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RICK > SEC Filings for RICK > Form 10-K on 16-Dec-2013All Recent SEC Filings

Show all filings for RICKS CABARET INTERNATIONAL INC | Request a Trial to NEW EDGAR Online Pro

Form 10-K for RICKS CABARET INTERNATIONAL INC


16-Dec-2013

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.

OVERVIEW

The following Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") is intended to help the reader understand Rick's Cabaret International, Inc., our operations and our present business environment. MD&A is provided as a supplement to - and should be read in conjunction with - our consolidated financial statements and the accompanying notes thereto contained in "Item 8. Financial Statements and Supplementary Data" of this report. This overview summarizes the MD&A, which includes the following sections:

Our Business - a general description of our business and the adult nightclub industry, our objective, our strategic priorities, our core capabilities, and challenges and risks of our business.
Critical Accounting Policies and Estimates - a discussion of accounting policies that require critical judgments and estimates.

Operations Review - an analysis of our Company's consolidated results of operations for the three years presented in our consolidated financial statements.
Liquidity and Capital Resources - an analysis of cash flows; aggregate contractual obligations and an overview of financial position.

GENERAL INFORMATION

We operate in the adult nightclub industry:

1. We own and/or operate upscale adult nightclubs serving primarily businessmen and professionals. Our nightclubs are in Houston, Austin, San Antonio, Dallas, Fort Worth, Beaumont, Longview, Harlingen, Edinburg, Abilene, Lubbock, El Paso and Odessa, Texas; Charlotte, North Carolina; Minneapolis, Minnesota; New York, New York; Miami Gardens, Florida; Los Angeles, California; Philadelphia, Pennsylvania, Phoenix, Arizona and Indianapolis, Indiana. No sexual contact is permitted at any of our locations.

2. We own a media division, including the leading trade magazine serving the multi-billion dollar adult nightclubs industry. We also own an industry trade show, one other industry trade publications and more than 15 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. Media revenues include the sale of advertising content and revenues from an annual Expo convention. Our fiscal year end is September 30.

Our goal is to use our Company's assets - our brands, financial strength and the talent and strong commitment of our management and associates - to become more competitive and to accelerate growth in a manner that creates value for our shareholders.

CRITICAL ACCOUNTING POLICIES

Management's discussion and analysis of financial condition and results of operations are based upon our financial statements, which have been prepared in accordance with United States generally accepted accounting principles ("GAAP"). GAAP consists of a set of standards issued by the FASB and other authoritative bodies in the form of FASB Statements, Interpretations, FASB Staff Positions, Emerging Issues Task Force consensuses and American Institute of Certified Public Accountants Statements of Position, among others. The FASB recognized the complexity of its standard-setting process and embarked on a revised process in 2004 that culminated in the release on July 1, 2009 of the Accounting Standards Codification ("ASC"). The ASC does not change how Company accounts for its transactions or the nature of related disclosures made. Rather, the ASC results in changes to how the Company references accounting standards within its reports. This change was made effective by the FASB for periods ending on or after September 15, 2009. The Company has updated references to GAAP in this Annual Report on Form 10-K to reflect the guidance in the ASC. The preparation of these consolidated financial statements requires our management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On a regular basis, we evaluate these estimates, including investment impairment. These estimates are based on management's historical industry experience and on various other assumptions that are believed to be reasonable under the circumstances. Actual results may differ from these estimates.

Property and Equipment

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

Goodwill and Intangible Assets

FASB ASC 350, Intangibles - Goodwill and Other addresses the accounting for goodwill and other intangible assets. Under FASB ASC 350, goodwill and intangible assets with indefinite lives are no longer amortized, but reviewed on an annual basis for impairment. 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

In accordance with ASC 205, long-lived assets, such as property, plant, and equipment, and purchased intangible assets subject to amortization, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to estimated undiscounted future cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated future cash flows, an impairment charge is recognized by the amount by which the carrying amount of the asset exceeds the fair value of the asset. Assets to be disposed of would be separately presented in the balance sheet and reported at the lower of the carrying amount or fair value less costs to sell, and are no longer depreciated. The assets and liabilities of a disposal group classified as held for sale would be presented separately in the appropriate asset and liability sections of the balance sheet.

