to operate successfully depends on the protection provided to us under the First Amendment to the U.S. Constitution. From time to time, private advocacy groups have sought to target our nightclubs by petitioning for non-renewal of certain of our permits and licenses. Furthermore, private advocacy groups which have influences on certain financial institutions have managed to sway these financial institutions into not doing business with us. In addition to possibly limiting our operations and financing options, negative publicity campaigns, lawsuits and boycotts could negatively affect our businesses and cause additional financial harm by discouraging investors from investing in our securities or requiring that we incur significant expenditures to defend our business.

 

Our revenues could be significantly affected by limitations relating to permits to sell alcoholic beverages.

 

We derive a significant portion of our revenues from the sale of alcoholic beverages. States in which we operate may have laws which may limit the availability of a permit to sell alcoholic beverages, or which may provide for suspension or revocation of a permit to sell alcoholic beverages in certain circumstances. The temporary or permanent suspension or revocations of any such permits would have a material adverse effect on our revenues, financial condition and results of operations. In all states where we operate, management believes we are in compliance with applicable city, county, state or other local laws governing the sale of alcohol.

 

Activities or conduct at our nightclubs may cause us to lose necessary business licenses, expose us to liability, or result in adverse publicity, which may increase our costs and divert management’s attention from our business.

 

We are subject to risks associated with activities or conduct at our nightclubs that are illegal or violate the terms of necessary business licenses. Some of our nightclubs operate under licenses for sexually oriented businesses and are afforded some protection under the First Amendment to the U.S. Constitution. While we believe that the activities at our nightclubs comply with the terms of such licenses, and that the element of our business that constitutes an expression of free speech under the First Amendment to the U.S. Constitution is protected, activities and conduct at our nightclubs may be found to violate the terms of such licenses or be unprotected under the U.S. Constitution. This protection is limited to the expression and not the conduct of an entertainer. An issuing authority may suspend or terminate a license for a nightclub found to have violated the license terms. Illegal activities or conduct at any of our nightclubs may result in negative publicity or litigation. Such consequences may increase our cost of doing business, divert management’s attention from our business and make an investment in our securities unattractive to current and potential investors, thereby lowering our profitability and our stock price.

 

We have developed comprehensive policies aimed at ensuring that the operation of each of our nightclubs is conducted in conformance with local, state and federal laws. We have a “no tolerance” policy on illegal drug use in or around our facilities. We continually monitor the actions of entertainers, waitresses and customers to ensure that proper behavior standards are met. However, such policies, no matter how well designed and enforced, can provide only reasonable, not absolute, assurance that the policies’ objectives are being achieved. Because of the inherent limitations in all control systems and policies, there can be no assurance that our policies will prevent deliberate acts by persons attempting to violate or circumvent them. Notwithstanding the foregoing limitations, management believes that our policies are reasonably effective in achieving their purposes.

 

We rely heavily on information technology in our operations and any material failure, weakness, interruption or breach of security could prevent us from effectively operating our business.

 

Our operations and corporate functions rely heavily on information systems, including point-of-sale processing, management of our supply chain, payment of obligations, collection of cash, electronic communications, data warehousing to support analytics, finance and accounting systems, mobile technologies to enhance the customer experience, and other various processes and procedures, some of which are handled by third parties. Our ability to efficiently and effectively manage our business depends significantly on the reliability and capacity of these systems. The failure of these systems to operate effectively, maintenance problems, upgrading or transitioning to new platforms, or a breach in security relating to these systems could result in delays in consumer service and reduce efficiency in our operations. These problems could adversely affect our results of operations, and remediation could result in significant, unplanned capital investments.

 

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Security breaches of confidential customer information or personal employee information may adversely affect our business.

 

A significant portion of our revenues are paid through debit and credit cards. Other restaurants and retailers have experienced significant security breaches in which debit and credit card information or other personal information of their customers have been stolen. We also maintain certain personal information regarding our employees. Although we aim to safeguard our technology systems, they could potentially be vulnerable to damage, disability or failures due to physical theft, fire, power outage, telecommunication failure or other catastrophic events, as well as from internal and external security breaches, employee error or malfeasance, denial of service attacks, viruses, worms and other disruptive problems caused by hackers and cyber criminals. A breach in our systems that compromises the information of our customers or employees could result in widespread negative publicity, damage to our reputation, a loss of customers, and legal liabilities. We may in the future become subject to lawsuits or other proceedings for purportedly fraudulent transactions arising from the actual or alleged theft of our customers’ debit and credit card information or if customer or employee information is obtained by unauthorized persons or used inappropriately. Any such claim or proceeding, or any adverse publicity resulting from such an event, may have a material adverse effect on our business.

 

Our acquisitions may result in disruptions in our business and diversion of management’s attention.

 

We have made and may continue to make acquisitions of complementary nightclubs, restaurants or related operations. Any acquisitions will require the integration of the operations, products and personnel of the acquired businesses and the training and motivation of these individuals. Such acquisitions may disrupt our operations and divert management’s attention from day-to-day operations, which could impair our relationships with current employees, customers and partners. We may also incur debt or issue equity securities to pay for any future acquisitions. These issuances could be substantially dilutive to our stockholders. In addition, our profitability may suffer because of acquisition-related costs or amortization, or impairment costs for acquired goodwill and other intangible assets. If management is unable to fully integrate acquired business, products or persons with existing operations, we may not receive the benefits of the acquisitions, and our revenues and stock trading price may decrease.

 

The impact of new club or restaurant openings could result in fluctuations in our financial performance.

 

Performance of any new club or restaurant location will usually differ from its originally targeted performance due to a variety of factors, and these differences may be material. New clubs and restaurants typically encounter higher customer traffic and sales in their initial months, which may decrease over time. Accordingly, sales achieved by new or reconcepted locations may not be indicative of future operating results. Additionally, we incur substantial pre-opening expenses each time we open a new establishment, which expenses may be higher than anticipated. Due to the foregoing factors, results for any one fiscal quarter are not necessarily indicative of results to be expected for any other fiscal quarter or for a full fiscal year.

 

We must continue to meet NASDAQ Global Market Continued Listing Requirements, or we risk delisting.

 

Our securities are currently listed for trading on the NASDAQ Global Market. We must continue to satisfy NASDAQ’s continued listing requirements or risk delisting which would have an adverse effect on our business. If our securities are ever delisted from NASDAQ, they may trade on the over-the-counter market, which may be a less liquid market. In such case, our shareholders’ ability to trade or obtain quotations of the market value of shares of our common stock would be severely limited because of lower trading volumes and transaction delays. These factors could contribute to lower prices and larger spreads in the bid and ask prices for our securities. Additionally, we are presently not in compliance with NASDAQ Listing Rule 5250(c)(1), which requires timely filing of all required periodic financial reports with the SEC. Although we intend to regain compliance with Listing Rule 5250(c)(1) by filing all such reports as soon as practicable, there is no assurance that we will be able to maintain compliance with Listing Rule 5250(c)(1) or any of the other NASDAQ continued listing requirements.

 

 11  
   

 

We may be subject to allegations, defamations, or other detrimental conduct by third parties, which could harm our reputation and cause us to lose customers and/or contribute to a deflation of our stock price.

 

We have been subject to allegations by third parties or purported former employees, negative internet postings, and other adverse public exposure on our business, operations and staff compensation. We may also become the target of defamations or other detrimental conduct by third parties or disgruntled former or current employees. Such conduct may include complaints, anonymous or otherwise, to regulatory agencies, media or other organizations. We may be subject to government or regulatory investigation or other proceedings as a result of such third-party conduct and may be required to spend significant time and incur substantial costs to address such third-party conduct, and there is no assurance that we will be able to conclusively refute each of the allegations within a reasonable period of time, or at all. Any government or regulatory investigations initiated as a result of the above may cause a deflation in our stock price. Additionally, allegations, directly or indirectly against us, may be posted on the internet, including social media platforms by anyone, whether or not related to us, on an anonymous basis. Any negative publicity on us or our management can be quickly and widely disseminated. Social media platforms and devices immediately publish the content of their subscribers and participants post, often without filters or checks on accuracy of the content posted. Information posted may be inaccurate and adverse to us, and it may harm our reputation, business or prospects. The harm may be immediate without affording us an opportunity for redress or correction. Our reputation may be negatively affected as a result of the public dissemination of negative and potentially false information about our business and operations, which in turn may cause us to lose customers.

 

We could be subject to liability, penalties and other restrictive sanctions and adverse consequences arising out of an SEC investigation.

 

We are cooperating with an SEC investigation as discussed in Note 11 to our consolidated financial statements included in this Annual Report on Form 10-K. We cannot predict the outcome or impact of this matter, and there exists the possibility that we could be subject to liability, penalties and other restrictive sanctions and adverse consequences if the SEC or any other government agency were to pursue legal action in the future. Moreover, we expect to incur costs in responding to related requests for information and subpoenas, and if instituted, in defending against any governmental proceedings.

 

We incur significant costs as a result of operating as a public company, and our management devotes substantial time to new compliance initiatives.

 

We will incur significant legal, accounting and other expenses that our non-public competition does not incur. The Sarbanes-Oxley Act of 2002 (the “Sarbanes-Oxley Act”), as well as new rules subsequently implemented by the SEC, have imposed various requirements on public companies, including requiring certain corporate governance practices. Our management and other personnel devote a substantial amount of time to these compliance initiatives. Moreover, these rules and regulations increase our legal and financial compliance costs, and will make some activities more time-consuming and costly.

 

In addition, the Sarbanes-Oxley Act requires, among other things, that we maintain effective internal control over financial reporting and effective disclosure controls and procedures. In particular, under Section 404 of the Sarbanes-Oxley Act, we are required to perform system and process evaluation and testing on the effectiveness of our internal control over financial reporting, and our independent registered public accounting firm is required to report on the effectiveness of our internal control over financial reporting. In performing this evaluation and testing, both our management and our independent registered public accounting firm concluded that our internal control over financial reporting is not effective as of September 30, 2019 because of a material weakness. We are, however, addressing this issue and remediating our material weakness. Upon finalizing the remediation of this material weakness, we believe our internal control will be deemed effective. Correcting this issue, and thereafter our continued compliance with Section 404 will require that we incur substantial accounting expense and expend significant management efforts. Moreover, if we are not able to correct our internal control issues and comply with the requirements of Section 404 in a timely manner, or if in the future we or our independent registered public accounting firm identifies deficiencies in our internal controls over financial reporting that are deemed to be material weaknesses, the market price of our stock could decline, and we could be subject to sanctions or investigations by the SEC or other regulatory authorities, which would require additional financial and management resources.

 

 12  
   

 

We have identified a material weakness in our internal control over financial reporting

 

Management, including our Chief Executive Officer and our Chief Financial Officer, assessed the effectiveness of our internal control over financial reporting as of September 30, 2019 and concluded that we did not maintain effective internal control over financial reporting. Specifically, management identified a material weakness over financial statement close and reporting—see Item 9A, “Controls and Procedures,” below. While certain actions have been taken to implement a remediation plan to address this material weakness and to enhance our internal control over financial reporting, if this material weakness is not remediated, it could adversely affect our ability to report our financial condition and results of operations in a timely and accurate manner, which could negatively affect investor confidence in our company, and, as a result, the value of our common stock could be adversely affected.

 

Our quarterly operating results may fluctuate and could fall below the expectations of securities analysts and investors due to seasonality and other factors, some of which are beyond our control, resulting in a decline in our stock price.

 

Our nightclub operations are affected by seasonal factors. Historically, we have experienced reduced revenues from April through September with the strongest operating results occurring from October through March. As a result, our quarterly and annual operating results and comparable restaurant sales may fluctuate significantly as a result of seasonality and the factors discussed above. Accordingly, results for any one fiscal quarter are not necessarily indicative of results to be expected for any other fiscal quarter or for any fiscal year and same-store sales for any particular future period may decrease. In the future, operating results may fall below the expectations of securities analysts and investors. In that event, the price of our common stock would likely decrease.

 

We may have uninsured risks in excess of our insurance coverage.

 

We maintain insurance in amounts we consider adequate for personal injury and property damage to which the business of the Company may be subject. However, there can be no assurance that uninsured liabilities in excess of the coverage provided by insurance, which liabilities may be imposed pursuant to the Texas “dram shop” statute or similar “dram shop” statutes or common law theories of liability in other states where we operate or expand. For example, the Texas “dram shop” statute provides a person injured by an intoxicated person the right to recover damages from an establishment that wrongfully served alcoholic beverages to such person if it was apparent to the server that the individual being sold, served or provided with an alcoholic beverage was obviously intoxicated to the extent that he presented a clear danger to himself and others. An employer is not liable for the actions of its employee who over-serves if (i) the employer requires its employees to attend a seller training program approved by the TABC; (ii) the employee has actually attended such a training program; and (iii) the employer has not directly or indirectly encouraged the employee to violate the law. It is our policy to require that all servers of alcohol working at our clubs in Texas be certified as servers under a training program approved by the TABC, which certification gives statutory immunity to the sellers of alcohol from damage caused to third parties by those who have consumed alcoholic beverages at such establishment pursuant to the TABC. There can be no assurance, however, that uninsured liabilities may not arise in the markets in which we operate which could have a material adverse effect on the Company.

 

Our previous liability insurer may be unable to provide coverage to us and our subsidiaries.

 

As previously reported, the Company and its subsidiaries were insured under a liability policy issued by Indemnity Insurance Corporation, RRG (“IIC”) through October 25, 2013. The Company and its subsidiaries changed insurance companies on that date.

 

On November 7, 2013, the Court of Chancery of the State of Delaware entered a Rehabilitation and Injunction Order (“Rehabilitation Order”), which declared IIC impaired, insolvent and in an unsafe condition and placed IIC under the supervision of the Insurance Commissioner of the State of Delaware (“Commissioner”) in her capacity as receiver (“Receiver”). The Rehabilitation Order empowered the Commissioner to rehabilitate IIC through a variety of means, including gathering assets and marshaling those assets, as necessary. Further, the order stayed or abated pending lawsuits involving IIC as the insurer until May 6, 2014.

 

On April 10, 2014, the Court of Chancery of the State of Delaware entered a Liquidation and Injunction Order With Bar Date (“Liquidation Order”), which ordered the liquidation of IIC and terminated all insurance policies or contracts of insurance issued by IIC. The Liquidation Order further ordered that all claims against IIC must have been filed with the Receiver before the close of business on January 16, 2015 and that all pending lawsuits involving IIC as the insurer were further stayed or abated until October 7, 2014. As a result, the Company and its subsidiaries no longer had insurance coverage under the liability policy with IIC. The Company has retained counsel to defend against and evaluate these claims and lawsuits. We are funding 100% of the costs of litigation and will seek reimbursement from the bankruptcy receiver. The Company filed the appropriate claims against IIC with the Receiver before the January 16, 2015 deadline and has provided updates as requested; however, there are no assurances of any recovery from these claims. It is unknown at this time what effect this uncertainty will have on the Company. As previously stated, since October 25, 2013, the Company obtained general liability coverage from other insurers, which have covered and/or will cover any claims arising from actions after that date. As of September 30, 2019, we have 2 remaining unresolved claims out of the original 71 claims.

 

 13  
   

 

The protection provided by our service marks is limited.

