UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q/A

(Amendment No. 1)

 

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

 

For the quarterly period ended December 31, 2018

 

[  ] TRANSITION REPORT PURSUANT TO 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)

 

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 [X] No [  ]

 

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, or a smaller reporting company. 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]

 

As of February 1, 2019, 9,690,500 shares of the registrant’s common stock were outstanding.

 

 

 

   
 

 

EXPLANATORY NOTE ON AMENDMENT

 

On February 11, 2019, RCI Hospitality Holdings, Inc. filed its Quarterly Report on Form 10-Q for the quarterly period ended December 31, 2018 (“Form 10-Q”). We are filing this Amendment No. 1 to Form 10-Q to revise both Section 302 Certifications filed as Exhibits 31.1 and 31.2 to the Form 10-Q to conform with the requirements of Item 601 of Regulation S-K, including to correct the introductory section of paragraph 4 to include language that was inadvertently omitted. Because the certification relates to the entire Form 10-Q, we are including the entire filing with this Amendment No.1.

 

This Amendment No. 1 speaks as of the filing date of the Form 10-Q, does not update information in the Form 10-Q to reflect events that have occurred subsequent to the filing date of the Form 10-Q, and does not modify or update in any way disclosures made in the Form 10-Q. Except as described above, no other amendments are being made to the Form 10-Q.

 

NOTE ABOUT FORWARD-LOOKING STATEMENTS

 

This Quarterly Report on Form 10-Q 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: Part I, Item 2 “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 Quarterly Report on Form 10-Q 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 operating and managing an adult business, the business climates in cities where it operates, the success or lack thereof in launching and building the company’s businesses, risks and uncertainties related to cyber security, conditions relevant to real estate transactions, and 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.

 

As used herein, the “Company,” “we,” “our,” and similar terms include RCI Hospitality Holdings, Inc. and its subsidiaries, unless the context indicates otherwise.

 

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RCI HOSPITALITY HOLDINGS, INC.

FORM 10-Q

TABLE OF CONTENTS

 

    Page
PART I FINANCIAL INFORMATION  
     
Item 1. Financial Statements 4
     
  Condensed Consolidated Balance Sheets as of December 31, 2018 (unaudited) and September 30, 2018 4
     
  Condensed Consolidated Statements of Income (unaudited) for the three months ended December 31, 2018 and 2017 5
     
  Condensed Consolidated Statements of Cash Flows (unaudited) for the three months ended December 31, 2018 and 2017 6
     
  Notes to Condensed Consolidated Financial Statements (unaudited) 8
     
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 20
     
Item 3. Quantitative and Qualitative Disclosures about Market Risk 32
     
Item 4. Controls and Procedures 32
     
PART II OTHER INFORMATION  
     
Item 1. Legal Proceedings 36
     
Item1A. Risk Factors 36
     
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 36
     
Item 6. Exhibits 37
     
  Signatures 38

 

 3 

 

 

PART I FINANCIAL INFORMATION

 

Item 1. Financial Statements.

 

RCI HOSPITALITY HOLDINGS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except par value)

 

   December 31,   September 30, 
   2018   2018 
   (unaudited)   (As Revised)  
ASSETS          
Current assets          
Cash and cash equivalents  $9,387   $17,726 
Accounts receivable, net   5,583    7,320 
Inventories   2,578    2,353 
Prepaid insurance   3,603    4,910 
Other current assets   1,560    1,591 
Assets held for sale   2,356    2,902 
Total current assets   25,067    36,802 
Property and equipment, net   187,502    172,403 
Notes receivable   3,467    2,874 
Goodwill   54,731    43,591 
Intangibles, net   77,289    71,532 
Other assets   1,466    2,530 
Total assets  $349,522   $329,732 
           
LIABILITIES AND STOCKHOLDERS’ EQUITY          
Current liabilities          
Accounts payable  $2,357   $2,825 
Accrued liabilities   11,940    11,973 
Current portion of long-term debt   14,898    19,047 
Total current liabilities   29,195    33,845 
Deferred tax liability, net   21,473    19,552 
Long-term debt, net of current portion   138,197    121,580 
Other long-term liabilities   1,567    1,423 
Total liabilities   190,432    176,400 
           
Commitments and contingencies (Note 10)          
           
Stockholders’ 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; 9,705 and 9,719 shares issued and outstanding as of December 31, 2018 and September 30, 2018, respectively   97    97 
Additional paid-in capital   63,857    64,212 
Retained earnings   95,179    88,906 
Accumulated other comprehensive income   -   220 
Total RCIHH stockholders’ equity   159,133    153,435 
Noncontrolling interests   (43)   (103)
Total stockholders’ equity   159,090    153,332 
Total liabilities and stockholders’ equity  $

349,522

   $329,732 

 

See accompanying notes to condensed consolidated financial statements.

 

 4 

 

 

RCI HOSPITALITY HOLDINGS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(in thousands, except per share data)

(unaudited)

 

   For the Three Months 
   Ended December 31, 
   2018   2017 
Revenues          
Sales of alcoholic beverages  $18,310   $17,805 
Sales of food and merchandise   5,690    5,307 
Service revenues   17,331    15,889 
Other   2,692    2,211 
Total revenues   44,023    41,212 
Operating expenses          
Cost of goods sold          
Alcoholic beverages sold   3,736    3,755 
Food and merchandise sold   1,984    2,094 
Service and other   92    36 
Total cost of goods sold (exclusive of items shown separately below)   5,812    5,885 
Salaries and wages   12,096    11,377 
Selling, general and administrative   14,027    12,812 
Depreciation and amortization   2,053    1,909 
Other charges (gains), net   (1,097)   89 
Total operating expenses   32,891    32,072 
Income from operations   11,132    9,140 
Other income (expenses)          
Interest expense   (2,521)   (3,079)
Interest income   51    67 
Non-operating loss   (447)   - 
Income before income taxes   8,215    6,128 
Income tax expense (benefit)   1,811    (8,227)
Net income   6,404    14,355 
Net income attributable to noncontrolling interests   (60)   (44)
Net income attributable to RCIHH common shareholders  $6,344   $14,311 
           
Earnings per share          
Basic  $0.65   $1.47 
Diluted  $0.65   $1.47 
Weighted average number of common shares outstanding          
Basic   9,713    9,719 
Diluted   9,713    9,719 
           
Dividends per share  $0.03   $0.03 

 

See accompanying notes to condensed consolidated financial statements.

 

 5 

 

 

RCI HOSPITALITY HOLDINGS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

 

   For the Three Months 
   Ended December 31, 
   2018   2017 
CASH FLOWS FROM OPERATING ACTIVITIES          
Net income  $6,404   $14,355 
Adjustments to reconcile net income to net cash provided by operating activities:          
Depreciation and amortization   2,053    1,909 
Deferred tax expense (credit)   458    (9,697)
Loss (gain) on sale of assets   (1,176)   140 
Unrealized loss on equity securities   447    - 
Amortization of debt discount and issuance costs   95    324 
Deferred rent   142    75 
Gain on insurance settlements   -    (20)
Debt prepayment penalty   -    543 
Changes in operating assets and liabilities:          
Accounts receivable   1,723    (926)
Inventories   (163)   (270)
Prepaid expenses and other assets   1,939    1,044 
Accounts payable and accrued liabilities   (470)   668 
Net cash provided by operating activities   11,452    8,145 
CASH FLOWS FROM INVESTING ACTIVITIES          
Proceeds from sale of assets   1,245    632 
Proceeds from insurance   -    20 
Proceeds from notes receivable   32    28 
Additions to property and equipment   (7,295)   (2,769)
Acquisition of businesses, net of cash acquired   (13,500)   - 
Net cash used in investing activities   (19,518)   (2,089)
CASH FLOWS FROM FINANCING ACTIVITIES          
Proceeds from long-term debt   5,652    58,920 
Payments on long-term debt   (5,279)   (61,256)
Debt prepayment penalty   -    (543)
Purchase of treasury stock   (355)   - 
Payment of dividends   (291)   (292)
Payment of loan origination costs   -    (799)
Distribution to noncontrolling interests   -    (54)
Net cash used in financing activities   (273)   (4,024)
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS   (8,339)   2,032 
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD   17,726    9,922 
CASH AND CASH EQUIVALENTS AT END OF PERIOD  $9,387   $11,954 
           
CASH PAID DURING PERIOD FOR:          
Interest, net of amounts capitalized  $2,345   $2,890 
Income taxes  $243   $157 

 

See accompanying notes to condensed consolidated financial statements.

 

 6 

 

 

Non-cash and other transactions:

 

During the quarter ended December 31, 2018, in conjunction with the borrowings of $2.35 million from certain investors, the Company exchanged two notes payable with principal balances of $300,000 and $100,000 for two new notes amounting to $450,000 and $200,000, respectively. The Company received cash amounting to $1.95 million on the entire transaction. See Note 6.

 

During the quarter ended December 31, 2018, the Company acquired two clubs for a total acquisition price of $25.5 million by paying a total of $13.5 million at closing and executing three seller-financed notes for a total of $12.0 million. See Note 14.

