Unassociated Document  
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 June 30, 2011

¨ 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 x No ¨

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 August 2, 2011, 9,873,151 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 June 30, 2011 and September 30, 2010
1
     
 
Consolidated Statements of Income for the three and nine months ended June 30, 2011 and 2010
3
     
 
Consolidated Statements of Cash Flows for the nine months ended June 30, 2011 and 2010
4
     
 
Notes to Consolidated Financial Statements
6
     
Item 2.
Management's Discussion and Analysis of Financial Condition and Results of Operations
18
     
Item 3.
Quantitative and Qualitative Disclosures about Market Risk
29
     
Item 4.
Controls and Procedures
30
     
PART II 
OTHER INFORMATION
 
     
Item 1.
Legal Proceedings
30
     
Item 1A.
Risk Factors
31
     
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
31
     
Item 6.
Exhibits
32
     
 
Signatures
33

 
i

 
 
 
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)
 
June 30,
2011
   
September
30, 2010
 
   
(UNAUDITED)
       
Assets
           
Current assets:
           
Cash and cash equivalents
  $ 12,356     $ 18,614  
Accounts receivable:
               
Trade, net
    840       662  
Other, net
    3,133       207  
Marketable securities
    500       -  
Inventories
    1,169       1,093  
Deferred tax asset
    2,285       2,037  
Prepaid expenses and other current assets
    1,292       333  
Assets of discontinued operations
    129       4,629  
Total current assets
    21,704       27,575  
                 
Property and equipment, net
    62,507       56,900  
                 
Other assets:
               
Goodwill and indefinite lived intangibles, net
    63,706       61,835  
Definite lived intangibles, net
    904       1,139  
Other
    2,987       922  
Total other assets
    67,597       63,896  
                 
Total assets
  $ 151,808     $ 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)
 
June 30,
2011
   
September 30,
2010
 
   
(UNAUDITED)
       
Liabilities and Stockholders' Equity
           
Current liabilities:
           
Accounts payable
  $ 782     $ 699  
Accrued liabilities
    3,187       4,313  
Texas patron tax liability
    6,136       3,955  
Current portion of derivative liabilities
    1,143       1,276  
Current portion of long-term debt
    6,238       5,461  
Liabilities of discontinued operations
    127       2,995  
Total current liabilities
    17,613       18,699  
                 
Deferred tax liability
    21,275       15,288  
Other long-term liabilities
    769       719  
Long-term debt
    30,699       34,803  
Derivative liabilities at fair value, less current portion
    238       1,243  
Total liabilities
    70,594       70,752  
                 
Commitments and contingencies
               
                 
Temporary equity - Common stock, subject to put rights 84 and 198 shares, respectively
    1,932       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; 9,723 and 9,766 shares issued and outstanding, respectively
    97       98  
Additional paid-in capital
    62,446       62,326  
Accumulated other comprehensive loss
    (5 )     -  
Retained earnings
    13,401       7,515  
Total Rick’s permanent stockholders’ equity
    75,939       69,939  
Noncontrolling interests
    3,343       3,314  
Total permanent stockholders’ equity
    79,282       73,253  
                 
Total liabilities and stockholders’ equity
  $ 151,808     $ 148,371  

See accompanying notes to consolidated financial statements.

 
2

 

RICK'S CABARET INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME

(in thousands, except per share
data)
 
FOR THE THREE MONTHS
ENDED JUNE 30,
   
FOR THE NINE MONTHS
ENDED JUNE 30,
 
                         
   
2011
   
2010
   
2011
   
2010
 
   
(UNAUDITED)
   
(UNAUDITED)
 
                         
Revenues:
                       
Sales of alcoholic beverages
  $ 8,149     $ 7,029     $ 24,312     $ 21,371  
Sales of food and merchandise
    1,891       1,578       5,469       4,648  
Service revenues
    9,553       8,331       28,637       25,507  
Internet revenues
    113       144       359       433  
Media revenues
    176       203       585       771  
Other
    911       737       2,678       2,202  
Total revenues
    20,793       18,022       62,040       54,932  
                                 
Operating expenses:
                               
Cost of goods sold
    2,710       2,254       7,793       6,887  
Salaries and wages
    4,683       4,109       13,503       12,074  
Stock compensation
    -       44       -       132  
Other general and administrative:
                               
Taxes and permits
    3,101       2,750       9,333       8,426  
Charge card fees
    405       315       1,047       907  
Rent
    756       668       2,305       1,957  
Legal and professional
    635       854       1,547       2,207  
Advertising and marketing
    838       665       2,651       2,465  
Insurance
    300       244       851       687  
Utilities
    394       349       1,143       1,077  
Depreciation and amortization
    980       837       2,855       2,363  
Other
    1,626       1,419       4,646       4,341  
Total operating expenses
    16,428       14,508       47,674       43,523  
Operating income
    4,365       3,514       14,366       11,409  
                                 
Other income (expense):
                               
Interest income and other
    2       5       57       11  
Interest expense
    (1,033 )     (1,231 )     (3,170 )     (3,227 )
Gain on settlement of debt
    903       -       903       -  
Gain (loss) on change in fair value of derivative instruments
     (216 )      (407 )      266        22  
Income from continuing operations before income taxes
     4,021        1,881        12,422        8,215  
Income taxes
    1,500       762       4,231       2,869  
Income from continuing operations
    2,521       1,119       8,191       5,346  
Loss from discontinued operations, net of income taxes
     (1,580 )      (202 )      (2,146 )      (555 )
Net income
    941       917       6,045       4,791  
Less: net income attributable to noncontrolling  interests
    (53 )     (60 )     (159 )     (207 )
Net income attributable to Rick’s Cabaret International, Inc.
  $ 888     $ 857     $ 5,886     $ 4,584  
                                 
