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EX-31.2 - RCI HOSPITALITY HOLDINGS, INC.v210241_ex31-2.htm
EX-31.1 - RCI HOSPITALITY HOLDINGS, INC.v210241_ex31-1.htm
EX-32.1 - RCI HOSPITALITY HOLDINGS, INC.v210241_ex32-1.htm
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

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

For the quarterly period ended December 31, 2010

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission File Number: 001-13992

RICK’S CABARET INTERNATIONAL, INC.
(Exact name of registrant as specified in its charter)

Texas
76-0458229
(State or other jurisdiction of
(I.R.S. Employer Identification No.)
incorporation or organization)
 

10959 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 and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted 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 and post such files). Yes ¨ No ¨ NOT APPLICABLE

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 ¨
 
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 January 31, 2011, 9,970,020 shares of the Registrant’s Common Stock were outstanding.
 
 
 

 

RICK'S CABARET INTERNATIONAL, INC.
 
TABLE OF CONTENTS
PART I
FINANCIAL INFORMATION
 
     
Item 1.
Financial Statements
 
     
 
Consolidated Balance Sheets as of December 31, 2010 and September 30, 2010
1
     
 
Consolidated Statements of Income for the three months ended December 31, 2010 and 2009
3
     
 
Consolidated Statements of Cash Flows for the three months ended December 31, 2010 and 2009
4
     
 
Notes to Consolidated Financial Statements
5
     
Item 2.
Management's Discussion and Analysis of Financial Condition and  Results of Operations
14
     
Item 3.
Quantitative and Qualitative Disclosures about Market Risk
24
     
Item 4.
Controls and Procedures
24
     
PART II
OTHER INFORMATION
 
     
Item 1.
Legal Proceedings
25
     
Item1A.
Risk Factors
25
     
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
25
     
Item 6.
Exhibits
26
     
 
Signatures
27
 
 
ii

 
 
PART I      FINANCIAL INFORMATION

Item 1.
Financial Statements.

RICK'S CABARET INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS

ASSETS
 
(in thousands, except per share data)
 
December 31,
2010
   
September 30,
2010
 
   
(UNAUDITED)
       
Assets
           
Current assets:
           
Cash and cash equivalents
  $ 18,719     $ 19,168  
Accounts receivable:
               
Trade, net
    830       888  
Other, net
    278       204  
Marketable securities
    479       -  
Inventories
    1,481       1,264  
Deferred tax asset
    1,753       1,504  
Prepaid expenses and other current assets
    716       951  
Assets of discontinued operations
    133       148  
Total current assets
    24,389       24,127  
                 
Property and equipment, net
    59,262       59,559  
                 
Other assets:
               
Goodwill and indefinite lived intangibles, net
    62,076       62,076  
Definite lived intangibles, net
    1,080       1,197  
Other
    1,520       1,412  
Total other assets
    64,676       64,685  
                 
Total assets
  $ 148,327     $   148,371  
 
See accompanying notes to consolidated financial statements.

 
1

 

RICK'S CABARET INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
 
(in thousands, except per share data)
 
December 31,
2010
   
September 30,
2010
 
    
(UNAUDITED)
       
Liabilities and Stockholders' Equity
           
Current liabilities:
           
Accounts payable
  $ 629     $ 731  
Accrued liabilities
    4,106       4,529  
Texas patron tax liability
    4,650       3,955  
Current portion of derivative liabilities
    1,236       1,276  
Current portion of long-term debt
    8,663       7,883  
Liabilities of discontinued operations
    53       47  
Total current liabilities
    19,337       18,421  
                 
Deferred tax liability
    15,456       15,566  
Other long-term liabilities
    736       719  
Long-term debt
    33,446       34,803  
Derivative liabilities at fair value, less current portion
    816       1,243  
Total liabilities
    69,791       70,752  
                 
Commitments and contingencies
               
                 
Temporary equity - Common stock, subject to put rights 183 and 293 shares, respectively
    4,020       4,366  
                 
PERMANENT STOCKHOLDERS' EQUITY:
               
Preferred stock, $.10 par, 1,000 shares authorized; none issued and outstanding
    -       -  
Common stock, $.01 par, 20,000 shares authorized; 9,676 and 9,766 shares issued and outstanding, respectively
    97       98  
Additional paid-in capital
    61,542       62,326  
Accumulated other comprehensive loss
    (26 )     -  
Retained earnings
    9,590       7,515  
Total Rick’s permanent stockholders’ equity
    71,203       69,939  
Noncontrolling interests
    3,313       3,314  
Total permanent stockholders’ equity
    74,516       73,253  
                 
Total liabilities and stockholders’ equity
  $ 148,327     $ 148,371  

See accompanying notes to consolidated financial statements.

 
2

 

RICK'S CABARET INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF INCOME
 
   
Three Months Ended
December 31,
 
(in thousands, except per share data)
 
2010
   
2009
 
   
(UNAUDITED)
 
Revenues:
           
Sales of alcoholic beverages
  $ 8,359     $ 8,050  
Sales of food and merchandise
    1,784       1,590  
Service revenues
    9,412       9,292  
Internet revenues
    125       145  
Media revenues
    216       257  
Other
    962       671  
Total revenues
    20,858       20,005  
                 
Operating expenses:
               
Cost of goods sold
    2,518       2,456  
Salaries and wages
    4,676       4,310  
Stock-based compensation
    -       44  
Other general and administrative:
               
Taxes and permits
    3,063       2,836  
Charge card fees
    364       346  
Rent
    1,079       993  
Legal and professional
    485       650  
Advertising and marketing
    1,183       2,938  
Depreciation and amortization
    1,072       842  
Insurance
    303       262  
Utilities
    406       406  
Other
    1,579       1,536  
Total operating expenses
    16,728       17,619  
                 
Income from operations
    4,130       2,386  
                 
Other income (expense):
               
Interest income
    12       4  
Interest expense
    (1,124 )     (1,029 )
Gain on change in fair value of derivative instruments
    148       44  
                 
Income from continuing operations before income taxes
    3,166       1,405  
                 
Income taxes
    1,026       514  
                 
Income from continuing operations
    2,140       891  
Loss from discontinued operations, net of income taxes
    (11 )     (35 )
                 
Net income
    2,129       856  
Less: net income attributable to noncontrolling interests
    (53 )     (73 )
Net income attributable to Rick’s Cabaret International, Inc.
  $ 2,076     $ 783  
Basic earnings (loss) per share attributable to Rick’s shareholders:
               
Income from continuing operations
  $ 0.21     $ 0.09  
Loss from discontinued operations
    (0.00 )     (0.00 )
Net income
  $ 0.21     $ 0.08  
Diluted earnings (loss) per share attributable to Rick’s shareholders:
               
Income from continuing operations
  $ 0.21     $ 0.09  
Loss from discontinued operations
    (0.00 )     (0.00 )
Net income
  $ 0.21     $ 0.08  
                 
Weighted average number of common shares outstanding:
               
Basic
    10,043       9,370  
Diluted
    10,045       9,385  

Comprehensive income amounted to $2,049 and $783 for the three months ended December 31, 2010 and 2009, respectively.  This includes the changes in available-for-sale securities and net income.

See accompanying notes to consolidated financial statements.

