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: December 31, 2009
Business Overview: The Company operates upscale adult nightclubs, internet membership sites, and a media division. As of the reporting date, it owned or operated 18 adult nightclubs across the United States, including brands such as Rick's Cabaret, Club Onyx, and XTC Cabaret. The Company also manages internet properties including CoupleTouch.com and NaughtyBids.com.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Total revenues increased by 16.8% ($2.87 million) compared to the prior year quarter. This was driven by a 14.5% same-store sales increase and $823,000 in revenue from new clubs in Austin and Fort Worth.
• Expense Increases: Advertising and marketing expenses surged 150% to $2.94 million (from $1.17 million), primarily due to aggressive campaigns in Las Vegas and Dallas/Fort Worth. Legal and professional fees increased to $649,609 due to a labor lawsuit in New York and acquisition-related costs.
• Profitability: Despite revenue growth, Net Income attributable to shareholders decreased slightly by 1.0% due to the significant rise in operating expenses. Operating income declined by 3.6%.
• Cash Flow: Operating cash flow improved significantly from a use of $542,993 in the prior year to a generation of $3.23 million, largely due to the decision to withhold payment of Texas patron taxes pending litigation.
• Acquisitions: On December 18, 2009, the Company acquired "Joy of Austin" and the underlying property for a total consideration of approximately $4.55 million plus assumption of debt.

Outlook, Risks, and Management Commentary

• Segment Performance:
  • Club Operations: While same-store sales improved, specific locations remain unprofitable. Rick's Cabaret Las Vegas lost approximately $500,000 for the quarter due to marketing costs, though management noted profitability in January 2010. Club Onyx Philadelphia and Cabaret North Fort Worth also reported losses.
  • Media Division: Losses narrowed to $65,000 from $216,000 in the prior year due to cost controls.
  • Internet: Revenues declined slightly to $145,005 as the Company reduced promotional pricing on memberships.
• Strategic Moves: The Austin club, previously classified as a discontinued operation, is being renovated and will reopen in March 2010 under a new concept.
• Legal Contingency (Texas Patron Tax): A significant risk involves a $5 per-visitor surcharge in Texas. The Company has accrued $1.76 million in liabilities for this tax but has not paid it since June 2009, pending the outcome of a lawsuit challenging its constitutionality. Oral arguments are scheduled for March 25, 2010. If the Company prevails, previously paid taxes (over $2 million) may be refunded.
• Liquidity and Debt: The Company has $6.3 million in temporary equity (put options) and significant long-term debt. Management noted that while they have capital for renovations and acquisitions, there is no assurance of obtaining additional financing on reasonable terms.

Investor Verification Checklist

• Texas Tax Litigation Outcome: Verify the status of the Texas Supreme Court case regarding the $5 patron tax, as a loss could result in significant cash outflows or a gain if the $2 million+ paid previously is refunded.
• Las Vegas Turnaround: Confirm if the profitability reported in January 2010 for the Las Vegas location is sustainable given the high marketing spend.
• Derivative Liabilities: Review the fair value adjustments of derivative instruments (put options), which totaled $3.14 million in liabilities on the balance sheet, and their potential impact on equity.
• Acquisition Integration: Assess the financial contribution of the newly acquired "Joy of Austin" club in the subsequent quarter.
• Debt Covenants: Verify compliance with debt covenants given the mix of secured notes and the Company's cash position.