Basic earnings (loss) per share attributable to Rick’s shareholders:
                               
Income from continuing operations
  $ 0.25     $ 0.11     $ 0.81     $ 0.54  
Loss from discontinued operations
  $ (0.16 )   $ (0.02 )   $ (0.22 )   $ (0.06 )
Net income
  $ 0.09     $ 0.09     $ 0.59     $ 0.48  
Diluted earnings (loss) per share attributable to Rick’s shareholders:
                               
Income from continuing operations
  $ 0.25     $ 0.11     $ 0.80     $ 0.53  
Loss from discontinued operations
  $ (0.16 )   $ (0.02 )   $ (0.21 )   $ (0.06 )
Net income
  $ 0.09     $ 0.09     $ 0.59     $ 0.48  
                                 
Weighted average number of common  shares outstanding:
                               
Basic
    9,924       9,905       9,968       9,546  
Diluted
    9,941       9,958       9,983       9,876  

Comprehensive income for the three months ended June 30, 2011 and 2010 was $903 and $501, and for the nine months was $5,880 and $4,342, 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. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
 
(in thousands)
 
FOR THE NINE MONTHS
 
   
ENDED JUNE 30,
 
   
2011
   
2010
 
   
(UNAUDITED)
 
CASH FLOWS FROM OPERATING ACTIVITIES:
           
Net income
  $ 6,045     $ 4,791  
Loss from discontinued operations, net of income taxes
    2,146       555  
Income from continuing operations
    8,191       5,346  
Adjustments to reconcile net income to cash provided by operating activities:
               
Depreciation and amortization
    2,855       2,363  
Write-off of prepaid loan origination costs
    -       274  
Deferred taxes
    5,128       1,972  
Amortization of note discount
    109       137  
Gain on settlement of debt
    (903 )     -  
Beneficial conversion
    -       17  
Deferred rents
    49       58  
Gain on change in fair value of derivative instruments
    (266 )     (22 )
Stock compensation expense
    -       132  
Changes in operating assets and liabilities:
               
Accounts receivable
    (3,106 )     (458 )
Inventories
    (76 )     (89 )
Prepaid expenses and other assets
    (469 )     (777 )
Accounts payable and accrued liabilities
    1,362       3,326  
Cash provided by operating activities of continuing operations
    12,874       12,279  
Cash provided by (used in) operating activities of discontinued operations
    868       (247 )
Net cash provided by operating activities
    13,742       12,032  
                 
CASH FLOWS FROM INVESTING ACTIVITIES:
               
Purchase of marketable securities
    (505 )     (1,009 )
Additions to property and equipment
    (7,092 )     (7,136 )
Acquisition of businesses, net of cash acquired
    (1,967 )     (3,141 )
Payments from (additions to) notes receivable
    (2,000 )     1  
Cash used in investing activities of continuing operations
    (11,564 )     (11,285 )
Cash used in investing activities of discontinued operations
    (21 )     (26 )
Net cash used in investing activities
    (11,585 )     (11,311 )
                 
CASH FLOWS FROM FINANCING ACTIVITIES:
               
Proceeds from long-term debt
    -       9,258  
Payments related to put options
    (1,509 )     (1,568 )
Exercise of stock options
    189       14  
Payments on long-term debt
    (4,795 )     (1,521 )
Purchase of treasury stock
    (2,138 )     (891 )
Distribution to noncontrolling interests
    (162 )     (211 )
Cash provided by (used in) financing activities of continuing operations
    (8,415 )     5,081  
Cash used in financing activities of discontinued operations
    -       (385 )
Net cash provided by (used in) financing activities
    (8,415 )     4,696  
NET INCREASE (DECREASE) IN CASH
    (6,258 )     5,417  
CASH AT BEGINNING OF PERIOD
    18,614       12,440  
CASH AT END OF PERIOD
  $ 12,356     $ 17,857  
CASH PAID DURING PERIOD FOR:
               
Interest
  $ 2,675     $ 2,936  
Income taxes
  $ 2,361     $ 991  

See accompanying notes to consolidated financial statements.

 
4

 

Non-cash transactions:

During the nine months ended June 30, 2011, the Company purchased and retired 264,140 common treasury shares.  The cost of these shares was $2,137,794.

During the nine months ended June 30, 2011, the Company issued 26,320 shares of common stock for debt aggregating $269,780.

During the nine months ended June 30, 2011, the Company transferred 70,000 shares aggregating $1,400,000 from temporary equity to permanent equity in connection with the settlement of certain cross-litigation.

In June 2010, the Company issued detachable warrants in conjunction with debt to acquire 179,512 common shares of the Company.  The warrants were valued at $434,571 and this amount is classified as a discount on the related debt with the offset to additional paid-in capital and amortized over the life of the debt.

During the nine months ended June 30, 2010, the Company retired certain debt and accrued interest aggregating $7,463,074 in exchange for 895,255 shares of the Company’s common stock.

During the nine months ended June 30, 2010, the Company purchased and retired 92,500 shares of treasury stock at a cost aggregating $890,715.

See accompanying notes to consolidated financial statements.

 
5

 

RICK'S CABARET INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2011
(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 consolidated 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 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 presentation, consisting solely of normal recurring adjustments, have been made.  Operating results for the nine months ended June 30, 2011 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 since September 30, 2010.

Marketable Securities

Marketable securities at June 30, 2011 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 June 30, 2011, the Company’s marketable securities were classified as available-for-sale, which are carried at fair value, with unrealized gains and losses reported as accumulated other comprehensive loss within the permanent 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 nine month periods ended June 30, 2011 or 2010.  Marketable securities held at June 30, 2011 have a cost basis of approximately $505,056.