 

Our rights to the trade names “RCI Hospitality Holdings, Inc.,” “Rick’s,” “Rick’s Cabaret,” “Tootsie’s Cabaret,” “Club Onyx,” “XTC Cabaret,” “Temptations,” “Jaguars,” “Downtown Cabaret,” “Cabaret East,” Bombshells Restaurant and Bar,” and “Vee Lounge” are established under common law, based upon our substantial and continuous use of these trade names in interstate commerce, some of which have been in use at least as early as 1987. We have registered our service mark, “RICK’S AND STARS DESIGN,” and the “BOMBSHELLS RESTAURANT & BAR” logo design with the United States Patent and Trademark Office. We have also obtained service mark registrations from the Patent and Trademark Office for “RICK’S AND STARS DESIGN” logo, “RCI HOSPITALITY HOLDINGS, INC.,” “RICKS,” “RICK’S CABARET,” “CLUB ONYX,” “XTC CABARET,” “SCARLETT’S CABARET,” “SILVER CITY CABARET,” “BOMBSHELLS RESTAURANT AND BAR”, “THE SEVILLE CLUB”, “DOWN IN TEXAS SALOON”, “CLUB DULCE”, “THE BLACK ORCHID”, “HOOPS CABARET”, “VEE LOUNGE,” “STUDIO 80”, “FOXY’S CABARET,” and “EXOTIC DANCER” are registered through service mark registrations issued by the United States Patent and Trademark Office. As of this date, we have pending registration applications for the names “TOOTSIES CABARET”, “Toys for Tatas”, “In The Biz”, “Better Flight, Better Price!” and “Bombshells Officer’s Club”. We also own the rights to numerous trade names associated with our media division. There can be no assurance that the steps we have taken to protect our service marks will be adequate to deter misappropriation of our protected intellectual property rights. Litigation may be necessary in the future to protect our rights from infringement, which may be costly and time consuming. The loss of the intellectual property rights owned or claimed by us could have a material adverse effect on our business.

 

Anti-takeover effects of the issuance of our preferred stock could adversely affect our common stock.

 

Our Board of Directors has the authority to issue up to 1,000,000 shares of preferred stock in one or more series, to fix the number of shares constituting any such series, and to fix the rights and preferences of the shares constituting any series, without any further vote or action by the stockholders. The issuance of preferred stock by the Board of Directors could adversely affect the rights of the holders of our common stock. For example, such issuance could result in a class of securities outstanding that would have preferences with respect to voting rights and dividends and in liquidation over the common stock, and could (upon conversion or otherwise) enjoy all of the rights appurtenant to common stock. The Board’s authority to issue preferred stock could discourage potential takeover attempts and could delay or prevent a change in control of the Company through merger, tender offer, proxy contest or otherwise by making such attempts more difficult to achieve or costlier. There are no issued and outstanding shares of preferred stock; there are no agreements or understandings for the issuance of preferred stock; and the Board of Directors has no present intention to issue preferred stock.

 

Future sales or the perception of future sales of a substantial amount of our common stock may depress our stock price.

 

The market price of our common stock could decline as a result of sales of substantial amounts of our common stock in the public market, or as a result of the perception that these sales could occur. In addition, these factors could make it more difficult for us to raise funds through future offerings of common stock.

 

 14  
   

 

Our stock price has been volatile and may fluctuate in the future.

 

The trading price of our securities may fluctuate significantly. This price may be influenced by many factors, including:

 

  our performance and prospects;
     
  the depth and liquidity of the market for our securities;
     
  investor perception of us and the industry in which we operate;
     
  changes in earnings estimates or buy/sell recommendations by analysts;
     
  general financial and other market conditions; and
     
  domestic economic conditions.

 

Public stock markets have experienced, and may experience, extreme price and trading volume volatility. These broad market fluctuations may adversely affect the market price of our securities.

 

We are dependent on key personnel.

 

Our future success is dependent, in a large part, on retaining the services of Eric Langan, our President and Chief Executive Officer. Mr. Langan possesses a unique and comprehensive knowledge of our industry. While Mr. Langan has no present plans to leave or retire in the near future, his loss could have a negative effect on our operating, marketing and financial performance if we are unable to find an adequate replacement with similar knowledge and experience within our industry. We maintain key-man life insurance with respect to Mr. Langan. Mr. Langan’s employment agreement recently expired. Although we are presently in the process of negotiating a new employment agreement with Mr. Langan, there can be no assurance that Mr. Langan will continue to be employed by us.

 

Cumulative voting is not available to our stockholders.

 

Cumulative voting in the election of Directors is expressly denied in our Articles of Incorporation. Accordingly, the holder or holders of a majority of the outstanding shares of our common stock may elect all of our Directors.

 

Our directors and officers have limited liability and have rights to indemnification.

 

Our Articles of Incorporation and Bylaws provide, as permitted by governing Texas law, that our directors and officers shall not be personally liable to us or any of our stockholders for monetary damages for breach of fiduciary duty as a director or officer, with certain exceptions. The Articles further provide that we will indemnify our directors and officers against expenses and liabilities they incur to defend, settle, or satisfy any civil litigation or criminal action brought against them on account of their being or having been its directors or officers unless, in such action, they are adjudged to have acted with gross negligence or willful misconduct.

 

The inclusion of these provisions in the Articles may have the effect of reducing the likelihood of derivative litigation against directors and officers and may discourage or deter stockholders or management from bringing a lawsuit against directors and officers for breach of their duty of care, even though such an action, if successful, might otherwise have benefited us and our stockholders.

 

 15  
   

 

The Articles provide for the indemnification of our officers and directors, and the advancement to them of expenses in connection with any proceedings and claims, to the fullest extent permitted by Texas law. The Articles include related provisions meant to facilitate the indemnitee’s receipt of such benefits. These provisions cover, among other things: (i) specification of the method of determining entitlement to indemnification and the selection of independent counsel that will in some cases make such determination, (ii) specification of certain time periods by which certain payments or determinations must be made and actions must be taken, and (iii) the establishment of certain presumptions in favor of an indemnitee.

 

Insofar as indemnification for liabilities arising under the Securities Act may be permitted to our directors, officers and controlling persons pursuant to the foregoing provisions, we have been advised that in the opinion of the Securities and Exchange Commission, such indemnification is against public policy as expressed in the Securities Act and is therefore unenforceable.

 

A failure to maintain food safety throughout the supply chain and food-borne illness concerns may have an adverse effect on our business.

 

Food safety is a top priority, and we dedicate substantial resources to ensuring that our guests enjoy safe, quality food products. However, food safety issues could be caused at the point of source or by food suppliers or distributors and, as a result, be out of our control. In addition, regardless of the source or cause, any report of food-borne illnesses such as E. coli, hepatitis A, trichinosis or salmonella, and other food safety issues including food tampering or contamination, at one of our restaurants or clubs could adversely affect the reputation of our brands and have a negative impact on our sales. Even instances of food-borne illness, food tampering or food contamination occurring solely at restaurants of our competitors could result in negative publicity about the food service industry generally and adversely impact our sales. The occurrence of food-borne illnesses or food safety issues could also adversely affect the price and availability of affected ingredients, resulting in higher costs and lower margins.

 

Other risk factors may adversely affect our financial performance.

 

Other risk factors that could cause our actual results to differ materially from those indicated in the forward-looking statements by affecting, among many things, pricing, consumer spending and consumer confidence, include, without limitation, changes in economic conditions and financial and credit markets, credit availability, increased fuel costs and availability for our employees, customers and suppliers, health epidemics or pandemics or the prospects of these events (such as reports on avian flu), consumer perceptions of food safety, changes in consumer tastes and behaviors, governmental monetary policies, changes in demographic trends, terrorist acts, energy shortages and rolling blackouts, and weather (including, major hurricanes and regional snow storms) and other acts of God.

 

Item 1B. Unresolved Staff Comments.

 

None.

 

Item 2. Properties.

 

As of September 30, 2019, we own 48 real estate properties. On 35 of these properties, we operate clubs or restaurants. We lease multiple other properties to third-party tenants. Three of our owned properties are in locations where we previously operated clubs, but now lease the buildings to third parties. Five are non-income-producing properties for corporate use, including our corporate office. We have two properties that are under construction for future Bombshells sites (one opened in October 2019 and the other opened in January 2020), with one adjacent property that may be offered for sale in the future. Eleven of our clubs and restaurants are in leased locations.

 

Our principal corporate office is located at 10737 Cutten Road, Houston, Texas 77066, consisting of a 21,000-square foot corporate office and an 18,000-square foot warehouse facility.

 

 16  
   

 

Below is a list of locations we operated as of September 30, 2019:

 

Name of Establishment   Fiscal Year Acquired/Opened 
Club Onyx, Houston, TX   1995 
Rick’s Cabaret, Minneapolis, MN   1998 
XTC Cabaret, Austin, TX   1998 
XTC Cabaret, San Antonio, TX   1998 
Rick’s Cabaret, New York City, NY   2005 
Club Onyx, Charlotte, NC   2005(1)
Rick’s Cabaret, San Antonio, TX   2006 
XTC Cabaret, South Houston   2006(1)
Rick’s Cabaret, Fort Worth, TX   2007 
Tootsie’s Cabaret, Miami Gardens, FL   2008 
XTC Cabaret, Dallas, TX   2008 
Rick’s Cabaret, Round Rock, TX   2009 
Cabaret East, Fort Worth, TX   2010 
Rick’s Cabaret DFW, Fort Worth, TX   2011 
Downtown Cabaret, Minneapolis, MN   2011 
Temptations, Aledo, TX   2011(1)
Silver City Cabaret, Dallas, TX   2012 
Jaguars Club, Odessa, TX   2012 
Jaguars Club, Phoenix, AZ   2012 
Jaguars Club, Lubbock, TX   2012 
Jaguars Club, Longview, TX   2012 
Jaguars Club, Tye, TX   2012 
Jaguars Club, Edinburg, TX   2012 
Jaguars Club, El Paso, TX   2012 
Jaguars Club, Harlingen, TX   2012 
Studio 80, Fort Worth, TX   2013(1)
Bombshells, Dallas, TX   2013 
Temptations, Sulphur, LA   2013 
Temptations, Beaumont, TX   2013 
Vivid Cabaret, New York, NY   2014(1)
Bombshells, Austin, TX   2014(1)
Rick’s Cabaret, Odessa, TX   2014 
Bombshells, Spring TX   2014(1)
Bombshells, Houston, TX   2014(1)
Foxy’s Cabaret, Austin TX   2015 
The Seville, Minneapolis, MN   2015 
Hoops Cabaret and Sports Bar, New York, NY   2016(1)
Bombshells, Highway 290 Houston, TX   2017(1)
Scarlett’s Cabaret, Washington Park, IL   2017(2)
Scarlett’s Cabaret, Miami, FL   2017(1)
Bombshells, Pearland, TX   2018 
Kappa Men’s Club, Kappa, IL   2018 
Rick’s Cabaret, Chicago, IL   2019 
Rick’s Cabaret, Pittsburgh, PA   2019 
Bombshells I-10, Houston, TX   2019 
Bombshells 249, Houston, TX   2019 

 

(1) Leased location.
(2) This location was temporarily closed due to a fire and reopened in November 2019.

 

Our property leases are typically for a fixed rental rate without revenue percentage rentals. The lease terms generally have initial terms of 10 to 20 years with renewal terms of 5 to 20 years. At September 30, 2019, certain of our owned properties were collateral for mortgage debt amounting to approximately $91.2 million. Also, see more information in Notes 6, 9 and 11 to our consolidated financial statements.

 

Item 3. Legal Proceedings.

 

See the “Legal Matters” section within Note 11 to our consolidated financial statements within this Annual Report on Form 10-K for the requirements of this Item, which section is incorporated herein by reference.

 

Item 4. Mine Safety Disclosures.

 

Not applicable.

 

 17  
   

 

PART II

 

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

 

Our common stock is quoted on the NASDAQ Global Market under the symbol “RICK.”

 

Holders

 

On February 6, 2020, the closing stock price for our common stock as reported by NASDAQ was $18.00, and there were approximately 150 stockholders of record of our common stock (excluding broker held shares in “street name”). Currently, we estimate that there are approximately 5,900 stockholders having beneficial ownership in street name.

 

Transfer Agent and Registrar

 

The transfer agent and registrar for our common stock is Colonial Stock Transfer Company, Inc., 66 Exchange Place, 1st Floor, Salt Lake City, Utah 84111.

 

Dividend Policy

 

Prior to 2016, we had not paid cash dividends on our common stock. Starting in March 2016, in conjunction with our share buyback program (see discussion below), our Board of Directors has declared regular quarterly cash dividends of $0.03 per share, except for the fourth quarter of fiscal 2019 when we paid $0.04 per share. During fiscal 2019, 2018, and 2017, we paid an aggregate amount of $1.3 million, $1.2 million, and $1.2 million, respectively, for cash dividends.

 

Purchases of Equity Securities by the Issuer

 

Following is a summary of our purchases during the quarter ended September 30, 2019:

 

Period  Total Number of Shares (or Units) Purchased   Average Price Paid per Share (or Unit)(1)   Total Number of Shares (or Units) Purchased as Part of Publicly Announced Plans or Programs(2)   Maximum Number (or Approximate Dollar Value) of Shares (or Units) That May Yet be Purchased Under the Plans or Programs 
July 1-31, 2019   -         -   $10,776,929 
August 1-31, 2019   -         -   $10,776,929 
September 1-30, 2019   25,927   $20.74    25,927   $10,239,283 
Total   25,927   $20.74    25,927      

 

  (1) Prices include any commissions and transaction costs.
     
  (2) All shares were purchased pursuant to the repurchase plans approved by the Board of Directors.

 

Subsequent to September 30, 2019 through the filing date of this report, we purchased 332,671 shares of the Company’s common stock for a total of $6.4 million. On February 6, 2020, the Board of Directors increased the repurchase authorization by an additional $10.0 million.

 

 18  
   

 

Equity Compensation Plan Information

 

We have no stock options nor any other equity award outstanding under equity compensation plans as of September 30, 2019.

 

Equity Compensation Plan Information
   (a)   (b)   (c) 
           Number of Securities 
       Weighted-   Remaining Available 
       Average   for Future Issuance 
   Number of Securities   Exercise Price   Under Equity 
   to be Issued Upon   of Outstanding   Compensation 
   Exercise of   Options,   Plans [Excluding 
   Outstanding Options,   Warrants and   Securities Reflected 
Plan Category  Warrants and Rights   Rights   in Column (a)] 
             
Equity compensation plans approved by security holders       -          -    429,435(1)
                
Equity compensation plans not approved by security holders   -    -    - 
                
Total   -    -    429,435 

 

(1) Includes shares that may be granted in the form of either incentive stock options or non-qualified stock options under the 2010 Stock Option Plan (the “2010 Plan”). The 2010 Plan is administered by the Board of Directors or by a compensation committee of the Board of Directors. The Board of Directors has the exclusive power to select individuals to receive grants, to establish the terms of the options granted to each participant, provided that all options granted shall be granted at an exercise price not less than the fair market value of the common stock covered by the option on the grant date and to make all determinations necessary or advisable under the 2010 Plan.

 

Stock Performance Graph

 

The following chart compares the 5-year cumulative total stock performance of our common stock; the NASDAQ Composite Index (IXIC); and the Dow Jones U.S. Restaurant & Bar Index (DJUSRU), our peer index. The graph assumes a hypothetical investment of $100 on September 30, 2014 in each of our common stock and each of the indices, and that all dividends were reinvested. The measurement points utilized in the graph consist of the last trading day as of September 30 each year, representing the last day of our fiscal year. The calculations exclude trading commissions and taxes. We have selected the Dow Jones U.S. Restaurant & Bar Index as our peer index since it represents a broader group of restaurant and bar operators that are more aligned to our core business operations. RICK is a component of the NASDAQ Composite Index. The historical stock performance presented below is not intended to and may not be indicative of future stock performance.

 

 

 19  
   

 

Item 6. Selected Financial Data.

 

The following tables set forth certain of the Company’s historical financial data. The selected historical consolidated financial position data as of September 30, 2019 and 2018 (as revised) and results of operations data for the years ended September 30, 2019, 2018 (as revised), and 2017 have been derived from the Company’s audited consolidated financial statements and related notes included elsewhere in this Annual Report on Form 10-K. The selected historical consolidated financial data as of September 30, 2017, 2016, and 2015 and for the years ended September 30, 2016 and 2015 have been derived from the Company’s audited financial statements for such years, which are not included in this Annual Report on Form 10-K. The selected historical consolidated financial data set forth are not necessarily indicative of the results of future operations and should be read in conjunction with the discussion under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and the historical consolidated financial statements and accompanying notes included herein to enhance understanding of these data (in thousands, except per share data and percentages).

