NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1.
Basis of Presentation
The
accompanying unaudited condensed consolidated financial statements of RCI Hospitality Holdings, Inc. (the “Company or “RCIHH”)
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, 2019 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, 2019 included in the Company’s Annual Report on Form 10-K, as filed with the
Securities and Exchange Commission on February 13, 2020. 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 statement of the financial statements, consisting solely of normal recurring adjustments,
have been made. Operating results for the three months ended December 31, 2019 are not necessarily indicative of the results that
may be expected for the year ending September 30, 2020.
2.
Recent Accounting Standards and Pronouncements
In February 2016, the Financial Accounting
Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2016-02, Leases (Topic 842),
on accounting for leases which requires lessees to recognize most leases on their balance sheets for the rights and obligations
created by those leases. The guidance requires enhanced disclosures regarding the amount, timing, and uncertainty of cash flows
arising from leases, and will be effective for interim and annual periods beginning after December 15, 2018. Early adoption is
permitted. In July 2018, the FASB issued ASU 2018-11 providing for certain practical expedients in the implementation of ASU 2016-02.
The guidance requires the use of a modified retrospective approach. We adopted ASU 2016-02 and related amendments as of October
1, 2019 and elected the package of practical expedients permitted under the transition guidance within the new standard, which
among other things, allows us to retain historical lease classification, as well as relief from reviewing expired and existing
contracts to determine if they contain leases. Our adoption of the new leasing standard resulted in an increase of $27.3
million in our total assets as of October 1, 2019 due to the recognition of operating lease right-of-use assets net of the
reclassification of deferred rent liability of $1.2 million and an increase in total liabilities due to the recognition
of a $28.6 million operating lease liabilities. Our adoption of ASC 842 did not have an impact on our consolidated statements
of income and cash flows, except for additional required disclosures. See additional disclosures in Note 13.
In
June 2016, the FASB issued ASU 2016-13, Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses
on Financial Instruments. This ASU requires, among other things, the measurement of all expected credit losses for financial
assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts.
ASU 2016-13 replaces the existing incurred loss impairment model with an expected loss model which requires the use of forward-looking
information to calculate credit loss estimates. It also eliminates the concept of other-than-temporary impairment and requires
credit losses related to available-for-sale debt securities to be recorded through an allowance for credit losses rather than
as a reduction in the amortized cost basis of the securities. These changes will result in earlier recognition of credit losses.
The ASU is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. Early
application will be permitted for all entities for fiscal years, and interim periods within those fiscal years, beginning after
December 15, 2018. We are still evaluating the impact of this ASU, including all related updates, on the Company’s consolidated
financial statements.
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 accumulated other comprehensive income (“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 adopted ASU 2018-02 as of October 1, 2019. Our adoption of this guidance did not have an impact
on our consolidated financial statements.
In
August 2018, the FASB issued ASU No. 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework—Changes to the
Disclosure Requirements for Fair Value Measurement. ASU 2018-13 modifies the disclosure requirements of Accounting Standards
Codification (“ASC”) Topic 820 with certain removals, modifications, and additions. Eliminated disclosures that may
affect the Company include (1) transfers between level 1 and level 2 of the fair value hierarchy, and (2) policies related to
valuation processes and the timing of transfers between levels of the fair value hierarchy. Modified disclosures that may affect
the Company include (1) a requirement to disclose the timing of liquidation of an investee’s assets and the date when restrictions
from redemption might lapse if the entity has communicated the timing publicly for investments in certain entities that calculate
net asset value, and (2) clarification that the measurement uncertainty disclosure is to communicate information about the uncertainty
in measurement as of the reporting date. Additional disclosures that may affect the Company include (1) disclosure of changes
in unrealized gains and losses for the period included in other comprehensive income for recurring level 3 fair value measurements
held at the end of the reporting period, and (2) disclosure of the range and weighted average of significant unobservable inputs
used to develop level 3 fair value measurements. The update is effective for fiscal years, and interim periods within those fiscal
years, beginning after December 15, 2019. Early adoption is permitted for any removed or modified disclosures upon issuance of
the ASU and delay adoption of the additional disclosures until the effective date. We are still evaluating the impact of this
ASU on the Company’s consolidated financial statements.
RCI
HOSPITALITY HOLDINGS, INC.
