RCI HOSPITALITY HOLDINGS, INC. quarterly report, Q2 FY2014

Business context and reporting period

RCI Hospitality Holdings, Inc. filed this Form 10-Q under its then-registered name, Rick’s Cabaret International, Inc. The report covers the fiscal second quarter and six months ended March 31, 2014; the company operated a single reportable segment, nightclubs, with 43 establishments reported as of January 31, 2014. Dollar amounts below are in millions unless stated otherwise.

Key financial results

Six-month operating expenses rose to $49.220 million from $43.786 million. Rent and insurance costs increased, while legal and professional expense and stock-based compensation declined. Management attributed revenue growth mainly to acquired clubs. Same-location revenue was slightly lower: down $0.3 million for the quarter, with management citing severe winter weather and weak Club Onyx performance; excluding those units, quarterly same-store sales increased 3.8%. Six-month same-location revenue declined $0.130 million.

Balance sheet, debt and liquidity

• At March 31, cash and cash equivalents were $11.638 million, compared with $10.638 million at September 30, 2013. Total assets were $243.185 million.
• Total debt, including current maturities, was $84.673 million, compared with $78.592 million at September 30, 2013. Current debt was $13.148 million and long-term debt was $71.525 million. Six-month interest expense was $3.936 million.
• Current assets were $29.122 million and current liabilities were $38.406 million. Excluding the $14.640 million accrued Texas patron tax, management reported working capital of $5.3 million, versus $4.8 million at September 30.
• Six-month investing cash outflow was $14.023 million, including $8.198 million of property and equipment additions and $5.325 million for New York building development rights. Financing provided $3.426 million; cash increased by $1.000 million.
• Financing included $7.025 million of debt proceeds and $4.335 million of debt payments. The company also reported $4.3 million in seller-financed debt related to real estate and an aircraft, and conversion of $1.1 million of debt principal and interest into 113,750 shares.

Outlook, risks and unusual items

Management described the near-term outlook as strong and expected substantial operating cash flow in 2014, but provided no specific revenue or earnings guidance. It cited seasonal softness historically from April through September and said additional growth may require debt or equity financing; the company had no established credit lines and gave no assurance that future financing would be available on reasonable terms.

• Expansion: A Club O acquisition in Harvey, Illinois, remained subject to permits, due diligence and other closing conditions. The proposed business-asset purchase price was $9.060 million, comprising cash, restricted shares and a secured note; a related real-estate purchase was proposed for $2.000 million. The filing anticipated closing in May 2014, subject to conditions. Several club and restaurant openings were also planned for 2014.
• Texas patron tax: The company had accrued $14.640 million and had not paid the tax since the first quarter of 2009. On May 9, 2014, after quarter-end, an appeals court ruled against the Texas Entertainment Association; whether to seek rehearing or appeal remained undecided. The company said a favorable final outcome could result in a one-time gain, while an adverse outcome could affect the balance sheet. Management’s expectation that penalties might be waived and payment allowed over time is not assured.
• Other legal exposure: Nevada tax authorities asserted approximately $2.1 million, including penalties and interest, for live-entertainment taxes; the company disputed the assessment and had not accrued it. In a New York wage-and-hour case, the court granted plaintiffs summary judgment on federal minimum-wage claims and found entertainers to be employees of a subsidiary; other liability and class-related issues remained unresolved. The filing does not provide a clear estimated loss for these matters.
• Insurance: The company’s former liability insurer was placed into liquidation in April 2014. Coverage under its policy ended, and recovery on claims filed with the receiver is uncertain; the company noted potential exposure for incidents before October 25, 2013.
• Other items: Assets held for sale of $3.739 million included Beaumont land and a building, and an aircraft. The quarter included a $0.150 million lawsuit settlement expense and a $0.086 million gain on property sale. The filing also reported $0.148 million of expense for adviser warrants issued in February.

Important facts for investors to verify

• Progress and final resolution of the Texas patron-tax litigation, including payment, penalty and recovery exposure.
• Outcome and potential financial impact of the Nevada tax audit, New York wage litigation, and claims affected by the former insurer’s liquidation.
• Whether the Club O and other planned expansion projects closed or opened as expected, and their financing and contribution to results.
• Debt maturities, repayment capacity and access to financing, particularly given investment spending and the company’s reliance on debt.
• Performance of same-store sales and margins after winter-related disruption, weak Club Onyx results, pre-opening costs and higher rent and insurance expense.