 

Financial Statement Data:

 

   Years Ended September 30, 
   2019   2018   2017   2016   2015 
Revenue  $181,059   $165,748   $144,896   $134,860   $135,449 
Income from operations(2)  $34,701   $27,562   $23,139   $20,693   $20,727 
Operating margin   19.2%   16.6%   16.0%   15.3%   15.3%
Net income attributable to RCIHH(2)  $19,175   $20,879   $8,259   $11,218   $9,214 
Diluted earnings per share(2)  $1.99   $2.15   $0.85   $1.11   $0.89 
Capital expenditures  $21,184   $25,263   $11,249   $28,148   $19,259 
Dividends declared per share  $0.13   $0.12   $0.12   $0.09   $- 

 

   September 30, 
   2019   2018   2017   2016   2015 
Cash and cash equivalents  $14,097   $17,726   $9,922   $11,327   $8,020 
Total current assets  $34,771   $36,802   $26,242   $29,387   $16,935 
Total assets(2)  $353,637   $329,732   $299,884   $276,061   $266,527 
Total current liabilities (excluding current portion of long-term debt)  $18,454   $14,798   $13,671   $17,087   $15,580 
Long-term debt (including current portion)  $143,528   $140,627   $124,352   $105,886   $94,349 
Total liabilities  $185,336   $176,400   $164,659   $146,722   $138,973 
Total RCIHH stockholders’ equity(2)  $168,457   $153,435   $132,745   $126,755   $121,691 
Common shares outstanding   9,591    9,719    9,719    9,808    10,285 

 

Non-GAAP Measures and Other Data:

 

   Years Ended September 30, 
   2019   2018   2017   2016   2015 
Adjusted EBITDA(1)  $46,242   $44,387   $37,348   $34,531   $34,125 
Non-GAAP operating income(1)  $37,945   $37,000   $30,668   $27,566   $27,974 
Non-GAAP operating margin(1)   21.0%   22.3%   21.2%   20.4%   20.7%
Non-GAAP net income(1)  $22,287   $21,160   $13,953   $13,302   $13,873 
Non-GAAP diluted net income per share(1)  $2.31   $2.18   $1.43   $1.32   $1.34 
Free cash flow(1)  $33,316   $23,242   $19,281   $20,513   $14,889 
Same-store sales   -0.3%   4.6%   4.9%   -1.3%   -1.5%

 

(1) Reconciliation and discussion of non-GAAP financial measures are included under the “Non-GAAP Financial Measures” section of Item 7 – “Management’s Discussion and Analysis of Financial Condition and Results of Operations” that follows. These measures should be considered in addition to, rather than as a substitute for, U.S. GAAP measures. Certain line items in the fiscal 2018 “Non-GAAP Financial Measures” section have been revised, as affected by (2) below.
   
(2) We revised the consolidated balance sheet as of September 30, 2018 and the consolidated statements of income and cash flows for the year ended September 30, 2018 due to certain misstatements in our goodwill impairment testing. See Note 3 to our consolidated financial statements.

 

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

OVERVIEW

 

The following Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) is intended to help the reader understand RCI Hospitality Holdings, Inc., our operations and our present business environment. MD&A is provided as a supplement to, and should be read in conjunction with, our consolidated financial statements and the accompanying notes thereto contained in Item 8 – “Financial Statements and Supplementary Data” of this report. This overview summarizes the MD&A, which includes the following sections:

 

  Our Business — a general description of our business and the adult nightclub industry, our objective, our strategic priorities, our core capabilities, and challenges and risks of our business.
     
  Critical Accounting Policies and Estimates — a discussion of accounting policies that require critical judgments and estimates.
     
  Operations Review — an analysis of our Company’s consolidated results of operations for the three years presented in our consolidated financial statements.
     
  Liquidity and Capital Resources — an analysis of cash flows, aggregate contractual obligations, and an overview of financial position.

 

OUR BUSINESS

 

The following are our operating segments:

 

Nightclubs Our wholly-owned subsidiaries own and/or operate upscale adult nightclubs serving primarily businessmen and professionals. These nightclubs are in Houston, Austin, San Antonio, Dallas, Fort Worth, Beaumont, Longview, Harlingen, Edinburg, Abilene, Lubbock, El Paso and Odessa, Texas; Charlotte, North Carolina; Minneapolis, Minnesota; New York, New York; Miami Gardens and Pembroke Park, Florida; Pittsburgh, Pennsylvania; Phoenix, Arizona; and Washington Park, Kappa and Chicago, Illinois. No sexual contact is permitted at any of our locations. We also own and operate a Studio 80 dance club in Fort Worth, Texas. We also own and lease to third parties real properties that are adjacent to (or used to be locations of) our clubs.
   
Bombshells Our wholly-owned subsidiaries own and operate restaurants and sports bars in Houston, Dallas, Austin, Spring and Pearland, Texas under the brand name Bombshells Restaurant & Bar.
   
Other

Our wholly-owned subsidiaries own a media division (“Media Group”), including the leading trade magazine serving the multibillion-dollar adult nightclubs industry and the adult retail products industry. We also own an industry trade show, an industry trade publication and more than a dozen industry and social media websites. Included here is Drink Robust, which is licensed to sell Robust Energy Drink in the United States.

 

Our revenues are derived from the sale of liquor, beer, wine, food, merchandise; service revenues such as cover charges, membership fees, and facility use fees; and other revenues such as commissions from vending and ATM machines, real estate rental, valet parking, and other products and services for both nightclub and restaurant/sports bar operations. Other revenues include Media Group revenues for the sale of advertising content and revenues from our annual Expo convention, and Drink Robust sales. Our fiscal year-end is September 30.

 

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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.

 

Our goal is to use our Company’s assets—our brands, financial strength, and the talent and strong commitment of our management and employees—to become more competitive and to accelerate growth.

 

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

 

Management’s discussion and analysis of financial condition and results of operations are based upon our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”). The preparation of these consolidated financial statements requires our management to make assumptions and estimates about future events and apply judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. These estimates are based on management’s historical and industry experience and on various other assumptions that are believed to be reasonable under the circumstances. On a regular basis, we evaluate these accounting policies, assumptions, estimates and judgments to ensure that our financial statements are presented fairly and in accordance with GAAP. However, because future events and their effects cannot be determined with certainty, actual results may differ from our estimates, and such differences could be material.

 

A full discussion of our significant accounting policies is contained in Note 2 to our consolidated financial statements, which is included in Item 8 – “Financial Statements and Supplementary Data” of this report. We believe that the following accounting estimates are the most critical to aid in fully understanding and evaluating our financial results. These estimates require our most difficult, subjective or complex judgments because they relate to matters that are inherently uncertain. We have reviewed these critical accounting policies and estimates and related disclosures with our Audit Committee.

 

Long-Lived Assets

 

We review long-lived assets, such as property and equipment, and intangible assets subject to amortization, for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset or asset group may not be recoverable. These events or changes in circumstances include, but are not limited to, significant underperformance relative to historical or projected future operating results, significant changes in the manner of use of the acquired assets or the strategy for the overall business, and significant negative industry or economic trends. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of the asset group to the estimated undiscounted cash flows over the estimated remaining useful life of the primary asset included in the asset group. If the asset group is not recoverable, the impairment loss is calculated as the excess of the carrying value over the fair value. We define our asset group as an operating club or restaurant location, which is also our reporting unit or the lowest level for which cash flows can be identified. Key estimates in the undiscounted cash flow model include management’s estimate of the projected revenues and operating margins. If fair value is used to determine an impairment loss, an additional key assumption is the selection of a weighted-average cost of capital to discount cash flows. Assets to be disposed of are separately presented in the balance sheet and reported at the lower of the carrying amount or fair value less costs to sell and are no longer depreciated. During the fourth quarter of 2019, we impaired two clubs for a total of $4.2 million; during the fourth quarter of 2018, we impaired one club and one Bombshells by a total of $1.6 million; and during the fourth quarter of fiscal 2017, we impaired one club by $385,000.

 

Goodwill and Other Intangible Assets

 

Goodwill and other intangible assets that have indefinite useful lives are tested annually for impairment during our fourth fiscal quarter, and are tested for impairment more frequently if events and circumstances indicate that the asset might be impaired.

 

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Our impairment calculations require management to make assumptions and to apply judgment in order to estimate fair values. If our actual results are not consistent with our estimates and assumptions, we may be exposed to impairments that could be material. We do not believe that there is a reasonable likelihood that there will be a change in the estimates or assumptions we used that could cause a material change in our calculated impairment charges.

 

For our goodwill impairment review, we have the option to first perform a qualitative assessment to determine if it is more likely than not that the fair value of the reporting unit is less than its carrying value. This assessment is based on several factors, including industry and market conditions, overall financial performance, including an assessment of cash flows in comparison to actual and projected results of prior periods. If it is determined that it is more likely than not that the fair value of a reporting unit is less than its carrying value based on our qualitative analysis, or if we elect to skip this step, we perform a Step 1 quantitative analysis to determine the fair value of the reporting unit. The fair value is determined using market-related valuation models, including earnings multiples, discounted cash flows, and comparable asset market values. Key estimates in the discounted cash flow model include management’s estimate of the projected revenues and operating margins, along with the selection of a weighted-average cost of capital to discount cash flows. We recognize goodwill impairment in the amount that the carrying value of the reporting unit exceeds the fair value of the reporting unit, not to exceed the amount of goodwill allocated to the reporting unit, based on the results of our Step 1 analysis. For the year ended September 30, 2019, we identified four reporting units that were impaired and recognized a goodwill impairment loss totaling $1.6 million. For the year ended September 30, 2018, we identified two reporting units that were impaired and recognized a goodwill impairment loss totaling $834,000. For the year ended September 30, 2017, we identified four reporting units that were impaired and recognized a goodwill impairment loss totaling $4.7 million.

 

For indefinite-lived intangibles, specifically SOB licenses, we determine fair value by estimating the multiperiod excess earnings of the asset with key assumptions being similar to those used in the goodwill impairment valuation model. For indefinite-lived tradename, we determine fair value by using the relief from royalty method. The fair value is then compared to the carrying value and an impairment charge is recognized by the amount by which the carrying amount exceeds the fair value of the asset. We recorded impairment charges for SOB licenses amounting to $178,000 in 2019 related to one club, $3.1 million in 2018 related to three clubs, and $1.4 million in 2017 related to two clubs.

 

Investment

 

During the fourth quarter of fiscal 2017, we also fully impaired our remaining investment in Drink Robust amounting to $1.2 million. Available-for-sale investments are carried at fair value with the unrealized gain or loss recorded in other comprehensive income until our adoption of Accounting Standards Update No. 2016-01 on October 1, 2018, at which the change in fair value is recorded in current earnings. See Note 2 to our consolidated financial statements.

 

Income Taxes

 

We estimate certain components of our provision for income taxes. These estimates include depreciation and amortization expense allowable for tax purposes, allowable tax credits for items such as taxes paid on employee tip income, effective rates for state and local income taxes, and the deductibility of certain other items, among others. We adjust our annual effective income tax rate as additional information on outcomes or events becomes available.

 

On December 22, 2017, the Tax Act was signed into law. The Tax Act contains significant changes to corporate taxation, including reduction of the corporate tax rate from 35% to 21%, additional limitations on the tax deductibility of interest, immediate deductions for certain new investments instead of deductions for depreciation expense over time, and modification or repeal of many business deductions and credits. Our federal corporate income tax rate for fiscal 2018 was 24.5% percent and represents a blended income tax rate for the current fiscal year. For fiscal 2019, our federal corporate income tax rate was 21%.

 

Legal and Other Contingencies

 

As mentioned in Item 3 – “Legal Proceedings” and in a more detailed discussion in Note 11 to our consolidated financial statements, we are involved in various suits and claims in the normal course of business. We record a liability when it is probable that a loss has been incurred and the amount is reasonably estimable. There is significant judgment required in both the probability determination and as to whether an exposure can be reasonably estimated. In the opinion of management, there was not at least a reasonable possibility that we may have incurred a material loss, or a material loss in excess of a recorded accrual, with respect to loss contingencies for asserted legal and other claims. However, the outcome of legal proceedings and claims brought against the Company is subject to significant uncertainty. Therefore, although management considers the likelihood of such an outcome to be remote, if one or more of these legal matters were resolved against the Company in a reporting period for amounts in excess of management’s expectations, the Company’s consolidated financial statements for that reporting period could be materially adversely affected. In matters where there is insurance coverage, in the event we incur any liability, we believe it is unlikely we would incur losses in connection with these claims in excess of our insurance coverage.

 

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OPERATIONS REVIEW

 

Highlights of operations from fiscal 2019 compared to fiscal 2018 (with fiscal 2017 comparative data) are as follows:

 

  Revenues of $181.1 million compared to $165.7 million, a 9.2% increase

 

  Nightclubs revenue of $148.6 million compared to $140.1 million in 2018, a 6.1% increase
     
  Bombshells revenue of $30.8 million compared to $24.1 million in 2018, a 27.9% increase
     
  Fiscal 2017 total revenues of $144.9 million (Nightclubs revenue of $124.7 million and Bombshells revenue of $18.8 million)

 

  Consolidated same-store sales decrease of 0.3% (0.6% increase for Nightclubs and 6.1% decrease for Bombshells)

 

 

Consolidated, Nightclubs and Bombshells same-store sales in 2018 (compared to 2017) of +4.6%, +5.8% and -3.3%, respectively

     
 

Consolidated, Nightclubs and Bombshells same-store sales in 2017 (compared to 2016) of +4.9%, +5.1% and +3.5%, respectively

 

  Diluted earnings per share (“EPS”) of $1.99 compared to $2.15, a 7.4% decrease (non-GAAP diluted EPS* of $2.31 compared to $2.18, a 6.0% increase) (diluted EPS of $0.85 and non-GAAP diluted EPS of $1.43 in fiscal 2017)
     
 

Free cash flow* of $33.3 million compared to $23.2 million, a 43.3% increase ($19.3 million in fiscal 2017)

 

* Reconciliation and discussion of non-GAAP financial measures are included under the “Non-GAAP Financial Measures” section of this Item. These measures should be considered in addition to, rather than as a substitute for, U.S. GAAP measures.

 

The following common size tables present a comparison of our results of operations as a percentage of total revenues for the past three fiscal years:

 

   2019   2018   2017 
       (As Revised)     
Revenues               
Sales of alcoholic beverages   41.5%   41.7%   41.7%
Sales of food and merchandise   14.3%   13.5%   12.6%
Service revenues   37.6%   38.7%   40.1%
Other   6.6%   6.1%   5.6%
Total revenues   100.0%   100.0%   100.0%
Cost of goods sold               
Alcoholic beverages   20.4%   20.7%   21.7%
Food and merchandise   35.1%   36.3%   40.5%
Service and other   0.7%   0.6%   0.3%
Total cost of goods sold (exclusive of items shown separately below)   13.8%   13.8%   14.3%
Salaries and wages   27.5%   26.9%   27.6%
Selling, general and administrative   33.1%   32.5%   32.3%
Depreciation and amortization   5.0%   4.7%   4.8%
Other charges, net   1.4%   5.5%   5.0%
Total operating expenses   80.8%   83.4%   84.0%
Income from operations   19.2%   16.6%   16.0%
Other income (expenses)               
Interest expense   -5.6%   -6.0%   -6.0%
Interest income   0.2%   0.1%   0.2%
Unrealized loss on equity securities   -0.3%   -    - 
Income before income taxes   13.4%   10.8%   10.1%
Income tax expense (benefit)   2.7%   -1.9%   4.4%
Net income   10.7%   12.6%   5.7%

 

Percentages may not foot due to rounding. Percentage of revenue for individual cost of goods sold items pertains to their respective revenue line.