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
In
March 2019, the FASB issued ASU No. 2019-01, Leases (Topic 842): Codification Improvements. ASU 2019-01 aligns the guidance
for fair value of the underlying asset by lessors with existing guidance in Topic 842. The ASU requires that the fair value of
the underlying asset at lease commencement is its cost reflecting in volume or trade discounts that may apply. However, if there
has been a significant lapse of time between the date the asset was acquired and the lease commencement date, the definition of
fair value as outlined in Topic 820 should be applied. In addition, the ASU exempts both lessees and lessors from having to provide
certain interim disclosures in the fiscal year in which a company adopts the new leases standard. The update is effective for
fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. We are still evaluating the impact
of this ASU on the Company’s consolidated financial statements.
In
December 2019, the FASB issued ASU 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes. This
ASU simplifies accounting for income taxes by removing the following exceptions: (1) exception to the incremental approach for
intraperiod tax allocation, (2) exceptions to accounting for basis differences when there are ownership changes in foreign investments,
and (3) exception in interim period income tax accounting for year-to-date losses that exceed anticipated losses. The ASU also
improves financial statement preparers’ application of income tax related guidance for franchise taxes that are partially
based on income; transactions with a government that result in a step up in the tax basis of goodwill; separate financial statements
of legal entities that are not subject to tax; and enacted changes in tax laws in interim periods. The ASU is effective for public
business entities for fiscal years beginning after December 15, 2020, and interim periods within those fiscal years. Early adoption
is permitted for public business entities for periods for which financial statements have not been issued. An entity that elects
early adoption in an interim period should reflect any adjustments as of the beginning of the annual period that includes that
interim period. Additionally, an entity that elects early adoption should adopt all the amendments in the same period. We are
still evaluating the impact of this ASU on the Company’s consolidated financial statements.
RCI
HOSPITALITY HOLDINGS, INC.
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
3.
Revenues
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 unaudited condensed 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 lease revenues are recognized when earned (recognized over time) and are more appropriately
covered by guidance under ASC Topic 842, Leases (ASC 840 in prior year). See Note 13.
RCI
HOSPITALITY HOLDINGS, INC.
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Revenues,
as disaggregated by revenue type, timing of recognition, and reportable segment (see also Note 11), are shown below (in thousands):
|
|
Three
Months Ended December 31, 2019
|
|
|
Three
Months Ended December 31, 2018
|
|
|
|
Nightclubs
|
|
|
Bombshells
|
|
|
Other
|
|
|
Total
|
|
|
Nightclubs
|
|
|
Bombshells
|
|
|
Other
|
|
|
Total
|
|
Sales of alcoholic beverages
|
|
$
|
14,684
|
|
|
$
|
6,059
|
|
|
$
|
-
|
|
|
$
|
20,743
|
|
|
$
|
14,802
|
|
|
$
|
3,508
|
|
|
$
|
-
|
|
|
$
|
18,310
|
|
Sales of food and merchandise
|
|
|
3,264
|
|
|
|
4,183
|
|
|
|
-
|
|
|
|
7,447
|
|
|
|
3,207
|
|
|
|
2,483
|
|
|
|
-
|
|
|
|
5,690
|
|
Service revenues
|
|
|
17,094
|
|
|
|
99
|
|
|