 
6

 
 
RICK'S CABARET INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2011
(UNAUDITED)
 
3.  SIGNIFICANT ACCOUNTING POLICIES - continued

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.  Marketable securities are adjusted to fair market value at each balance sheet date.  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.

Discontinued Operations

In March 2011, the Company made the decision to sell its Las Vegas location and, in April 2011, sharply reduced its operations in order to eliminate losses as it seeks a buyer for the property.  The Company believes that it has done everything possible to make this location viable since its acquisition in 2008 and now believes it is in its shareholders’ best interests not to continue these efforts.  The club was shuttered and the landlord took over the property in June 2011.  Therefore, this club is recognized as a discontinued operation in the accompanying consolidated financial statements and has recognized a loss upon the closure of the club of $2.0 million in discontinued operations.

The Company has plans to sell a portion of the membership interest in the entity that previously operated its Rick’s Cabaret in Austin, Texas.  When the sale is closed, the Company will deconsolidate the subsidiary and carry it as an equity-method investment.  Accordingly, the club is recognized as a discontinued operation in the accompanying consolidated financial statements.
 
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 June 30, 2011 and 2010 were zero and $44,037, respectively, and were zero and $132,111 for the nine months then ended, respectively.  There were 25,000 and 5,000 stock option exercises for the nine months ended June 30, 2011 and 2010, respectively.  There were no stock option grants for the nine month periods ended June 30, 2011 and 2010.

 
7

 

RICK'S CABARET INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2011
(UNAUDITED)
 
4. STOCK OPTIONS AND STOCK-BASED EMPLOYEE COMPENSATION - continued

Below is the summary of common stock options outstanding as of June 30, 2011:

(in thousands)
Employee and Director Stock Option Plan:
 
Options
Authorized
   
Options
Outstanding
   
Options
Vested
   
Available
for Grant
 
1999 Stock Option Plan
    1,500       535       535       35  
 
Stock Option Activity

The following is a summary of all stock option transactions for the nine months ended June 30, 2011:

(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
    (5 )   $ 6.75              
Exercised
    (25 )   $ 7.55              
Outstanding as of June 30, 2011
    535     $ 10.08       1.14     $ 0  
Options exercisable as of June 30, 2011
    535     $ 10.08       1.14     $ 0  

5. GOODWILL AND OTHER INTANGIBLES

Following are the changes in the carrying amounts of goodwill and licenses for the nine months ended June 30, 2011 and 2010:

(in thousands)
 
2011
   
2010
 
   
Licenses
   
Goodwill
   
Licenses
   
Goodwill
 
Beginning balance
  $ 41,145     $ 20,693     $ 41,058     $ 21,010  
Intangibles acquired
    1,151       717       2,000       613  
Other
    -       -       -       41  
Ending balance
  $ 42,296     $ 21,410     $ 43,058     $ 21,664  

 
8

 

RICK'S CABARET INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2011
(UNAUDITED)

6.  SEGMENT INFORMATION

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

   
Three Months Ended
   
Nine Months Ended
 
(in thousands)
 
June 30,
   
June 30,
 
   
2011
   
2010
   
2011
   
2010
 
Business segment sales:
                       
Night clubs
  $ 20,504     $ 17,675     $ 61,096     $ 53,728  
Media
    176       203       585       771  
Internet websites
    113       144       359       433  
    $ 20,793     $ 18,022     $ 62,040     $ 54,932  
                                 
Business segment operating income:
                               
Night clubs
  $ 5,300     $ 4,955     $ 17,098     $ 14,286  
Media
    (114 )     (102 )     (235 )     (258 )
Internet websites
    (25 )     (6 )     (49 )     60  
General corporate
    (796 )     (1,333 )     (2,448 )     (2,679 )
    $ 4,365     $ 3,514     $ 14,366     $ 11,409  
                                 
Business segment capital expenditures:
                               
Night clubs
  $ 3,586     $ 4,638     $ 6,943     $ 5,893  
Other
    3       -       4       3  
General corporate
    11       234       145       1,240  
    $ 3,600     $ 4,872     $ 7,092     $ 7,136  
                                 
Business segment depreciation and amortization:
                               
Night clubs
  $ 683     $ 600     $ 2,011     $ 1,709  
Media
    5       5       15       15  
Internet websites
    1       1       3       7  
General corporate
    291       231       826       632  
    $ 980     $ 837     $ 2,855     $ 2,363  

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.

 
9

 

RICK'S CABARET INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2011
(UNAUDITED)

7.  COMMON STOCK

During the nine months ended June 30, 2011, the Company purchased and retired 264,140 shares of Company’s common stock for its treasury at an aggregate cost of $2.1 million.

During the nine months ended June 30, 2011, the Company issued 26,320 shares of the Company’s common stock for debt aggregating $269,780.

During the nine months ended June 30, 2010, the Company purchased and retired 92,500 shares of the Company’s common stock for its treasury at an aggregate cost of $890,715.