 
3

 

RICK'S CABARET INTERNATIONAL, INC.
 CONSOLIDATED STATEMENTS OF CASH FLOWS
 
   
FOR THE THREE MONTHS
 
(in thousands, except per share data)
 
ENDED DECEMBER 31,
 
   
2010
   
2009
 
   
(UNAUDITED)
 
 CASH FLOWS FROM OPERATING ACTIVITIES:
           
Net income
  $ 2,076     $ 783  
Loss from discontinued operations
    11       35  
Income from continuing operations
    2,087       818  
Adjustments to reconcile net income to cash provided by operating activities:
               
Depreciation and amortization
    1,072       842  
Deferred taxes
    (24 )     63  
Amortization of note discount
    37       45  
Gain on change in fair value of derivative instruments
    (148 )     (44 )
Beneficial conversion
    -       6  
Noncontrolling interests
    53       73  
Deferred rents
    16       19  
Stock compensation expense
    -       44  
Changes in operating assets and liabilities:
               
Accounts receivable
    (16 )     (12 )
Inventories
    (217 )     96  
Prepaid expenses and other assets
    127       (11 )
Accounts payable and accrued liabilities
    (165 )     1,319  
Cash provided by operating activities of continuing operations
    2,822       3,258  
Cash provided by (used in) operating activities of discontinued operations
    9       (24 )
Net cash provided by operating activities
    2,831       3,234  
                 
CASH FLOWS FROM INVESTING ACTIVITIES:
               
Additions to property and equipment
    (658 )     (1,392 )
Purchase of marketable securities
    (505 )     (1,009 )
Acquisition of businesses, net of cash acquired
    -       (2,672 )
Payments from notes receivable
    -       2  
Cash used in investing activities of continuing operations
    (1,163 )     (5,071 )
                 
CASH FLOWS FROM FINANCING ACTIVITIES:
               
Purchase of put options and payments on derivative instrument
    (556 )     (529 )
Payments on long-term debt
    (613 )     (685 )
Purchase of treasury stock
    (894 )     (253 )
Distribution to minority interests
    (54 )     (75 )
Cash used in financing activities of continuing operations
    (2,117 )     (1,542 )
                 
NET DECREASE IN CASH
    (449 )     (3,379 )
CASH AT BEGINNING OF PERIOD
    19,168       12,850  
CASH AT END OF PERIOD
  $ 18,719     $ 9,471  
CASH PAID DURING PERIOD FOR:
               
Interest
  $ 1,217     $ 746  
Income taxes
  $ 1,666     $ 245  

See accompanying notes to consolidated financial statements.

 
4

 
 
RICK'S CABARET INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2010
(UNAUDITED)
 
1.
BASIS OF PRESENTATION

The accompanying unaudited financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America 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 accounting principles generally accepted in the United States of America for complete financial statements.  However, except as disclosed herein, there has been no material change in the information disclosed in the notes to the financial statements for the year ended September 30, 2010 included in the Company's Annual Report on Form 10-K, as filed with the Securities and Exchange Commission.  The interim unaudited financial statements should be read in conjunction with those financial statements included in the Form 10-K.  In the opinion of management, all adjustments considered necessary for a fair presentation, consisting solely of normal recurring adjustments, have been made.  Operating results for the three months ended December 31, 2010 are not necessarily indicative of the results that may be expected for the year ending September 30, 2011.

2.  RECENT ACCOUNTING STANDARDS AND PRONOUNCEMENTS

In January 2010, new guidance was issued regarding improving disclosures about fair value measurements. This standard amends the disclosure guidance with respect to fair value measurements for both interim and annual reporting periods. Specifically, this standard requires new disclosures for significant transfers of assets or liabilities between Level 1 and Level 2 in the fair value hierarchy; separate disclosures for purchases, sales, issuance and settlements of Level 3 fair value items on a gross rather than net, basis; and more robust disclosure of the valuation techniques and inputs used to measure Level 2 and Level 3 assets and liabilities. Except for the detailed disclosures of changes in Level 3 items, which will be effective as of October 1, 2011, the remaining new disclosure requirements were effective as of October 1, 2010.

3. SIGNIFICANT ACCOUNTING POLICIES

Following are certain accounting principles and disclosures which are new in this quarter.

Marketable Securities

Marketable securities at December 31, 2010 consist of bond funds. ASC 320, Investments in Debt and Equity Securities, requires certain investments be recorded at fair value or amortized cost. The appropriate classification of the investments in marketable equity is determined at the time of purchase and re-evaluated at each balance sheet date. As of December 31, 2010, the Company’s marketable securities were classified as available-for-sale, which are carried at fair value, with unrealized gains and losses reported as other comprehensive income within the stockholders’ equity section of the accompanying consolidated balance sheets. The cost of marketable securities sold is determined on a specific identification basis. The fair value of marketable securities is based on quoted market prices based on Level 1 inputs — quoted prices (unadjusted) for identical assets or liabilities in active markets. There have been no realized gains or losses related to marketable securities for the quarters ended December 31, 2010 or 2009.  Marketable securities held at December 31, 2010 have a cost basis of approximately $505,056.

Fair Value of Financial Instruments

The Company calculates the fair value of its assets and liabilities which qualify as financial instruments and includes this additional information in the notes to consolidated financial statements when the fair value is different than the carrying value of these financial instruments. The estimated fair value of accounts receivable, accounts payable and accrued liabilities approximate their carrying amounts due to the relatively short maturity of these instruments. The carrying value of short and long-term debt also approximates fair value since these instruments bear market rates of interest. None of these instruments are held for trading purposes.

 
5

 
 
RICK'S CABARET INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2010
(UNAUDITED)
 
3. SIGNIFICANT ACCOUNTING POLICIES - continued

Discontinued Operations

In certain previous filings, the Company had recognized its Rick’s Cabaret in Austin, Texas as a discontinued operation.  That club was held for sale during a portion of 2009, but the Company decided to renovate and reopen the club and relaunch it with a new concept in April 2010.  After the club was not immediately successful, the Company closed the club again in July 2010.  The club began operating as Jaguars Gold Club in September 2010.

We closed our Divas Latinas club in Houston during September 2009.  This club is recognized in discontinued operations.

4. STOCK OPTIONS AND STOCK-BASED EMPLOYEE COMPENSATION

Employee and Director Stock Option Plans

In 1995, the Company adopted the 1995 Stock Option Plan (the “1995 Plan”) for employees and directors. In August 1999, the Company adopted the 1999 Stock Option Plan (the “1999 Plan”) and in 2010, the Company’s Board of Directors approved the 2010 Stock Option Plan (the “2010 Plan”) (collectively, “the Plans”).  The 2010 Plan will be submitted to the shareholders of the Company for adoption at the 2011 Annual Meeting of Shareholders. The options granted under the Plans may be either incentive stock options, or non-qualified options. The Plans are administered by the Board of Directors or by a compensation committee of the Board of Directors. The Board of Directors has the exclusive power to select individuals to receive grants, to establish the terms of the options granted to each participant, provided that all options granted shall be granted at an exercise price equal to at least 85% of the fair market value of the common stock covered by the option on the grant date and to make all determinations necessary or advisable under the Plans.

The compensation costs recognized for the three months ended December 31, 2010 and 2009 were zero and $44,037, respectively.  There were no stock option exercises for the three months ended December 31, 2010.  There were no stock option grants for the three month periods ended December 31, 2010 and 2009.