|
-
|
|
|
|
17,193
|
|
|
|
17,313
|
|
|
|
18
|
|
|
|
-
|
|
|
|
17,331
|
|
Other revenues
|
|
|
2,817
|
|
|
|
9
|
|
|
|
185
|
|
|
|
3,011
|
|
|
|
2,406
|
|
|
|
4
|
|
|
|
282
|
|
|
|
2,692
|
|
|
|
$
|
37,859
|
|
|
$
|
10,350
|
|
|
$
|
185
|
|
|
$
|
48,394
|
|
|
$
|
37,728
|
|
|
$
|
6,013
|
|
|
$
|
282
|
|
|
$
|
44,023
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Recognized at a point in time
|
|
$
|
37,434
|
|
|
$
|
10,350
|
|
|
$
|
178
|
|
|
$
|
47,962
|
|
|
$
|
37,392
|
|
|
$
|
6,013
|
|
|
$
|
267
|
|
|
$
|
43,672
|
|
Recognized over time
|
|
|
425
|
*
|
|
|
-
|
|
|
|
7
|
|
|
|
432
|
|
|
|
336
|
*
|
|
|
-
|
|
|
|
15
|
|
|
|
351
|
|
|
|
$
|
37,859
|
|
|
$
|
10,350
|
|
|
$
|
185
|
|
|
$
|
48,394
|
|
|
$
|
37,728
|
|
|
$
|
6,013
|
|
|
$
|
282
|
|
|
$
|
44,023
|
|
*
Lease revenue (included in Other Revenues) as covered by ASC Topic 842 in the current year (and ASC Topic 840 in the prior
year). 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 unaudited condensed consolidated balance sheet. A reconciliation
of contract liabilities with customers is presented below (in thousands):
|
|
Balance
at
September
30, 2019
|
|
|
Consideration
Received
|
|
|
Recognized
in Revenue
|
|
|
Balance
at
December
31, 2019
|
|
Ad revenue
|
|
$
|
76
|
|
|
$
|
221
|
|
|
$
|
(145
|
)
|
|
$
|
152
|
|
Expo revenue
|
|
|
-
|
|
|
|
269
|
|
|
|
-
|
|
|
|
269
|
|
Other
|
|
|
7
|
|
|
|
6
|
|
|
|
(8
|
)
|
|
|
5
|
|
|
|
$
|
83
|
|
|
$
|
496
|
|
|
$
|
(153
|
)
|
|
$
|
426
|
|
Contract
liabilities with customers are included in accrued liabilities as unearned revenues in our unaudited condensed consolidated balance
sheets (see also Note 4), while the revenues associated with these contract liabilities are included in other revenues in our
unaudited condensed consolidated statements of income.
RCI
HOSPITALITY HOLDINGS, INC.
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
4.
Selected Account Information
The
components of accrued liabilities are as follows (in thousands):
|
|
December
31, 2019
|
|
|
September
30, 2019
|
|
Insurance
|
|
$
|
3,188
|
|
|
$
|
4,937
|
|
Sales and liquor taxes
|
|
|
3,088
|
|
|
|
3,086
|
|
Payroll and related costs
|
|
|
2,950
|
|
|
|
2,892
|
|
Property taxes
|
|
|
2,089
|
|
|
|
1,675
|
|
Patron tax
|
|
|
617
|
|
|
|
595
|
|
Unearned revenues
|
|
|
426
|
|
|
|
83
|
|
Lawsuit settlement
|
|
|
75
|
|
|
|
115
|
|
Other
|
|
|
1,326
|
|
|
|
1,261
|
|
|
|
$
|
13,759
|
|
|
$
|
14,644
|
|
The
components of selling, general and administrative expenses are as follows (in thousands):
|
|
For
the Three Months
|
|
|
|
Ended
December 31,
|
|
|
|
2019
|
|
|
2018
|
|
Taxes and permits
|
|
$
|
2,674
|
|
|
$
|
2,181
|
|
Advertising and marketing
|
|
|
2,410
|
|
|
|
2,148
|
|
Supplies and services
|
|
|
1,534
|
|
|
|
1,456
|
|
Insurance
|
|
|
1,483
|
|
|
|
1,353
|
|
Legal
|
|
|
1,186
|
|
|
|
1,058
|
|
Lease
|
|
|
1,030
|
|
|
|
1,019
|
|
Charge card fees
|
|
|
1,046
|
|
|
|
933
|
|
Utilities
|
|
|
895
|
|
|
|
744
|
|
Security
|
|
|
848
|
|
|
|
709
|
|
Accounting and professional fees
|
|
|
1,208
|
|
|
|
650
|
|
Repairs and maintenance
|
|
|
797
|
|
|
|
587
|
|
Other
|
|
|
1,420
|
|
|
|
1,189
|
|
|
|
$
|
16,531
|
|
|
$
|
14,027
|
|
5.
Assets Held for Sale
As
of September 30, 2019, the Company had two real estate properties for sale. The aggregate estimated fair value of the properties
less cost to sell as of September 30, 2019 was approximately $2.9 million and was reclassified to assets held for sale in the
Company’s consolidated balance sheet. The assets were measured at the carrying value as adjusted for depreciation, which
was lower than the fair value at the date reclassified.