 

During the quarter ended December 31, 2017, the Company refinanced $81.2 million of long-term debt comprised of 21 notes payable with the execution of three notes payable with a lender bank. The new notes and the repaid balance included $18.7 million worth of debt with the same lender bank.

 

During the quarter ended December 31, 2017, the Company borrowed $7.1 million from a lender to purchase an aircraft by trading in an aircraft that the Company owned and the assumption of the old aircraft’s note payable liability.

 

 7 

 

 

RCI HOSPITALITY HOLDINGS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

1. Basis of Presentation

 

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP” or “U.S. GAAP”) for interim financial information and with the instructions to Form 10-Q of Regulation S-X. They do not include all information and footnotes required by GAAP for complete financial statements. The September 30, 2018 consolidated balance sheet data were derived from audited financial statements but do not include all disclosures required by GAAP. However, except as disclosed herein, there has been no material change in the information disclosed in the notes to the consolidated financial statements for the year ended September 30, 2018 included in the Company’s Annual Report on Form 10-K, as filed with the Securities and Exchange Commission on December 31, 2018. The interim unaudited condensed consolidated financial statements should be read in conjunction with those consolidated financial statements included in the Form 10-K. In the opinion of management, all adjustments considered necessary for a fair presentation of the financial statements, consisting solely of normal recurring adjustments, have been made. Operating results for the three months ended December 31, 2018 are not necessarily indicative of the results that may be expected for the year ending September 30, 2019.

 

2. Recent Accounting Standards and Pronouncements

 

In May 2014, the FASB issued Accounting Standards Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers (“ASU 2014-09”), 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.

 

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 will be included in non-operating gains/losses 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. The guidance requires the use of a modified retrospective approach. We expect our consolidated balance sheets to be materially impacted upon adoption due to the recognition of right-of-use assets and lease liabilities related to currently classified operating leases. As a preparation for the evaluation and implementation of the new lease standard, we have started to collect real property and equipment leases on prior years affected by the standard. While we anticipate changes in the classification of expenses in our income statement and the timing of recognition of these expenses, we are still evaluating the materiality of the implementation of this standard.

 

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RCI HOSPITALITY HOLDINGS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

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 June 2018, the FASB issued ASU 2018-07, Compensation—Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment Accounting. This ASU expands the scope of Topic 718, which currently only includes share-based payments issued to employees, to include share-based payments issued to nonemployees for goods and services. This ASU is effective for the Company for fiscal years beginning after December 15, 2018, including interim periods within that fiscal year. Early adoption is permitted, but no earlier than the Company’s adoption of ASU 2014-09. We are still evaluating the impact of this ASU on the Company’s 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.

 

Note 3. Revision of Prior Year Immaterial Misstatement

 

During the quarter ended December 31, 2018, the Company identified certain mechanical errors in our goodwill impairment analysis that was performed for our 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 will adjust the Form 10-K when filed in succeeding periods of this fiscal year.

 

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RCI HOSPITALITY HOLDINGS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

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 shareholders   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 Stockholders’ 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 stockholders’ equity   154,166    (834)   153,332 
Total liabilities and stockholders’ equity   330,566    (834)   329,732 

 

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 shareholders   (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.

 

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RCI HOSPITALITY HOLDINGS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

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.

 

Revenues, as disaggregated by revenue type, timing of recognition, and reportable segment (see Note 11), are shown below.

 

   Nightclubs   Bombshells   Other 
Quarter ended December 31, 2018:               
Sales of alcoholic beverages  $14,802   $3,508   $- 
Sales of food and merchandise   3,207    2,483    - 
Service revenues   17,313    18    - 
Other revenues   2,406    4    282 
   $37,728   $6,013   $282 
                
Recognized at a point in time  $37,392   $6,013   $267 
Recognized over time  $336*  $-   $15 
                
Quarter ended December 31, 2017:               
Sales of alcoholic beverages  $14,125   $3,680   $- 
Sales of food and merchandise   3,162    2,145    - 
Service revenues   15,889    -    - 
Other revenues   2,042    3    166 
   $35,218   $5,828   $166 
                
Recognized at a point in time  $34,927   $5,828   $145 
Recognized over time  $291*  $-   $21 

 

* Rental revenue (included in Other Revenues) as covered by ASC Topic 840. All other revenues are covered by ASC Topic 606.

 

The Company does not have contract assets with customers. The Company’s unconditional right to consideration for goods and services transferred to the customer is included in accounts receivable, net in our consolidated balance sheet. A reconciliation of contract liabilities with customers is presented below:

 

  

Balance at September 30,

2018

   Consideration Received   Recognized in Revenue   Balance at December 31, 2018 
Ad revenue  $126   $274   $(181)  $219 
Expo revenue   -    201    -    201 
Other   8    1    -    9 
   $134   $476   $(181)  $429 

 

Contract liabilities with customers are included in accrued liabilities as unearned revenues in our consolidated balance sheets (see also Note 5), while the revenues associated with these contract liabilities are included in other revenues in our consolidated statements of income.

 

 11 

 

 

RCI HOSPITALITY HOLDINGS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

5. Selected Account Information

 

The components of accrued liabilities are as follows (in thousands):

 

   December 31, 2018   September 30, 2018 
Insurance  $2,627   $3,807 
Payroll and related costs   2,584    2,293 
Property taxes   2,058    1,796 
Sales and liquor taxes   1,959    1,883 
Patron tax   640    532 
Unearned revenues   429    134 
Other   1,643    1,528 
   $11,940   $11,973 

 

The components of selling, general and administrative expenses are as follows (in thousands):

 

   For the Three Months 
   Ended December 31, 
   2018   2017 
Taxes and permits  $2,181   $2,166 
Advertising and marketing   2,148    1,965 
Supplies and services   1,456    1,368 
Insurance   1,353    1,259 
Legal   1,058    377 
Rent   1,019    940 
Charge card fees   933    887 
Utilities   744    695 
Security   709    638 
Accounting and professional fees   650    886 
Repairs and maintenance   587    570 
Other   1,189    1,061 
   $14,027   $12,812 

 

6. Long-Term Debt

 

On November 1, 2018, the Company raised $2.35 million through the issuance of 12% unsecured promissory notes to certain investors, which notes mature on November 1, 2021. The notes pay interest-only in equal monthly installments, with a lump sum principal payment at maturity. Among the promissory notes are two notes with a principal of $450,000 and $200,000. The $450,000 note was in exchange for a $300,000 12% note and the $200,000 note was in exchange for a $100,000 note, both of which were included in the May 1, 2017 financing to acquire Scarlett’s Cabaret in Miami. Also included in the $2.35 million borrowing is a $500,000 note borrowed from a related party (see Note 13).

 

On December 6, 2018, the Company amended the $5.0 million short-term note payable related to the Scarlett’s acquisition, which had a remaining balance of $3.0 million as of December 6, 2018, extending the maturity date from May 8, 2019, as previously amended, to May 8, 2020.

 

On December 11, 2018, the Company purchased an aircraft for $2.8 million with a $554,000 down payment and financed the remaining $2.2 million with a 5.49% promissory note payable in 20 years with monthly payments of $15,118, including interest.

 

As of December 31, 2018, the Company is in compliance with all its debt covenants.

 

 12 

 

 

RCI HOSPITALITY HOLDINGS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

7. Stockholders’ Equity

 

During the quarter ended December 31, 2018, the Company purchased and retired 14,111 common shares at a cost of approximately $355,000. The Company paid a $0.03 per share cash dividend totaling approximately $291,000.

 

During the quarter ended December 31, 2017, the Company did not purchase shares of its common stock. The Company also paid a $0.03 per share cash dividend totaling approximately $292,000.

 

On January 2, 2019, the Company’s Board of Directors authorized an additional $10.0 million to repurchase the Company’s common stock.

 

8. Earnings Per Share

 

Basic earnings per share (“EPS”) 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 EPS 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 (as adjusted for interest expense that would no longer occur if the debentures were converted).

 

During the quarter ended December 31, 2018 and 2017, the Company did not have adjustment items to reconcile the numerator and the denominator in the calculation of basic and diluted EPS.

 

 13 

 

 

RCI HOSPITALITY HOLDINGS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

9. Income Taxes

 

Income taxes were an expense of $1.8 million in the first quarter of 2019 compared to a benefit of $8.2 million in the first quarter of 2018. The effective income tax rate for the first quarter of 2019 was an expense of 22.0% compared to a benefit of 134.3% for the first quarter of 2018. Our effective tax rate is affected by state taxes, permanent differences, and tax credits, including the FICA tip credit, for both years while the first quarter of 2018 was significantly impacted by a $9.7 million reduction of our deferred tax liability caused by newly enacted tax laws.

 

The Tax Cuts and Jobs Act (“Tax Act”) was enacted on December 22, 2017, and includes, among other items, a reduction in the federal corporate income tax rate from 35% to 21% effective January 1, 2018. Our federal corporate income tax rate for fiscal 2018 was 24.5% percent and represents a blended income tax rate for our fiscal year ended September 30, 2018. For fiscal 2019, our federal corporate income tax rate will be 21%.