Goodwill and intangible assets that have indefinite useful lives are tested annually for impairment, and are tested for impairment more frequently if events and circumstances indicate that the asset might be impaired in accordance with ASC 350. An impairment loss is recognized to the extent that the carrying amount exceeds the asset's fair value. For goodwill, the impairment determination is made at the reporting unit level. The implied fair value of goodwill is determined by allocating the fair value of the reporting unit in a manner similar to a purchase price allocation. The residual fair value after this allocation is the implied fair value of the reporting unit goodwill.

None of our reporting units were at risk of failing step one of the impairment test (i.e. that fair value was not substantially in excess of carrying value) in either year.

Fair Value of Financial Instruments

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

Derivative Financial Instruments

The Company accounts for financial instruments that are indexed to and potentially settled in, its own stock, including stock put options, in accordance with the provisions of FASB ASC 815-40, Derivatives and Hedging - Contracts in Entity's Own Equity . Under certain circumstances that would require the Company to settle these equity items in cash, and without regard to probability, FASB ASC 815-40 would require the classification of all or part of the item as a liability and the adjustment of that reclassified amount to fair value at each reporting date, with such adjustments reflected in the Company's consolidated statements of income. The first instrument to meet the requirements of FASB ASC 815-40 for derivative accounting occurred in the quarter ended June 30, 2009 when the Company renegotiated the payback terms of certain put options and agreed to pledge as collateral to certain holders a second lien on certain property.

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.

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 605-45, Revenue Recognition - Principal Agent Considerations. Total sales and liquor taxes aggregated $8.5 million, $6.8 million and $6.0 million for the years ended September 30, 2013, 2012 and 2011, 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, 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.

Put Options

In certain situations, the Company has issued 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 agreed fixed price of the 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. We finished liquidating the put options during the quarter ended March 31, 2013 and we have no more obligations under the put options.

Earnings (Loss) Per Common Share

The Company computes earnings (loss) per share in accordance with FASB ASC 260, Earnings Per Share . FASB ASC 260 provides for the calculation of basic and diluted earnings per share. Basic earnings per share includes no dilution and is computed by dividing income available to common stockholders by the weighted average number of common shares outstanding for the period. Diluted earnings per share reflect the potential dilution of securities that could share in the earnings of the Company.

Potential common stock shares consist of shares that may arise from outstanding dilutive common stock options and warrants (the number of which is computed using the "treasury stock method") and from outstanding convertible debentures (the number of which is computed using the "if converted method"). Diluted EPS considers the potential dilution that could occur if the Company's outstanding common stock options, warrants and convertible debentures were converted into common stock that then shared in the Company's earnings (loss) (as adjusted for interest expense, that would no longer occur if the debentures were converted).

Stock Options

The Company has adopted the fair value recognition provisions of FASB ASC 718, Compensation-Stock Compensation. The critical estimates are volatility, expected life and risk-free rate.

The compensation cost recognized for the years ended September 30, 2013, 2012 and 2011 was $847,183, $314,761 and $8,254, respectively. There were zero stock options exercises for the years ended September 30, 2013 and 2012 and 25,000 for the year ended September 30, 2011.

OPERATIONS REVIEW

Results of Operations for the Fiscal Year Ended September 30, 2013 as Compared to the Fiscal Year Ended September 30, 2012

For the fiscal year ended September 30, 2013, we had consolidated total revenues of $112.2 million, compared to consolidated total revenues of $95.2 million for the year ended September 30, 2012. This was an increase of $17.0 million or 17.8%. The increase in total revenues was primarily due to revenues generated in our new clubs acquired in 2013 ($3.5 million in 2013), a full year of revenues from clubs purchased in 2012 (increase of $14.2 million) and increases in revenues from certain of our existing clubs, especially from our XTC Austin, Rick's DFW and Rick's Minnesota locations. Revenues from nightclub operations for same-location same-period decreased by 1.2%.

Our operating margin (income (loss) from operations divided by total revenues) was 19.7% for the year ended September 30, 2013 compared to 17.3% for the prior year.

Our income from operations for our nightclub operations for the same-location-same-period decreased by 1.1%.

Our net income was $9.2 million for the fiscal year ended September 30, 2013 compared to $7.6 million for the previous year. The increase in our net income is explained in the following paragraphs.