During
the quarter ended December 31, 2019, the Company classified as held-for-sale another real estate property. The aggregate estimated
fair value of the property less cost to sell was $1.9 million.
The
Company expects the properties held for sale, which are primarily comprised of land and buildings, to be sold within 12 months
through property listings by our real estate brokers.
The assets held for sale do not have liabilities
associated with them that need to be directly settled from the proceeds in the event of a transaction. The gain or loss on the
sale of these properties held for sale is included in other charges/gains, net in the unaudited condensed consolidated
statements of income.
RCI
HOSPITALITY HOLDINGS, INC.
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
6.
Long-term Debt
In
December 2019, the Company amended the $5.0 million short-term note payable related to the Scarlett’s acquisition in May
2017, which had a balance of $3.0 million as of the amendment date, extending the maturity date to October 1, 2022. The amendment
did not have an impact in the Company’s results of operations and cash flows.
Included
in the balance of long-term debt as of December 31, 2019 and September 30, 2019 is a $500,000 note borrowed from a related party
(see Note 12) and three notes totaling $600,000 borrowed from two non-officer employees and a family member of a non-officer employee
in which the terms of the notes are the same as the rest of the lender groups.
Subsequent
to the quarter ended December 31, 2019, in February 2020, in relation to a $4.0 million 12% note payable earlier refinanced on
August 15, 2018, the Company restructured the note with a private lender by executing a 12% 10-year note payable $57,388 monthly,
including interest, starting March 2020. The restructured note eliminates a scheduled balloon principal payment of $4.0 million
in August 2021. The refinancing did not have an impact in the Company’s results of operations and cash flows.
Also in February 2020, in relation to a $9.9
million 12% note payable that was partially paid during the December 2017 Refinancing Loan, the Company restructured the note,
which had a balance of $5.2 million as of the amendment date, by executing a 12% 10-year note payable $74,515 monthly, including
interest, starting March 2020. The restructured note eliminates a scheduled balloon principal payment of $3.8 million in October
2021. As a result of the refinancing, the Company wrote off approximately $25,400 in unamortized debt issuance cost as interest
expense in the unaudited condensed consolidated statement of income for the quarter ending March 31, 2020.
7.
Equity
During
the quarter ended December 31, 2019, the Company purchased and retired 332,671 common shares at a cost of approximately $6.4 million.
The Company paid a $0.03 per share cash dividend during the quarter totaling approximately $279,000.
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 also paid a $0.03 per share cash dividend during the quarter totaling approximately $291,000.
On
February 6, 2020, the Company’s Board of Directors authorized an additional $10.0 million to repurchase the Company’s
common stock. As of February 25, 2020, the Company has $13.8 million remaining to purchase additional shares under its share repurchase
program.
RCI
HOSPITALITY HOLDINGS, INC.
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
8.
Income Taxes
Income
tax expense was $1.6 million during the quarter ended December 31, 2019 compared to $1.8 million during the quarter ended December
31, 2018. The effective income tax rate was 22.0% for both quarters ended December 31, 2019 and 2018. Our effective tax rate for
both years is affected by state taxes, permanent differences, and tax credits, including the FICA tip credit.
The
Company or one of its subsidiaries file income tax returns for U.S. federal jurisdiction and various states. Fiscal years ended
September 30, 2016 and thereafter remain 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. Tax years 2014 through
2017 are now under examination for payroll taxes. The Company is also being examined for state income taxes, the outcome 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, 2019 and September
30, 2019, the liability for uncertain tax positions was $0 and $0, respectively. 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.
9.
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 recorded an $8.2 million pre-tax gain for the third quarter ended 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 $3.1 million and $3.4 million as of December 31, 2019 and September 30, 2019, 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.
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 have been filed with the Receiver before the close
of business on January 16, 2015 and that all pending lawsuits involving IIC as the insurer were further stayed or abated until
October 7, 2014. As a result, the Company and its subsidiaries no longer have insurance coverage under the liability policy with
IIC. The Company has retained counsel to defend against and evaluate these claims and lawsuits. We are funding 100% of the costs
of litigation and will seek reimbursement from the bankruptcy receiver. The Company filed the appropriate claims against IIC with
the Receiver before the January 16, 2015 deadline and has provided updates as requested; however, there are no assurances of any
recovery from these claims. It is unknown at this time what effect this uncertainty will have on the Company. As previously stated,
since October 25, 2013, the Company 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, 2019, we have 2 unresolved claims out of the original
71 claims.