Below is the summary of common stock options outstanding as of December 31, 2010:

(in thousands)
Employee and Director Stock Option Plan:
 
Options
Authorized
   
Options
Outstanding
   
Options
Vested
   
Available
for Grant
 
1999 Stock Option Plan
    1,500       565       565       35  
 
 
6

 

RICK'S CABARET INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2010
(UNAUDITED)
 
4. STOCK OPTIONS AND STOCK-BASED EMPLOYEE COMPENSATION - continued
 
Stock Option Activity

The following is a summary of all stock option transactions for the three months ended December 31, 2010:

(in thousands, except for per share
and year information)
 
Shares
   
Weighted
Average
Exercise Price
   
Weighted
Average
Remaining
Contractual
Term
(years)
   
Aggregate
Intrinsic
Value
 
                             
Outstanding as of September 30, 2010
    565     $ 9.94              
Granted
    -       -              
Cancelled or expired
    -       -              
Exercised
    -       -              
Outstanding as of December 31, 2010
    565     $ 9.94       1.58     $ 22  
Options exercisable as of December 31, 2010
    565     $ 9.94       1.58     $ 22  

5. GOODWILL AND OTHER INTANGIBLES

Following are the changes in the carrying amounts of goodwill and licenses for the three months ended December 31, 2010 and 2009:

(in thousands)
 
2010
   
2009
 
   
Licenses
   
Goodwill
   
Licenses
   
Goodwill
 
Beginning balance
  $ 42,617     $ 19,459     $ 41,260     $ 37,071  
Change in tax basis of assets
    (202 )     202       -       15  
Intangibles acquired
    -       -       2,004       -  
Ending balance
  $ 42,415     $ 19,661     $ 43,264     $ 37,086  
 
 
7

 

RICK'S CABARET INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2010
(UNAUDITED)

6.  SEGMENT INFORMATION

Below is the financial information related to the Company’s segments:

   
Three Months Ended
 
(in thousands)
 
December 31,
 
   
2010
   
2009
 
REVENUES
           
Night clubs
  $ 20,517     $ 19,603  
Media
    216       257  
Internet websites
    125       145  
    $ 20,858     $ 20,005  
                 
INCOME FROM CONTINUING OPERATIONS
               
BEFORE INCOME TAXES
               
Night clubs
  $ 4,365     $ 2,561  
Media
    (76 )     (65 )
Internet websites
    (4 )     21  
General corporate
    (1,119 )     (1,112 )
    $ 3,166     $ 1,405  

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

7.  COMMON STOCK

During the quarter ended December 31, 2009, the Company purchased 33,000 shares of Company common stock for its treasury at an aggregate cost of $252,885.  These shares have been retired.

During the quarter ended December 31, 2010, the Company purchased 123,800 shares of Company common stock for its treasury at an aggregate cost of $894,149.  These shares have been retired.

8.  EARNINGS PER SHARE (EPS)

The Company computes earnings per share in accordance with FASB ASC 260, Earnings Per Share.  ASC 260 provides for the calculation of basic and diluted earnings per share.  Basic earnings per share 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 stock warrants and options (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 stock options, warrants and convertible debentures were converted into common stock that then shared in the
 
 
8

 

RICK'S CABARET INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2010
(UNAUDITED)
 
8.  EARNINGS PER SHARE (EPS) - continued

Company’s earnings (as adjusted for interest expense, that would no longer occur if the debentures were converted).

Net earnings applicable to common stock and the weighted – average number of shares used for basic and diluted earnings per share computations are summarized in the table that follows:

   
FOR THE QUARTER ENDED
 
   
DECEMBER 31,
 
   
2010
   
2009
 
Basic earnings per share:
           
Income from continuing operations attributable to Rick's shareholders
  $ 2,087     $ 818  
Loss from discontinued operations, net of income taxes
    (11 )     (35 )
Net income attributable to Rick's shareholders
  $ 2,076     $ 783  
Average number of common shares outstanding
    10,043       9,370  
Basic earnings per share - income from continuing operations
  $ 0.21     $ 0.09  
Basic earnings per share - discontinued operations
  $ (0.00 )   $ (0.00 )
Basic earnings per share - net income attributable to Rick's shareholders
  $ 0.21     $ 0.08  
Diluted earnings per share:
               
Average number of common shares outstanding:
               
Common shares outstanding
    10,043       9,370  
Potential dilutive shares resulting from exercise of warrants and options (1)
    2       15  
Potential dilutive shares resulting from conversion of debentures (2)
    -       -  
Total average number of common shares outstanding used for dilution
    10,045       9,385  
Diluted earnings per share - income from continuing operations
               
attributable to Rick's shareholders
  $ 0.21     $ 0.09  
Diluted earnings per share - discontinued operations
  $ (0.00 )   $ (0.00 )
Diluted earnings per share - net income attributable to Rick's shareholders
  $ 0.21     $ 0.08  

(1)  All outstanding warrants and options were considered for the EPS computation.  Potential dilutive options and warrants of 889,081and 244,569 for the three months ended December 31, 2010 and 2009, respectively, have been excluded from earnings per share due to being anti-dilutive.
(2) Convertible debentures (principal and accrued interest) outstanding at December 31, 2010 and 2009 totaling $9,212,778 and $7,902,176, respectively, were convertible into common stock at a price of $10.25 per share in 2010 and  $8.75 to $12.00 per share in 2009.  Potential dilutive shares of 899,057 and 888,491 for the three months ended December 31, 2010 and 2009, respectively, have been excluded from earnings per share due to being anti-dilutive.

*EPS may not foot due to rounding.

 
9

 

RICK'S CABARET INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2010
(UNAUDITED)

9.  ACQUISITIONS

Joy of Austin

On December 18, 2009, the Company’s wholly owned subsidiary, RCI Entertainment (3105 I-35), Inc. (“RCI”), entered into and closed a Stock Purchase Agreement (the “RCI Purchase Agreement”) with Spiridon Karamalegos (“Karamalegos”), the Joy Club of Austin, Inc. (“JOY”) and North IH-35 Investments, Inc. (“NIII”), whereby RCI acquired 51% of the outstanding stock of JOY and 49% of the outstanding stock of NIII.  JOY is the owner and operator of the adult nightclub business known as “Joy of Austin” which leases and occupies the real property and improvements located at 3105 South IH-35, Round Rock, Texas 78664 (the “Property”).  NIII is the owner of the Property and leases the Property to JOY.  Contemporaneously with entry into the RCI Purchase Agreement, RCI and Karamalegos entered into an Assignment and Assumption Agreement (the “Assignment Agreement”), whereby Karamalegos assigned to RCI his right to acquire the remaining 49% of the outstanding stock of JOY and the remaining 51% of the outstanding stock of NIII, which right Karamalegos obtained pursuant to a Purchase Agreement entered into between Karamalegos, Evangelos Polycrates (“Polycrates”), JOY and NIII (the “Polycrates Purchase Agreement”).  Pursuant to the RCI Purchase Agreement and the Assignment Agreement, RCI acquired and owns 100% of the outstanding stock of JOY and 100% of the outstanding stock of NIII.

Pursuant to the terms of the RCI Purchase Agreement and the Assignment Agreement, RCI paid aggregate consideration of $4.5 million, plus assumption of a promissory note with First State Bank-Taylor (the “Purchase Price”), for the acquisition of JOY and NIII.  The Purchase Price was payable as follows:

 
(i)
$1.8 million by wire transfer to Karamalegos;

 
(ii)
$880,000 by wire transfer to Polycrates;

 
(iii)
$530,000 evidenced by a five (5) year secured promissory note to Karamalegos, bearing interest at the rate of 4.75% per annum and payable in sixty (60) equal monthly installments of principal and interest of $9,941 (the “Karamalegos Note”).  The Karamalegos Note is secured by a third lien in favor of Karamalegos against the Property and improvements located thereon and a second lien on all of the shares of JOY and NIII;

 
(iv)
$1.3 million evidenced by a five (5) year secured promissory note to Polycrates, bearing interest at the rate of 4.75% per annum and payable in sixty (60) equal monthly installments of principal and interest of $24,759 (the “Polycrates Note”).  The Polycrates Note is individually guaranteed by Karamalegos for the first thirty (30) months and is secured by a second lien in favor of Polycrates against the Property and improvements located thereon and a first lien on all of the shares of JOY and NIII; and

 
(v)
The assumption of a Promissory Note dated September 10, 2004, in the original principal amount of $850,000, executed by NIII and payable to First State Bank-Taylor, which Promissory Note had a current balance of $652,489 as of the date of acquisition, and is secured by the Property and improvements located thereon.  The note bears interest at the rate of 7.25%, payable in monthly installments of principal and interest of $7,761.  The interest rate is subject to adjustment on September 10, 2014 to the rate of prime plus 2.5%.  The note is due and payable on or before September 10, 2019.
 