 

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Below is a table presenting the changes in each line item of the income statement for the last three fiscal years (dollar amounts in thousands)

 

   Increase (Decrease) 
   2019 vs. 2018   2018 vs. 2017 
   Amount   %   Amount   % 
           (As Revised)     
Sales of alcoholic beverages  $6,020    8.7%  $8,681    14.4%
Sales of food and merchandise   3,397    15.1%   4,177    22.9%
Service revenues   3,951    6.2%   5,972    10.3%
Other   1,943    19.3%   2,022    25.1%
Total revenues   15,311    9.2%   20,852    14.4%
                     
Cost of goods sold                    
Alcoholic beverages   976    6.8%   1,213    9.2%
Food and merchandise   923    11.3%   735    9.9%
Service and other   129    28.7%   240    114.8%
Total cost of goods sold (exclusive of items shown separately below)   2,028    8.9%   2,188    10.6%
Salaries and wages   5,286    11.9%   4,518    11.3%
Selling, general and administrative   6,072    11.3%   7,049    15.1%
Depreciation and amortization   1,350    17.5%   802    11.6%
Other charges, net   (6,564)   -71.5%   1,872    25.6%
Total operating expenses   8,172    5.9%   16,429    13.5%
Income from operations   7,139    25.9%   4,423    19.1%
Other income/expenses                    
Interest expense   255    2.6%   1,190    13.6%
Interest income   75    32.1%   (32)   -12.0%
Unrealized loss on equity securities   612    100.0%   -    0.0%
Income before income taxes   6,347    35.6%   3,201    21.9%
Income tax expense/benefit   7,981    256.0%   (9,477)   -149.0%
Net income  $(1,634)   -7.8%  $12,678    153.1%

 

Revenues

 

Consolidated revenues increased by $15.3 million, or 9.2%, from 2018 to 2019, and increased by $20.9 million, or 14.4%, from 2017 to 2018. The increase from 2018 to 2019 was mainly due to a 10.9% increase from newly acquired or constructed units and a 0.3% increase in other revenues, partially offset by a 1.7% decrease from closed units and the impact of the 0.3% decline in same-store sales. The increase from 2017 to 2018 was primarily due to 11.5% in newly acquired or constructed or reconcepted locations, the impact of the 4.6% increase in consolidated same-store sales, and a minimal increase in other revenues, partially offset by a 1.8% decrease from closed locations.

 

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By reportable segment, revenues were as follows (in thousands):

 

   2019   2018   2017 
             
Nightclubs  $148,606   $140,060   $124,687 
Bombshells   30,828    24,094    18,830 
Other   1,625    1,594    1,379 
   $181,059   $165,748   $144,896 

 

Nightclubs segment revenues. Nightclubs revenues increased by 6.1% and 12.3% from 2018 to 2019 and from 2017 to 2018, respectively. A breakdown of the changes compared to total change in Nightclubs revenues is as follows:

 

   2019 vs. 2018   2018 vs. 2017 
Impact of 0.6% and 5.8% increase in same-store sales, respectively, to total revenues   0.5%   5.6%
Newly acquired and reconcepted units   7.4%   8.5%
Closed units   (2.1)%   (1.8)%
Other   0.4%   0.1%
    6.1%   12.3%

 

By type of revenue line item, changes in Nightclubs segment revenue dollars are broken down as:

 

   2019 vs. 2018   2018 vs. 2017 
Sales of alcoholic beverages   4.5%   12.6%
Sales of food and merchandise   2.5%   12.2%
Service revenues   6.0%   10.4%
Other   22.6%   27.0%

 

Nightclubs segment sales mix did not change much through the three fiscal years:

 

   2019   2018   2017 
             
Sales of alcoholic beverages   38.5%   39.1%   39.0%
Sales of food and merchandise   8.8%   9.1%   9.1%
Service revenues   45.7%   45.7%   46.5%
Other   7.0%   6.1%   5.4%
    100.0%   100.0%   100.0%

 

Included in the 2019 new units are Rick’s Cabaret Chicago and Rick’s Cabaret Pittsburgh, which were acquired in November 2018 (see Note 15 to our consolidated financial statements) and contributed $5.0 million and $4.6 million in revenues for 2019 since acquisition date. Included in the 2018 new units is Kappa Men’s Club, which was acquired in May 2018.

 

Included in other revenues of the Nightclubs segment is real estate rental revenue amounting to $1.7 million in 2019, $1.2 million in 2018, and $1.1 million in 2017.

 

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Bombshells segment revenues. Bombshells revenues increased by 27.9% from 2018 to 2019 and by 28.0% from 2017 to 2018. A breakdown of the changes compared to total changes in Bombshells revenues is as follows:

 

   2019 vs. 2018   2018 vs. 2017 
Impact of 6.1% and 3.3% decrease in same-store sales, respectively, to total revenues   (5.1)%   (3.2)%
New units   32.4%   32.5%
Closed units   0.6%   (1.4)%
    27.9%   28.0%

 

By type of revenue line item, changes in Bombshells segment revenues are broken down as:

 

   2019 vs. 2018   2018 vs. 2017 
Sales of alcoholic beverages   24.7%   21.5%
Sales of food and merchandise   31.7%   40.4%
Service revenues   224.0%   (58.0)%
Other   4.3%   35.3%

 

Bombshells segment sales mix for the three fiscal years is as follows:

 

   2019   2018   2017 
             
Sales of alcoholic beverages   57.9%   59.4%   62.6%
Sales of food and merchandise   41.5%   40.3%   36.7%
Service revenues   0.5%   0.2%   0.6%
Other   0.1%   0.1%   0.1%
    100.0%   100.0%   100.0%

 

Bombshells 290 was opened early in the fourth quarter of 2017. Bombshells Pearland was opened in the third quarter of 2018. Bombshells I-10 was opened in the first quarter of 2019, while Bombshells 249 was opened in the second quarter of 2019.

 

Other segment revenues. Other revenues included revenues from Drink Robust in 2019 and 2018. After a brief period when a majority of our interest in Drink Robust was sold, we later reacquired Drink Robust in March 2018 (see Note 15 to our consolidated financial statements). Drink Robust sales were $231,000, $141,000, and $0 in fiscal 2019, 2018, and 2017, respectively, which excludes intercompany sales to Nightclubs and Bombshells units. Media business revenues were $1.4 million, $1.4 million, and $1.2 million in fiscal 2019, 2018, and 2017, respectively.

 

Operating Expenses

 

Total operating expenses, as a percent of revenues, were 80.8%, 83.4%, and 84.0% for the fiscal year 2019, 2018, and 2017, respectively. Significant contributors to the change in operating expenses as a percent of revenues are explained below.

 

Cost of goods sold includes cost of alcoholic and non-alcoholic beverages, food, cigars and cigarettes, merchandise, media printing/binding and media. As a percentage of consolidated revenues, consolidated cost of goods sold was 13.8%, 13.8%, and 14.3% for fiscal 2019, 2018, and 2017, respectively. See above for breakdown of percentages for each line item of consolidated cost of goods sold as it relates to the respective consolidated revenue line. For the Nightclubs segment, cost of goods sold was 11.2%, 11.8%, and 12.7% for fiscal 2019, 2018, and 2017, respectively, which was primarily caused by sales mix shifting over to high-margin revenues. Bombshells cost of goods sold of 25.3%, 24.7%, and 24.8% for fiscal 2019, 2018, and 2017, respectively, which was mainly driven by food cost inflation.

 

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Consolidated salaries and wages increased by $5.3 million, or 11.9%, from 2018 to 2019 and by $4.5 million, or 11.3%, from 2017 to 2018. The dollar increase from 2018 to 2019 primarily came from newly opened units plus the impact of pre-opening salaries and wages on still under-construction Bombshells units. The dollar increase from 2017 to 2018 was mainly from new club and restaurant openings. As a percentage of revenues, consolidated salaries and wages has been fairly stable at 27.5%, 26.9%, and 27.6% for fiscal year 2019, 2018, and 2017, respectively.

 

By reportable segment, salaries and wages are broken down as follows (in thousands):

 

   2019   2018   2017 
Nightclubs  $32,267   $30,788   $28,329 
Bombshells   8,887    5,804    4,393 
Other   617    789    970 
General corporate   8,062    7,166    6,337 
   $49,833   $44,547   $40,029 

 

Unit-level manager payroll is included in salaries and wages of each location, while payroll for regional manager and above are included in general corporate.

 

The components of consolidated selling, general and administrative expenses are in the tables below (dollars in thousands):

 

   Years Ended September 30,   Percentage of Revenues 
   2019   2018   2017   2019   2018   2017 
Taxes and permits  $10,779   $9,545   $8,026    6.0%   5.8%   5.5%
Advertising and marketing   8,392    7,536    6,704    4.6%   4.5%   4.6%
Supplies and services   5,911    5,344    4,873    3.3%   3.2%   3.4%
Insurance   5,429    5,473    4,006    3.0%   3.3%   2.8%
Rent   3,896    3,720    3,258    2.2%   2.2%   2.2%
Legal   5,180    3,586    3,074    2.9%   2.2%   2.1%
Utilities   3,165    2,969    2,824    1.7%   1.8%   1.9%
Charge card fees   3,803    3,244    2,783    2.1%   2.0%   1.9%
Security   2,973    2,617    2,251    1.6%   1.6%   1.6%
Accounting and professional fees   2,815    2,944    2,159    1.6%   1.8%   1.5%
Repairs and maintenance   2,980    2,184    2,091    1.6%   1.3%   1.4%
Other   4,573    4,662    4,726    2.5%   2.8%   3.3%
   $59,896   $53,824   $46,775    33.1%   32.5%   32.3%

 

By reportable segment, selling, general and administrative expenses are broken down as follows (in thousands):

 

   2019   2018   2017 
Nightclubs  $40,033   $38,200   $34,074 
Bombshells   10,441    7,454    5,663 
Other   356    467    621 
General corporate   9,066    7,703    6,417 
   $59,896   $53,824   $46,775 

 

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The significant variances in selling, general and administrative expenses are as follows:

 

Taxes and permits increased by $1.2 million, or 12.9%, from 2018 to 2019 primarily due to new units, higher taxes on those new units, and increases in patron taxes and property taxes as a result of increased sales revenues. Taxes and permits increased by $1.5 million, or 18.9%, from 2017 to 2018 primarily due to an increased operating activity and the previously mentioned sales tax audit settlements in 2018. As a percentage of revenues, taxes and permits were 6.0%, 5.8%, and 5.5% for 2019, 2018, and 2017, respectively.

 

Advertising and marketing increased by $856,000, or 11.4%, from 2018 to 2019 and increased by $832,000, or 12.4%, from 2017 to 2018 mainly due to new units. As a percentage of revenues, advertising and marketing was relatively flat at 4.6%, 4.5%, and 4.6% for 2019, 2018, and 2017, respectively.

 

Insurance decreased nominally by $44,000, or 0.8%, from 2018 to 2019. It increased by $1.5 million, or 36.6%, from 2017 to 2018 primarily due to an increase in general liability insurance premiums and additional property insurance.

 

Rent expense increased by $176,000, or 4.7%, from 2018 to 2019 mainly due to adjustments in deferred rent liability in fiscal year 2018. Rent expense increased by $462,000, or 14.2% from 2017 to 2018 primarily due to Scarlett’s Miami, which was acquired in May 2017, and Bombshells 290, which was opened in July 2017. As a percentage of revenues, rent expense has been flat at 2.2% in all three years.

 

Legal expenses increased in 2019 from 2018 by $1.6 million, or 44.5%, mainly due to SEC-related matters. Legal expenses increased by $512,000, or 16.7%, from 2017 to 2018 primarily due to increased legal activity on on-going litigation cases.

 

Charge card fees increased by $559,000, or 17.5%, from 2018 to 2019, and by $461,000, or 16.6%, from 2017 to 2018. Both increases were directly related to higher revenues from prior year. As a percentage of revenues, charge card fees were 2.1%, 2.0%, and 1.9% in 2019, 2018, and 2017, respectively.

 

Accounting and professional fees decreased by $129,000, or 4.4%, from 2018 to 2019 mainly due to consulting services during our ERP implementation in 2018. Accounting and professional fees increased by $785,000, or 36.4%, from 2017 to 2018 primarily due to our hiring of an outside internal controls consultant in 2018 and the previously mentioned ERP implementation consultants.

 

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Depreciation and amortization increased by $1.4 million, or 17.5%, from 2018 to 2019, and increased by $802,000, or 11.6%, from 2017 to 2018 coming from newly acquired and constructed units.

 

The components of other charges, net are in the table below (dollars in thousands):

 

   Years Ended September 30,   Percentage of Revenues 
   2019   2018   2017   2019   2018   2017 
       (As Revised)                 
Impairment of assets  $6,040   $5,570   $7,639    3.3%   3.4%   5.3%
Settlement of lawsuits   225    1,669    317    0.1%   1.0%   0.2%
Loss (gain) on sale of businesses and assets   (2,877)   1,965    (542)   -1.6%   1.2%   -0.4%
Gain on insurance   (768)   (20)   -    -0.4%   -0.0%   - 
Gain on settlement of patron tax   -    -    (102)   -    -    -0.1%
Total other charges, net  $2,620   $9,184   $7,312    1.4%   5.5%   5.0%

 

The significant variances in other charges, net are discussed below:

 

During the year ended September 30, 2017, we recorded aggregate impairment charges of $7.6 million ($1.4 million in the third quarter and $6.2 million in the fourth quarter) for the goodwill of four club locations ($4.7 million), including one that we have put up for sale during the fiscal year; for property and equipment of one club ($385,000); for SOB license of two club locations ($1.4 million), and for our remaining investment in Drink Robust ($1.2 million). During the year ended September 30, 2018, we recorded a loss on the note owed to us the by former owner of Drink Robust in relation to our reacquisition of Drink Robust ($1.55 million in the second quarter), impairment related to licenses of three clubs ($3.1 million in the fourth quarter), impairment related to goodwill of two clubs ($834,000 in the fourth quarter), and impairment related to long-lived assets of a club that closed and a still-operating Bombshells ($1.6 million in the fourth quarter). During the year ended September 30, 2019, we recorded aggregate impairment charges amounting to $6.0 million related to goodwill of four clubs ($1.6 million), SOB license of one club ($178,000), and property and equipment of two clubs ($4.2 million). See Notes 15 and 17 to our consolidated financial statements for further discussion.

 

Income from Operations

 

Below is a table which reflects segment contribution to income from operations (in thousands):

 

   2019   2018   2017 
       (As Revised)     
Nightclubs  $50,724   $43,624   $35,138 
Bombshells   2,307    2,040    3,084 
Other   (309)   (252)   (522)
General corporate   (18,021)   (17,850)   (14,561)
   $34,701   $27,562   $23,139 

 

Our operating margin (income from operations divided by revenues) was 19.2% in 2019, 16.6% in 2018, and 16.0% in 2017. Nightclubs operating margin was 34.1%, 31.1%, and 28.2% in 2019, 2018, and 2017, respectively, primarily due to the closure of underperforming units, fixed expense leverage on increasing sales, and impairment of assets of $5.9 million, $4.4 million, and $6.5 million for 2019, 2018, and 2017, respectively. Bombshells operating margin was 7.4%, 8.5%, and 16.4% in 2019, 2018, and 2017, respectively, mainly due to pre-opening expenses in 2019 (particularly in salaries and wages and selling, general and administrative expenses) and impairment of assets of $1.1 million in 2018.

 

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Excluding the impact of settlement of lawsuits, impairment of assets, gain on insurance, gain on patron tax settlement, and gain on sale of businesses and assets, operating margin for the Nightclub segment would have been 35.9%, 35.1%, and 33.1% for 2019, 2018, and 2017, respectively. Excluding the impact of impairment of assets, loss on sale of assets, and settlement of lawsuits, Bombshells segment operating margin would have been 7.6%, 15.1%, and 16.4% for 2019, 2018, and 2017, respectively. Refer to discussion of Non-GAAP Financial Measures on page 32.

 

Interest Expense

 

Interest expense increased by $255,000 from 2018 to 2019, and increased by $1.2 million from 2017 to 2018. The increase in interest expense is due to higher average debt balance partially offset by lower weighted average interest rate. During the first quarter of 2018, we significantly increased our debt balance with our $81 million refinancing, but that transaction also significantly reduced our weighted average interest rate. During 2019, our debt repayments were significantly higher than our borrowing, excluding borrowings from acquisitions, thereby reducing interest expense as a percentage of revenue.

 

We consider rent plus interest expense as our occupancy costs since most of our debts are for real property where our clubs and restaurants are located. For occupancy cost purposes, we exclude non-real-estate-related interest expense. As a percentage of revenues, total occupancy costs, with its components, are shown below.