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

(in thousands, except per share data)
 
FOR THE QUARTER
   
FOR THE NINE MONTHS
 
   
ENDED JUNE 30,
   
ENDED JUNE 30,
 
   
2011
   
2010
   
2011
   
2010
 
Basic earnings per share:
                       
Income from continuing operations attributable to Rick's shareholders
  $ 2,468     $ 1,059     $ 8,032     $ 5,139  
Loss from discontinued operations, net of income taxes
    (1,580 )     (202 )     (2,146 )     (555 )
Net income attributable to Rick's shareholders
  $ 888     $ 857     $ 5,886     $ 4,584  
Average number of common shares outstanding
    9,924       9,905       9,968       9,546  
Basic earnings per share - income from continuing operations
  $ 0.25     $ 0.11     $ 0.81     $ 0.54  
Basic earnings per share - discontinued operations
  $ (0.16 )   $ (0.02 )   $ (0.22 )   $ (0.06 )
Basic earnings per share - net income attributable to Rick's shareholders
  $ 0.09     $ 0.09     $ 0.59     $ 0.48  
Diluted earnings per share:
                               
Income from continuing operations attributable to Rick's shareholders
  $ 2,468     $ 1,059     $ 8,032     $ 5,139  
Adjustment to net earnings from assumed conversion of debentures (1)
    -       -       -       117  
Adjusted income from continuing operations
    2,558       1,059       8,122       5,256  
Discontinued operations
    (1,580 )     (202 )     (2,146 )     (555 )
Adjusted net income attributable to Rick's shareholders
  $ 888     $ 857     $ 5,886     $ 4,701  
Average number of common shares outstanding:
                               
Common shares outstanding
    9,924       9,905       9,968       9,546  
Potential dilutive shares resulting from exercise of warrants and options (2)
    17       53       15       46  
Potential dilutive shares resulting from conversion of debentures (3)
    -       -       -       284  
Total average number of common shares outstanding used for dilution
    9,941       9,958       9,983       9,876  
Diluted earnings per share - income from continuing operations atrributable to Rick's shareholders
  $ 0.25     $ 0.11     $ 0.80     $ 0.53  
Diluted earnings per share - discontinued operations
  $ (0.16 )   $ (0.02 )   $ (0.21 )   $ (0.06 )
Diluted earnings per share - net income attributable to Rick's shareholders
  $ 0.09     $ 0.09     $ 0.59     $ 0.48  

 
10

 

RICK'S CABARET INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2011
(UNAUDITED)

8.  EARNINGS PER SHARE (“EPS”) - continued

(1)  Represents interest expense on dilutive convertible debentures that would not occur if they were assumed converted.
(2)   All outstanding warrants and options were considered for the EPS computation.
(3) Convertible debentures (principal and accrued interest) outstanding at June 30, 2011 and 2010 totaling approximately $7,370,000 and $9,455,000, respectively, were convertible into common stock at a price of $10.25 per share.  Potential dilutive shares of 719,046 and 69,552 for the three months ended June 30, 2011 and 2010, respectively, and 719,046 and 36,629 for the nine months ended June 30, 2011 and 2010, respectively, have been excluded from earnings per share due to being anti-dilutive.

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:

 
11

 

RICK'S CABARET INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2011
(UNAUDITED)

9.  ACQUISITIONS - continued

 
(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 ninety (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 ninety (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.

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 income.

 
12

 

RICK'S CABARET INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2011
(UNAUDITED)

9.  ACQUISITIONS - continued

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.

Fort Worth Gentlemen’s Club

On June 1, 2010, our wholly owned subsidiary RCI Entertainment (3315 North Freeway FW), Inc. (the “Purchaser”) completed the acquisition of certain assets (the “Purchased Assets”) of Restaurant Associates, Inc., a Texas corporation (the “Seller”) pursuant to an Asset Purchase Agreement (the “Purchase Agreement”) between Purchaser, Seller, Voldar, LLC, a Texas limited liability company (“Voldar”), Sherri Mofid (“Mofid”), John Faltynski (“Faltynski”) and James Noryian (“Noryian”).  The Purchase Agreement was executed and closed on June 1, 2010.  Seller owned and operated an adult entertainment cabaret known as “Fort Worth Gentleman’s Club” (the “Club”), located at 3315 North Freeway, Fort Worth, Texas 76106 (the “Real Property”). 

At closing, Purchaser paid Seller $2,155,520 cash by wire-transfer for the Purchased Assets.  Purchaser also entered into two lease agreements, a lease agreement for the Real Property with Voldar (the “Voldar Lease”) and a lease agreement for unimproved property adjacent to the Real Property (the “Adjacent Property”) with Mofid (the “Mofid Lease”).  Each lease agreement has a term of five years with one five year option to extend at the discretion of Purchaser.  Each lease agreement also grants Purchaser an option to purchase the respective properties from Voldar and Mofid.  Purchaser may exercise the options to purchase any time after the twelfth month but before the expiration of the lease agreements (including their optional extensions).  The option to purchase the Real Property and the option to purchase the Adjacent Property must be exercised contemporaneously. The purchase price upon exercise of the option to purchase the Real Property will range from $4,500,000 to $5,175,000 during the five-year term.  The purchase price upon exercise of the option to purchase the Adjacent Property will range from $500,000 to $575,000 during the five-year term.

Also pursuant to the agreements described above, Mofid and Voldar entered into a five-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
  $ 42  
Property and equipment and other assets
    1,301  
Non-compete agreement
    200  
Goodwill
    613  
Net assets acquired
  $ 2,156  

 
13

 

RICK'S CABARET INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2011
(UNAUDITED)

9.  ACQUISITIONS - continued

The Company incurred approximately $23,000 in legal costs associated with the acquisition, which are included in legal and professional expense in the accompanying consolidated statement of income.

The results of operations of this entity are included in the Company’s consolidated results of operations since June 1, 2010. 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.

RCI Dining Services (Airport Freeway)

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, for an aggregate purchase price of $4,565,000.   A Purchase Agreement and Build-to-Suit 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.