Following is a comparison of the Company's income statement for the years ended September 30, 2013 and 2012 with percentages compared to total revenue:

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

                                               2013         %          2012         %

Sales of alcoholic beverages                $   43,189       38.5 % $   38,687       40.6 %
Sales of food and merchandise                   12,249       10.9 %      8,810        9.3 %
Service Revenues                                49,974       44.5 %     41,942       44.0 %
Other                                            6,796        6.1 %      5,781        6.1 %
Total Revenues                                 112,208      100.0 %     95,220      100.0 %

Cost of Goods Sold                              14,152       12.6 %     12,644       13.3 %
Salaries & Wages                                25,145       22.4 %     20,857       21.9 %
Stock-based Compensation                           847        0.8 %        315        0.3 %
Taxes and permits                               17,607       15.7 %     14,639       15.4 %
Charge card fees                                 1,482        1.3 %      1,352        1.4 %
Rent                                             3,642        3.2 %      2,872        3.0 %
Legal & professional                             3,114        2.8 %      5,861        6.2 %
Advertising and marketing                        4,611        4.1 %      4,046        4.2 %
Depreciation and amortization                    5,314        4.7 %      4,921        5.2 %
Insurance                                        2,208        2.0 %      1,439        1.5 %
Utilities                                        2,241        2.0 %      1,762        1.9 %
Gain (loss) on sale of assets and other             16        0.0 %        332        0.3 %
Other                                            9,716        8.7 %      7,667        8.1 %

Total operating expenses                        90,095       80.3 %     78,707       82.7 %
Income from operations                          22,113       19.7 %     16,513       17.3 %

Interest income                                      9        0.0 %         19        0.0 %
Interest expense                               (6,538)       -5.8 %    (4,003)       -4.2 %
Interest expense - loan origination costs        (539)       -0.5 %      (310)       -0.3 %
Gain (loss) on change in fair value of
derivative instruments                               1        0.0 %        117        0.1 %
Income from continuing operations before
income taxes                                $   15,046       13.4 % $   12,336       13.0 %

Other revenues include ATM commissions earned, video games and other vending and certain promotion fees charged to our entertainers. The Company recognizes 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 and media. Our cost of goods sold for the nightclub operations for the year ended September 30, 2013 was 12.6% of our total revenues from club operations compared to 13.3% for the year ended September 30, 2012. Cost of goods sold for same-location-same-period decreased to 12.8% for the year ended September 30, 2013 compared to 13.3% for the year ended September 30, 2012, principally due to the addition of the Jaguars locations, which are BYOB (Bring Your Own Booze) with lower costs, for the entire year. We continued our efforts to achieve reductions in cost of goods sold of the club operations through improved inventory management. We are continuing a program to improve margins from liquor and food sales and food service efficiency.

The increase in payroll and related costs, stated as "Salaries & Wages" above, was primarily due to the addition of the new clubs in 2013 and 2012. Payroll for same-location-same-period of club continuing operations decreased slightly to $16.78 million for the year ended September 30, 2013 from $16.84 million for the previous year. Management currently believes that its labor and management staff levels are appropriate.

The increase in stock-based compensation in 2012 results from the issuance of options in June and July 2012 to employees and Board of Directors. These options vested after one year and, thus, the cost of these options were principally expensed in the 2013 fiscal year.

Taxes and permits consists principally of payroll taxes, property taxes, sales and alcohol taxes, licenses and permits and the patron tax in our nightclubs in Texas. The increase in 2013 results principally from the new clubs acquired. Patron taxes amounted to $3.2 million and $3.0 million for the years ended September 30, 2013 and 2012, respectively.

Legal and professional expenses decreased principally due to certain one-time lawsuit and other legal settlements amounting to $2.5 million and $462,000 in legal fees related to new acquisitions in 2012.

Insurance expense increased due to the new clubs but also due to a general increase in the insurance for our industry and due to our loss history for general liability insurance.

Depreciation and amortization increased approximately $0.4 million from the year ended September 30, 2012, due to the new clubs purchased during 2013 and 2012.

Utilities increased principally due to new clubs.

Other expenses increased due to the new clubs acquired.

We added more debt from acquisitions while we paid off debt as we amortize the loans. As of September 30, 2013, the balance of long-term debt was $78.6 million compared to $63.5 million a year earlier. The increase is principally attributable to adding $24.8 million in debt in the 2013 acquisitions, principally real estate.