 

   2019   2018   2017 
Rent   2.2%   2.2%   2.2%
Interest   5.6%   5.4%   6.0%
Total occupancy cost   7.8%   7.7%   8.3%

 

Income Taxes

 

Income taxes were an expense of $4.9 million in 2019, a benefit of $3.1 million in 2018, and an expense of $6.4 million in 2017. Our effective income tax rate was a 20.1% expense in 2019, a 17.5% benefit in 2018, and a 43.4% expense in 2017. The components of our annual effective income tax rate are the following:

 

   2019   2018   2017 
Computed expected income tax expense   21.0%   24.5%   34.0%
State income taxes, net of federal benefit   2.8%   4.5%   2.0%
Deferred taxes on subsidiaries acquired/sold   -    4.0%   - 
Permanent differences   0.2%   0.5%   0.7%
Change in deferred tax liability rate   -    -49.5%   9.1%
Reserve for uncertain tax position   -    -    2.8%
Tax credits   -3.7%   -4.5%   -3.9%
Other   -0.1%   3.1%   -1.3%
Total effective income tax rate   20.1%   -17.5%   43.4%

 

During fiscal year 2017, due to higher income before tax, our income tax rate has increased to 37%, of which has impacted the fourth quarter with the change in rate from 35% in the first nine months of the year and in prior years. A full year impact in the change in rate of our deferred tax liability has also been recognized in the fourth quarter. The change in deferred tax liability rate for 2017 is due to the 1% increase in our effective tax rate from the increase in the federal rate and also an increase in the states rate. This amount results from increasing by 2% the rate applied to our entire deferred tax liabilities at the beginning of the year. The reserve for uncertain tax positions results from an audit of the returns of one of the states in which we operate. As a result of the items discussed above which affected the fiscal year, the fourth quarter effective tax rate rose to 99.6% expense on a pre-tax loss.

 

On December 22, 2017, during our first quarter 2018, the Tax Cuts and Jobs Act (the “Tax Act”) was enacted into law, which provides for significant changes to the U.S. Internal Revenue Code of 1986, as amended, such as a reduction in the statutory federal corporate tax rate from a maximum of 35% to a flat 21% rate effective from January 1, 2018 forward and changes and limitations to certain tax deductions. The Company has a fiscal year end of September 30, so the change to the statutory corporate tax rate results in a blended federal statutory rate of 24.5% for its fiscal year 2018. The increase in state tax effective rate from 2017 to 2018 was mainly caused by the impact of return-to-provision true-up, which has an expense impact in 2018 while having a benefit in 2017.

 

During fiscal 2019, the effective income tax rate has normalized to 20.1%, with the rate difference from the statutory federal corporate tax rate of 21% coming from offsetting impact of state income tax, net of federal benefit, and tax credits that are mostly FICA tip credits.

 

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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) gains or losses on settlement of patron tax case. 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 shareholders and diluted earnings per share. Adjustment items are: (a) amortization of intangibles, (b) impairment of assets, (c) costs and charges related to debt refinancing, (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, (h) gains or losses on settlement of patron tax case, 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 20.1%, 24.5% and 37.0% effective tax rate of the pre-tax non-GAAP income before taxes for the 2019, 2018 and 2017, 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. The calculated amount for adjustment (i) above in fiscal 2018 was significantly affected by the change in the statutory federal corporate tax rate caused by the Tax Act.

 

Adjusted EBITDA. We calculate adjusted EBITDA by excluding the following items from net income attributable to RCIHH common shareholders: (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) gains or losses on settlement of patron tax case. 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 the unleveraged performance return on our investments. Adjusted EBITDA multiple is also used as a 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.

 

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The following tables present our non-GAAP performance measures for the periods indicated (in thousands, except per share amounts and percentages):

 

   For the Year Ended 
   September 30, 
   2019   2018   2017 
Reconciliation of GAAP net income to Adjusted EBITDA               
Net income attributable to RCIHH common shareholders(1)  $19,175   $20,879   $8,259 
Income tax expense (benefit)   4,863    (3,118)   6,359 
Interest expense, net   9,900    9,720    8,498 
Settlement of lawsuits   225    1,669    317 
Gain on settlement of patron tax case   -    -    (102)
Impairment of assets(1)   6,040    5,570    7,639 
Loss (gain) on sale of businesses and assets   (2,877)   1,965    (542)
Depreciation and amortization   9,072    7,722    6,920 
Unrealized loss on equity securities   612    -    - 
Gain on insurance   (768)   (20)   - 
Adjusted EBITDA  $46,242   $44,387   $37,348 
                
Reconciliation of GAAP net income to non-GAAP net income               
Net income attributable to RCIHH common shareholders(1)  $19,175   $20,879   $8,259 
Amortization of intangibles   624    254    217 
Settlement of lawsuits   225    1,669    317 
Gain on settlement of patron tax case   -    -    (102)
Impairment of assets(1)   6,040    5,570    7,639 
Loss (gain) on sale of businesses and assets   (2,877)   1,965    (542)
Costs and charges related to debt refinancing   -    827    - 
Unrealized loss on equity securities   612    -    - 
Gain on insurance   (768)   (20)   - 
Net income tax effect of adjustments above   (744)   (9,984)   (1,835)
Non-GAAP net income  $22,287   $21,160   $13,953 

 

   For the Year Ended 
   September 30, 
   2019   2018   2017 
Reconciliation of GAAP diluted earnings per share to non-GAAP diluted earnings per share               
Diluted shares   9,657    9,719    9,743 
GAAP diluted earnings per share(1)  $1.99   $2.15   $0.85 
Amortization of intangibles   0.06    0.03    0.02 
Settlement of lawsuits   0.02    0.17    0.03 
Gain on settlement of patron tax case   -    -    (0.01)
Impairment of assets(1)   0.63    0.57    0.78 
Loss (gain) on sale of businesses and assets   (0.30)   0.20    (0.06)
Costs and charges related to debt refinancing   -    0.09    - 
Unrealized loss on equity securities   0.06    -    - 
Gain on insurance   (0.08)   (0.00)   - 
Net income tax effect of adjustments above   (0.08)   (1.02)   (0.18)
Non-GAAP diluted earnings per share  $2.31   $2.18   $1.43 
                
Reconciliation of GAAP operating income to non-GAAP operating income               
Income from operations(1)  $34,701   $27,562   $23,139 
Amortization of intangibles   624    254    217 
Settlement of lawsuits   225    1,669    317 
Gain on settlement of patron tax case   -    -    (102)
Impairment of assets(1)   6,040    5,570    7,639 
Loss (gain) on sale of businesses and assets   (2,877)   1,965    (542)
Gain on insurance   (768)   (20)   - 
Non-GAAP operating income  $37,945   $37,000   $30,668 
                
Reconciliation of GAAP operating margin to non-GAAP operating margin               
GAAP operating margin(1)   19.2%   16.6%   16.0%
Amortization of intangibles   0.3%   0.2%   0.1%
Settlement of lawsuits   0.1%   1.0%   0.2%
Gain on settlement of patron tax case   -    -%   -0.1%
Impairment of assets(1)   3.3%   3.4%   5.3%
Loss (gain) on sale of businesses and assets   -1.6%   1.2%   -0.4%
Gain on insurance   -0.4%   -0.0%   - 
Non-GAAP operating margin   21.0%   22.3%   21.2%

 

* Per share amounts and percentages may not foot due to rounding.

 

(1) These amounts have been revised for fiscal 2018, as explained in Note 3 to our consolidated financial statements.

 

The adjustments to reconcile net income attributable to RCIHH common shareholders to non-GAAP net income exclude the impact of adjustments related to noncontrolling interests, which is immaterial. In the calculation of non-GAAP diluted earnings per share for fiscal 2017, we take into consideration the adjustment to net income from assumed conversion of debentures (see Note 2 to the consolidated financial statements).

 

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LIQUIDITY AND CAPITAL RESOURCES

 

We believe our ability to generate cash from operating activities is one of our fundamental financial strengths. The near-term outlook for our business remains strong, and we expect to generate substantial cash flows from operations in fiscal 2020 and beyond. As a result of our expected cash flows from operations, we have significant flexibility to meet our financial commitments. The Company has 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 equity. We have a history of borrowing funds in private transactions and from sellers in acquisition transactions and continue to have the ability to borrow funds at reasonable interest rates in that manner. We also have historically utilized these cash flows to invest in maintenance capital expenditures for existing units, adult nightclubs acquisitions, and restaurants/sports bars construction.

 

The following table presents a summary of our cash flows from operating, investing, and financing activities (in thousands):

 

   Year Ended September 30, 
   2019   2018   2017 
Operating activities  $37,174   $25,769   $21,094 
Investing activities   (27,147)   (26,339)   (18,524)
Financing activities   (13,656)   8,374    (3,975)
Net increase (decrease) in cash and cash equivalents  $(3,629)  $7,804   $(1,405)

 

We require capital principally for the acquisition of new clubs, construction of new Bombshells, renovation of older units, and investments in technology. We also utilize capital to repurchase our common stock as part of our share repurchase program based on our capital allocation strategy guidelines and to pay our quarterly dividends.

 

As of September 30, 2019, we had negative working capital of $2.3 million (excluding the impact of assets held for sale amounting to $2.9 million) compared to working capital of $55,000 as of September 30, 2018 (excluding the impact of assets held for sale amounting to $2.9 million). The decrease in working capital is principally due to the following items:

 

  Net payments of long-term debt to our lenders;
     
  Business acquisitions and purchase of capital expenditures; and
     
  Partially offset by operating cash flow for the year.

 

We believe that our current sources of liquidity and capital will be more than sufficient to finance our continued operations and growth plans not only within the next 12 months, but for the next 18 to 24 months. Refer to sections on Debt Financing and Contractual Obligations and Commitments below for a discussion of long-term liquidity and capital resources.

 

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Cash Flows from Operating Activities

 

Following are our summarized cash flows from operating activities (in thousands):

 

   Year Ended September 30, 
   2019   2018   2017 
       (As Revised)     
Net income  $19,326   $20,960   $8,282 
Depreciation and amortization   9,072    7,722    6,920 
Deferred tax expense (benefit)   821    (6,775)   2,273 
Impairment of assets   6,040    5,570    7,639 
Net change in operating assets and liabilities   3,941    (5,156)   (3,645)
Other   (2,026)   3,448    (375)
   $37,174   $25,769   $21,094 

 

Net cash flows from operating activities increased from 2018 to 2019 primarily from higher income from operations plus lower income taxes paid. Net cash flows from operating activities increased from 2017 to 2018 mainly due to higher income from operations partially offset by higher income taxes and interest expense in 2018.

 

Cash Flows from Investing Activities

 

Following are our summarized cash flows from investing activities (in thousands):

 

   Year Ended September 30, 
   2019   2018   2017 
Proceeds from sale of businesses and assets  $7,223   $811   $2,145 
Proceeds from insurance and notes receivable   258    147    107 
Issuance of notes receivable   (420)   -    - 
Additions to property and equipment   (20,708)   (25,263)   (11,249)
Acquisition of businesses, net of cash acquired   (13,500)   (2,034)   (9,527)
   $(27,147)  $(26,339)  $(18,524)

 

We opened four new units in 2019 (acquired two clubs in Chicago, Illinois and Pittsburgh, Pennsylvania, and built two new Bombshells in Houston, Texas); opened two new units in 2018 (one acquired club in Kappa, Illinois and one built Bombshells in Pearland, Texas); and opened five new units in 2017 (including two acquired and one reconcepted from a Bombshells to a club). See Note 15 to our consolidated financial statements. As of September 30, 2019, 2018, and 2017, we had $8.9 million, $6.4 million, and $1.6 million in construction-in-progress related mostly to Bombshells opening in the subsequent fiscal year.

 

Following is a reconciliation of our additions to property and equipment for the years ended September 30, 2019, 2018, and 2017 (in thousands):

 

   Year Ended September 30, 
   2019   2018   2017 
Purchase of real estate*  $-   $12,260   $6,024 
New capital expenditures in new clubs and Bombshells units and equipment   16,850    10,476    3,412 
Maintenance capital expenditures   3,858    2,527    1,813 
Total capital expenditures, excluding business acquisitions  $20,708   $25,263   $11,249 

 

* Excludes real estate acquired through business acquisitions.

 

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Cash Flows from Financing Activities

 

Following are our summarized cash flows from financing activities (in thousands):

 

   Year Ended September 30, 
   2019   2018   2017 
Proceeds from long-term debt  $13,511   $84,233   $12,399 
Payments on long-term debt   (22,924)   (72,830)   (13,080)
Payment of dividends   (1,252)   (1,168)   (1,170)
Purchase of treasury stock   (2,901)   -    (1,099)
Payment of loan origination costs   (20)   (1,138)   (735)
Debt prepayment penalty   -    (543)   (75)
Distribution of noncontrolling interests   (70)   (180)   (215)
   $(13,656)  $8,374   $(3,975)

 

We purchased shares of our common stock representing 128,040 shares, 0 shares, and 89,685 shares in 2019, 2018, and 2017, respectively. We have paid quarterly dividends of $0.03 per share for fiscal 2019, 2018 and 2017, except for the fourth quarter of 2019 where we paid $0.04 per share. See Note 9 to our consolidated financial statements for a detailed discussion of our debt obligations.

 

Non-GAAP Cash Flow Measure

 

Management also uses certain non-GAAP cash flow measures such as free cash flows. We define free cash flow as net cash provided by operating activities less maintenance capital expenditures. See table below (in thousands):

 

   2019   2018   2017 
Net cash provided by operating activities  $37,174   $25,769   $21,094 
Less: Maintenance capital expenditures   3,858    2,527    1,813 
Free cash flow  $33,316   $23,242   $19,281 

 

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. Our free cash flow after long-term debt repayments was $10.4 million, $(49.6) million, and $6.2 million during fiscal 2019, 2018, and 2017, respectively. Free cash flow after long-term debt repayments in fiscal 2018 was significantly impacted by our $81.2 million refinancing in December 2017.

 

Debt Financing

 

See Note 9 to our consolidated financial statements for detail regarding our long-term debt activity.

 

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Contractual Obligations and Commitments

 

We have long-term contractual obligations primarily in the form of debt obligations and operating leases. The following table (in thousands) summarizes our contractual obligations and their aggregate maturities as well as future minimum rent payments. Future interest payments related to debt were estimated using the interest rate in effect at September 30, 2019.

 

   Payments Due by Period 
   Total   2020   2021   2022   2023   2024   Thereafter 
Long-term debt – regular  $80,442   $8,822   $9,499   $7,756   $7,279   $7,685   $39,401 
Long-term debt – balloon   64,561    7,163    6,466    6,273    1,970    -    42,689 
Interest payments   

52,566

    9,435    8,223    6,430    5,829    5,254    

17,395

 
Operating leases(a)   36,225    3,237    3,154    3,057    2,889    2,850    21,038 

 

  (a) Effective October 1, 2019, we will adopt Accounting Standards Update No. 2016-02, Leases (Topic 842), which will significantly affect our accounting of all leases. See Note 2 to our consolidated financial statements. However, we do not expect changes in our contractual obligations for future lease payments related to all of our leases existing as of September 30, 2019, except for any expected exercise of renewal options allowed in the adoption of ASC 842.

 

Other than the debt refinancing and other notes payable financing described in Note 9 to the consolidated financial statements, we are not aware of any event or trend that would potentially significantly affect liquidity. In the event such a trend develops, we believe our working capital and capital expenditure requirements will be adequately met by cash flows from operations. 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.

