RICK

Business Context and Reporting Period

Company: Rick's Cabaret International, Inc. (RCI Hospitality Holdings, Inc.)
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: March 31, 2011
Business Overview: The Company operates upscale adult nightclubs, internet membership sites, and a media division serving the adult entertainment industry. As of the reporting date, it owned or operated 22 adult nightclubs and one non-adult nightclub across the United States.

Key Financial Metrics

Note: Debt includes current portion of long-term debt ($6,223) and long-term debt ($32,078). Working capital is calculated as Total Current Assets ($26,800) minus Total Current Liabilities ($20,516).

Material Changes vs. Prior Period

• Revenue Growth: Total revenues increased 1.8% ($400,000) for the quarter and 3.0% ($1.3 million) for the six months compared to the prior year periods. This growth was driven primarily by new club acquisitions in Fort Worth and Austin, Texas.
• Same-Location Performance: Revenues for same-location-same-period club operations decreased, principally due to a significant decline in the Las Vegas club's performance.
• Profitability: Operating income remained relatively flat for the quarter ($5,115 vs. $5,132) but increased significantly for the six months ($9,225 vs. $7,463). Net income attributable to shareholders increased 33.8% for the six-month period ($4,998 vs. $3,727).
• Expense Management: Advertising and marketing expenses decreased significantly (down 21.9% for the quarter and 47.0% for the six months) due to improved marketing costs in Las Vegas. Legal and professional fees also declined due to reduced activity in a New York labor lawsuit.
• Interest Expense: Interest expense increased due to additional debt obtained in June 2010 to finance new club purchases.

Guidance, Outlook, Risks, and Unusual Items

• Las Vegas Divestiture: The Company decided to sell its Las Vegas location in March 2011 and sharply reduced operations to eliminate losses. Assets are classified as "held for sale."
• Subsequent Acquisitions: In April 2011 (post-period), the Company acquired "The Gold Club" in Indianapolis for $1.675 million.
• Legal Contingency (Texas Tax): A significant risk involves a $5 per visitor surcharge in Texas. While a lower court ruled the tax unconstitutional, the State of Texas is appealing. The Company has accrued approximately $5.4 million in liabilities for this tax as of March 31, 2011, pending the outcome of the Texas Supreme Court review.
• Derivative Instruments: The Company recorded a gain of $333,000 (quarter) and $481,000 (six months) on the change in fair value of derivative instruments (put options), driven by the rising price of its common stock.
• Outlook: Management expects the Media Division to become profitable as the economy improves. The Company plans to reopen the former Rick's Cabaret in Austin as a dance nightclub in May 2011.

Investor Verification Checklist

• Texas Tax Liability: Verify the status of the Texas Supreme Court appeal regarding the $5 patron tax and the potential impact of the $5.4 million accrued liability on future cash flows.
• Las Vegas Sale: Monitor the progress of the sale of the Las Vegas nightclub and the realization of the subsequent gain from the debt settlement ($900,000 expected in April 2011).
• Debt Covenants: Review the terms of the $38.3 million total debt, including the impact of interest rate adjustments on the First State Bank-Taylor note.
• Derivative Obligations: Assess the maximum potential obligation of $4.8 million related to put options if the stock price were to fall to zero.
• Same-Store Sales: Analyze the trend of same-location revenues, specifically the continued underperformance of the Las Vegas and Philadelphia locations.