 
10

 

RICK'S CABARET INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2010
(UNAUDITED)

9.  ACQUISITIONS - continued

Also pursuant to the agreements described above, Karamalegos entered into a four (4) year Non-Competition Agreement with RCI, and Polycrates entered into a three (3) year Non-Competition Agreement with RCI.

The following information summarizes the allocation of fair values assigned to the assets and liabilities at the acquisition date.

(in thousands)

Net current assets
 
$
44
 
Property and equipment and other assets
   
2,955
 
Non-compete agreement
   
200
 
Goodwill
   
2,031
 
SOB licenses
   
2,004
 
Deferred tax liability
   
(2,031
)
Net assets acquired
 
$
5,203
 

The Company incurred approximately $43,000 in legal costs associated with the acquisition, which are included in legal and professional expense in the accompanying consolidated statement of operations.

Goodwill in the acquisition represents the offset to the deferred tax liability recorded as a result of the difference in the basis of the net assets for tax and financial purposes.  The goodwill is not deductible for income tax purposes.  The results of operations of this entity are included in the Company’s consolidated results of operations since December 18, 2009. This acquisition was made to further the Company’s growth objective of acquiring nightclubs that will quickly contribute to the Company’s earnings per share.  Proforma results of operations have not been provided, as the amounts were not deemed material to the consolidated financial statements.

10.  INCOME TAXES

Income tax expense on continuing operations for the periods presented differs from the “expected” federal income tax expense computed by applying the U.S. federal statutory rate of 34% to earnings before income taxes for the three months ended December 31, as a result of the following:
 
(in thousands)
 
2010
   
2009
 
             
Computed expected tax expense
  $ 1,076     $ 478  
State income taxes
    30       38  
Permanent differences
    (63 )     21  
Other
    (17 )     (23 )
Total income tax expense - continuing operations
  $ 1,026     $ 514  
 
 
11

 

RICK'S CABARET INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2010
(UNAUDITED)

10.  INCOME TAXES - continued

Included in the Company’s deferred tax liabilities at December 31, 2010 is approximately $14.7 million representing the tax effect of indefinite lived intangible assets from club acquisitions which are not deductible for tax purposes.  These deferred tax liabilities will remain in the Company’s balance sheet until the related clubs are sold.

11. COMMITMENTS AND CONTINGENCIES

Beginning January 1, 2008, the Company’s Texas clubs became subject to a new state law requiring each club to collect and pay a $5 surcharge for every club visitor.  A lawsuit was filed by the Texas Entertainment Association (“TEA”), an organization to which the Company is a member, alleging the fee amounts to be an unconstitutional tax.  On March 28, 2008, a State District Court Judge in Travis County, Texas ruled that the new state law violates the First Amendment to the United States Constitution and is therefore invalid.  The judge’s order enjoined the State from collecting or assessing the tax.  The State appealed the Court’s ruling.  In Texas, when cities or the State give notice of appeal, it supersedes and suspends the judgment, including the injunction.  Therefore, the judgment of the District Court cannot be enforced until the appeals are completed.  Given the suspension of the judgment, the State has opted to collect the tax pending the outcome of its appeal.  On June 5, 2009, the Court of Appeals for the Third District (Austin) affirmed the District Court’s judgment that the Sexually Oriented Business (“S.O.B.”) Fee violated the First Amendment to the U.S. Constitution. The Attorney General of Texas has asked the Texas Supreme Court to review the case. On August 26, 2009, the Texas Supreme Court ordered both sides to submit briefs on the merits, while not yet deciding whether to grant the State’s Petition for review. The State’s brief was filed on September 25, 2009 and the Texas Entertainment Association’s brief was filed on October 15, 2009.  On February 12, 2010, Supreme Court of Texas granted review of the Petition by the Attorney General of Texas.  Oral argument of the matter was heard on March 25, 2010.  The Company is awaiting a ruling from the Texas Supreme Court.

The Company has paid the tax for the first five calendar quarters under protest and expensed the tax in the accompanying consolidated financial statements, except for two locations in Dallas where the taxes have not been paid, but the Company is accruing and expensing the liability.  For the subsequent quarters, as a result of the Third Court’s decision, the Company accrued the fee, but did not pay the State.  As of December 31, 2010, the Company has approximately $4.7 million in accrued liabilities for this tax.  Patron tax expense amounted to approximately $695,000 and $583,000 for the quarters ended December 31, 2010 and 2009, respectively.  The Company has paid more than $2 million to the State of Texas since the inception of the tax. The Company’s Texas clubs have filed a separate lawsuit against the State to demand repayment of the taxes.  If the State’s appeal ultimately fails, the Company’s current amount paid under protest would be repaid or applied to future admission tax and other Texas state tax liabilities.

12.  SUBSEQUENT EVENTS

On January 3, 2011, the Company’s wholly owned subsidiaries, RCI Dining Services (Airport Freeway), Inc. (“RCI Dining”) and RCI Holdings, Inc. (“RCI”) completed the purchase of a new gentlemen’s club adjacent to the south end of the Dallas-Ft. Worth International Airport and the purchase of the underlying real property, respectively, for an aggregate purchase price of $4,500,000.   A Purchase Agreement and Build-to-Suit
 
 
12

 

RICK'S CABARET INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2010
(UNAUDITED)
 
12.  SUBSEQUENT EVENTS - continued
 
Turnkey Construction Agreement had previously been entered into in December 2009, which agreement provided for the construction of the new club and the purchase of the real property located at 15000 Airport Freeway (Highway 183), Fort Worth, Texas.
 
 
13

 

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

The following discussion should be read in conjunction with our audited consolidated financial statements and related notes thereto included in this quarterly report.

FORWARD LOOKING STATEMENT AND INFORMATION

The Company is including the following cautionary statement in this Form 10-Q to make applicable and take advantage of the safe harbor provision of the Private Securities Litigation Reform Act of 1995 for any forward-looking statements made by, or on behalf of, the Company.  Forward-looking statements include statements concerning plans, objectives, goals, strategies, future events or performance and underlying assumptions and other statements, which are other than statements of historical facts.  Certain statements in this Form 10-Q are forward-looking statements.  Words such as "expects," “believes,” "anticipates," “may," and "estimates" and similar expressions are intended to identify forward-looking statements. Such statements are subject to risks and uncertainties that could cause actual results to differ materially from those projected.  Such risks and uncertainties are set forth below.  Our expectations, beliefs and projections are expressed in good faith and are believed by us to have a reasonable basis, including without limitation, management's examination of historical operating trends, data contained in our records and other data available from third parties, but there can be no assurance that management's expectation, beliefs or projections will result, be achieved, or be accomplished.  In addition to other factors and matters discussed elsewhere herein, the following are important factors that, in our view, could cause material adverse effects on our financial condition and results of operations: the risks and uncertainties relating to our Internet operations, the impact and implementation of the sexually oriented business ordinances in the jurisdictions where our facilities operate, competitive factors, the timing of the openings of other clubs, the availability of acceptable financing to fund corporate expansion efforts, and the dependence on key personnel.  We have no obligation to update or revise these forward-looking statements to reflect the occurrence of future events or circumstances.