Shareholder
Class and Derivative Actions
In
May and June 2019, three putative securities class action complaints were filed against RCI Hospitality Holdings, Inc. and certain
of its officers in the Southern District of Texas, Houston Division. The complaints allege violations of Sections 10(b) and 20(a)
of the Securities Exchange Act of 1934 and 10b-5 promulgated thereunder based on alleged materially false and misleading statements
made in the Company’s SEC filings and disclosures as they relate to various alleged transactions by the Company and management.
The complaints seek unspecified damages, costs, and attorneys’ fees. These lawsuits are Hoffman v. RCI Hospitality Holdings,
Inc., et al. (filed May 21, 2019, naming the Company and Eric Langan); Gu v. RCI Hospitality Holdings, Inc., et al. (filed May
28, 2019, naming the Company, Eric Langan, and Phil Marshall); and Grossman v. RCI Hospitality Holdings, Inc., et al. (filed June
28, 2019, naming the Company, Eric Langan, and Phil Marshall). The plaintiffs in all three cases moved to consolidate the purported
class actions. On January 10, 2020 an order consolidating the Hoffman, Grossman, and Gu cases was entered by the Court. The consolidated
case is styled In re RCI Hospitality Holdings, Inc., No. 4:19-cv-01841. On February 24, 2020, the plaintiffs in the consolidated
case filed an Amended Class Action Complaint, continuing to allege violations of Sections 10(b) and 20(a) of the Securities Exchange
Act of 1934 and 10b-5 promulgated thereunder. In addition to naming the Company, Eric Langan, and Phil Marshall, the amended complaint
also adds director Nour-Dean Anakar and former director Steven Jenkins as defendants. The Company intends to vigorously defend
against this action and will move to dismiss the lawsuit. This action is in its preliminary phase, and a potential loss
cannot yet be estimated.
RCI
HOSPITALITY HOLDINGS, INC.
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
On
August 16, 2019, a shareholder derivative action was filed in the Southern District of Texas, Houston Division against officers
and directors, Eric S. Langan, Phillip Marshall, Nour-Dean Anakar, Yura Barabash, Luke Lirot, Travis Reese, former director Steven
Jenkins, and RCI Hospitality Holdings, Inc., as nominal defendant. The action alleges that the individual officers and directors
made or caused the Company to make a series of materially false and/or misleading statements and omissions regarding the Company’s
business, operations, prospects, and legal compliance and engaged in or caused the Company to engage in, inter alia, related party
transactions, questionable uses of corporate assets, and failure to maintain internal controls. The action asserts claims for
breach of fiduciary duty, unjust enrichment, abuse of control, gross mismanagement, waste of corporate assets, and violations
of Sections 14(a), 10(b) and 20(a) of the Securities Exchange Act of 1934. The complaint seeks injunctive relief, damages, restitution,
costs, and attorneys’ fees. The case, Cecere v. Langan, et al., is in its early stage, and a potential loss cannot
yet be estimated.
SEC
Matter and Internal Review
In
mid- and late 2018, a series of negative articles about the Company was anonymously published in forums associated with the short-selling
community. Subsequently in 2019, the SEC initiated an informal inquiry. In connection with these events, a special committee of
the Company’s audit committee engaged independent outside counsel to conduct an internal review. Management of the Company
fully cooperated with the internal review conducted by the special committee and its outside counsel. The board of directors has
implemented the recommendations resulting from the internal review. As of the date hereof, the internal review has been completed
subject to any ongoing cooperation with regulatory authorities.
Since
the initiation of the informal inquiry by the SEC in early 2019, the Company and its management have fully cooperated and continue
to fully cooperate with the SEC matter, which has now converted to a formal investigation and is ongoing. At this time, the Company
is unable to predict the duration, scope, result or related costs associated with the investigation. The Company is also unable
to predict what, if any, action may be taken as a result of the investigation. Any determination by the SEC that the Company’s
activities were not in compliance with federal securities laws or regulations, however, could result in the imposition of fines,
penalties, disgorgement, or equitable relief, which could have a material adverse effect on the Company.