Non-GAAP Financial Measures

In addition to our financial information presented in accordance with GAAP, management uses certain "non-GAAP financial measures" within the meaning of the SEC Regulation G, to clarify and enhance understanding of past performance and prospects for the future. Generally, a non-GAAP financial measure is a numerical measure of a company's operating performance, financial position or cash flows that excludes or includes amounts that are included in or excluded from the most directly comparable measure calculated and presented in accordance with GAAP. We monitor non-GAAP financial measures because it describes the operating performance of the company and helps management and investors gauge our ability to generate cash flow, excluding some recurring charges that are included in the most directly comparable measures calculated and presented in accordance with GAAP. Relative to each of the non-GAAP financial measures, we further set forth our rationale as follows:

Non-GAAP Operating Income and Non-GAAP Operating Margin. We exclude from GAAP operating income and GAAP operating margin amortization of intangibles, patron taxes, gains and losses from asset sales, stock-based compensation charges, litigation and other one-time legal settlements and acquisition costs. We believe that excluding these items assists investors in evaluating period-over-period changes in our operating income and operating margin without the impact of items that are not a result of our day-to-day business and operations.

Non-GAAP Net Income and Non-GAAP Net Income per Basic Share and per Diluted Share. We exclude from GAAP net income and GAAP net income per diluted share and per basic share amortization of intangibles, patron taxes, income tax expense, impairment charges, gains and losses from asset sales, stock-based compensation, litigation, loss from discontinued operations and other one-time legal settlements and acquisition costs, and include the Non-GAAP provision for income taxes, calculated as the tax-effect at 35% effective tax rate of the pre-tax non-GAAP income before taxes less stock-based compensation, because we believe that excluding such measures helps management and investors better understand our operating activities.

Adjusted EBITDA. We exclude from GAAP net income depreciation expense, amortization of intangibles, income tax, interest expense, interest income, gains and losses from asset sales, acquisition costs, litigation and other one-time legal settlements and impairment charges because we believe that adjusting for such items helps management and investors better understand operating activities. 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.

The following tables present our non-GAAP measures for the periods indicated (in thousands, except per share amounts):

                                             For the Year Ended
                                                September 30,
          (in thousands)              2013          2012          2011
Reconciliation of GAAP net income
to
Adjusted EBITDA
GAAP net income                    $     9,191   $     7,578   $     7,846
Income tax expense                       5,501         4,374         5,403
Interest expense and income and
gain on derivative                       7,067         4,177         4,042
Litigation and other one-time
settlements                                707         2,533             -
Acquisition costs                          166             -           119
Loss from discontinued operations          143           172         2,195
Depreciation and amortization            5,314         4,921         3,904
Adjusted EBITDA                    $    28,089   $    23,755   $    23,509

Reconcilation of GAAP net income
(loss) to
non-GAAP net income
GAAP net income                    $     9,191   $     7,578   $     7,846
Patron tax                               3,236         3,019         2,875
Amortization of intangibles                409           463           459
(Gain) loss on change in fair
value of derivative instruments            (1)         (117)         (129)
Stock-based compensation                   847           315             8
Litigation and other one-time
settlements                                707         2,533             -
Income tax expense                       5,501         4,374         5,403
Acquisition costs                          166           462           100
Loss from discontinued operations,
net of income taxes                        143           172         2,195
Non-GAAP provision for income
taxes                                  (6,773)       (6,469)       (6,562)
Non-GAAP net income                $    13,426   $    12,330   $    12,195

Reconciliation of GAAP diluted net
income
per share to non-GAAP diluted net
income per
share

Fully diluted shares                     9,615         9,697         9,932
GAAP net income                    $      0.96   $      0.78   $      0.79
Patron tax                                0.34          0.31          0.29
Amortization of intangibles               0.04          0.05          0.05
(Gain) loss on change in fair
value of derivative instruments         (0.00)        (0.01)        (0.01)
Stock-based compensation                  0.09          0.03          0.00
Litigation and other one-time
settlements                               0.07          0.26             -
Income tax expense                        0.57          0.45          0.54
Acquisition costs                         0.02          0.05          0.01
Loss from discontinued operations,
net of income taxes                       0.01          0.02          0.22
Non-GAAP provision for income
taxes                                   (0.70)        (0.67)        (0.66)
Non-GAAP diluted net income per
share                              $      1.40   $      1.27   $      1.23

Reconciliation of GAAP operating
income to
. . .
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