 

The following table presents a summary of such indicators (dollars in thousands):

 

       Increase       Increase     
   2019   (Decrease)   2018   (Decrease)   2017 
                     
Sales of alcoholic beverages  $75,140    8.7%  $69,120    14.4%  $60,439 
Sales of food and merchandise   25,830    15.1%   22,433    22.9%   18,256 
Service revenues   68,055    6.2%   64,104    10.3%   58,132 
Other   12,034    19.3%   10,091    25.1%   8,069 
Total revenues  $181,059    9.2%  $165,748    14.4%  $144,896 
Net cash provided by operating activities  $37,174    44.3%  $25,769    22.2%  $21,094 
Adjusted EBITDA*  $46,242    4.2%  $44,387    18.8%  $37,348 
Free cash flow*  $33,316    43.3%  $23,242    20.5%  $19,281 
Long-term debt (end of period)  $143,528    2.1%  $140,627    13.1%  $124,352 

 

* See definition and calculation of Adjusted EBITDA and Free Cash Flow under Non-GAAP Financial Measures and Liquidity and Capital Resources above.

 

 37  
   

 

We have not established financing other than the notes payable discussed in Note 9 to the consolidated financial statements. 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.

 

Share Repurchase

 

As part of our capital allocation strategy, we buy back shares in the open market or through negotiated purchases, as authorized by our Board of Directors. During fiscal years 2019, 2018, and 2017, we paid for treasury stock amounting to $2.9 million, $0, and $1.1 million representing 128,040 shares, 0 shares, and 89,685 shares, respectively. We have $10.2 million remaining to purchase additional shares as of September 30, 2019. Subsequent to September 30, 2019 through the filing date of this report, we purchased 332,671 shares of the Company’s common stock for a total of $6.4 million. On February 6, 2020, the Board of Directors increased the repurchase authorization by an additional $10.0 million.

 

For additional details regarding our Board approved share repurchase plans, please refer to Item 5 – Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

 

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.

 

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.

 

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 eight of the existing Bombshells as of September 30, 2019 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.

 

 38  
   

 

During fiscal 2017, we acquired two clubs, one in Florida (Scarlett’s Miami) and another in Illinois (Hollywood Showclub) and certain adjacent real estate for an aggregate purchase price of $30.2 million. See Note 15 to the consolidated financial statements for details of the transactions. We subsequently relaunched Hollywood Showclub as Scarlett’s St. Louis.

 

During fiscal 2018, we reacquired Drink Robust (see Note 15 to our consolidated financial statements). Also in fiscal 2018, we acquired a club in Kappa, Illinois for $1.5 million, financed by a $1.0 million seller note with interest at 8%. The Kappa transaction provides for the purchase of the real estate for $825,000 and other non-real-estate business assets for $180,000, with goodwill amounting to $495,000. See Note 15 to the consolidated financial statements for details of the transactions.

 

During fiscal 2019, we acquired two clubs, one in Illinois (rebranded as Rick’s Cabaret Chicago) and another in Pennsylvania (rebranded as Rick’s Cabaret Pittsburgh) for an aggregate purchase price of $25.5 million. See Note 15 to the consolidated financial statements for details of the transactions.

 

We opened two Bombshells units in fiscal 2019.

 

In October 2018, the Company sold its nightclub in Philadelphia for a total sales price of $1.0 million, payable $375,000 in cash at closing and a 9% note payable over a 10-year period. See Note 15 to the consolidated financial statements for details of the disposition.

 

Subsequent to the end of fiscal 2019, we opened two Bombshells units.

 

On November 5, 2019, the Company announced that its subsidiaries have signed definitive agreements to acquire the assets and related real estate of a well-established, top gentlemen’s club located in the Northeast Corridor for $15.0 million. As of the filing of this report, closing of this transaction is still pending subject to certain conditions. Under the terms of the agreements, Company subsidiaries will pay $7.2 million for the club and $7.8 million for the real estate using $4.0 million in seller financing at 6.0% for the club with the balance of cash from an anticipated $11.0 million bank loan at a blended rate of 6.25%.

 

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.

 

Item 7A. Quantitative and Qualitative Disclosures About Market Risk

 

The items in our financial statements subject to market risk are potential debt instruments with variable interest rates. We do not carry any debt with a variable interest rate in effect as of September 30, 2019. Certain of our debt have variable interest rates, but will only be effective in future years.

 

Item 8. Financial Statements and Supplementary Data.

 

The information required by this Item begins on page 40.

 

 39  
   

 

RCI HOSPITALITY HOLDINGS, INC.

CONSOLIDATED FINANCIAL STATEMENTS

 

Table of Contents

 

Report of Independent Registered Public Accounting Firm 41
   
Consolidated Financial Statements:  
   
Consolidated Balance Sheets at September 30, 2019 and 2018 42
   
Consolidated Statements of Income for the years ended September 30, 2019, 2018, and 2017 43
   
Consolidated Statements of Comprehensive Income for the years ended September 30, 2019, 2018, and 2017 44
   
Consolidated Statements of Changes in Equity for the years ended September 30, 2019, 2018, and 2017 45
   
Consolidated Statements of Cash Flows for the years ended September 30, 2019, 2018, and 2017 46
   
Notes to Consolidated Financial Statements 47

 

 40  
   

 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

To the Board of Directors and Stockholders of

RCI Hospitality Holdings, Inc.

 

Opinion on the Consolidated Financial Statements

 

We have audited the accompanying consolidated balance sheets of RCI Hospitality Holdings, Inc. (the “Company”) as of September 30, 2019 and 2018, and the related consolidated statements of income, comprehensive income, stockholders’ equity, and cash flows for each of the years in the three-year period ended September 30, 2019, and the related notes (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of September 30, 2019 and 2018, and the results of its operations and its cash flows for each of the years in the three-year period ended September 30, 2019, in conformity with accounting principles generally accepted in the United States of America.

 

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (“PCAOB”), RCI Hospitality Holdings, Inc.’s internal control over financial reporting as of September 30, 2019, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) and our report dated February 13, 2020 expressed an adverse opinion.

 

Basis for Opinion

 

These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s consolidated financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

 

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion.

 

/s/ Friedman LLP

 

We have served as the Company’s auditor since 2019.

 

Marlton, New Jersey

 

February 13, 2020

 

 41  
   

 

RCI HOSPITALITY HOLDINGS, INC.

CONSOLIDATED BALANCE SHEETS

(in thousands, except per share data)

 

   September 30, 
   2019   2018 
       (As Revised) 
ASSETS          
Current assets          
Cash and cash equivalents  $14,097   $17,726 
Accounts receivable, net   6,289    7,320 
Current portion of notes receivable   954    - 
Inventories   2,598    2,353 
Prepaid insurance   5,446    4,910 
Other current assets   2,521    1,591 
Assets held for sale   2,866    2,902 
Total current assets   34,771    36,802 
Property and equipment, net   183,956    172,403 
Notes receivable, net of current portion   4,211    2,874 
Goodwill   53,630    43,591 
Intangibles, net   75,951    71,532 
Other assets   1,118    2,530 
Total assets  $353,637   $329,732 
           
LIABILITIES AND EQUITY          
Current liabilities          
Accounts payable  $3,810   $2,825 
Accrued liabilities   14,644    11,973 
Current portion of long-term debt   15,754    19,047 
Total current liabilities   34,208    33,845 
Deferred tax liability, net   21,658    19,552 
Long-term debt, net of current portion and debt discount and issuance costs   127,774    121,580 
Other long-term liabilities   1,696    1,423 
Total liabilities   185,336    176,400 
           
Commitments and contingencies (Note 11)          
           
Equity          
Preferred stock, $0.10 par value per share; 1,000 shares authorized; none issued and outstanding   -    - 
Common stock, $0.01 par value per share; 20,000 shares authorized; 9,591 and 9,719 shares issued and outstanding as of September 30, 2019 and 2018, respectively   96    97 
Additional paid-in capital   61,312    64,212 
Retained earnings   107,049    88,906 
Accumulated other comprehensive income   -    220 
Total RCIHH stockholders’ equity   168,457    153,435 
Noncontrolling interests   (156)   (103)
Total equity   168,301    153,332 
Total liabilities and equity  $353,637   $329,732 

 

See accompanying notes to consolidated financial statements.

 

 42  
   

 

RCI HOSPITALITY HOLDINGS, INC.

CONSOLIDATED STATEMENTS OF INCOME

(in thousands, except per share data)

 

   Years Ended September 30, 
   2019   2018   2017 
       (As Revised)     
Revenues               
Sales of alcoholic beverages  $75,140   $69,120   $60,439 
Sales of food and merchandise   25,830    22,433    18,256 
Service revenues   68,055    64,104    58,132 
Other   12,034    10,091    8,069 
Total revenues   181,059    165,748    144,896 
Operating expenses               
Cost of goods sold               
Alcoholic beverages sold   15,303    14,327    13,114 
Food and merchandise sold   9,056    8,133    7,398 
Service and other   578    449    209 
Total cost of goods sold (exclusive of items shown separately below)   24,937    22,909    20,721 
Salaries and wages   49,833    44,547    40,029 
Selling, general and administrative   59,896    53,824    46,775 
Depreciation and amortization   9,072    7,722    6,920 
Other charges, net   2,620    9,184    7,312 
Total operating expenses   146,358    138,186    121,757 
Income from operations   34,701    27,562    23,139 
Other income (expenses)               
Interest expense   (10,209)   (9,954)   (8,764)
Interest income   309    234    266 
Unrealized loss on equity securities   (612)   -    - 
Income before income taxes   24,189    17,842    14,641 
Income tax expense (benefit)   4,863    (3,118)   6,359 
Net income   19,326    20,960    8,282 
Net income attributable to noncontrolling interests   (151)   (81)   (23)
Net income attributable to RCIHH common shareholders  $19,175   $20,879   $8,259 
                
Earnings per share               
Basic  $1.99   $2.15   $0.85 
Diluted  $1.99   $2.15   $0.85 
                
Weighted average number of common shares outstanding               
Basic   9,657    9,719    9,731 
Diluted   9,657    9,719    9,743 
                
Dividends per share  $0.13   $0.12   $0.12 

 

See accompanying notes to consolidated financial statements.

 

 43  
   

 

RCI HOSPITALITY HOLDINGS, INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(in thousands)

 

   Years Ended September 30, 
   2019   2018   2017 
       (As Revised)     
Net income  $19,326   $20,960   $8,282 
Amount reclassified from accumulated other comprehensive income   (220)   -    - 
Other comprehensive income:               
Unrealized holding gain on available-for-sale securities, net of tax of $85 in 2018   -    220    - 
Comprehensive income   19,106    21,180    8,282 
Comprehensive income attributable to noncontrolling interests   (151)   (81)   (23)
Comprehensive income attributable to RCI Hospitality Holdings, Inc.  $18,955   $21,099   $8,259 

 

See accompanying notes to consolidated financial statements.

 

 44  
   

 

RCI HOSPITALITY HOLDINGS, INC.

CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY

Years Ended September 30, 2019, 2018, and 2017

(in thousands)

 

   Common Stock   Additional       Accumulated
Other
   Treasury Stock        
   Number       Paid-In   Retained   Comprehensive   Number       Noncontrolling   Total 
   of Shares   Amount   Capital   Earnings   Income   of Shares   Amount   Interests   Equity 
Balance at September 30, 2016   9,808   $    97   $64,552   $62,106   $                 -    -   $-   $        2,584   $129,339 
Purchase of treasury shares   -    -    -    -    -    (89)   (1,099)   -    (1,099)
Canceled treasury shares   (89)   -    (1,099)   -    -    89    1,099    -    - 
Payment of dividends   -    -    -    (1,170)   -    -    -    -    (1,170)
Payments to noncontrolling interests   -    -    -    -    -    -    -    (215)   (215)
Divestiture in Drink Robust   -    -    -    -    -    -    -    88    88 
Net income   -    -    -    8,259    -    -    -    23    8,282 
                                              
Balance at September 30, 2017   9,719   97   63,453   69,195   -    -   -   2,480   135,225 
Payment of dividends   -    -    -    (1,168)   -    -    -    -    (1,168)
Payments to noncontrolling interests   -    -    -    -    -    -    -    (180)   (180)
Equity impact of additional investment in TEZ   -    -    759    -    -    -    -    (2,484)   (1,725)
Change in marketable securities   -    -    -         220    -    -    -    220 
Net income (as revised)   -    -    -    20,879    -    -    -    81    20,960 
                                              
Balance at September 30, 2018 (as revised)   9,719   97   64,212   88,906   220    -   -   (103)  153,332 
Reclassification upon adoption of ASU 2016-01   -    -    -    220    (220)   -    -    -    - 
Purchase of treasury shares   -    -    -    -    -    (128)   (2,901)   -    (2,901)
Canceled treasury shares   (128)   (1)   (2,900)   -    -    128    2,901    -    - 
Payment of dividends   -    -    -    (1,252)   -    -    -    -    (1,252)
Payments to noncontrolling interests   -    -    -    -    -    -    -    (70)   (70)
Divestiture in other entities   -    -    -    -    -    -    -    (134)   (134)
Net income   -    -    -    19,175    -    -    -    151    19,326 
                                              
Balance at September 30, 2019   9,591   $96   $61,312   $107,049   $-    -   $-   $(156)  $168,301 

 

See accompanying notes to consolidated financial statements.

 

 45  
   

 

RCI HOSPITALITY HOLDINGS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

 

   Years Ended September 30, 
   2019   2018   2017 
       (As Revised)     
CASH FLOWS FROM OPERATING ACTIVITIES               
Net income  $19,326   $20,960   $8,282 
Adjustments to reconcile net income to net cash provided by operating activities:               
Depreciation and amortization   9,072    7,722    6,920 
Deferred tax expense (benefit)   821    (6,775)   2,273 
Loss (gain) on sale of businesses and assets   (2,966)   2,162    (838)
Impairment of assets   6,040    5,570    7,639 
Amortization of debt discount and issuance costs   334    560    218 
Unrealized loss on equity securities   612    -    - 
Gain on insurance   (288)   (20)   - 
Gain on settlement of patron tax   -    -    (102)
Deferred rent expense   282    203    272 
Debt prepayment penalty   -    543    75 
Changes in operating assets and liabilities:               
Accounts receivable   1,576    (3,622)   878 
Inventories   (216)   (199)   (19)
Prepaid insurance, other current assets and other assets   (681)   (2,589)   (1,526)
Accounts payable and accrued liabilities   3,262    1,254    (2,978)
Net cash provided by operating activities   37,174    25,769    21,094 
                
CASH FLOWS FROM INVESTING ACTIVITIES               
Proceeds from sale of businesses and assets   7,223    811    2,145 
Proceeds from notes receivable   158    127    107 
Proceeds from insurance   100    20    - 
Issuance of notes receivable   (420)   -    - 
Additions to property and equipment   (20,708)   (25,263)   (11,249)
Acquisition of businesses, net of cash acquired   (13,500)   (2,034)   (9,527)
Net cash used in investing activities   (27,147)   (26,339)   (18,524)
                
CASH FLOWS FROM FINANCING ACTIVITIES               
Proceeds from long-term debt   13,511    84,233    12,399 
Payments on long-term debt   (22,924)   (72,830)   (13,080)
Purchase of treasury stock   (2,901)   -    (1,099)
Payment of dividends   (1,252)   (1,168)   (1,170)
Payment of loan origination costs   (20)   (1,138)   (735)
Debt prepayment penalty   -    (543)   (75)
Distribution to noncontrolling interests   (70)   (180)   (215)
Net cash provided by (used in) financing activities   (13,656)   8,374    (3,975)
                
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS   (3,629)   7,804    (1,405)
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR   17,726    9,922    11,327 
CASH AND CASH EQUIVALENTS AT END OF YEAR  $14,097   $17,726   $9,922 
                
CASH PAID DURING YEAR FOR:               
Interest paid, net of amounts capitalized  $9,797   $9,685   $8,347 
Income taxes paid (net of refunds of $42, $42 and $794 in 2019, 2018 and 2017, respectively)  $3,686   $5,832   $4,096 

 

Non-cash investing and financing transactions:

 

   Years Ended September 30, 
   2019   2018   2017 
Debt incurred with seller in connection with acquisition of businesses  $12,000   $1,000   $20,552 
Notes receivable received as proceeds from sale of assets  $1,775   $-   $- 
Unrealized gain on marketable securities  $-  $305   $- 
Note payable reduction from sale proceeds of property  $-   $-   $1,500 
Refinanced long-term debt  $400   $8,354   $8,000 
Net increase in notes payable from trade-in of aircraft  $-   $5,063   $- 
Unpaid liabilities on capital expenditures  $

476

   $

-

   $

-

 

 

See accompanying notes to consolidated financial statements.