GENERAL

We operate in three businesses in the adult entertainment industry:
 
1.
We own and/or operate upscale adult nightclubs serving primarily businessmen and professionals. Our nightclubs offer live adult entertainment, restaurant and bar operations. Through our subsidiaries, we currently own and/or operate a total of twenty-one adult nightclubs that offer live adult entertainment, restaurant and bar operations. Seven of our clubs operate under the name "Rick's Cabaret"; four operate under the name “Club Onyx”, upscale venues that welcome all customers but cater especially to urban professionals, businessmen and professional athletes; six operate under the name "XTC Cabaret"; one club operates as “Tootsie’s Cabaret”, one operates as “Cabaret North”, one operates as “Jaguars Gold Club” and one operates as “Cabaret East”.  Additionally, we have opened another Rick’s Cabaret near DFW International Airport on January 20, 2011.  Our nightclubs are in Houston, Austin, San Antonio, Dallas and Fort Worth, Texas; Charlotte, North Carolina; Minneapolis, Minnesota; New York, New York; Miami Gardens, Florida; Philadelphia, Pennsylvania and Las Vegas, Nevada.  No sexual contact is permitted at any of our locations.

2.
We have extensive Internet activities.

 
a)
We currently own two adult Internet membership Web sites at www.CoupleTouch.com and www.xxxpassword.com. We acquire xxxpassword.com site content from wholesalers.

 
b)
We operate an online auction site www.NaughtyBids.com. This site provides our customers with the opportunity to purchase adult products and services in an auction format. We earn revenues by charging fees for each transaction conducted on the automated site.
 
 
14

 

3.
In April 2008, we acquired a media division, including the leading trade magazine serving the multi-billion dollar adult nightclubs industry. As part of the transaction we also acquired two industry trade shows, two other industry trade publications and more than 25 industry websites.

Our nightclub revenues are derived from the sale of liquor, beer, wine, food, merchandise, cover charges, membership fees, independent contractors' fees, commissions from vending and ATM machines, valet parking and other products and services. Our Internet revenues are derived from subscriptions to adult content Internet websites, traffic/referral revenues, and commissions earned on the sale of products and services through Internet auction sites, and other activities. Media revenues include sale of advertising content and revenues from an annual Expo convention.  Our fiscal year end is September 30.

For several years, we have greatly reduced our usage of promotional pricing for membership fees for our adult entertainment web sites. This reduced our revenues from these web sites.

CRITICAL ACCOUNTING POLICIES

Management’s discussion and analysis of financial condition and results of operations are based upon our financial statements, which have been prepared in accordance with United States generally accepted accounting principles (“GAAP”).  GAAP consists of a set of standards issued by the FASB and other authoritative bodies in the form of FASB Statements, Interpretations, FASB Staff Positions, Emerging Issues Task Force consensuses and American Institute of Certified Public Accountants Statements of Position, among others.  The FASB recognized the complexity of its standard-setting process and embarked on a revised process in 2004 that culminated in the release on July 1, 2009 of the Accounting Standards Codification (“ASC”).  The ASC does not change how Company accounts for its transactions or the nature of related disclosures made.  Rather, the ASC results in changes to how the Company references accounting standards within its reports.  This change was made effective by the FASB for periods ending on or after September 15, 2009.  The Company has updated references to GAAP in this Annual Report on Form 10-K to reflect the guidance in the ASC.  The preparation of these 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.

Accounts and Notes Receivable

Trade accounts receivable for the nightclub operation is primarily comprised of credit card charges, which are generally converted to cash in two to five days after a purchase is made.  The media division’s accounts receivable is primarily comprised of receivables for advertising sales and Expo registration. The Company’s accounts receivable, other is comprised of employee advances and other miscellaneous receivables. The long-term portion of notes receivable are included in other assets in the accompanying consolidated balance sheets. The Company recognizes interest income on notes receivable based on the terms of the agreement and based upon management’s evaluation that the notes receivable and interest income will be collected. The Company recognizes allowances for doubtful accounts or notes when, based on management judgment, circumstances indicate that accounts or notes receivable will not be collected.

Inventories

Inventories include alcoholic beverages, food, and Company merchandise. Inventories are carried at the lower of cost, average cost, which approximates actual cost determined on a first-in, first-out (“FIFO”) basis, or market.
 
 
15

 

Property and Equipment

Property and equipment are stated at cost. Provisions for depreciation and amortization are made using straight-line rates over the estimated useful lives of the related assets and the shorter of useful lives or terms of the applicable leases for leasehold improvements. Buildings have estimated useful lives ranging from 29 to 40 years. Furniture, equipment and leasehold improvements have estimated useful lives between five and 40 years. Expenditures for major renewals and betterments that extend the useful lives are capitalized. Expenditures for normal maintenance and repairs are expensed as incurred. The cost of assets sold or abandoned and the related accumulated depreciation are eliminated from the accounts and any gains or losses are charged or credited in the accompanying consolidated statement of income of the respective period.

Goodwill and Intangible Assets

FASB ASC 350, Goodwill and Other Intangibles Assets addresses the accounting for goodwill and other intangible assets. Under FASB ASC 350, goodwill and intangible assets with indefinite lives are no longer amortized, but reviewed on an annual basis for impairment. All of the Company’s goodwill and intangible assets relate to the nightclub segment, except for $567,000 related to the media segment.  Definite lived intangible assets are amortized on a straight-line basis over their estimated lives.  Fully amortized assets are written-off against accumulated amortization.

Impairment of Long-Lived Assets

The Company reviews property and equipment and intangible assets with definite lives for impairment whenever events or changes in circumstances indicate the carrying amount of an asset may not be recoverable. Recoverability of these assets is measured by comparison of its carrying amounts to future undiscounted cash flows the assets are expected to generate. If property and equipment and intangible assets with definite lives are considered to be impaired, the impairment to be recognized equals the amount by which the carrying value of the asset exceeds its fair value.  Assets are grouped at the lowest level for which there are identifiable cash flows, principally at the club level, when assessing impairment. Cash flows for our club assets are identified at the individual club level.  The Company’s annual evaluation was performed as of September 30, 2010, based on a projected discounted cash flow method using a discount rate determined by management to be commensurate with the risk inherent in the current business model. Certain of our acquisitions, specifically Las Vegas, Philadelphia and the original Rick’s Cabaret in Austin (now operated by a partner as “Jaguars Gold Club”), have been underperforming, principally due to the recent general economic downturn, especially in Las Vegas, but also due to certain specific operational issues, such as the change of concept in Philadelphia and the cab fare marketing issues in Las Vegas.   We have determined that there is a net asset impairment at September 30, 2010, relating to these three nightclub operations.  

Fair Value of Financial Instruments

The Company calculates the fair value of its assets and liabilities which qualify as financial instruments and includes this additional information in the notes to consolidated financial statements when the fair value is different than the carrying value of these financial instruments. The estimated fair value of accounts receivable, accounts payable and accrued liabilities approximate their carrying amounts due to the relatively short maturity of these instruments. The carrying value of short and long-term debt also approximates fair value since these instruments bear market rates of interest. None of these instruments are held for trading purposes.

Derivative Financial Instruments
 
The Company accounts for financial instruments that are indexed to and potentially settled in, its own stock, including stock put options, in accordance with the provisions of FASB ASC 815, Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in  a Companys Own Stock.  Under certain circumstances that would require the Company to settle these equity items in cash, and without regard to probability, FASB ASC 815 would require the classification of all or part of the item as a liability and the adjustment of that reclassified amount to fair value at each reporting date, with such adjustments reflected in the Company’s consolidated statements of income.  The first instrument to meet the requirements of FASB ASC 815 for derivative accounting occurred in the quarter ended June 30, 2009 when the Company renegotiated the payback terms of certain put options and agreed to pledge as collateral to certain holders a second lien on certain property.