 

Additionally, for the fiscal year ended September 30, 2018, in accordance with FASB ASC Topic 740, we remeasured our deferred tax balances to reflect the reduced rate that will apply when these deferred taxes are settled or realized in future periods. The remeasurement resulted in a $8.7 million full year adjustment of our net deferred tax liabilities reflected in our consolidated balance sheet as of September 30, 2018 and a corresponding income tax benefit reflected in our consolidated statements of earnings for the fiscal year ended September 30, 2018. The SEC staff issued Staff Accounting Bulletin No. 118 which allows companies to record provisional amounts during a measurement period that is similar to the measurement period used when accounting for business combinations. While we are able to make a reasonable estimate of the impacts of the Tax Act, adjustments may occur and may be affected by other factors, including, but not limited to, further refinement of our calculations, changes in interpretations and assumptions and regulatory changes from the Internal Revenue Service, the SEC, the FASB, and various tax jurisdictions.

 

Under generally accepted accounting principles, the Company uses the asset and liability method of accounting for income taxes. Under this 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. At September 30, 2017, the Company’s deferred tax assets and liabilities were determined based on the then-current enacted federal tax rate of 35%. As a result of the reduction in the corporate income tax rate under the Tax Act, the Company revalued its deferred tax assets and liabilities at December 31, 2017. Deferred tax assets and liabilities expected to be realized in fiscal year 2018 were re-measured using the aforementioned blended rate. All remaining deferred tax assets and liabilities were re-measured using the new statutory federal rate of 21%. There were no additional measurement adjustments since September 30, 2018 until the end of the measurement period on December 22. 2018.

 

The Company or one of its subsidiaries files income tax returns for U.S. federal jurisdiction and various states. Fiscal year ended September 30, 2016 remains open to tax examination. The Company’s federal income tax returns for the years ended September 30, 2015, 2014 and 2013 have been examined by the Internal Revenue Service with no changes. These years are now under examination for payroll taxes. The Company is also being examined for state income taxes, the settlement of which may occur within the next twelve months.

 

The Company accounts for uncertain tax positions pursuant to ASC Topic 740, Income Taxes. As of December 31, 2018 and September 30, 2018, the liability for uncertain tax positions totaled approximately $165,000 as of each date, which is included in current liabilities on our condensed consolidated balance sheets. The Company recognizes interest accrued related to uncertain tax positions in interest expense and penalties in selling, general and administrative expenses in our consolidated statements of income.

 

 14 

 

 

RCI HOSPITALITY HOLDINGS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

10. Commitments and Contingencies

 

Legal Matters

 

Texas Patron Tax

 

In 2015, the Company reached a settlement with the State of Texas over the payment of the state’s Patron Tax on adult club customers. To resolve the issue of taxes owed, the Company agreed to pay $10.0 million in equal monthly installments of $119,000, without interest, over 84 months, beginning in June 2015, for all but two non-settled locations. The Company agreed to remit the Patron Tax on a monthly basis, based on the current rate of $5 per customer. For accounting purposes, the Company has discounted the $10.0 million at an imputed interest rate of 9.6%, establishing a net present value for the settlement of $7.2 million. As a consequence, the Company has recorded an $8.2 million pre-tax gain for the third quarter ending June 30, 2015, representing the difference between the $7.2 million and the amount previously accrued for the tax.

 

In March 2017, the Company settled with the State of Texas for one of the two remaining unsettled Patron Tax locations. To resolve the issue of taxes owed, the Company agreed to pay a total of $687,815 with $195,815 paid at the time the settlement agreement was executed followed by 60 equal monthly installments of $8,200 without interest.

 

The aggregate balance of Patron Tax settlement liability, which is included in long-term debt in the consolidated balance sheets, amounted to $4.2 million and $4.5 million as of December 31, 2018 and September 30, 2018, respectively.

 

A Declaratory judgment action was brought by five operating subsidiaries of the Company to challenge a Texas Comptroller administrative rule related to the $5 per customer Patron Tax Fee assessed against Sexually Oriented Businesses. An administrative rule attempted to expand the fee to cover venues featuring dancers using latex cover as well as traditional nude entertainment. The administrative rule was challenged on both constitutional and statutory grounds. On November 19, 2018, the Court issued an order that a key aspect of the administrative rule is invalid based on it exceeding the scope of the Comptroller’s authority. Constitutional challenges remain and will be resolved at trial.

 

 15 

 

 

RCI HOSPITALITY HOLDINGS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Indemnity Insurance Corporation

 

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 be filed with the Receiver before the close of business on January 16, 2015 and that all pending lawsuits involving IIC as the insurer are further stayed or abated until October 7, 2014. As a result, the Company and its subsidiaries no longer have insurance coverage under the liability policy with IIC. Currently, there are several civil lawsuits pending against the Company and its subsidiaries. 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 has obtained general liability coverage from other insurers, which have covered and/or will cover any claims arising from actions after that date. As of December 31, 2018, we have 2 unresolved claims out of the original 71 claims.

 

General

 

The Company has been sued by a landlord in the 333rd Judicial District Court of Harris County, Texas for a Houston Bombshells which was under renovation in 2015. The plaintiff alleges RCI Hospitality Holdings, Inc.’s subsidiary, BMB Dining Services (Willowbrook), Inc., breached a lease agreement by constructing an outdoor patio, which allegedly interfered with the common areas of the shopping center, and by failing to provide Plaintiff with proposed plans before beginning construction. Plaintiff also asserts RCI Hospitality Holdings, Inc. is liable as guarantor of the lease. The lease was for a Bombshells restaurant to be opened in the Willowbrook Shopping Center in Houston, Texas. Both RCI Hospitality Holdings, Inc. and BMB Dining Services (Willowbrook), Inc. have denied liability and assert that Plaintiff has failed to mitigate its claimed damages. Further, BMB Dining Services (Willowbrook), Inc. asserts that Plaintiff affirmatively represented that the patio could be constructed under the lease and has filed counter claims and third-party claims against Plaintiff and Plaintiff’s manager asserting that they committed fraud and that the landlord breached the applicable agreements. While the case was tried to a jury in late September 2018 and an adverse judgment was entered in January 2019, such judgment remains modifiable, substantial disputes remain related to the legal impact of the jury’s verdict, and the parties are currently engaged in motion practice to resolve their disputes. It is unknown at this time whether the resolution of this uncertainty will have a material effect on the Company’s financial condition.

 

 16 

 

 

RCI HOSPITALITY HOLDINGS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

On June 23, 2014, Mark H. Dupray and Ashlee Dupray filed a lawsuit against Pedro Antonio Panameno and our subsidiary JAI Dining Services (Phoenix) Inc. (“JAI Phoenix”) in the Superior Court of Arizona for Maricopa County. The suit alleged that Mr. Panameno injured Mr. Dupray in a traffic accident after being served alcohol at an establishment operated by JAI Phoenix. The suit alleged that JAI Phoenix was liable under theories of common law dram shop negligence and dram shop negligence per se. After a jury trial proceeded to a verdict in favor of the plaintiffs against both defendants, in April 2017 the Court entered a judgment under which JAI Phoenix’s share of compensatory damages is approximately $1.4 million and its share of punitive damages is $4 million. In May 2017, JAI Phoenix filed a motion for judgment as a matter of law or, in the alternative, motion for new trial. The Court denied this motion in August 2017. In September 2017, JAI Phoenix filed a notice of appeal. In June 2018, the matter was heard by the Arizona Court of Appeals. On November 15, 2018 the Court of Appeals vacated the jury’s verdict and remanded the case to the trial court. It is anticipated that a new trial will occur at some point in the future. JAI Phoenix will continue to vigorously defend itself.

 

Settlements of lawsuits for the quarters ended December 31, 2018 and 2017 total $60,000 and $27,000, respectively. As of December 31, 2018 or September 30, 2018, the Company has nothing accrued related to settlement of lawsuits.

 

11. Segment Information

 

The Company owns and operates adult nightclubs and Bombshells Restaurants and Bars. The Company has identified such reportable segments based on management responsibility and the nature of the Company’s products, services, and costs. There are no major distinctions in geographical areas served as all operations are in the United States. The Company measures segment profit (loss) as income (loss) from operations. Segment assets are those assets controlled by each reportable segment. The Other category below includes our media and energy drink divisions that are not significant to the consolidated financial statements.