Other
On
March 26, 2016, an image infringement lawsuit was filed in federal court in the Southern District of New York against the Company
and several of its subsidiaries. Plaintiffs allege that their images were misappropriated, intentionally altered and published
without their consent by clubs affiliated with the Company. The causes of action asserted in Plaintiffs’ Complaint include
alleged violations of the Federal Lanham Act, the New York Civil Rights Act, and other statutory and common law theories. The
Company contends that there is insurance coverage under an applicable insurance policy. The insurer has raised several issues
regarding coverage under the policy. At this time, this disagreement remains unresolved. The Company has denied all allegations,
continues to vigorously defend against the lawsuit and continues to believe the matter is covered by insurance.
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. The case was tried to a jury in late September 2018 and an adverse judgment was entered in
January 2019 in the amount totaling $1.0 million, which includes damages, attorney fees and interest. The matter is being appealed.
The appeal process required that a check be deposited in the registry of the court in the amount of $690,000, which was deposited
in April 2019 and included in other current assets in both consolidated balance sheets as of December 31, 2019 and September 30,
2019. Management believes that the case has no merit and is vigorously defending itself in the appeal.
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.
As
set forth in the risk factors as disclosed in the Company’s Annual Report on Form 10-K for the fiscal year ended September
30, 2019, the adult entertainment industry standard is to classify adult entertainers as independent contractors, not employees.
While we take steps to ensure that our adult entertainers are deemed independent contractors, from time to time, we are named
in lawsuits related to the alleged misclassification of entertainers. Claims are brought under both federal and where applicable,
state law. Based on the industry standard, the manner in which the independent contractor entertainers are treated at the clubs,
and the entertainer license agreements governing the entertainer’s work at the clubs, the Company believes that these lawsuits
are without merit. Lawsuits are handled by attorneys with an expertise in the relevant law and are defended vigorously.
General
In
the regular course of business affairs and operations, we are subject to possible loss contingencies arising from third-party
litigation and federal, state, and local environmental, labor, health and safety laws and regulations. We assess the probability
that we could incur liability in connection with certain of these lawsuits. Our assessments are made in accordance with generally
accepted accounting principles, as codified in ASC 450-20, and is not an admission of any liability on the part of the Company
or any of its subsidiaries. In certain cases that are in the early stages and in light of the uncertainties surrounding them,
we do not currently possess sufficient information to determine a range of reasonably possible liability. In matters where there
is insurance coverage, in the event we incur any liability, we believe it is unlikely we would incur losses in connection with
these claims in excess of our insurance coverage.
Settlements
of lawsuits for the quarter ended December 31, 2019 and 2018 amount to approximately $24,000 and $60,000, respectively. As of
December 31, 2019 and September 30, 2019, the Company has accrued $75,000 and $115,000 in accrued liabilities, respectively, related
to settlement of lawsuits.
10.
Acquisition
On
November 5, 2019, the Company announced that its subsidiaries have signed definitive agreements to acquire the assets and related
real estate of a well-established, top gentlemen’s club located in the Northeast Corridor for $15.0 million. Under the terms
of the agreements, Company subsidiaries will pay $7.2 million for the club and $7.8 million for the real estate using $4.0 million
in seller financing at 6.0% for the club with the balance of cash from an anticipated $11.0 million bank loan at a blended rate
of 6.25%. As of the filing of this report, closing of this transaction is still pending subject to certain conditions. The Company
will not present pro forma results of operations for this acquisition because the acquisition did not meet the threshold of a
significant acquisition under Regulation S-X 3-05.
RCI
HOSPITALITY HOLDINGS, INC.