 
16

 

Revenue Recognition

The Company recognizes revenue from the sale of alcoholic beverages, food and merchandise, other revenues and services at the point-of-sale upon receipt of cash, check, or credit card charge.

The Company recognizes Internet revenue from monthly subscriptions to its online entertainment sites when notification of a new or existing subscription and its related fee are received from the third party hosting company or from the credit card company, usually two to three days after the transaction has occurred. The monthly fee is not refundable. The Company recognizes Internet auction revenue when payment is received from the credit card as revenues are not deemed estimable nor collection deemed probable prior to that point.

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 in August.

Sales and Liquor Taxes

The Company recognizes sales and liquor taxes paid as revenues and an equal expense in accordance with FASB ASC 605, How Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement.  Total sales and liquor taxes aggregated $1.4 million and 1.3 million for the three months ended December 31, 2010 and 2009, respectively.
 
Advertising and Marketing

Advertising and marketing expenses are primarily comprised of costs related to public advertisements and giveaways, which are used for promotional purposes. Advertising and marketing expenses are expensed as incurred and are included in operating expenses in the accompanying consolidated statements of income.

Income Taxes

Deferred income taxes are determined using the liability method in accordance with FASB ASC 740, Accounting for Income Taxes. 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. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. In addition, a valuation allowance is established to reduce any deferred tax asset for which it is determined that it is more likely than not that some portion of the deferred tax asset will not be realized.

FASB ASC 740 creates a single model to address accounting for uncertainty in tax positions by prescribing a minimum recognition threshold a tax position is required to meet before being recognized in the financial statements. FASB ASC 740 also provides guidance on derecognition, measurement, classification, interest and penalties, accounting in interim periods, disclosure and transition. There are no unrecognized tax benefits to disclose in the notes to the consolidated financial statements.

 
17

 

Put Options

In certain situations, the Company issues restricted common shares as partial consideration for acquisitions of certain businesses or assets.  Pursuant to the terms and conditions of the governing acquisition agreements, the holder of such shares has the right, but not the obligation, to put a fixed number of the shares on a monthly basis back to the Company at a fixed price per share.  The Company may elect during any given month to either buy the monthly shares or, if management elects not to do so, the holder can sell the monthly shares in the open market, and any deficiency between the amount which the holder receives from the sale of the monthly shares and the value of shares will be paid by the Company.  The Company has accounted for these shares in accordance with the guidance established by FASB ASC 480 as a reclassification of the value of the shares from permanent to temporary equity.  As the shares become due, the Company transfers the value of the shares back to permanent equity, less any amount paid to the holder.  Also see “Derivative Financial Instruments” above.

Earnings (Loss) Per Common Share
 
The Company computes earnings (loss) per share in accordance with FASB ASC 260, Earnings Per Share. FASB ASC 260 provides for the calculation of basic and diluted earnings per share. Basic earnings per share 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 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 stock options, warrants and convertible debentures were converted into common stock that then shared in the Company’s earnings (loss) (as adjusted for interest expense, that would no longer occur if the debentures were converted).

Stock Options

The Company has adopted the fair value recognition provisions of FASB ASC 718, CompensationStock Compensation.

The compensation cost recognized for the three months ended December 31, 2010 and 2009 was zero and $44,037, respectively.  There were no stock options exercises for the three months ended December 31, 2010 and 2009.

RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED DECEMBER 31, 2010 AS COMPARED TO THE THREE MONTHS ENDED DECEMBER 31, 2009

For the three months ended December 31, 2010, we had consolidated total revenues of $20.9 million compared to consolidated total revenues of $20.0 million for the three months ended December 31, 2009, an increase of $853,000 or 4.3%.  The increase in total revenues was primarily attributable to the increase in revenues generated by new clubs in Austin (acquired in Mid-December 2009) and Fort Worth, Texas (2 clubs acquired in June and July 2010), in the amount of $1.4 million.  The increase created by these new clubs was offset slightly by a decrease in same-store sales of approximately $715,000, due principally to a decrease in sales at Rick’s Las Vegas of approximately $466,000.
 
 
18

 

 Following is a comparison of our consolidated income statements for the quarters ended December 31, 2010 and 2009 with percentages compared to total revenue:

(in thousands)
 
2010
   
%
   
2009
   
%
 
                         
Sales of alcoholic beverages
  $ 8,359       40.1 %   $ 8,050       40.2 %
Sales of food and merchandise
    1,784       8.6 %     1,590       7.9 %
Service Revenues
    9,412       45.1 %     9,292       46.4 %
Internet Revenues
    125       0.6 %     145       0.7 %
Media
    216       1.0 %     257       1.3 %
Other
    962       4.6 %     671       3.4 %
Total Revenues
    20,858       100.0 %     20,005       100.0 %
                                 
Cost of Goods Sold
    2,518       12.1 %     2,456       12.3 %
Salaries & Wages
    4,676       22.4 %     4,310       21.5 %
Stock-based Compensation
    -       0.0 %     44       0.2 %
Taxes and permits
    3,063       14.7 %     2,836       14.2 %
Charge card fees
    364       1.7 %     346       1.7 %
Rent
    1,079       5.2 %     993       5.0 %
Legal & professional
    485       2.3 %     650       3.2 %
Advertising and marketing
    1,183       5.7 %     2,938       14.7 %
Depreciation and amortization
    1,072       5.1 %     842       4.2 %
Insurance
    303       1.5 %     262       1.3 %
Utilities
    406       1.9 %     406       2.0 %
Other
    1,579       7.6 %     1,536       7.7 %
                                 
Total operating expenses
    16,728       80.2 %     17,619       88.1 %
                                 
Income from continuing operations
    4,130       19.8 %     2,386       11.9 %
                                 
Interest income
    12       0.1 %     4       0.0 %
Interest expense
    (1,124 )     -5.4 %     (1,029 )     -5.1 %
Gain  on change in fair value of derivative instruments
    148       0.7 %     44       0.2 %
Income from continuing operations before income taxes
  $ 3,166       15.2 %   $ 1,405       7.0 %

Following is an explanation of significant variances in the above amounts.

Service revenues include cover charges fees paid by entertainers, room rentals, memberships and fees charged for credit card processing.  Other revenues include ATM commissions earned, video games and other vending and certain promotion fees charged to our entertainers.   We recognize revenue from other revenues and services at the point-of-sale upon receipt of cash, check, or credit card charge.

Cost of goods sold includes cost of alcoholic and non-alcoholic beverages, food, cigars and cigarettes, merchandise, media printing/binding, media postage and internet traffic purchases and webmaster payouts.  Media cost of goods amounted to $50,468 and $55,274 for the quarters ended December 31, 2010 and 2009, respectively.  The cost of goods sold for the club operations for the three months ended December 31, 2010 was 12.0% compared to 12.2% for the three months ended December 31, 2009.  The cost of goods sold from our internet operations for the three months ended December 31, 2010 was 2.1% compared to 2.2% for the three months ended December 31, 2009.  The cost of goods sold for same-location-same-period of club operations for the three months ended December 31, 2010 was 12.1%, compared to 12.2% for the same period ended December 31, 2009.

 
19

 

The increase in payroll and related costs, stated as “Salaries & Wages” above, was primarily due to the addition of the new clubs during 2010.   Payroll for same-location-same-period of club operations increased to $3.6 million for the three months ended December 31, 2010 from $3.5 million for the same period ended December 31, 2009.  Management currently believes that its labor and management staff levels are appropriate.