 

Below is the financial information related to the Company’s segments (in thousands):

 

   For the Three Months 
   Ended December 31, 
   2018   2017 
Revenues          
Nightclubs  $37,728   $35,218 
Bombshells   6,013    5,828 
Other   282    166 
   $44,023   $41,212 
           
Income (loss) from operations          
Nightclubs  $15,387   $13,371 
Bombshells   119    891 
Other   (119)   (137)
General corporate   (4,255)   (4,985)
   $11,132   $9,140 
           
Depreciation and amortization          
Nightclubs  $1,507   $1,335 
Bombshells   292    336 
Other   104    2 
General corporate   150    236 
   $2,053   $1,909 
           
Capital expenditures          
Nightclubs  $447   $450 
Bombshells   4,009    2,228 
Other   9    - 
General corporate   2,830    91 
   $7,295   $2,769 

 

 17 

 

 

RCI HOSPITALITY HOLDINGS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

   December 31, 2018   September 30, 2018 
      

(As Revised)

 
Total assets          
Nightclubs  $269,313   $252,335 
Bombshells   43,540    39,560 
Other   2,144    1,978 
General corporate   34,525    35,859 
   $

349,522

   $329,732 

 

General corporate expenses include corporate salaries, health insurance and social security taxes for officers, legal, accounting and information technology employees, corporate taxes and insurance, legal and accounting fees, depreciation and other corporate costs such as automobile and travel costs. Management considers these to be non-allocable costs for segment purposes.

 

12. Noncontrolling Interests

 

Noncontrolling interests represent the portion of equity in a consolidated entity held by owners other than the consolidating parent. Noncontrolling interests are reported in the consolidated balance sheets within equity, separately from stockholders’ equity. Revenue, expenses and net income attributable to both the Company and the noncontrolling interests are reported in the consolidated statements of income.

 

Our consolidated financial statements include noncontrolling interests related principally to the Company’s ownership of 51% of an entity which owns one of the Company’s nightclubs in New York City.

 

13. Related Party Transactions

 

Presently, our Chairman and President, Eric Langan, personally guarantees all of the commercial bank indebtedness of the Company. Mr. Langan receives no compensation or other direct financial benefit for any of the guarantees.

 

Included in the $2.35 million borrowing on November 1, 2018 (see Note 6) was a $500,000 note borrowed from a related party. The terms of this related party note are similar to the rest of the lender group in the November 1, 2018 transaction.

 

14. Acquisitions and Disposition

 

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 $625,000 9% note payable over a 10-year period. The note is payable interest-only for twelve months at the conclusion of which time a balloon payment of $250,000 is due, and then the remainder of the principal and interest is payable in 108 equal installments of $5,078 per month until October 2028. The buyer will lease the property from the Company’s real estate subsidiary under the following terms: $36,000 per month lease payments for ten years; renewal option for a succeeding ten years at a minimum of $48,000 per month; lessee has option to purchase the property for $6.0 million during a term beginning November 2023 and expiring in October 2028. The Company recorded a gain on the sale transaction of approximately $879,000, which is included in other charges (gains), net in our consolidated statement of income during the quarter ended December 31, 2018.

 

 18 

 

 

RCI HOSPITALITY HOLDINGS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

On November 1, 2018, a club in Chicago was acquired for a total consideration of $10.5 million with $6.0 million cash paid at closing, including acquisition-related costs, and the $4.5 million in a 6-year seller financed note with interest at 7%. The Company paid approximately $37,000 in acquisition-related costs for this transaction, which is included in selling, general and administrative expenses in our consolidated statement of income. The club generated revenue of approximately $742,000 since acquisition date.

 

The following information summarizes the preliminary allocation of fair values assigned to the assets at acquisition date (in thousands):

 

Land and building  $4,325 
Inventory   57 
Furniture and equipment   50 
Noncompete   100 
SOB license   5,968 
Goodwill   

1,463

 
Deferred tax liability   

(1,463

)
Net assets  $10,500 

 

On November 5, 2018, a Pittsburgh club was acquired for a total consideration of $15.1 million, with $7.6 million cash paid at closing, including acquisition-related costs, and two seller notes payable. The first note is 2-year 7% note for $2.0 million, and the second is a 10-year 8% note for $5.5 million. The Company paid approximately $134,000 in acquisition-related costs for this transaction, which is included in selling, general and administrative expenses in our consolidated statement of income. The club generated revenue of approximately $892,000 since acquisition date.

 

The following information summarizes the preliminary allocation of fair values assigned to the assets at acquisition date (in thousands):

 

Land and building  $5,000 
Inventory   23 
Furniture and equipment   200 
Noncompete   100 
Goodwill   9,677 
Net assets  $15,000 

 

It is management’s expectation that the purchase price of these acquisitions will be allocated to assets, including land, buildings, inventory, noncompetes, SOB license, and goodwill; however, the final purchase price allocation of the two clubs remains subject to post-closing adjustments until the Company has completed final valuation and accounting for the transactions.

 

Subsequent to the quarter ended December 31, 2018, the Company sold a held-for-sale property in Dallas, Texas for a total sales price of $1.4 million, payable $163,000 in cash at closing, net of closing costs and property taxes of $87,000, and a $1.15 million 8% note payable over a three-year period. The note is payable $9,619 per month, principal and interest, for the first 35 months with the remaining balance payable at maturity. The buyer has the option to extend the maturity date by one year at least 60 days prior to maturity, as long as the buyer is not in default. The Company recorded a preliminary gain on the sale transaction of approximately $383,000.

 

 19 

 

 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

The following discussion should be read in conjunction with our consolidated financial statements and related notes thereto included in this quarterly report, and the audited consolidated financial statements and related notes included in our Annual Report on Form 10-K for the year ended September 30, 2018.

 

Overview

 

RCI Hospitality Holdings, Inc. (“RCIHH”) is a holding company engaged in a number of activities in the hospitality and related businesses. All services and management operations are conducted by subsidiaries of RCIHH, including RCI Management Services, Inc.

 

Through our subsidiaries, as of December 31, 2018, we operated a total of 46 establishments that offer live adult entertainment and/or restaurant and bar operations. We also operated a leading business communications company serving the multi-billion-dollar adult nightclubs industry. We have two principal reportable segments: Nightclubs and Bombshells. We combine other operating segments into “Other.” In the context of club and restaurant/sports bar operations, the terms the “Company,” “we,” “our,” “us” and similar terms used in this report refer to subsidiaries of RCIHH. RCIHH was incorporated in the State of Texas in 1994. Our corporate offices are located in Houston, Texas.

 

Critical Accounting Policies and Estimates

 

The preparation of the unaudited consolidated financial statements requires our management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On a regular basis, we evaluate these estimates, including investment impairment. These estimates are based on management’s historical industry experience and on various other assumptions that are believed to be reasonable under the circumstances. Actual results may differ from these estimates.

 

For a description of the accounting policies that, in management’s opinion, involve the most significant application of judgment or involve complex estimation and which could, if different judgment or estimates were made, materially affect our reported financial position, results of operations, or cash flows, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Policies and Estimates” in our Annual Report on Form 10-K for the fiscal year ended September 30, 2018 filed with the SEC on December 31, 2018.

 

During the three months ended December 31, 2018, there were no significant changes in our accounting policies and estimates other than the newly adopted accounting standards that are disclosed in Note 2 to our consolidated financial statements.

 

Results of Operations

 

A summary of the operating results and the strategic activities of the Company during the quarter ended December 31, 2018 is as follows:

 

  Revenues of $44.0 million during the first quarter of fiscal 2019 compared to $41.2 million during the first quarter of fiscal 2018, a 6.8% increase (Nightclubs revenue of $37.7 million compared to $35.2 million, a 7.1% increase; and Bombshells revenue of $6.0 million compared to $5.8 million, a 3.2% increase)
  Consolidated same-store sales increase of 0.7% (4.3% increase for Nightclubs and 20.5% decrease for Bombshells)
  Diluted earnings per share (“EPS”) of $0.65 compared to $1.47, a 55.8% decrease (non-GAAP diluted EPS* of $0.61 compared to $0.53, a 15.1% increase)
  Net cash provided by operating activities of $11.5 million compared to $8.1 million, a 40.6% increase (free cash flow* of $11.1 million compared to $7.5 million, a 47% increase)
  Completed the acquisition of one club in Pittsburgh, Pennsylvania for $15.0 million and another club in Chicago, Illinois for $10.5 million

 

* Reconciliation and discussion of non-GAAP financial measures are included in the “Non-GAAP Financial Measures” section below.