 

 46  
   

 

RCI HOSPITALITY HOLDINGS, INC.

Notes to Consolidated Financial Statements

 

1. Nature of Business

 

RCI Hospitality Holdings, Inc. (the “Company”) is a holding company incorporated in Texas in 1994. Through its subsidiaries, the Company currently owns and operates establishments that offer live adult entertainment, restaurant, and/or bar operations. These establishments are located in Houston, Austin, San Antonio, Dallas, Fort Worth, Odessa, Lubbock, Longview, Abilene, Edinburg, El Paso, Harlingen and Beaumont, Texas, as well as Minneapolis, Minnesota; Pittsburgh, Pennsylvania; Charlotte, North Carolina; New York, New York; Pembroke Park and Miami Gardens, Florida; Phoenix, Arizona; Sulphur, Louisiana; and Chicago, Washington Park and Kappa, Illinois. The Company also owns and operates media businesses for adults. The Company’s corporate offices are located in Houston, Texas.

 

2. Summary of Significant Accounting Policies

 

Basis of Accounting

 

The accounts are maintained and the consolidated financial statements have been prepared using the accrual basis of accounting in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP” or “GAAP”).

 

Principles of Consolidation

 

The consolidated financial statements include the accounts of the Company and its subsidiaries in which a controlling interest is owned. Intercompany accounts and transactions have been eliminated in consolidation.

 

Fiscal Year

 

Our fiscal year ends on September 30. References to years 2019, 2018, and 2017 are for fiscal years ended September 30, 2019, 2018, and 2017, respectively. Our fiscal quarters chronologically end on December 31, March 31, June 30 and September 30.

 

Use of Estimates

 

The preparation of consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect certain reported amounts in the consolidated financial statements and accompanying notes. Estimates and assumptions are based on historical experience, forecasted future events, and various other assumptions that we believe to be reasonable under the circumstances. Estimates and assumptions may vary under different circumstances and conditions. We evaluate our estimates and assumptions on an ongoing basis.

 

Cash and Cash Equivalents

 

The Company considers as cash equivalents all highly liquid investments with a maturity of three months or less when purchased. The Company maintains deposits in several financial institutions, which may at times exceed amounts covered by insurance provided by the U.S. Federal Deposit Insurance Corporation (“FDIC”). The Company has not experienced any losses related to amounts in excess of FDIC limits.

 

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RCI HOSPITALITY HOLDINGS, INC.

Notes to Consolidated Financial Statements

 

2. Summary of Significant Accounting Policies - continued

 

Accounts and Notes Receivable

 

Accounts receivable for club and restaurant operations are primarily comprised of credit card charges, which are generally converted to cash in two to five days after a purchase is made. The media division’s accounts receivable are primarily comprised of receivables for advertising sales and Expo registration. Accounts receivable also include employee advances, construction advances, and other miscellaneous receivables. Long-term notes receivable, which have original maturity of more than one year, include consideration from the sale of certain investment interest entities and real estate. The Company recognizes interest income on notes receivable based on the terms of the agreement and based upon management’s evaluation that the notes receivable and interest income will be collected. The Company recognizes allowances for doubtful accounts or notes when, based on management judgment, circumstances indicate that accounts or notes receivable will not be collected. Allowance for doubtful accounts balance was $101,000 and $0 as of September 30, 2019 and 2018, respectively (see Note 5).

 

Inventories

 

Inventories include alcoholic beverages, energy drinks, food, and Company merchandise. Inventories are carried at the lower of cost (on a first-in, first-out (“FIFO”) basis), or net realizable value.

 

Property and Equipment

 

Property and equipment are stated at cost. Provisions for depreciation and amortization are made using straight-line rates over the estimated useful lives of the related assets, and the shorter of useful lives or terms of the applicable leases for leasehold improvements. Buildings have estimated useful lives ranging from 29 to 40 years. Furniture and equipment have estimated useful lives of 5 to 7 years, while leasehold improvements are depreciated at the shorter of the lease term or estimated useful life. Expenditures for major renewals and betterments that extend the useful lives are capitalized. Expenditures for normal maintenance and repairs are expensed as incurred. The cost of assets sold, retired or abandoned and the related accumulated depreciation are written off from the accounts, and any gains or losses are charged or credited in the accompanying consolidated statement of income of the respective period. Interest expense from related debt incurred during site construction is capitalized, which amounted to $597,000 in fiscal 2019, $319,000 in fiscal 2018, and $43,000 in fiscal 2017.

 

Goodwill and Other Intangible Assets

 

Goodwill and other intangible assets with indefinite lives are not amortized but reviewed on an annual basis for impairment. Definite-lived intangible assets are amortized on a straight-line basis over their estimated lives.

 

The costs of transferable licenses purchased through open markets are capitalized as indefinite-lived intangible assets. The costs of obtaining non-transferable licenses that are directly issued by local government agencies are expensed as incurred. Annual license renewal fees are expensed over their renewal term.

 

Goodwill and other intangible assets that have indefinite useful lives are tested annually for impairment during our fourth fiscal quarter and are tested for impairment more frequently if events and circumstances indicate that the asset might be impaired. An impairment loss is recognized to the extent that the carrying amount exceeds the asset’s fair value.

 

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RCI HOSPITALITY HOLDINGS, INC.

Notes to Consolidated Financial Statements

 

2. Summary of Significant Accounting Policies - continued

 

For our goodwill impairment review, we have the option to first perform a qualitative assessment to determine if it is more likely than not that the fair value of the reporting unit is less than its carrying value. This assessment is based on several factors, including industry and market conditions, overall financial performance, including an assessment of cash flows in comparison to actual and projected results of prior periods. If it is determined that it is more likely than not that the fair value of a reporting unit is less than its carrying value based on our qualitative analysis, or if we elect to skip this step, we perform a Step 1 quantitative analysis to determine the fair value of the reporting unit. The fair value is determined using market-related valuation models, including earnings multiples, discounted cash flows, and comparable asset market values. We recognize goodwill impairment in the amount that the carrying value of the reporting unit exceeds the fair value of the reporting unit, not to exceed the amount of goodwill allocated to the reporting unit, based on the results of our Step 1 analysis. For the year ended September 30, 2019, we identified four reporting units that were impaired and recognized a goodwill impairment loss totaling $1.6 million. For the year ended September 30, 2018, we identified two reporting units that were impaired and recognized a goodwill impairment loss totaling $834,000. For the year ended September 30, 2017, we identified four reporting units that were impaired and recognized a goodwill impairment loss totaling $4.7 million. See Note 17.

 

For indefinite-lived intangibles, specifically SOB licenses, we determine fair value by estimating the multiperiod excess earnings of the asset. For indefinite-lived tradename, we determine fair value by using the relief from royalty method. The fair value is then compared to the carrying value and an impairment charge is recognized by the amount by which the carrying amount exceeds the fair value of the asset. We recorded impairment charges for SOB licenses amounting to $178,000 in 2019 related to one club, $3.1 million in 2018 related to three clubs, and $1.4 million in 2017 related to two clubs, which are included in other charges, net in the consolidated statements of income. See Note 17.

 

Impairment of Long-Lived Assets

 

The Company reviews long-lived assets, such as property, plant, and equipment, and intangible assets subject to amortization, for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset or asset group may not be recoverable. These events or changes in circumstances include, but are not limited to, significant underperformance relative to historical or projected future operating results, significant changes in the manner of use of the acquired assets or the strategy for the overall business, and significant negative industry or economic trends. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of the asset group to the estimated undiscounted cash flows over the estimated remaining useful life of the primary asset included in the asset group. If the asset group is not recoverable, the impairment loss is calculated as the excess of the carrying value over the fair value. We define our asset group as an operating club or restaurant location, which is also our reporting unit or the lowest level for which cash flows can be identified. Assets to be disposed of are separately presented in the balance sheet and reported at the lower of the carrying amount or fair value less costs to sell and are no longer depreciated. For assets held for sale, we measure fair value using an estimation based on quoted prices for similar items in active or inactive markets (level 2) developed using observable data. The assets and liabilities of a disposal group classified as held for sale are presented separately in the appropriate asset and liability sections of the balance sheet. During the fourth quarter of fiscal 2019, the Company impaired two clubs for a total of $4.2 million; during the fourth quarter 2018, the Company impaired one club and one Bombshells for a total of $1.6 million; and during the fourth quarter of 2017, the Company impaired one club for $385,000. See Notes 6 and 17.

 

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RCI HOSPITALITY HOLDINGS, INC.

Notes to Consolidated Financial Statements

 

2. Summary of Significant Accounting Policies - continued

 

Fair Value of Financial Instruments

 

The Company calculates the fair value of its assets and liabilities which qualify as financial instruments and includes this additional information in the notes to consolidated financial statements when the fair value is different than the carrying value of these financial instruments. The estimated fair value of accounts receivable, accounts payable and accrued liabilities approximate their carrying amounts due to the relatively short maturity of these instruments. The carrying value of notes receivable and short and long-term debt also approximates fair value since these instruments bear market rates of interest. None of these instruments are held for trading purposes.

 

Comprehensive Income

 

Comprehensive income is the total of net income or loss and all other changes in net assets arising from non-owner sources, which are referred to as items of other comprehensive income. An analysis of changes in components of accumulated other comprehensive income is presented in the consolidated statements of comprehensive income.

 

Revenue Recognition

 

See “Impact of Recently Issued Accounting Standards” section below regarding ASC 606 and Note 4.

 

Advertising and Marketing

 

Advertising and marketing expenses are primarily comprised of costs related to public advertisements and giveaways, which are used for promotional purposes. Advertising and marketing expenses are expensed as incurred and are included in selling, general and administrative expenses in the accompanying consolidated statements of income. See Note 5.

 

Income Taxes

 

The Company and its subsidiaries are subject to U.S. federal income tax and income taxes imposed in the state and local jurisdictions where we operate our businesses. Deferred income taxes are determined using the liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. In addition, a valuation allowance is established to reduce any deferred tax asset for which it is determined that it is more likely than not that some portion of the deferred tax asset will not be realized.

 

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RCI HOSPITALITY HOLDINGS, INC.

Notes to Consolidated Financial Statements

 

2. Summary of Significant Accounting Policies - continued

 

U.S. GAAP creates a single model to address accounting for uncertainty in tax positions by prescribing a minimum recognition threshold a tax position is required to meet before being recognized in the financial statements. We recognize penalties related to unrecognized tax benefits as a component of selling, general and administrative expenses, and recognize interest accrued related to unrecognized tax benefits in interest expense.

 

Investments

 

Investments in companies in which the company has a 20% to 50% interest are accounted for using the equity method, which are carried at cost and adjusted for the Company’s proportionate share of their undistributed earnings or losses. Investments in companies in which the Company owns less than a 20% interest, or where the Company does not exercise significant influence, are accounted for at cost and reviewed for any impairment. Cost and equity method investments are included in other assets in the Company’s consolidated balance sheets. The Company sold 31% of Drink Robust on September 29, 2016, retaining 20%. Because the Company had no ability to direct the management of the investee company or exert significant influence, the investment was accounted for at cost beginning on the date of sale. During the fourth quarter of fiscal 2017, we determined our investment in Drink Robust was impaired and recognized an other-than-temporary impairment totaling $1.2 million which brought our carrying value of this investment to zero. In relation to the reacquisition of Drink Robust in 2018, we have consolidated the operations of Drink Robust and eliminated the investment in consolidation. See Note 15.

 

Earnings Per Share

 

Basic earnings per share includes no dilution and is computed by dividing income available to common stockholders by the weighted average number of common shares outstanding for the period. Diluted earnings per share reflect the potential dilution of securities that could share in the earnings of the Company. Potential common stock shares consist of shares that may arise from outstanding dilutive common restricted stock, stock options and warrants (the number of which is computed using the treasury stock method) and from outstanding convertible debentures (the number of which is computed using the if-converted method). Diluted earnings per share considers the potential dilution that could occur if the Company’s outstanding common restricted stock, stock options, warrants and convertible debentures were converted into common stock that then shared in the Company’s earnings or losses (as adjusted for interest expense, that would no longer be incurred if the debentures were converted).

 

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RCI HOSPITALITY HOLDINGS, INC.

Notes to Consolidated Financial Statements

 

2. Summary of Significant Accounting Policies - continued

 

Net earnings applicable to common stock and the weighted average number of shares used for basic and diluted earnings (loss) per share computations are summarized in the table that follows (in thousands, except per share data):

 

   For the Year Ended 
   September 30, 
   2019   2018   2017 
Numerator -               
Net income attributable to RCIHH shareholders - basic  $19,175   $20,879   $8,259 
Adjustment to net income from assumed conversion of debentures(1)   -    -    5 
Adjusted net income attributable to RCIHH shareholders - diluted  $19,175   $20,879   $8,264 
Denominator -               
Weighted average number of common shares outstanding - basic   9,657    9,719    9,731 
Effect of potentially dilutive convertible debentures   -    -    12 
Adjusted weighted average number of common shares outstanding - diluted   9,657    9,719    9,743 
                
Basic earnings per share  $1.99   $2.15   $0.85 
Diluted earnings per share  $1.99   $2.15   $0.85 

 

(1) Represents interest expense on dilutive convertible securities that would not occur if they were assumed converted.

 

(2) There were no outstanding warrants and options to be considered for the EPS computation for all periods presented.

 

Convertible debentures amounting to $0, $0, and $0.9 million were dilutive in 2019, 2018, and 2017, respectively.

 

Stock Options

 

The Company recognizes all employee stock-based compensation as a cost in the consolidated financial statements. Equity-classified awards are measured at the grant date fair value of the award and recognized as expense over their requisite service period. The Company estimates grant date fair value using the Black-Scholes option-pricing model. The critical estimates are volatility, expected life and risk-free rate.

 

At September 30, 2019 and 2018, the Company has no stock options outstanding.

 

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RCI HOSPITALITY HOLDINGS, INC.

Notes to Consolidated Financial Statements

 

2. Summary of Significant Accounting Policies - continued

 

Legal and Other Contingencies

 

The Company records a liability when it is probable that a loss has been incurred and the amount is reasonably estimable. There is significant judgment required in both the probability determination and as to whether an exposure can be reasonably estimated. In the opinion of management, there was not at least a reasonable possibility that we may have incurred a material loss, or a material loss in excess of a recorded accrual, with respect to loss contingencies for asserted legal and other claims. The Company recognizes legal fees and expenses, including those related to legal contingencies, as incurred.

 

Generally, the Company recognizes gain contingencies when they are realized or when all related contingencies have been resolved.

 

The Company maintains insurance that covers claims arising from risks associated with the Company’s business including claims for workers’ compensation, general liability, property, auto, and business interruption coverage. The Company carries substantial insurance to cover such risks with large deductibles and/or self-insured retention. These policies have been structured to limit our per-occurrence exposure. The Company believes, and the Company’s experience has been, that such insurance policies have been sufficient to cover such risks.

 

Fair Value Accounting

 

The Company utilizes valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs to the extent possible. The Company determines fair value based on assumptions that market participants would use in pricing an asset or liability in the principal or most advantageous market. When considering market participant assumptions in fair value measurements, the following fair value hierarchy distinguishes between observable and unobservable inputs, which are categorized in one of the following levels.

 

U.S. GAAP establishes a three-tier fair value hierarchy, which prioritizes the inputs used in the valuation methodologies in measuring fair value:

 

  Level 1 – Observable inputs that reflect quoted prices (unadjusted) for identical assets or liabilities in active markets.
     
  Level 2 – Include other inputs that are directly or indirectly observable in the marketplace.
     
  Level 3 – Unobservable inputs which are supported by little or no market activity.

 

The fair value hierarchy also requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.