The slight increase in taxes as a percentage of total revenues is due to the two new clubs in Texas with its patron tax.

The significant decrease in the advertising and marketing is principally due to the reduction of the marketing costs in Las Vegas during 2010 and to a significant radio campaign in the Dallas/Fort Worth market in  2009.  Rick’s Las Vegas lost approximately $500,000 for the quarter ended December 31, 2009 on revenues of $3.1 million and lost approximately $370,000 for the 2010 quarter on revenues of $1.1 million.

The decrease in legal and professional expense is principally due to a continuing labor lawsuit in New York which was more active in 2009.

The increase in interest expense was attributable to our obtaining an additional $2 million of net new debt in June 2010 to finance the purchase of new clubs.

Income taxes, as a percentage of income before taxes was 32.4% and 36.6% for the quarters ended December 31, 2010 and 2009, respectively.  The decrease in 2010 is due to a change in permanent differences in 2010, principally the gain on change in fair value of derivative instruments.

The increase in net income was primarily due to the decrease in expenses detailed above (principally advertising and marketing) while increasing revenues.   Operating income (exclusive of corporate overhead) for same-location-same-period of club operations increased to $5.1 million for the three months ended December 31, 2010 from $3.4 million for same period ended December 31, 2009, or by 51.9%.

Our Media Division lost approximately $76,000 before income taxes for the quarter ended December 31, 2010 compared to a loss of approximately $65,000 in the 2009 quarter.  As the economy improves, we believe the Media Division will become profitable as we control costs and increase marketing revenues.

Adjusted EBITDA for the three months ended December 31, 2010 and 2009 was $5.3 million and $3.2 million, respectively.

Adjusted EBITDA is a financial statement measure that was not derived in accordance with GAAP. We use adjusted EBITDA (earnings before interest expense, income taxes, depreciation, amortization and impairment charges) as a non-GAAP performance measure. In calculating adjusted EBITDA, we exclude our largest recurring non-cash charge, depreciation, amortization and impairment charges. 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.  Also, we exclude interest cost in our calculation of adjusted EBITDA. 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. Reconciliations from net income to adjusted EDITDA are provided below for the quarters ended December 31:
 
(in thousands)
 
2010
   
2009
 
Income from continuing operations
  $ 2,140     $ 891  
Net income from noncontrolling interests
    (53 )     (73 )
Income taxes
    1,026       514  
Interest expense
    1,124       1,029  
Depreciation and amortization
    1,072       842  
Adjusted EBITDA
  $ 5,309     $ 3,203  
 
 
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Our adjusted EBITDA does not include interest expense, income taxes, depreciation, amortization and impairment charges. Because we have borrowed money in order to finance our operations, interest expense is a necessary element of our costs and our ability to generate revenues. Because we use capital assets, depreciation, amortization and impairment charges are also necessary elements of our costs. Also, the payment of income taxes is a necessary element of our operations. Therefore, any measures that exclude these elements have material limitations. To compensate for these limitations, we believe that it is appropriate to consider both net earnings (loss) determined under GAAP, as well as adjusted EBITDA, to evaluate our performance. Also, we separately analyze any significant fluctuations in interest expense, depreciation, amortization, impairment charges and income taxes.

The accompanying consolidated financial statements reflect the following as discontinued operations as of and for the three months ended December 31, 2010 and 2009.

We closed our Divas Latinas club in Houston during September 2009.  This club is recognized in discontinued operations.

In previous filings, we recognized our Rick’s Cabaret in Austin, Texas as a discontinued operation.  That club was held for sale during a portion of 2009, but we decided to renovate and reopen the club and we relaunched it with a new concept in April 2010.  When the club was not immediately successful, we closed the club again in July 2010.  The club reopened again in September 2010, operating as “Jaguars Gold Club”.  Accordingly, the Austin club is recognized in continuing operations in the accompanying consolidated financial statements.

Following is summarized information regarding the discontinued operations:

   
Quarter Ended December 31,
 
   
2010
   
2009
 
Loss from discontinued operations
  $ (18 )     (55 )
Income tax - discontinued operations
    7       20  
Total loss from discontinued operations, net of tax
  $ (11 )   $ (35 )

Major classes of assets and liabilities included as assets and liabilities of discontinued operations as of:
   
December 31,
   
September 30,
 
   
2010
   
2010
 
Current assets
  $ 26     $ 30  
Property and equipment
    105       115  
Other assets
    2       3  
Current liabilities
    (20 )     (14 )
Long-term liabilities
    (33 )     (33 )
Net assets (liabilities)
  $ 80     $ 101  
 
 
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LIQUIDITY AND CAPITAL RESOURCES

Working Capital and Cash Flows

At December 31, 2010, we had working capital of $5.1 million compared to $377,552 at December 31, 2009.  The significant increase is due to our profits and also the net cash still available from the convertible debt which is principally long-term in nature.

Net cash provided by operating activities in the three months ended December 31, 2010 was $2.8 million compared to $3.2 million for the three months ended December 31, 2009.  The decrease in cash provided by operating activities was primarily due to the increased acquisition of inventories and the payment of income taxes and accounts payable during the quarter ended December 31, 2010.

We used $1.2 million of cash in investing activities during the three months ended December 31, 2010 compared to $5.1 million during the three months ended December 31, 2009.  The decrease was principally due to the acquisition of the new club in Austin, Texas in December 2009, purchase of marketable securities and more additions to property and equipment in 2009.  Cash of $2.1 million was used by financing activities during the three months ended December 31, 2010 compared to $1.5 million cash used during the three months ended December 31, 2009.  The increase in cash used by financing activities is primarily the result of the purchase of treasury stock in 2010.

We require capital principally for construction or acquisition of new clubs, renovation of older clubs and investments in technology.  We may also utilize capital to repurchase our common stock as part of our share repurchase program.

Put Options
 
As part of certain of our acquisition transactions, we have entered into Lock-Up/Leak-Out Agreements with the sellers pursuant to which, on or after a contractual period after the closing date, the seller shall have the right, but not the obligation, to have us purchase from seller a certain number of our shares of common stock issued in the transactions in an amount and at a rate of not more than a contractual number of the shares per month (the “Monthly Shares”) calculated at a price per share equal to a contractual value per share (“Value of the Rick’s Shares”). At our election during any given month, we may either buy the Monthly Shares or, if we elect not to buy the Monthly Shares from the seller, then the seller shall sell the Monthly Shares in the open market. Any deficiency between the amount which the seller receives from the sale of the Monthly Shares and the value of the shares shall be paid by us within three (3) business days of the date of sale of the Monthly Shares during that particular month. Our obligation to purchase the Monthly Shares from the Seller shall terminate and cease at such time as the seller has received a contractual amount from the sale of the Rick’s Shares and any deficiency. Under the terms of the Lock-Up/Leak-Out Agreements, the seller may not sell more than a contractual number of our shares per 30-day period, regardless of whether the seller “Puts” the shares to us or sells them in the open market or otherwise.

The maximum obligation that could be owed if our stock were valued at zero is $7.0 million at December 31, 2010.  If we are required to buy back any of these put options, the buy-back transaction will be purely a balance sheet transaction, affecting only Temporary Equity or Derivative Liability and Stockholders’ Equity and will have no income statement effect.  The only income statement effect from these put options is the “mark to market” valuation quarterly of the derivative liability.

Following is a schedule of the annual obligation (after the renegotiation) we would have if our stock price remains in the future at the closing market price on December 31, 2010 of $7.83 per share, of which there can be no assurance: (This includes the derivative financial instruments recognized in our balance sheet at December 31, 2010.)
 