 

 20 

 

 

The following table summarizes our results of operations for the three months ended December 31, 2018 and 2017 (dollars in thousands):

 

   For the Three Months Ended     
   December 31, 2018   December 31, 2017   Increase (Decrease) 
   Amount   % of Revenues   Amount   % of Revenues   Amount   % 
Revenues                              
Sales of alcoholic beverages  $18,310    41.6%  $17,805    43.2%  $505    2.8%
Sales of food and merchandise   5,690    12.9%   5,307    12.9%   383    7.2%
Service revenues   17,331    39.4%   15,889    38.6%   1,442    9.1%
Other   2,692    6.1%   2,211    5.4%   481    21.8%
Total revenues   44,023    100.0%   41,212    100.0%   2,811    6.8%
Operating expenses                              
Cost of goods sold                              
Alcoholic beverages sold   3,736    20.4%   3,755    21.1%   (19)   -0.5%
Food and merchandise sold   1,984    34.9%   2,094    39.5%   (110)   -5.3%
Service and other   92    0.5%   36    0.2%   56    155.6%
Total cost of goods sold (exclusive of items shown separately below)   5,812    13.2%   5,885    14.3%   (73)   -1.2%
Salaries and wages   12,096    27.5%   11,377    27.6%   719    6.3%
Selling, general and administrative   14,027    31.9%   12,812    31.1%   1,215    9.5%
Depreciation and amortization   2,053    4.7%   1,909    4.6%   144    7.5%
Other charges (gains), net   (1,097)   -2.5%   89    0.2%   (1,186)   1,332.6%
Total operating expenses   32,891    74.7%   32,072    77.8%   819    2.6%
Income from operations   11,132    25.3%   9,140    22.2%   1,992    21.8%
Other income (expenses)                              
Interest expense   (2,521)   -5.7%   (3,079)   -7.5%   (558)   -18.1%
Interest income   51    0.1%   67    0.2%   (16)   -23.9%
Non-operating loss   (447)   -1.0%   -    -    447    100.0%
Income before income taxes   

8,215

    18.7%   6,128    14.9%   2,087    34.1%
Income tax expense (benefit)   1,811    4.1%   (8,227)   -20.0%   10,038    122.0%
Net income  $6,404    14.5%  $14,355    34.8%  $(7,951)   -55.4%

 

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

 

 21 

 

 

Revenues

 

Consolidated revenues increased by $2.8 million, or 6.8%, due primarily to an 8.0% increase from new units, 0.7% increase in same-store sales (contributing the same percentage increase in total revenues), a 2.2% decrease from closed units, and a 0.4% increase in other revenues. Nightclub same-store sales increased by 4.3% while Bombshells same-store sales decreased by 20.5%.

 

Segment contribution to total revenues was as follows (in thousands):

 

   For the Three Months 
   Ended December 31, 
   2018   2017 
Nightclubs  $37,728   $35,218 
Bombshells   6,013    5,828 
Other   282    166 
   $44,023   $41,212 

 

Nightclubs same-store sales growth continued to reflect effective marketing, management and appeal, combined with a good economy. Sales from new clubs included $1.6 million from the two clubs we acquired in November 2018 and $267,000 from a club acquired in May 2018.

 

Bombshells same-store sales had tough year-over-year comparisons partly due to the higher Houston area business generated in October 2017 from the pro baseball championship and a shorter playoff cycle in the current quarter. However, each month of the current quarter showed significant same-store sales improvement on a sequential basis. Sales from new units were primarily from two Houston area locations that opened in April 2018 and in December 2018.

 

Operating Expenses

 

Total operating expenses, as a percent of revenues, decreased to 74.7% from 77.8% from year-ago although dollar value increased by $819,000, or 2.6%, which was significantly affected by gains from the sale of a Philadelphia club and two assets held for sale. Significant contributors to the changes in operating expenses are explained below.

 

Cost of goods sold decreased by 1.2% though total revenues increased by 6.8% due to tighter food cost control piloted in some of our larger clubs. As a percent of total revenues, cost of goods sold decreased to 13.2% from 14.3% mainly due to tighter food cost control piloted in some of our larger clubs, higher sales in higher-margin Nightclub markets such as New York and Minneapolis, and lower sales at Bombshells.

 

Salaries and wages increased by $719,000, or 6.3%, mainly due to newly acquired and opened units. As a percent of total revenues, salaries and wages were flat at 27.5% from 27.6%.

 

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Selling, general and administrative expenses increased by $1.2 million, or 9.5%, primarily due to increases in legal expenses, advertising and marketing, and various other individually insignificant increases, partially offset by decreases in professional fees. Legal expenses increased mainly due to trial costs associated with two cases and the acquisition of two clubs, while advertising and marketing increased primarily due to additional expenses from acquired clubs and a new marketing program for Bombshells. Professional fees decreased primarily due to fiscal 2017 year-end audit overage costs billed in the first quarter of 2018. As a percent of total revenues, selling, general and administrative expenses increased to 31.9% from 31.1% mainly due to legal expenses.

 

Depreciation and amortization increased by $144,000, or 7.5% due to higher unit count.

 

Other charges (gains), net resulted to a net gain of $1.1 million in the current quarter compared to a net charge of $89,000 in the prior-year quarter. The primarily causes of the shift were the gains from the sale of a club in Philadelphia and two assets held for sale. Net cash proceeds from the three transactions amounted to $1.2 million, excluding another $625,000 in note receivable from the Philadelphia club sale.

 

Income from Operations

 

For the three months ended December 31, 2018 and 2017, our operating margin was 25.3% and 22.2%, respectively. The main drivers for the increase in operating margin are the gains from the sale of certain assets and the decrease in cost of goods sold, as discussed above.

 

Segment contribution to income from operations is presented in the table below (in thousands):

 

   For the Three Months 
   Ended December 31, 
   2018   2017 
Nightclubs  $15,387   $13,371 
Bombshells   119    891 
Other   (119)   (137)
General corporate   (4,255)   (4,985)
   $11,132   $9,140 

 

Operating margin for the Nightclubs segment was 40.8% and 38.0% for the three months ended December 31, 2018 and 2017, respectively, while operating margin for Bombshells was 2.0% and 15.3%, respectively. The increase in Nightclubs operating margin was mainly due to the increase in sales mix of higher-margin service revenue, favorable leverage caused by fixed expenses on increasing sales and the contribution of newly acquired units. The decrease in Bombshells operating margin was primarily due to negative same-stores sales and the costs associated with the new marketing program.

 

Non-Operating Items

 

Interest expense decreased to $2.5 million from $3.1 million due to the writeoff of debt issuance costs and prepayment penalties related to our debt refinancing amounting to $827,000 and the higher weighted average interest rate in the prior year. This was partially offset by the higher average debt balance in the current year.

 

Our total occupancy costs, defined as the sum of rent expense and interest expense, exclusive of prior-year refinancing-related costs above, were 8.0% and 7.7% of revenue during the quarter ended December 31, 2018 and 2017, respectively. The higher occupancy costs in the current quarter were due to the interest expense incurred at multiple Bombshells units under construction, which do not currently contribute to revenue as well as a higher debt balance.

 

As part of our adoption of ASU 2016-01, we recorded a $447,000 unrealized loss on the market value of equity securities during the current quarter. The cumulative net gain in market value of available-for sale securities, which was recorded in accumulated other comprehensive income as of September 30, 2018, has been reclassified to retained earnings as of the beginning of the quarter ended December 31, 2018.

 

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Income Taxes

 

Income taxes were an expense of $1.8 million in the first quarter of 2019 compared to a benefit of $8.2 million in the first quarter of 2018. The effective income tax rate for the first quarter of 2019 was an expense of 22.0% compared to a benefit of 134.3% for the first quarter of 2018. Our effective tax rate is affected by state taxes, permanent differences, and tax credits, including the FICA tip credit, for both years while the first quarter of 2018 was significantly impacted by a $9.7 million reduction of our deferred tax liability caused by newly enacted tax laws.

 

The Tax Cuts and Jobs Act (“Tax Act”) was enacted on December 22, 2017, and includes, among other items, a reduction in the federal corporate income tax rate from 35% to 21% effective January 1, 2018. Our federal corporate income tax rate for fiscal 2018 was 24.5% percent and represents a blended income tax rate for our fiscal year ended September 30, 2018. For fiscal 2019, our federal corporate income tax rate will be 21%.

 

Additionally, for the fiscal year ended September 30, 2018, in accordance with FASB ASC Topic 740, we remeasured our deferred tax balances to reflect the reduced rate that will apply when these deferred taxes are settled or realized in future periods. The remeasurement resulted in a $8.7 million full year adjustment of our net deferred tax liabilities reflected in our consolidated balance sheet as of September 30, 2018 and a corresponding income tax benefit reflected in our consolidated statements of earnings for the fiscal year ended September 30, 2018. The SEC staff issued Staff Accounting Bulletin No. 118 which allows companies to record provisional amounts during a measurement period that is similar to the measurement period used when accounting for business combinations. While we are able to make a reasonable estimate of the impacts of the Tax Act, adjustments may occur and may be affected by other factors, including, but not limited to, further refinement of our calculations, changes in interpretations and assumptions and regulatory changes from the Internal Revenue Service, the SEC, the FASB, and various tax jurisdictions.

 

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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: amortization of intangibles, gains or losses on sale of assets, gain on insurance, and settlement of lawsuits. We believe that excluding these items assists investors in evaluating period-over-period changes in our operating income and operating margin without the impact of items that are not a result of our day-to-day business and operations.

 

Non-GAAP Net Income and Non-GAAP Net Income per Diluted Share. We calculate non-GAAP net income and non-GAAP net income per diluted share by excluding or including certain items to net income attributable to RCIHH common shareholders and diluted earnings per share. Excluded items are: amortization of intangibles, costs and charges related to debt refinancing, income tax expense (benefit), gains or losses on sale of assets, gain on insurance, and settlement of lawsuits. Included item is the non-GAAP provision for current and deferred income taxes, calculated at 22.2% and 26.5% effective tax rate of the pre-tax non-GAAP income before taxes for the quarter ended December 31, 2018 and 2017, respectively. We believe that excluding and including such items help management and investors better understand our operating activities.