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

(in thousands)

Building, land and contents
  $ 3,126  
Equipment and signs
    288  
SOB license
    1,151  
Net assets
  $ 4,565  

Gold Club of Indy, LLC

The Company’s wholly owned subsidiaries, RCI Dining Services (Indiana), Inc. (“RCI Indiana”) and RCI Holdings, Inc. (“RCI Holdings”), entered into a Third Amendment to Purchase Agreement (the “Amended Purchase Agreement”) with the Gold Club of Indy, LLC (“GCI”), the Estate of Albert Pfeiffer, deceased, and Lori Pfeiffer, personal representative of the Estate of Albert Pfeiffer, deceased, and sole member of GCI.  GCI owned and operated an adult entertainment cabaret known as “The Gold Club,” located at 3551 Lafayette Road, Indianapolis, Indiana 46222.  GCI also owned the real property where The Gold Club is located.  The Amended Purchase Agreement transactions closed on April 22, 2011, whereby (i) RCI Indiana acquired from Pfeiffer all assets which are used for the business of The Gold Club for $825,000 and (ii) RCI Holdings acquired from GCI the real property where The Gold Club is located, including the improvements thereon, for $850,000, for total aggregate consideration of $1,657,000, net of certain accrued property taxes.

 
14

 

RICK'S CABARET INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2011
(UNAUDITED)

9.  ACQUISITIONS - continued
 
Also at closing of the Amended Purchase Agreement, Lori Pfeiffer entered into a Non-Competition Agreement with RCI Indiana, pursuant to which she agreed not to compete with The Gold Club within Indianapolis, Indiana or any of the adjacent counties for a period of five years.

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

(in thousands)

Building, land and contents
  $ 750  
Equipment and furniture
    90  
Noncompete
    100  
Goodwill
    717  
Net assets
  $ 1,657  

The results of operations of this entity are included in the Company’s consolidated results of operations since April 22, 2011. 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:

   
For the Three Months
   
For the Nine Months
 
(in thousands)
 
Ended June 30,
   
Ended June 30,
 
   
2011
   
2010
   
2011
   
2010
 
Computed expected tax expense
  $ 1,367     $ 640     $ 4,223     $ 2,793  
State income taxes
    45       12       105       89  
Stock option disqualifying dispositions and other permanent differences
    88       110       (97 )     (13 )
Total income tax expense
  $ 1,500     $ 762     $ 4,231     $ 2,869  

 
15

 

RICK'S CABARET INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2011
(UNAUDITED)

10.  INCOME TAXES - continued

Included in the Company’s deferred tax liabilities at June 30, 2011 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.

The Company recognizes interest accrued in interest expense and penalties in operating expenses. During the nine months ended June 30, 2011 and 2010, the Company recognized approximately $34,000 and $50,000, respectively, in interest and penalties. The Company or one of its subsidiaries files income tax returns in the U.S. federal jurisdiction, and various states.  The last three years remain open to tax examination.

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, the 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 June 30, 2011, the Company has approximately $6.1 million in accrued liabilities for this tax.  Patron tax expense amounted to approximately $691,000 and $670,000 for the quarters ended June 30, 2011 and 2010, 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.  GAIN ON SETTLEMENT OF DEBT

In April 2011, the Company settled certain cross-litigation with the former sellers of the Las Vegas club.  As a result of the settlement, the Company paid the sellers approximately $1.6 million in cash as full settlement of its obligation under a debt instrument with a remaining principal and interest balance at the time of $2.5 million.  The Company has recorded a gain of approximately $900,000 in the quarter ended June 30, 2011 as a result of the settlement.  In addition, the Company and the sellers agreed to cancel the Lock-up/Leak-out Agreement and the Company’s obligation to purchase from the sellers any of the remaining 70,000 shares which the sellers hold.  This resulted in the Company transferring $1.4 million from Temporary Equity to Permanent Equity in the quarter ended June 30, 2011.

 
16

 

RICK'S CABARET INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2011
(UNAUDITED)

13.  SUBSEQUENT EVENTS

New Acquisition

Pursuant to the Asset Purchase Agreement, as amended, on July 28, 2011, The Company acquired substantially all of the assets associated or used in connection with the operation of Schiek’s Palace Royale for the purchase price of $2,875,000.

In connection with the Asset Purchase Agreement, on March 22, 2011, our wholly owned subsidiary, RCI Holdings, Inc. (“RCI Holdings”), entered into a Real Estate Purchase Agreement with 4th Street Partnership LLLP, a Minnesota limited liability limited partnership (“4th Street”), which owned the real property where Schiek’s Palace Royale is located.  The parties amended the Real Estate Purchase Agreement on May 31, 2011 and on July 26, 2011.  Pursuant to the terms of the Real Estate Purchase Agreement, as amended, on July 28, 2011, RCI Holdings acquired the real property where Schiek’s Palace Royale is located for a purchase price of $3,250,000.

 
17

 

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.  The Company's expectations, beliefs and projections are expressed in good faith and are believed by the Company to have a reasonable basis, including without limitation, management's examination of historical operating trends, data contained in the Company's 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 the view of the Company, could cause material adverse effects on the Company's 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.  The Company has 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 and 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 and restaurant and bar operations.  Eight 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 clubs operate under the name “XTC Cabaret”; one club operates as “Tootsie’s”, one club operates as “Cabaret East”, one club operates as “Cabaret North” and one club that operates as “Downtown Cabaret”. 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 Indianapolis, Indiana.  No sexual contact is permitted at any of our locations.

2.
We have Internet activities.

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

 
18

 

 
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.

3.
We operate a media division, including the leading trade magazine serving the multi-billion dollar adult nightclubs industry. This division also includes 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”).  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.

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 20 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.

 
19

 

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 not 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, 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 determined that there was 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.  Marketable securities are adjusted to fair market value at each balance sheet date. 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 Company’s 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 requires 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. 

 
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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 $1.5 million and $1.3 million for the three months ended June 30, 2011 and 2010, 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.
 
 
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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, Distinguishing Liabilities From Equity, 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 Per Common Share
 
The Company computes earnings 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 (as adjusted for interest expense, that would no longer occur if the debentures were converted).

Stock Options

We utilize the fair value recognition provisions of FASB ASC 718, Compensation—Stock Compensation to account for stock options issued.