 

The Company classifies its marketable securities as available-for-sale, which are reported at fair value. Unrealized holding gains and losses, net of the related income tax effect, if any, on available-for-sale securities were excluded from income and were reported as accumulated other comprehensive income in equity until our adoption of ASU 2016-01 as of October 1, 2018. Realized gains and losses (and unrealized gains and losses upon the adoption of ASU 2016-01) from securities classified as available-for-sale are included in comprehensive income. The Company measures the fair value of its marketable securities based on quoted prices for identical securities in active markets, or Level 1 inputs. Available-for-sale securities, which are included in other assets in the consolidated balance sheets, had a balance of $148,000 and $760,000 as of September 30, 2019 and 2018.

 

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RCI HOSPITALITY HOLDINGS, INC.

Notes to Consolidated Financial Statements

 

2. Summary of Significant Accounting Policies - continued

 

In accordance with U.S. GAAP, the Company reviews its marketable securities to determine whether a decline in fair value of a security below the cost basis is other than temporary. Should the decline be considered other than temporary, the Company writes down the cost basis of the security and include the loss in current earnings as opposed to an unrealized holding loss. No losses or other-than-temporary impairments in our marketable securities portfolio were recognized during the years ended September 30, 2019, 2018, and 2017.

 

Assets and Liabilities that are Measured at Fair Value on a Nonrecurring Basis

 

Assets and liabilities that are measured at fair value on a nonrecurring basis relate primarily to tangible property and equipment, goodwill and other intangible assets, which are remeasured when the derived fair value is below carrying value in the consolidated balance sheets. For these assets, the Company does not periodically adjust carrying value to fair value except in the event of impairment. If it is determined that impairment has occurred, the carrying value of the asset is reduced to fair value and the difference is included in other charges, net in the consolidated statements of income.

 

Assets and liabilities that are measured at fair value on a nonrecurring basis are as follows (in thousands):

 

       Fair Value at Reporting Date Using 
       Quoted Prices in       Significant 
       Active Markets for   Significant Other   Unobservable 
   September 30,   Identical Asset   Observable Inputs   Inputs 
Description  2019   (Level 1)   (Level 2)   (Level 3) 
Property and equipment, net  $10,926   $-   $        -   $10,926 
Indefinite-lived intangibles   5,323    -    -    5,323 
Definite-lived intangibles   200    -    -    200 
Goodwill   11,627    -    -    11,627 
Other assets (equity securities)   148    148    -    - 

 

       Fair Value at Reporting Date Using 
       Quoted Prices in       Significant 
       Active Markets for   Significant Other   Unobservable 
   September 30,   Identical Asset   Observable Inputs   Inputs 
Description  2018   (Level 1)   (Level 2)   (Level 3) 
Goodwill  $1,999   $-   $       -   $1,999 
Property and equipment, net   141    -    -    141 
Indefinite-lived intangibles   4,618    -    -    4,618 
Notes receivable   0    -    -    0 
Other assets (equity securities)   760    760    -    - 

 

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RCI HOSPITALITY HOLDINGS, INC.

Notes to Consolidated Financial Statements

 

2. Summary of Significant Accounting Policies - continued

 

   Unrealized Gain (Loss/Impairments) Recognized 
   Years Ended September 30, 
Description  2019   2018   2017 
       (As Revised)     
Goodwill  $(1,638)  $(834)  $(4,697)
Property and equipment, net   (4,224)   (1,615)   (385)
Indefinite-lived intangibles   (178)   (3,121)   (1,401)
Assets held for sale   -    -    - 
Other assets (equity securities)   (612)   305    (1,156)

 

Impact of Recently Issued Accounting Standards

 

In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers (“ASU 2014-09” and codified as Accounting Standards Codification No. 606, “ASC 606”), which supersedes nearly all existing revenue recognition guidance under GAAP. The core principle of ASU 2014-09 is to recognize revenues when promised goods or services are transferred to customers in an amount that reflects the consideration to which an entity expects to be entitled for those goods or services. ASU 2014-09 defines a five-step process to achieve this core principle and, in doing so, more judgment and estimates may be required within the revenue recognition process than are required under existing GAAP. The standard’s effective date has been deferred by the issuance of ASU No. 2015-14, and is effective for annual periods beginning after December 15, 2017, and interim periods therein. The guidance permits using either of the following transition methods: (i) a full retrospective approach reflecting the application of the standard in each prior reporting period with the option to elect certain practical expedients, or (ii) a retrospective approach with the cumulative effect of initially adopting ASU 2014-09 recognized at the date of adoption (which includes additional footnote disclosures). Early application is permitted but not before December 15, 2016, the ASU’s original effective date. The Company adopted the new revenue recognition standard as of October 1, 2018 using the cumulative effect method, which did not have a material impact on its consolidated financial statements. See Note 4 for new disclosures as required by ASC 606.

 

In January 2016, the FASB issued ASU No. 2016-01, Financial Instruments—Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities, which amends the guidance on the classification and measurement of financial instruments. Although the ASU retains many current requirements, it significantly revises an entity’s accounting related to (1) the classification and measurement of investments in equity securities and (2) the presentation of certain fair value changes for financial liabilities measured at fair value. The ASU also amends certain disclosure requirements associated with the fair value of financial instruments. The amendments of the ASU are effective for us for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The Company adopted ASU 2016-01 as of October 1, 2018. Our adoption required the Company to reclassify $220,000 from accumulated other comprehensive income to retained earnings as of the beginning of the quarter ended December 31, 2018. All succeeding unrealized gains or losses related the changes in the market value of our equity securities are included in other income/expenses in our consolidated statement of income.

 

In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842), on accounting for leases which requires lessees to recognize most leases on their balance sheets for the rights and obligations created by those leases. The guidance requires enhanced disclosures regarding the amount, timing, and uncertainty of cash flows arising from leases, and will be effective for interim and annual periods beginning after December 15, 2018. Early adoption is permitted. In July 2018, the FASB issued ASU 2018-11 providing for certain practical expedients in the implementation of ASU 2016-02. The guidance requires the use of a modified retrospective approach. We will adopt ASU 2016-02 and related amendments as of the beginning of our fiscal first quarter ending December 31, 2019. We will be electing the package of practical expedients permitted under the transition guidance within the new standard, which among other things, allows us to retain historical lease classification, as well as relief from reviewing expired and existing contracts to determine if they contain leases. We expect our total assets as of October 1, 2019 to have an increase of approximately $24.5 million due to the recognition of operating lease right-of-use assets, and a corresponding increase in total liabilities due to the recognition of operating lease liabilities after the reversal of our deferred rent liability balance as of September 30, 2019. We do not expect ASC 842 to have an impact on our consolidated statements of income and cash flows. As a result of the adoption of ASC 842, we do not expect our future minimum lease payments for the fiscal first quarter ending December 31, 2019 related to leases existing as of September 30, 2019 to be materially different from the amounts disclosed in future minimum lease commitments in Note 11.

 

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RCI HOSPITALITY HOLDINGS, INC.

Notes to Consolidated Financial Statements

 

2. Summary of Significant Accounting Policies - continued

 

In June 2016, the FASB issued ASU 2016-13, Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. This ASU requires, among other things, the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. ASU 2016-13 replaces the existing incurred loss impairment model with an expected loss model which requires the use of forward-looking information to calculate credit loss estimates. It also eliminates the concept of other-than-temporary impairment and requires credit losses related to available-for-sale debt securities to be recorded through an allowance for credit losses rather than as a reduction in the amortized cost basis of the securities. These changes will result in earlier recognition of credit losses. The ASU is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. Early application will be permitted for all entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. We are still evaluating the impact of this ASU, including all related updates, on the Company’s consolidated financial statements. 

 

In February 2018, the FASB issued ASU 2018-02, Income Statement—Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income. This ASU provides financial statement preparers with an option to reclassify stranded tax effects within AOCI to retained earnings in each period in which the effect of the change in the U.S. federal corporate income tax rate in the Tax Cuts and Jobs Act (“Tax Act”) is recorded. The ASU requires financial statement preparers to disclose (1) a description of the accounting policy for releasing income tax effects from AOCI; (2) whether they elect to reclassify the stranded income tax effects from the Tax Act; and (3) information about the other income tax effects that are reclassified. The amendments affect any organization that is required to apply the provisions of Topic 220, Income Statement—Reporting Comprehensive Income, and has items of other comprehensive income for which the related tax effects are presented in other comprehensive income as required by GAAP. The ASU is effective for all organizations for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. Early adoption is permitted. Organizations should apply the proposed amendments either in the period of adoption or retrospectively to each period (or periods) in which the effect of the change in the U.S. federal corporate income tax rate in the Tax Act is recognized. We believe that the adoption of this ASU will not have a material impact on our consolidated financial statements.

 

In August 2018, the FASB issued ASU No. 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework—Changes to the Disclosure Requirements for Fair Value Measurement. ASU 2018-13 modifies the disclosure requirements of Accounting Standards Codification (“ASC”) Topic 820 with certain removals, modifications, and additions. Eliminated disclosures that may affect the Company include (1) transfers between level 1 and level 2 of the fair value hierarchy, and (2) policies related to valuation processes and the timing of transfers between levels of the fair value hierarchy. Modified disclosures that may affect the Company include (1) a requirement to disclose the timing of liquidation of an investee’s assets and the date when restrictions from redemption might lapse if the entity has communicated the timing publicly for investments in certain entities that calculate net asset value, and (2) clarification that the measurement uncertainty disclosure is to communicate information about the uncertainty in measurement as of the reporting date. Additional disclosures that may affect the Company include (1) disclosure of changes in unrealized gains and losses for the period included in other comprehensive income for recurring level 3 fair value measurements held at the end of the reporting period, and (2) disclosure of the range and weighted average of significant unobservable inputs used to develop level 3 fair value measurements. The update is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. Early adoption is permitted for any removed or modified disclosures upon issuance of the ASU and delay adoption of the additional disclosures until the effective date. We are still evaluating the impact of this ASU on the Company’s consolidated financial statements.

 

In March 2019, the FASB issued ASU No. 2019-01, Leases (Topic 842): Codification Improvements. ASU 2019-01 aligns the guidance for fair value of the underlying asset by lessors with existing guidance in Topic 842. The ASU requires that the fair value of the underlying asset at lease commencement is its cost reflecting in volume or trade discounts that may apply. However, if there has been a significant lapse of time between the date the asset was acquired and the lease commencement date, the definition of fair value as outlined in Topic 820 should be applied. In addition, the ASU exempts both lessees and lessors from having to provide certain interim disclosures in the fiscal year in which a company adopts the new leases standard. The update is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. We are still evaluating the impact of this ASU on the Company’s consolidated financial statements.

 

In December 2019, the FASB issued ASU 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes. This ASU simplifies accounting for income taxes by removing the following exceptions: (1) exception to the incremental approach for intraperiod tax allocation, (2) exceptions to accounting for basis differences when there are ownership changes in foreign investments, and (3) exception in interim period income tax accounting for year-to-date losses that exceed anticipated losses. The ASU also improves financial statement preparers’ application of income tax related guidance for franchise taxes that are partially based on income; transactions with a government that result in a step up in the tax basis of goodwill; separate financial statements of legal entities that are not subject to tax; and enacted changes in tax laws in interim periods. The ASU is effective for public business entities for fiscal years beginning after December 15, 2020, and interim periods within those fiscal years. Early adoption is permitted for public business entities for periods for which financial statements have not been issued. An entity that elects early adoption in an interim period should reflect any adjustments as of the beginning of the annual period that includes that interim period. Additionally, an entity that elects early adoption should adopt all the amendments in the same period. We are still evaluating the impact of this ASU on the Company’s consolidated financial statements.

 

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RCI HOSPITALITY HOLDINGS, INC.

Notes to Consolidated Financial Statements

 

3. Revision of Prior Year Immaterial Misstatement

 

During the quarter ended December 31, 2018 (first quarter of fiscal 2019), the Company identified certain mechanical errors in its goodwill impairment analysis that was performed for its annual impairment testing for fiscal year ended September 30, 2018. These errors related to the use of an incorrect income tax rate assumption and the exclusion of certain debt service payments as part of our goodwill impairment testing for two of our reporting units, which resulted in a goodwill impairment charge of $834,000.

 

The Company assessed the materiality of these errors considering both qualitative and quantitative factors and determined that for both the quarter and fiscal year ended September 30, 2018, the errors were immaterial. The Company has decided to correct these immaterial errors as revisions to our previously issued financial statements and has adjusted this Form 10-K insofar as fiscal 2018 is concerned.

 

The tables below present the impact of the revision in the Company’s consolidated financial statements (in thousands):

 

   Fiscal Year Ended September 30, 2018 
   As Previously Reported   Adjustments   As Revised 
Statement of Income/Comprehensive Income:               
Other charges, net  $8,350   $834   $9,184 
Total operating expenses   137,352    834    138,186 
Income from operations   28,396    (834)   27,562 
Income before income taxes   18,676    (834)   17,842 
Net income   21,794    (834)   20,960 
Net income attributable to RCIHH common stockholders   21,713    (834)   20,879 
Earnings per share - basic  $2.23   $(0.08)  $2.15 
Earnings per share - diluted  $2.23   $(0.08)  $2.15 
Comprehensive income  $22,014   $(834)  $21,180 
Comprehensive income attributable to RCI Hospitality Holdings, Inc.   21,933    (834)   21,099 

 

   September 30, 2018 
   As Previously Reported   Adjustment   As Revised 
Balance Sheet/Statement of Changes in Equity               
Goodwill  $44,425   $(834)  $43,591 
Total assets   330,566    (834)   329,732 
Retained earnings   89,740    (834)   88,906 
Total RCIHH stockholders’ equity   154,269    (834)   153,435 
Total equity   154,166    (834)   153,332 
Total liabilities and equity   330,566    (834)   329,732 

 

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RCI HOSPITALITY HOLDINGS, INC.

Notes to Consolidated Financial Statements

 

3. Revision of Prior Year Immaterial Misstatement - continued

 

The table below presents the impact of the revision in the Company’s notes to its consolidated financial statements related to unaudited quarterly results of operations (in thousands):

 

   Quarter Ended September 30, 2018 
   As Previously Reported   Adjustment   As Revised 
Income from operations  $1,533   $(834)  $699 
Net loss attributable to RCIHH common stockholders   (2,672)   (834)   (3,506)
Loss per share - basic  $(0.27)  $(0.09)  $(0.36)
Loss per share - diluted  $(0.27)  $(0.09)  $(0.36)

 

The consolidated statements of cash flows are not presented because there is no impact on total cash flows from operating activities, investing activities and financing activities. Certain components of net cash provided by operating activities changed, as caused by the revision, but the net change amounted to zero for both quarter and fiscal year ended September 30, 2018.

 

4. Revenues

 

On October 1, 2018, the Company adopted ASC Topic 606, Revenue from Contracts with Customers (formerly ASU 2014-09). The Company recognizes revenue from the sale of alcoholic beverages, food and merchandise, service and other revenues at the point-of-sale upon receipt of cash, check, or credit card charge, net of discounts and promotional allowances based on consideration specified in implied contracts with customers. Sales and liquor taxes collected from customers and remitted to governmental authorities are presented on a net basis in the accompanying consolidated statements of income. The Company recognizes revenue when it satisfies a performance obligation (point in time of sale) by transferring control over a product or service to a customer.

 

Commission revenues, such as ATM commission, are recognized when the basis for such commission has transpired. Revenues from the sale of magazines and advertising content are recognized when the issue is published and shipped. Revenues and external expenses related to the Company’s annual Expo convention are recognized upon the completion of the convention, which normally occurs during our fiscal fourth quarter. Other rental revenues are recognized when earned (recognized over time) and are more appropriately covered by guidance under ASC Topic 840, Leases (under ASC 842 commencing on October 1, 2019).

 

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RCI HOSPITALITY HOLDINGS, INC.

Notes to Consolidated Financial Statements

 

4. Revenues - continued

 

Revenues, as disaggregated by revenue type, timing of recognition, and reportable segment (see also Note 18), are shown below (in thousands).

 

   Fiscal 2019 
   Nightclubs   Bombshells   Other   Total 
Sales of alcoholic beverages  $57,277   $17,863   $-   $75,140 
Sales of food and merchandise   13,051    12,779    -    25,830 
Service revenues   67,893    162    -    68,055