 

Adjusted EBITDA. We calculate adjusted EBITDA by excluding the following items from net income attributable to RCIHH common shareholders: depreciation expense, amortization of intangibles, income tax expense (benefit), net interest expense, gains or losses on sale of assets, gain on insurance, and settlement of lawsuits. We believe that adjusting for such items helps management and investors better understand our operating activities. Adjusted EBITDA provides a core operational performance measurement that compares results without the need to adjust for federal, state and local taxes which have considerable variation between domestic jurisdictions. The results are, therefore, without consideration of financing alternatives of capital employed. We use adjusted EBITDA as one guideline to assess our unleveraged performance return on our investments. Adjusted EBITDA is also the target benchmark for our acquisitions of nightclubs.

 

We also use certain non-GAAP cash flow measures such as free cash flow. See “Liquidity and Capital Resources” section for further discussion.

 

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The following tables present our non-GAAP performance measures for the quarters ended December 31, 2018 and 2017 (in thousands, except per share amounts and percentages):

 

   For the Three Months 
   Ended December 31, 
   2018   2017 
Reconciliation of GAAP net income to Adjusted EBITDA        
Net income attributable to RCIHH common shareholders  $6,344   $14,311 
Income tax expense (benefit)   1,811    (8,227)
Interest expense, net   2,470    3,012 
Settlement of lawsuits   60    27 
Loss (gain) on sale of assets   (1,157)   82 
Unrealized loss on equity securities   447    - 
Gain on insurance   -    (20)
Depreciation and amortization   2,053    1,909 
Adjusted EBITDA  $12,028   $11,094 
           
Reconciliation of GAAP net income (loss) to non-GAAP net income          
Net income attributable to RCIHH common shareholders  $6,344   $14,311 
Amortization of intangibles   156    48 
Settlement of lawsuits   60    27 
Income tax expense (benefit)   1,811    (8,227)
Loss (gain) on sale of assets   (1,157)   82 
Unrealized loss on equity securities   447    - 
Gain on insurance   -    (20)
Costs and charges related to debt refinancing   -    827 
Non-GAAP benefit (expense) for income taxes          
Current   (1,109)   45 
Deferred   (592)   (1,913)
Non-GAAP net income  $5,960   $5,180 
           
Reconciliation of GAAP diluted earnings per share to non-GAAP diluted earnings per share          
Diluted shares   9,713    9,719 
GAAP diluted earnings per share  $0.65   $1.47 
Amortization of intangibles   0.02    0.00 
Settlement of lawsuits   0.01    0.00 
Income tax expense   0.19    (0.85)
Loss (gain) on sale of assets   (0.12)   0.01 
Unrealized loss on equity securities   0.05    - 
Gain on insurance   -    (0.00)
Costs and charges related to debt refinancing   -    0.09 
Non-GAAP benefit (expense) for income taxes          
Current   (0.12)   0.00 
Deferred   (0.06)   (0.19)
Non-GAAP diluted earnings per share  $0.61   $0.53 
           
Reconciliation of GAAP operating income to non-GAAP operating income          
Income from operations  $11,132   $9,140 
Amortization of intangibles   156    48 
Settlement of lawsuits   60    27 
Loss (gain) on sale of assets   (1,157)   82 
Gain on insurance   -    (20)
Non-GAAP operating income  $10,191   $9,277 
           
Reconciliation of GAAP operating margin to non-GAAP operating margin          

Income from operations

   25.3%   22.2%
Amortization of intangibles   0.4%   0.1%
Settlement of lawsuits   0.1%   0.1%
Loss (gain) on sale of assets   -2.6%   0.2%
Gain on insurance   -   0.0%
Non-GAAP operating margin   23.1%   22.5%

 

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

 

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.

 

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Liquidity and Capital Resources

 

At December 31, 2018, our cash and cash equivalents were $9.4 million compared to $17.7 million at September 30, 2018. Because of the large volume of cash we handle, we have very stringent cash controls. As of December 31, 2018, we had negative working capital of $6.5 million compared to a positive working capital of $55,000 as of September 30, 2018, both figures excluding assets held for sale of $2.4 million as of December 31, 2018 and $2.9 million as of September 30, 2018. We believe our ability to generate cash from operating activities is one of our fundamental financial strengths. Our net cash provided by operating activities increased to $11.5 million during the quarter ended December 31, 2018 from $8.1 million during the quarter ended December 31, 2017. The near-term outlook for our business remains strong, and we expect to generate substantial cash flows from operations for the entire fiscal 2019. As a result of our expected cash flows from operations, we have significant flexibility to meet our financial commitments.

 

We have not recently raised capital through the issuance of equity securities. Instead, we use debt financing to lower our overall cost of capital and increase our return on stockholders’ equity. We have a history of borrowing funds in private transactions and from sellers in acquisition transactions, and have recently secured traditional bank financing on our new development projects and refinancing of our existing notes payable. We continue to have the ability to borrow funds at reasonable interest rates from those sources. We also have historically utilized these cash flows to invest in property and equipment, adult nightclubs and restaurants/sports bars.

 

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

 

   For the Three Months 
   Ended December 31, 
   2018   2017 
Operating activities  $11,452   $8,145 
Investing activities   (19,518)   (2,089)
Financing activities   (273)   (4,024)
Net increase (decrease) in cash and cash equivalents  $(8,339)  $2,032 

 

Cash Flows from Operating Activities

 

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

 

   For the Three Months 
   Ended December 31, 
   2018   2017 
Net income  $6,404   $14,355 
Depreciation and amortization   2,053    1,909 
Deferred tax expense (benefit)   458    (9,697)
Debt prepayment penalty   -    543 
Net change in operating assets and liabilities   3,029    516 
Other   (492)   519 
Net cash provided by operating activities  $11,452   $8,145 

 

Net cash provided by operating activities increased from year-to-year due primarily to the increase in income from operations, lower interest expense paid, and a favorable net change in operating assets and liabilities, partially offset by higher income taxes paid.

 

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Cash Flows from Investing Activities

 

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

 

  

For the Three Months

Ended December 31,

 
   2018   2017 
Additions to property and equipment  $(7,295)  $(2,769)
Acquisition of businesses, net of cash acquired   (13,500)   - 
Proceeds from sale of assets   1,245    632 
Proceeds from insurance   -    20 
Proceeds from notes receivable   32    28 
Net cash used in investing activities  $(19,518)  $(2,089)

 

Following is a breakdown of our additions to property and equipment for the quarters ended December 31, 2018 and 2017 (in thousands):

 

  

For the Three Months

Ended December 31,

 
   2018   2017 
New facilities and equipment  $6,919   $2,161 
Maintenance capital expenditures   376    608 
Total capital expenditures  $7,295   $2,769 

 

The capital expenditures during the quarter ended December 31, 2018 were composed primarily of construction and development costs for four new locations, while the capital expenditures during the quarter ended December 31, 2017 were composed primarily of construction and development costs for one new location. Variances in capital expenditures are primarily due to the number and timing of new, remodeled, or reconcepted locations under construction.

 

Current quarter acquisitions of $13.5 million relate to $7.5 million cash paid on the Pittsburgh club acquisition and the $6.0 million cash paid on the Chicago club acquisition.

 

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Cash Flows from Financing Activities

 

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

 

   For the Three Months 
   Ended December 31, 
   2018   2017 
Proceeds from long-term debt  $5,652   $58,920 
Payments on long-term debt   (5,279)   (61,256)
Debt prepayment penalty   -    (543)
Purchase of treasury stock   (355)   - 
Payment of dividends   (291)   (292)
Payment of loan origination costs   -    (799)
Distribution to noncontrolling interests   -    (54)
Net cash used in financing activities  $(273)  $(4,024)

 

We purchased 14,111 shares treasury shares at an average price of $25.21 during the quarter ended December 31, 2018, while we did not purchase shares of our Company’s common stock during the quarter ended December 31, 2017. We paid quarterly dividends of $0.03 per share during both current and prior-year quarters.

 

On November 1, 2018, the Company raised $2.35 million through the issuance of 12% unsecured promissory notes to certain investors, which notes mature on November 1, 2021. The notes pay interest-only in equal monthly installments, with a lump sum principal payment at maturity. Among the promissory notes are two notes with a principal of $450,000 and $200,000. The $450,000 note was in exchange for a $300,000 12% note and the $200,000 note was in exchange for a $100,000 note, both of which were included in the May 1, 2017 financing to acquire Scarlett’s Cabaret in Miami. Also included in the $2.35 million borrowing is a $500,000 note borrowed from a related party. See Note 5 to our consolidated financial statements.

 

On December 6, 2018, the Company amended the $5.0 million short-term note payable related to the Scarlett’s acquisition, which had a remaining balance of $3.0 million as of December 6, 2018, extending the maturity date from May 8, 2019, as previously amended, to May 8, 2020. See Note 6 to our consolidated financial statements.

 

On December 11, 2018, the Company purchased an aircraft for $2.8 million with a $554,000 down payment and financed the remaining $2.2 million with a 5.49% promissory note payable in 20 years with monthly payments of $15,118, including interest.