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
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,
|
|
|
|
2019
|
|
|
2018
|
|
Revenues
|
|
|
|
|
|
|
|
|
Nightclubs
|
|
$
|
37,859
|
|
|
$
|
37,728
|
|
Bombshells
|
|
|
10,350
|
|
|
|
6,013
|
|
Other
|
|
|
185
|
|
|
|
282
|
|
|
|
$
|
48,394
|
|
|
$
|
44,023
|
|
|
|
|
|
|
|
|
|
|
Income (loss) from operations
|
|
|
|
|
|
|
|
|
Nightclubs
|
|
$
|
13,776
|
|
|
$
|
15,387
|
|
Bombshells
|
|
|
1,573
|
|
|
|
119
|
|
Other
|
|
|
(207
|
)
|
|
|
(119
|
)
|
General corporate
|
|
|
(5,456
|
)
|
|
|
(4,255
|
)
|
|
|
$
|
9,686
|
|
|
$
|
11,132
|
|
|
|
|
|
|
|
|
|
|
Depreciation and amortization
|
|
|
|
|
|
|
|
|
Nightclubs
|
|
$
|
1,470
|
|
|
$
|
1,507
|
|
Bombshells
|
|
|
417
|
|
|
|
292
|
|
Other
|
|
|
104
|
|
|
|
104
|
|
General corporate
|
|
|
213
|
|
|
|
150
|
|
|
|
$
|
2,204
|
|
|
$
|
2,053
|
|
|
|
|
|
|
|
|
|
|
Capital expenditures
|
|
|
|
|
|
|
|
|
Nightclubs
|
|
$
|
2,332
|
|
|
$
|
447
|
|
Bombshells
|
|
|
1,725
|
|
|
|
4,009
|
|
Other
|
|
|
-
|
|
|
|
9
|
|
General corporate
|
|
|
1
|
|
|
|
2,830
|
|
|
|
$
|
4,058
|
|
|
$
|
7,295
|
|
|
|
December
31, 2019
|
|
|
September
30, 2019
|
|
Total assets
|
|
|
|
|
|
|
|
|
Nightclubs
|
|
$
|
292,966
|
|
|
$
|
274,071
|
|
Bombshells
|
|
|
51,567
|
|
|
|
44,144
|
|
Other
|
|
|
1,853
|
|
|
|
1,773
|
|
General corporate
|
|
|
29,787
|
|
|
|
33,649
|
|
|
|
$
|
376,173
|
|
|
$
|
353,637
|
|
RCI
HOSPITALITY HOLDINGS, INC.
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
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.
Certain
real estate assets previously wholly assigned to Bombshells have been subdivided and allocated to other future development or
investment projects. Accordingly, those asset costs have been transferred out of the Bombshells segment.
12.
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. The balance of our commercial bank indebtedness,
net of debt discount and issuance costs, as of December 31, 2019 and September 30, 2019 is $86.3 million and $86.8 million, respectively.
Included
in the $2.35 million borrowing on November 1, 2018 was a $500,000 note borrowed from a related party (Ed Anakar, an employee of
the Company and brother of our director Nourdean Anakar). The terms of this related party note are the same as the rest of the
lender group in the November 1, 2018 transaction.
We
used the services of Sherwood Forest Creations, LLC, a furniture fabrication company that manufactures tables, chairs and other
furnishings for our Bombshells locations, as well as providing ongoing maintenance. Sherwood Forest is owned by a brother of Eric
Langan. Amounts billed to us for goods and services provided by Sherwood Forest were $19,144 and $9,743 during the quarter ended
December 31, 2019 and 2018, respectively. As of December 31, 2019 and September 30, 2019, we owed Sherwood Forest $6,347 and $6,588,
respectively, in unpaid billings.
TW
Mechanical LLC (“TW Mechanical”) provided plumbing and HVAC services to both a third-party general contractor providing
construction services to the Company, as well as directly to the Company during fiscal 2020 and 2019. A son-in-law of Eric Langan
owns a noncontrolling interest in TW Mechanical. Amounts billed by TW Mechanical to the third-party general contractor were $11,827
and $76,300 for the quarter ended December 31, 2019 and 2018, respectively. Amounts billed directly to the Company were $1,825
and $0 for the quarter ended December 31, 2019 and 2018, respectively. As of December 31, 2019 and September 30, 2019, the Company
owed TW Mechanical $206 and $0, respectively, in unpaid direct billings.
13.
Leases
The
Company leases certain facilities and equipment under operating leases. Under ASC 840, lease expense for the Company’s operating
leases, which generally have escalating rentals over the term of the lease, is recorded using the straight-line method over the
initial lease term whereby an equal amount of lease expense is attributed to each period during the term of the lease, regardless
of when actual payments are made. Generally, this results in lease expense in excess of cash payments during the early years of
a lease and lease expense less than cash payments in the later years. The difference between lease expense recognized and actual
lease payments is accumulated and included in other long-term liabilities in the consolidated balance sheets.