The stock option compensation costs recognized for the quarters ended June 30, 2011 and 2010 were $0 and $44,037, respectively, and were $0 and $132,111, respectively, for the nine months then ended.  There were no stock options grants nor exercises for the quarters ended June 30, 2011 and 2010.

RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED JUNE 30, 2011 AS COMPARED TO THE THREE MONTHS ENDED JUNE 30, 2010

For the three months ended June 30, 2011, we had consolidated total revenues of $20.8 million compared to consolidated total revenues of $18.0 million for the three months ended June 30, 2010, an increase of $2.8 million or 15.4%.  The increase in total revenues was primarily attributable to clubs acquired during last year along with positive results from the NBA Championship series in Dallas and Miami and strong quarters from the Rick’s locations in San Antonio and Minneapolis.  Total revenues for same-location-same-period of club operations increased by 9.0% to $19.2 million for the three months ended June 30, 2011 from $17.6 million for the same period ended June 30, 2010.

Following is a comparison of the Company’s income statement for the quarters ended June 30, 2011 and 2010 with percentages compared to total revenue:

(in thousands)
 
2011
   
%
   
2010
   
%
 
                         
Sales of alcoholic beverages
  $ 8,149       39.2 %   $ 7,029       39.0 %
Sales of food and merchandise
    1,891       9.1 %     1,578       8.8 %
Service revenues
    9,553       45.9 %     8,331       46.2 %
Internet revenues
    113       0.5 %     144       0.8 %
Media
    176       0.8 %     203       1.1 %
Other
    911       4.4 %     737       4.1 %
Total revenues
    20,793       100.0 %     18,022       100.0 %
                                 
Cost of goods sold
    2,710       13.0 %     2,254       12.5 %
Salaries and wages
    4,683       22.5 %     4,109       22.8 %
Stock-based compensation
    -       0.0 %     44       0.2 %
Taxes and permits
    3,101       14.9 %     2,750       15.3 %
Charge card fees
    405       1.9 %     315       1.7 %
Rent
    756       3.6 %     668       3.7 %
Legal and professional
    635       3.1 %     854       4.7 %
Advertising and marketing
    838       4.0 %     665       3.7 %
Insurance
    300       1.4 %     244       1.4 %
Utilities
    394       1.9 %     349       1.9 %
Depreciation and amortization
    980       4.7 %     837       4.6 %
Other
    1,626       7.8 %     1,419       7.9 %
                                 
Total operating expenses
    16,428       79.0 %     14,508       80.5 %
Income from operations
    4,365       21.0 %     3,514       19.5 %
                                 
Interest and other income
    2       0.0 %     5       0.0 %
Interest expense
    (1,033 )     -5.0 %     (1,231 )     -6.8 %
Gain on settlement of debt
    903       4.3 %     -       0.0 %
Loss on change in fair value of derivative instruments
    (216 )     -1.0 %     (407 )     -2.3 %
                                 
Income from continuing operations before income taxes
  $ 4,021       19.3 %   $ 1,881       10.4 %

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 36.4% and 20.9% for the quarters ended June 30, 2011 and 2010, respectively.  The cost of goods sold for the club operations for the three months ended June 30, 2011 was 12.9% compared to 12.5% for the three months ended June 30, 2010.  The cost of goods sold from our internet operations for the three months ended June 30, 2011 was 2.0% compared to 1.8% for the three months ended June 30, 2010.  The cost of goods sold for same-location-same-period of club operations for the three months ended June 30, 2011 was 12.8%, compared to12.5% for the same period ended June 30, 2010.

The increase in payroll and related costs, stated as “Salaries & Wages” above, was primarily due to the addition of the new clubs.   Payroll for same-location-same-period of club operations was $3.5 million for the three months ended June 30, 2011 compared to $3.3 million for the three months ended June 30, 2010.  Management currently believes that its labor and management staff levels are appropriate.

Generally, the increase in other expense categories is due to the increase in clubs and revenues.

 
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The decrease in interest expense was attributable to the write-off of prepaid loan origination costs amounting to approximately $274,000 in June 2010 when we converted $7.2 million in debt to common stock.

Income taxes, as a percentage of income before taxes was 37.3% and 40.5% for the quarters ended June 30, 2011 and 2010, respectively due to the tax effect of the nondeductible loss on change in fair value of derivative instruments.

The loss on the change in fair value of derivative instruments is due to the falling price of the Company’s common stock in each quarter.

The gain on settlement of debt was the result of the settlement of certain cross-litigation with the former sellers of the Las Vegas club.

Operating income (exclusive of corporate overhead) for same-location-same-period of club operations was $5.7 million for the three months ended June 30, 2011 compared to $4.7 million for the three months ended June 30, 2010.

Our Media Division lost approximately $113,000 before income taxes for the quarter ended June 30, 2011 compared to a loss of approximately $102,000 in the 2010 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 June 30, 2011 and 2010 was $6.0 million and $3.9 million, respectively.

Adjusted EBITDA is a financial statement measure that was not derived in accordance with GAAP. We use adjusted EBITDA (earnings from continuing operations 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 June 30:

(in thousands)
 
2011
   
2010
 
Income from continuing operations
  $ 2,521     $ 1,119  
Income taxes
    1,500       762  
Interest expense
    1,033       1,231  
Depreciation and amortization
    980       837  
Adjusted EBITDA
  $ 6,034     $ 3,949  

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 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.