 

Management also uses certain non-GAAP cash flow measures such as free cash flow. Free cash flow is derived from net cash provided by operating activities less maintenance capital expenditures. We use free cash flow as the baseline for the implementation of our capital allocation strategy.

 

   For the Three Months 
   Ended December 31, 
   2018   2017 
Net cash provided by operating activities  $11,452   $8,145 
Less: Maintenance capital expenditures   376    608 
Free cash flow  $11,076   $7,537 

 

Though we generated a sizeable amount of free cash flow during the quarter ended December 31, 2018, we still ended with a net decrease in cash and cash equivalents from the most recent year-end due to our acquisition of two new clubs.

 

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Other than the notes payable financing described above, 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 for the quarters ended December 31:

 

       Increase       Increase     
   2018   (Decrease)   2017   (Decrease)   2016 
                     
Sales of alcoholic beverages  $18,310    2.8%  $17,805    23.9%  $14,375 
Sales of food and merchandise   5,690    7.2%   5,307    26.1%   4,207 
Service revenues   17,331    9.1%   15,889    17.9%   13,475 
Other   2,692    21.8%   2,211    31.5%   1,682 
Total revenues   44,023    6.8%   41,212    22.1%   33,739 
Net cash provided by operating activities  $11,452    40.6%  $8,145    47.5%  $5,521 
Adjusted EBITDA*  $12,028    8.4%  $11,094    38.6%  $8,006 
Free cash flow*  $11,076    47.0%  $7,537    47.0%  $5,127 
Long-term debt  $153,095    21.5%  $125,992    19.3%  $105,620 

 

* See definition and calculation of Adjusted EBITDA and Free Cash Flow above in the Non-GAAP Financial Measures subsection of Results of Operations.

 

Share Repurchase

 

We purchased 14,111 shares of our stock at an average price of $25.21 per share during the quarter ended December 31, 2018, while we did not purchase shares of our common stock during the quarter ended December 31, 2017. As of December 31, 2018, we have $2.8 million remaining to purchase additional shares under our share repurchase program.

 

Subsequent to the quarter ended December 31, 2018, the Company’s Board of Directors authorized an additional $10.0 million to repurchase the Company’s common stock. See Note 7 to the consolidated financial statements.

 

Other Liquidity and Capital Resources

 

We have not established financing other than the notes payable discussed in Note 6 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.

 

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 for prior years. 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 dancers who are now independent contractors into employees.

 

The sexually-oriented business industry is highly competitive with respect to price, service and location, as well as the professionalism of the entertainment. Although management believes that we are well-positioned to compete successfully in the future, there can be no assurance that we will be able to maintain our high level of name recognition and prestige within the marketplace.

 

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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.

 

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, we believe we are able to make better investment decisions unless there is another strategic rationale, in management’s opinion.

 

Based on our current capital allocation strategy:

 

  We consider buying back our own stock if the after-tax yield on free cash flow climbs over 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.

 

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 seven of the currently existing Bombshells 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.

 

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We plan to open four Bombshells in fiscal 2019, including one that opened in December 2018.

 

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 3. Quantitative and Qualitative Disclosures About Market Risk.

 

As of December 31, 2018, there were no material changes to the information provided in Item 7A of the Company’s Annual Report on Form 10-K for fiscal year ended September 30, 2018.

 

Item 4. Controls and Procedures.

 

Evaluation of Disclosure Controls and Procedures

 

The Company maintains disclosure controls and procedures, defined in Rule 13a-15(e) under the Exchange Act, that are designed to ensure that the information required to be filed or submitted with the SEC under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to management of the company with the participation of its principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.

 

In connection with the preparation of this Quarterly Report on Form 10-Q for the quarter ended December 31, 2018, an evaluation was performed under the supervision and with the participation of management, including the chief executive officer and chief financial officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures. Based on their evaluation, they have concluded that our disclosure controls and procedures were not effective as of December 31, 2018. This determination is based on the previously reported material weaknesses management previously identified in our internal control over financial reporting, as described below. We are in the process of remediating the material weaknesses, as described below, which should remedy our disclosure controls and procedures. We will continue to monitor this issue.

 

Previously Reported Material Weaknesses in Internal Control Over Financial Reporting

 

In our Annual Report for the year ended September 30, 2018, filed with the SEC on December 31, 2018, management concluded that our internal control over financial reporting was not effective as of September 30, 2018. In management’s evaluation, the following deficiencies were identified as material weaknesses:

 

  Control Environment

 

The control environment, which is the responsibility of senior management, helps set the tone of the organization, influences the control consciousness of its officers and employees, and is an important component affecting how the organization performs financial analysis, accounting and financial reporting. A proper organizational tone can be promoted through a variety of means, such as well documented and communicated policies, a commitment to hiring competent employees, the manner and content of oral and written communications, strong internal controls and effective governance.

 

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Control Environment, Risk Assessment and Monitoring

 

We did not properly design or maintain effective controls over the control environment, risk assessment, and monitoring components which contributed to a number of material weaknesses at the control activity level. As it relates to the control environment and risk assessment, we did not have a sufficient complement of accounting, financial, and information technology personnel with an appropriate level of knowledge to assess internal control risks, address known internal control weaknesses, and address the Company’s overall financial reporting and information technology requirements. As it relates to monitoring, we did not perform timely and ongoing evaluations to ascertain whether the components of internal control are present and functioning. The failures within these three COSO components contributed to the following material weaknesses at the control activity level:

 

  Control Activities

 

  Revenues – We did not properly design or maintain effective controls over the segregation of cash counts at our nightclubs and restaurants, the information produced by our point-of-sale systems, other revenues generated outside the point-of-sale system, and the review of journal entries used to record revenue transactions.

 

  Complex Accounting and Management Estimates – We did not properly design or maintain effective controls over complex accounting and management estimates related to the impairment analyses for indefinite lived intangible assets, goodwill, and property and equipment, and the accounting for income taxes, assets held for sale, business combinations, debt modifications, and useful lives of leasehold improvements, which resulted in certain instances of incorrect accounting and improper valuation decisions.

 

  Financial Statement Close and Reporting – We did not properly design or maintain effective controls, in aggregate, over the period end financial close and reporting process to enable timely reporting of complete and accurate financial information. Specifically, we lacked controls to define financial statement review thresholds, consistently perform independent reviews of journal entries prior to posting, and consistently prepare, approve, and retain adequate supporting documentation for financial statement balances and the related footnote disclosures.
  Information Technology – We did not properly design or maintain effective controls to prevent unauthorized access to certain systems, programs and data, and provide for periodic review and monitoring of access and changes in programs, including review of security logs and analysis of segregation of duties conflicts.  
  Segregation of Duties – We did not maintain effective policies, procedures, or controls in aggregate to ensure adequate segregation of duties within the Company’s business processes, financial applications, and IT systems. Specifically, we did not have appropriate controls in place to adequately assess the segregation of job responsibilities and system user access for initiating, authorizing, and recording transactions.

 

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Remediation Efforts to Address Material Weaknesses

 

As disclosed in our most recent Annual Report on Form 10-K, we have, and continue to, identify and implement actions to improve our internal control over financial reporting and disclosure controls and procedures including actions to enhance our resources and training with respect to financial reporting and disclosure responsibilities, and increase utilization of accounting system functionality, with continued oversight from the Audit Committee.

 

We have taken, and continue to take, the actions described below to remediate the identified material weaknesses. As we continue to evaluate and work to improve our internal controls over financial reporting, our senior management may determine to take additional measures to address control deficiencies or determine to modify the remediation efforts described in this section. While the Audit Committee and senior management are closely monitoring the implementation, until the remediation efforts discussed in this section, including any additional remediation efforts that our senior management identifies as necessary, are completed, tested and determined effective, the material weaknesses described above will continue to exist.

 

Control Environment, Risk Assessment and Monitoring

 

Our Board of Directors has directed senior management to ensure that a proper, consistent tone is communicated throughout the organization, which emphasizes the expectation that previously existing deficiencies will be rectified through implementation of processes and controls to ensure strict compliance with U.S. GAAP and regulatory requirements. We also have taken steps to effect a proper tone through our policies and personnel. To effect this, we have hired an external consulting firm to effectively act as an internal audit department to assist in the organizational risk assessment, identification of control activities, and the enhancement of ongoing monitoring activities related to such controls.

 

Control Activities

 

Strengthening the controls and processes regarding the recording and reporting of revenue – Currently, one of our point-of-sale (“POS”) system providers does not issue an SOC 1 report. An SOC 1 Report (System and Organization Controls Report) is a report on Controls at a Service Organization which are relevant to user entities’ internal control over financial reporting. As a result of the non-issuance of this report by the provider, it is necessary for us to use alternative procedures to gain the required level of confidence regarding the reliability of this system to accurately report sale information. In the case of credit card sales, data is effectively processed using other third-party providers with whom we have a higher degree of confidence. We will work to implement stronger controls regarding the verification of data from the POS provider if no service provider internal controls adequacy report can be obtained. In the case of cash sales, we would seek to point to compensating detective controls, such as nightly cash counts and monthly detailed revenue reconciliations to potentially detect any irregularities. Such controls will be evaluated for proper segregation of duties both in the nightly cash counts and in the related journal entries to remediate controls over both point-of-sale and other revenues. We would seek to strengthen these controls in the future to provide the required level of confidence necessary to prevent a material weakness.