For the Year Ended September 30:
 
(in thousands)
 
2011
  $ 2,450  
2012
    2,043  
2013
    137  
Total
  $       4,630  
 
 
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Each $1.00 per share movement of our stock price has an aggregate effect of $303,000 on the total obligation.

Other Liquidity and Capital Resources

We have not established lines of credit or financing other than the above mentioned notes payable and our existing debt.  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.

On September 29, 2008, our Board of Directors authorized us to repurchase up to $5 million worth of our common stock.  During the three months ended December 31, 2010, we purchased 90,800 shares of common stock in the open market at prices ranging from $7.03 to $7.43.  During the three months ended December 31, 2009, we purchased 48,200 shares of common stock in the open market at prices ranging from $3.54 to $5.95.

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 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.

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 with the strongest operating results occurring during October through March.  Our experience to date indicates that there does not appear to be a seasonal fluctuation in our Internet activities.

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 is: (a) to open new clubs after careful market research, (b) to acquire existing clubs in locations that are consistent with our growth and income targets and which appear receptive to the upscale club formula we have developed, as is the case with the acquisitions of the clubs in Austin, Dallas and Fort Worth, Texas, Miami Gardens, Florida,  Philadelphia, Pennsylvania, and Las Vegas, Nevada, (c) 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, (d) to develop new club concepts that are consistent with our management and marketing skills, (e) to acquire real estate in connection with club operations, although some clubs may be in leased premises, and/or (f) to enter into licensing agreements in strategic locations.

 
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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.

We also expect to continue to grow our Internet profit centers. We plan to focus on high-margin Internet activities that leverage our marketing skills while requiring a low level of start-up cost and ongoing operating costs and refine and tune our Internet sites for better positioning in organic search rankings amongst the major search providers.  We will restructure affiliate programs to provide higher incentives to our current affiliates to better promote our Internet sites, while actively seeking new affiliates to send traffic to our Internet sites. 

The acquisition of additional clubs and/or internet operations will require us to obtain additional debt or issuance of 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, 2010, 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, 2010.

Item 4. Controls and Procedures.
 
Evaluation of Disclosure Controls and Procedures
 
Under the supervision and with the participation of the Company’s senior management, including the Company’s chief executive officer and chief financial officer, the Company conducted an evaluation of the effectiveness of the design and operation of the Company’s disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), as of the end of the period covered by this quarterly report (the “Evaluation Date”). Based on this evaluation, the Company’s chief executive officer and chief financial officer concluded as of the Evaluation Date that the Company’s disclosure controls and procedures were effective such that the information relating to the Company, including consolidated subsidiaries, required to be disclosed in the Company’s Securities and Exchange Commission (“SEC”) reports (i) is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms, and (ii) is accumulated and communicated to the Company’s management, including the Company’s chief executive officer and chief financial officer, as appropriate to allow timely decisions regarding required disclosure.
 
Changes in Internal Control Over Financial Reporting
 
There have been no changes in the Company’s internal control over financial reporting that occurred during the quarter ended December 31, 2010 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.

Beginning January 1, 2008, the Company’s Texas clubs became subject to a new state law requiring each club to collect and pay a $5 surcharge for every club visitor.  A lawsuit was filed by the Texas Entertainment Association (“TEA”), an organization to which the Company is a member, alleging the fee amounts to be an unconstitutional tax.  On March 28, 2008, a State District Court Judge in Travis County, Texas ruled that the new state law violates the First Amendment to the United States Constitution and is therefore invalid.  The judge’s order enjoined the State from collecting or assessing the tax.  The State appealed the Court’s ruling.  In Texas, when cities or the State give notice of appeal, it supersedes and suspends the judgment, including the injunction.  Therefore, the judgment of the District Court cannot be enforced until the appeals are completed.  Given the suspension of the judgment, the State has opted to collect the tax pending the outcome of its appeal.  On June 5, 2009, the Court of Appeals for the Third District (Austin) affirmed the District Court’s judgment that the Sexually Oriented Business (“S.O.B.”) Fee violated the First Amendment to the U.S. Constitution. The Attorney General of Texas has asked the Texas Supreme Court to review the case. On August 26, 2009, the Texas Supreme Court ordered both sides to submit briefs on the merits, while not yet deciding whether to grant the State’s Petition for review. The State’s brief was filed on September 25, 2009 and the Texas Entertainment Association’s brief was filed on October 15, 2009.  On February 12, 2010, Supreme Court of Texas granted review of the Petition by the Attorney General of Texas.  Oral argument of the matter was heard on March 25, 2010.  The Company is awaiting a ruling from the Texas Supreme Court.

The Company has paid the tax for the first five calendar quarters under protest and expensed the tax in the accompanying consolidated financial statements, except for two locations in Dallas where the taxes have not been paid, but the Company is accruing and expensing the liability.  For the subsequent quarters, as a result of the Third Court’s decision, the Company accrued the fee, but did not pay the State.  As of December 31, 2010, the Company has approximately $4.7 million in accrued liabilities for this tax.  Patron tax expense amounted to approximately $695,000 and $583,000 for the quarters ended December 31, 2010 and 2009, respectively.  The Company has paid more than $2 million to the State of Texas since the inception of the tax. The Company’s Texas clubs have filed a separate lawsuit against the State to demand repayment of the taxes.  If the State’s appeal ultimately fails, the Company’s current amount paid under protest would be repaid or applied to future admission tax and other Texas state tax liabilities.

Item 1A. Risk Factors.

In addition to the other information set forth in this report, you should carefully consider the factors discussed in Part I, “Item 1A. Risk Factors” in the Company’s Annual Report on Form 10-K for the year ended September 30, 2010, as such factors could materially affect the Company’s business, financial condition or future results.  In the three months ended December 31, 2010, there were no material changes to the risk factors disclosed in the Company’s 2010 Annual Report on Form 10-K.  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.

During the three months ended December 31, 2010, we purchased 90,800 shares of common stock in the open market at prices ranging from $7.03 to $7.43 per share. During the three months ended December 31, 2010, we purchased 33,000 shares of common stock from put option holders at prices ranging from $6.98 to $7.47 per share.    Following is a summary of our purchases by month:

 
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Period:
 
(a)
   
(b)
   
(c)
   
(d)
 
Month Ending
 
Total Number
of Shares (or
Units)
Purchased
   
Average Price
Paid per Share
   
Total Number of
Shares (or Units)
Purchased as
Part of Publicly
Announced Plans
or Programs
   
Maximum
Number (or
Approximate
Dollar Value) of
Shares (or Units)
that May Yet be
Purchased Under
the Plans or
Programs
 
October 31, 2010
    11,000     $ 7.30       -        
November 30, 2010
    86,800     $ 7.25       -     $ 3,623,872  
December 31, 2010
    26,000     $ 7.08       -     $ 3,439,746  
                                 
Total
    123,800     $ 7.23       -     $ 3,439,746  

Item 6. Exhibits.

Exhibit 31.1 – Certification of Chief Executive Officer of Rick’s Cabaret International, 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.

Exhibit 31.2 – Certification of Chief Financial Officer of Rick’s Cabaret International, 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.

Exhibit 32.1 — Certification of Chief Executive Officer and Chief Financial Officer of Rick’s Cabaret International, Inc. pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and Section 1350 of 18 U.S.C. 63.
 
 
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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.

 
RICK'S CABARET INTERNATIONAL, INC.
 
     
Date:  February 9, 2010
By:
/s/ Eric S. Langan
 
 
Eric S. Langan
 
 
Chief Executive Officer and President
 

Date:  February 9, 2010
By:
/s/ Phillip K. Marshall
 
 
Phillip K. Marshall
 
 
Chief Financial Officer and Principal Accounting Officer
 
 
 
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