 
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RESULTS OF OPERATIONS FOR THE NINE MONTHS ENDED JUNE 30, 2011 AS COMPARED TO THE NINE MONTHS ENDED JUNE 30, 2010

For the nine months ended June 30, 2011, we had consolidated total revenues of $62.0 million compared to consolidated total revenues of $54.9 million for the nine months ended June 30, 2010, an increase of $7.1 million or 12.9%.  The increase in total revenues was primarily attributable to clubs acquired during last year along with positive results from the NBA Championship series in Dallas and Miami and strong quarters from the Rick’s locations in San Antonio and Minneapolis.  Total revenues for same-location-same-period of club continuing operations increased 5.1% to $54.7 million for the nine months ended June 30, 2011 from $52.0 million for the same period ended June 30, 2010.

Following is a comparison of the Company’s income statement for the nine months ended June 30, 2011 and 2010 with percentages compared to total revenue:

(in thousands)
 
2011
   
%
   
2010
   
%
 
                         
Sales of alcoholic beverages
  $ 24,312       39.2 %   $ 21,371       38.9 %
Sales of food and merchandise
    5,469       8.8 %     4,648       8.5 %
Service revenues
    28,637       46.2 %     25,507       46.4 %
Internet revenues
    359       0.6 %     433       0.8 %
Media
    585       0.9 %     771       1.4 %
Other
    2,678       4.3 %     2,202       4.0 %
Total revenues
    62,040       100.0 %     54,932       100.0 %
                                 
Cost of goods sold
    7,793       12.6 %     6,887       12.5 %
Salaries and wages
    13,503       21.8 %     12,074       22.0 %
Stock-based compensation
    -       0.0 %     132       0.2 %
Taxes and permits
    9,333       15.0 %     8,426       15.3 %
Charge card fees
    1,047       1.7 %     907       1.7 %
Rent
    2,305       3.7 %     1,957       3.6 %
Legal and professional
    1,547       2.5 %     2,207       4.0 %
Advertising and marketing
    2,651       4.3 %     2,465       4.5 %
Insurance
    851       1.4 %     687       1.3 %
Utilities
    1,143       1.8 %     1,077       2.0 %
Depreciation and amortization
    2,855       4.6 %     2,363       4.3 %
Other
    4,646       7.5 %     4,341       7.9 %
                                 
Total operating expenses
    47,674       76.8 %     43,523       79.2 %
Income from operations
    14,366       23.2 %     11,409       20.8 %
                                 
Interest and other income
    57       0.1 %     11       0.0 %
Interest expense
    (3,170 )     -5.1 %     (3,227 )     -5.9 %
Gain on settlement of debt
    903       1.5 %     -       0.0 %
Gain on change in fair value of derivative instruments
    266       0.4 %     22       0.0 %
                                 
Income from continuing operations before income taxes
  $ 12,422       20.0 %   $ 8,215       15.0 %

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.

 
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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 29.4% and 26.3% for the nine months ended June 30, 2011 and 2010, respectively.  The cost of goods sold for the club operations for the nine months ended June 30, 2011 was 12.5% compared to 12.4% for the nine months ended June 30, 2010.  The cost of goods sold from our internet operations for the nine months ended June 30, 2011 was 2.1% compared to 2.3% for the nine months ended June 30, 2010.  The cost of goods sold for same-location-same-period of club operations for the nine months ended June 30, 2011 was 12.3%, for each of the nine months ended June 30, 2011 and 2010.

Payroll for same-location-same-period of club operations increased to $9.7 million for the nine months ended June 30, 2011 from $9.4 million for the same period ended June 30, 2010.  Management currently believes that its labor and management staff levels are appropriate.

The decrease in legal and accounting expense is principally due to a continuing labor lawsuit in New York which was more active in 2010.

Generally, the increase in other expense categories is due to the increase in clubs and revenues.

The decrease in interest expense was attributable to the write-off of prepaid loan origination costs amounting to approximately $274,000 in June 2010 when we converted $7.2 million in debt to common stock.

The gain on the change in fair value of derivative instruments is due to the rising price of the Company’s common stock over the nine months.

Income taxes, as a percentage of income before taxes was 34.1% and 34.9% for the nine months ended June 30, 2011 and 2009, respectively.

The gain on settlement of debt was the result of the settlement of certain cross-litigation with the former sellers of the Las Vegas club.

The increase in net income was primarily due to the decrease in expenses detailed above while increasing revenues, especially in the first quarter.  Operating income (exclusive of corporate overhead) for same-location-same-period of club operations increased to $17.6 million for the nine months ended June 30, 2011 from $14.7 million for same period ended June 30, 2010, or by 19.6%.

Our Media Division lost approximately $236,000 before income taxes for the nine months ended June 30, 2011 compared to a loss of approximately $258,000 in the nine months ended June 30, 2010.  As the economy improves, we believe the Media Division will become profitable as we control costs and increase marketing revenues.

Adjusted EBITDA for the nine months ended June 30, 2011 and 2010 was $18.4 million and $13.8 million, respectively.

Adjusted EBITDA is a financial statement measure that was not derived in accordance with GAAP. We use adjusted EBITDA (earnings from continuing operations 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 nine months ended June 30:

 
25

 

(in thousands)
 
2011
   
2010
 
Income from continuing operations
  $ 8,191     $ 5,346  
Income taxes
    4,231       2,869  
Interest expense
    3,170       3,227  
Depreciation and amortization
    2,855       2,363  
Adjusted EBITDA
  $ 18,447     $ 13,805  

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 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.

Discontinued Operations

 In March 2011, the Company made the decision to sell its Las Vegas location and, in April 2011, sharply reduced its operations in order to eliminate losses as it seeks a buyer for the property.  The Company believes that it has done everything possible to make this location viable since its acquisition in 2008 and now believes it is in its shareholders’ best interests not to continue these efforts.  The club was shuttered and the landlord took over the property in June 2011.  Therefore, this club is recognized as a discontinued operation in the accompanying financial statements and has recognized a loss on the closure of $2.0 million in discontinued operations.