 

Strengthening internal controls over complex accounting and management estimates and financial statement preparation – Subsequent to September 30, 2018, we have committed to resolve the controls over complex accounting and estimates and prevent instances of incorrect accounting, incorrect financial statement preparation and improper valuation decisions, by increasing our own level of competency as well as using third-party consultants to assist where necessary such as with our goodwill, indefinite-lived intangible assets, and property and equipment impairment analyses whenever necessary and also using appropriate third-party resources to help with the analysis and accounting for assets held for sale, business combinations, income taxes, debt modifications, assessment of useful lives of leasehold improvements, and other complex accounting matters.

 

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Strengthening internal controls over financial statement close and reporting – With the oversight of our Audit Committee, we have continued to take proactive steps and implement additional measures to remediate the underlying causes of the material weaknesses. We are taking significant steps to improve our risk assessment process and monitoring structure, as follows:

 

  The new ERP system described below has and will continue to assist us in strengthening the controls over financial reporting, and we have also added an overlay of review of our financial statements during our financial reporting process.
     
  On top of the ERP system described above, we have also implemented, in April 2018, a new monitoring and security software to automate our segregation of duties as well as access monitoring controls and generate compliance documentation. The effective implementation of this software remains in process as we evaluate both manual and automated controls impacted by segregation of duties.
     
  We have upgraded our accounting staff with certain newly hired accountants.
     
  We have retained a more robust outside consulting firm to assist us in evaluating, redesigning and implementing necessary steps to maintain adequate internal controls. As this work did not begin until May 2018, we expect to have a much improved control structure with their assistance for an entire fiscal year in 2019.
     
  We will develop proper controls to evaluate monthly and quarterly financial statement variances.
     
  We will develop proper controls over the review and evaluation of financial statement balances and the related footnote disclosures.
     
  We will consider certain enhanced journal review procedures which will ensure that proper review can be executed and evidenced.

 

Strengthening the information technology application – We were previously aware of the limitations of our accounting software and had been in the planning/implementation process of replacing the software for many months prior to September 30, 2017. In October 2017, we completed the conversion to a new Enterprise Resource Planning (“ERP”) system which, along with changes to our manual internal controls, we believe has resolved some of the issues detailed above relating to the information systems. The new ERP system has features that prevent unauthorized access to certain programs and data, and also provides for periodic review and monitoring of access including review of security logs. In addition to the ERP system, we are taking steps to improve monitoring of access to point-of-sale systems at remote locations, as well as review of change management protocols.

 

Strengthening our segregation of duties issues – The features mentioned above include proper segregation of duties within our journal entry process, including analysis of segregation of duties conflicts, which we hope to more fully utilize in fiscal year 2019. We have also hired a Director of ERP & Business Intelligence. In addition to the segregation of duties improvements, there will be continuing improvements in the controls that would mitigate any potential conflicts, most importantly regarding the length of time the controls have been operating effectively.

 

Changes in Internal Control Over Financial Reporting

 

Other than as described above, no changes in the Company’s internal control over financial reporting that occurred during the quarter ended December 31, 2018 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

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PART II—OTHER INFORMATION

 

Item 1. Legal Proceedings.

 

See the “Legal Matters” section within Note 9 of the condensed consolidated financial statements within this Quarterly Report on Form 10-Q, which information is incorporated herein by reference.

 

Item 1A. Risk Factors.

 

There were no material changes to the risk factors disclosed in the Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2018. The risks described in the Annual Report on Form 10-K are not the only risks the Company faces. Additional risks and uncertainties not currently known to the Company, or that the Company deems to be immaterial, also may have a material adverse impact on the Company’s business, financial condition or results of operations.

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.

 

In September 2008, our Board of Directors authorized us to repurchase up to $5.0 million worth of our common stock in the open market or in privately negotiated transactions. As of April 2013, we completed the repurchase of all $5.0 million in stock authorized under this plan. In April 2013, our Board of Directors authorized us to repurchase up to an additional $3.0 million worth of our common stock, and in May 2014, our Board of Directors increased the repurchase authorization by another $7.0 million. In May 2016, the Board of Directors increased the repurchase authorization by an additional $5.0 million. During the quarter ended December 31, 2018, we purchased 14,111 shares of our common stock in the open market at prices ranging from $24.85 to $25.15 per share. As of December 31, 2018, we have $2.8 million remaining to purchase additional shares. In January 2019, the Board of Directors increased the repurchase authorization by an additional $10.0 million.

 

Following is a summary of our purchases during the quarter ended December 31, 2018:

 

Period  Total Number of Shares (or Units) Purchased   Average Price Paid per Share (or Unit)(2)   Total Number of Shares (or Units) Purchased as Part of Publicly Announced Plans or Programs(1)   Maximum Number (or Approximate Dollar Value) of Shares (or Units) That May Yet be Purchased Under the Plans or Programs 
October 1-31, 2018   -         -   $3,141,101 
November 1-30, 2018   14,111   $25.21    14,111   $2,785,378 
December 1-31, 2018   -         -   $2,785,378 
Total   14,111   $25.21    14,111      

 

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

 

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Item 6. Exhibits.

 

Exhibit No.   Description
3.1   Articles of Incorporation dated December 9, 1994. (Incorporated by reference from Form SB-2 filed with the SEC on January 11, 1995.) *
     
3.2   Certificate of Amendment to Articles of Incorporation dated September 9, 2008. (Incorporated by reference from Definitive Schedule 14A filed with the SEC on July 21, 2008.) *
     
3.3   Certificate of Amendment to Articles of Incorporation dated August 6, 2014. (Incorporated by reference from Definitive Schedule 14A filed with the SEC on June 24, 2014.) *
     
3.4   Amended and Restated Bylaws. (Incorporated by reference from Form 8-K filed with the SEC on March 16, 2016.) *
     
4.1   Consolidated, Amended and Restated Promissory Note for $62,539,366.08 with Centennial Bank (Incorporated by reference from Form 8-K filed with the SEC on December 19, 2017) *
     
4.2   Amended and Restated Promissory Note for $10,558,311.35 with Centennial Bank (Incorporated by reference from Form 8-K filed with the SEC on December 19, 2017) *
     
4.3   Amended and Restated Promissory Note for $8,147,572.57 with Centennial Bank (Incorporated by reference from Form 8-K filed with the SEC on December 19, 2017) *
     
10.1   Employment Agreement with Eric S. Langan. (Incorporated by reference from Form 8-K filed with the SEC on May 4, 2018.) *
     
10.2   Employment Agreement with Travis Reese. (Incorporated by reference from Form 8-K filed with the SEC on May 4, 2018.) *
     
10.3   Employment Agreement with Phillip K. Marshall. (Incorporated by reference from Form 8-K filed with the SEC on May 4, 2018.) *
     
10.4   Loan Agreement between RCI Holdings, Inc. and Centennial Bank (Incorporated by reference from Form 8-K filed with the SEC on December 19, 2017) *
     
10.5   Absolute Unconditional and Continuing Guaranty of RCI Hospitality Holdings, Inc. to Centennial Bank (Incorporated by reference from Form 8-K filed with the SEC on December 19, 2017) *
     
10.6   Absolute Unconditional and Continuing Guaranty of Eric S. Langan to Centennial Bank (Incorporated by reference from Form 8-K filed with the SEC on December 19, 2017) *
     
31.1   Certification of Chief Executive Officer of RCI Hospitality Holdings, Inc. required by Rule 13a-14(1) or Rule 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
     
31.2   Certification of Chief Financial Officer of RCI Hospitality Holdings, Inc. required by Rule 13a-14(1) or Rule 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
     
32   Certification of Chief Executive Officer and Chief Financial Officer of RCI Hospitality Holdings, Inc. pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and Section 1350 of 18 U.S.C. 63.
     
101.INS   XBRL Instance Document.
101.SCH   XBRL Taxonomy Extension Schema Document.
101.CAL   XBRL Taxonomy Extension Calculation Linkbase Document.
101.DEF   XBRL Taxonomy Extension Definition Linkbase Document.
101.LAB   XBRL Taxonomy Extension Label Linkbase Document.
101.PRE   XBRL Taxonomy Extension Presentation Linkbase Document.

 

* Incorporated by reference from our previous filings with the SEC.

 

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SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized.

 

  RCI HOSPITALITY HOLDINGS, INC.
   
Date: February 11, 2019 By: /s/ Eric S. Langan
    Eric S. Langan
    Chief Executive Officer and President

 

Date: February 11, 2019 By:  /s/ Phillip K. Marshall
    Phillip K. Marshall
    Chief Financial Officer and Principal Accounting Officer

 

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