Included
in lease expense in our unaudited condensed consolidated statements of income (see Note 4) were lease payments for a house
that the Company’s CEO rented to the Company for corporate housing for its out-of-town Bombshells management and trainers,
of which lease expense totaled $19,500 and $19,500 for the quarter ended December 31, 2019 and 2018, respectively. This lease
terminated on December 31, 2019.
Undiscounted
future minimum annual lease obligations as of September 30, 2019 are as follows (in thousands):
2020
|
|
$
|
3,237
|
|
2021
|
|
|
3,154
|
|
2022
|
|
|
3,057
|
|
2023
|
|
|
2,889
|
|
2024
|
|
|
2,850
|
|
Thereafter
|
|
|
21,038
|
|
Total
future minimum lease obligations
|
|
$
|
36,225
|
|
Included
in the future minimum lease obligations are billboard and outdoor sign leases. These leases were recorded as advertising and
marketing expenses, and included in selling, general and administrative expenses in our unaudited condensed consolidated
statements of income. Under ASC 840, we recorded lease expense amounting to $1.0 million during the quarter ended December 31, 2018.
The
Company adopted ASC 842 as of October 1, 2019. The Company’s adoption of ASC 842 included renewal or termination options
for varying periods which we deemed reasonably certain to exercise. This determination is based on our consideration of certain
economic, strategic and other factors that we evaluate at lease commencement date and reevaluate throughout the lease term.
Some
leasing arrangements require variable payments that are dependent on usage or may vary for other reasons, such as payments for
insurance and tax payments. The variable portion of lease payments is not included in our right-of-use assets or lease liabilities.
Rather, variable payments, other than those dependent upon an index or rate, are expensed when the obligation for those payments
is incurred and are included in lease expenses recorded in selling, general and administrative expenses in our unaudited condensed
consolidated statement of income.
We
have elected to apply the short-term lease exception for all underlying asset classes, which mainly includes equipment leases.
That is, leases with a term of 12 months or less are not recognized on the balance sheet, but rather expensed on a straight-line
basis over the lease term. We do not include significant restrictions or covenants in our lease agreements, and residual value
guarantees are generally not included within our operating leases.
Our
adoption of ASC 842 did not have a material impact on our lease revenue accounting as a lessor. See Note 3.
Future
maturities of lease liabilities as of December 31, 2019 are as follows (in thousands):
|
|
Principal
Payments
|
|
|
Interest
Payments
|
|
|
Total
Payments
|
|
January
– December 2020
|
|
$
|
1,521
|
|
|
$
|
1,664
|
|
|
$
|
3,185
|
|
January
– December 2021
|
|
|
1,658
|
|
|
|
1,568
|
|
|
|
3,226
|
|
January
– December 2022
|
|
|
1,755
|
|
|
|
1,465
|
|
|
|
3,220
|
|
January
– December 2023
|
|
|
1,674
|
|
|
|
1,361
|
|
|
|
3,035
|
|
January
– December 2024
|
|
|
1,818
|
|
|
|
1,256
|
|
|
|
3,074
|
|
Thereafter
|
|
|
19,840
|
|
|
|
6,220
|
|
|
|
26,060
|
|
|
|
$
|
28,266
|
|
|
$
|
13,534
|
|
|
$
|
41,800
|
|
Total
lease expense, under ASC 842, was included in selling, general and administrative expenses in our unaudited condensed consolidated statement of income, except for sublease income which was included in other revenue, for the quarter ended December
31, 2019 as follows (in thousands):
Operating lease expense – fixed payments
|
|
$
|
842
|
|
Variable lease expense
|
|
|
65
|
|
Short-term equipment and other lease expense (includes $146 recorded in advertising and
marketing, and $125 recorded in repairs and maintenance; see Note 4)
|
|
|
394
|
|
Sublease income
|
|
|
(2
|
)
|
Total lease expense, net
|
|
$
|
1,299
|
|
|
|
|
|
|
Other information:
|
|
|
|
|
Operating cash outflows from operating leases
|
|
$
|
1,255
|
|
Weighted average remaining lease term
|
|
|
13
years
|
|
Weighted average discount rate
|
|
|
6.1
|
%
|