The Company has plans to sell a portion of the membership interest in the entity that previously operated its Rick’s Cabaret in Austin, Texas.  When the sale is closed, the Company will deconsolidate the subsidiary and carry it as an equity-method investment.  Accordingly, the club is recognized as a discontinued operation in the accompanying financial statements.

Following is summarized information regarding these discontinued operations:

(in thousands)
 
Quarter Ended June 30,
 
   
2011
   
2010
 
Loss from discontinued operations
  $ (233 )   $ (311 )
Loss on disposition
    (2,197 )     -  
Income tax - discontinued operations
    850       109  
Total loss from discontinued operations, net of tax
  $ (1,580 )   $ (202 )

 
26

 
 
   
Nine Months Ended June 30,
 
   
2011
   
2010
 
Loss from discontinued operations
  $ (1,105 )   $ (855 )
Loss on disposition
    (2,197 )     -  
Income tax - discontinued operations
    1,156       300  
Total loss from discontinued operations, net of tax
  $ (2,146 )   $ (555 )
  
Major classes of assets and liabilities included as assets and liabilities of discontinued operations as of:
   
June 30,
   
September 30,
 
(in thousands)
  2011     2010  
Current assets
  $ 33     $ 1,065  
Property and equipment
    -       2,774  
Other assets
    96       790  
Current liabilities
    (127 )     (262 )
Long-term liabilities
    -       (2,733 )
Net assets
  $ 2     $ 1,634  
 
LIQUIDITY AND CAPITAL RESOURCES

Working Capital and Cash Flows

At June 30, 2011, we had working capital of approximately $4.1 million compared to approximately $8.9 million at September 30, 2010.  The decrease is principally due to the purchase of 2 nightclubs and the real estate of another club aggregating $8.7 million during the nine months, payments on long-term debt and purchase of put options and related derivatives during the period.

Net cash provided by operating activities in the nine months ended June 30, 2011 was $13.7 million compared to $12.0 million for the nine months ended June 30, 2010.  The increase in cash provided by operating activities was primarily due to the increase in net income for the nine months ended June 30, 2011.

We used $11.6 million of cash in investing activities during the nine months ended June 30, 2011 compared to $11.3 million during the nine months ended June 30, 2010.  Cash of $8.4 million was used by financing activities during the nine months ended June 30, 2011 compared to $4.7 million cash provided during the nine months ended June 30, 2010. The change was principally due to the proceeds from long-term debt of $9.3 million in June 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.

 
27

 

In April 2011, we settled certain cross-litigation with the former sellers of the Las Vegas club.  As a result of the settlement, the Company paid the sellers approximately $1.6 million in cash as full settlement of its obligation under a debt instrument with a remaining principal and interest balance at the time of $2.5 million.  The Company has recorded a gain of approximately $900,000 in April 2011 as a result of the settlement.  In addition, the Company and the sellers agreed to cancel the Lock-up/Leak-out Agreement and the Company’s obligation to purchase from the sellers any of the remaining 70,000 shares which the sellers hold.  This resulted in the Company transferring $1.4 million from Temporary Equity to Permanent Equity in April 2011.  The following disclosures do not include these 70,000 shares.

The maximum obligation that could be owed if our stock were valued at zero is $4.0 million at June 30, 2011.  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 June 30, 2011 of $8.44 per share, of which there can be no assurance: (This includes the derivative financial instruments recognized in our balance sheet at June 30, 2011.)
 
For the Year Ended September 30:
 
(in thousands)
 
2011
  $ 516  
2012
    1,966  
2013
    132  
Total
  $ 2,614  

Each $1.00 per share movement of our stock price has an aggregate effect of $168,000 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 $5,000,000 worth of our common stock in the open market.  During the nine months ended June 30, 2011 and 2010, 49,340 shares and zero shares, respectively, were purchased under this program.

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.

 
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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 Indianapolis, Indiana, (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.

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 June 30, 2011, 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.

 
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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 June 30, 2011 that have materially affected or are reasonably likely to materially affect the Company’s internal control over financial reporting.

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, the 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 June 30, 2011, the Company has approximately $6.1 million in accrued liabilities for this tax.  Patron tax expense amounted to approximately $691,000 and $670,000 for the quarters ended June 30, 2011 and 2010, 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.

 
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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 June 30, 2011, 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 June 30, 2011, we purchased 49,340 shares of common stock on the open market at an average price of $8.24 per share.  During the three months ended June 30, 2011, we purchased 33,000 shares of common stock from put option holders at prices ranging from $9.32 to $10.99 per share.  Following is a summary of our purchases by month:

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
 
April 30, 2011
    11,000     $ 10.99       -     $ 3,414,746  
May 31, 2011
    11,000     $ 10.25       -     $ 3,414,746  
June 30, 2011
    60,340     $ 9.32       -     $ 3,008,301  
Total for the three months ended June 30, 2011
      82,340     $ 9.02         -     $ 3,008,301  

 
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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 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.

Exhibit 32.2 — Certification of 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.
 
101.INS — XBRL Instance Document.
     
101.SCH — XBRL Taxonomy Extension Schema Document.
     
101.CAL — XBRL Taxonomy Extension Calculation Linkbase Document.
     
101.DEF — XBRL Taxonomy Extension Definition Linkbase Document.
     
101.LAB — XBRL Taxonomy Extension Label Linkbase Document.
     
101.PRE — XBRL Taxonomy Extension Presentation Linkbase Document

 
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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:  August 9, 2011
By:
/s/ Eric S. Langan
 
 
Eric S. Langan
 
Chief Executive Officer and President

Date:  August 9, 2011
By:
/s/ Phillip K. Marshall
 
 
Phillip K. Marshall
 
Chief Financial Officer and Principal Accounting Officer

 
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