RCI Hospitality Holdings - 10-Q quarterly report FY

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

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

For the quarterly period ended June 30, 2009

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

Commission File Number: 001-13992

(Exact name of registrant as specified in its charter)

10959 Cutten Road

Houston, Texas 77066

(Address of principal executive offices) (Zip Code)

(281) 397-6730

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x   No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ¨ No ¨

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 ¨ Non-accelerated filer ¨ Smaller reporting company x

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 5, 2009, 9,111,566 shares of the Registrant’s Common Stock were outstanding.

PART I                      FINANCIAL INFORMATION

RICK'S CABARET INTERNATIONAL, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

See accompanying notes to consolidated financial statements.

RICK'S CABARET INTERNATIONAL, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

LIABILITIES AND STOCKHOLDERS' EQUITY

See accompanying notes to consolidated financial statements.

RICK'S CABARET INTERNATIONAL, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

Comprehensive income for the three months ended June 30, 2009 and 2008 was $1,784,493 and $1,824,755, and for the nine months were $3,401,449 and $6,258,048, respectively.  This includes the changes in available-for-sale securities and net income.

See accompanying notes to consolidated financial statements.

RICK'S CABARET INTERNATIONAL, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

See accompanying notes to consolidated financial statements.

Non-cash transactions:

In June 2009, the Company retired its treasury stock amounting to $2,511,813 by a charge to additional paid-in capital.

In April 2009, the Company acquired 15,218 of its shares subject to put options with notes payable totaling $350,000.

In April 2009, the Company transferred $5,175,000 from temporary equity and recorded the fair value of the resulting derivative financial instrument of $3,751,192.  The difference was recognized in additional paid-in capital.

In March 2009, the Company sold 100% of the common stock of Texas S&I which owned and operated the  Encounters nightclub for $40,000, including a note for $35,000.

On November 30, 2007, the Company purchased Tootsie’s Cabaret in Florida for $25,486,000 (which includes inventories and other assets), payable to the sellers $15,486,000 in cash, $10,000,000 pursuant to two secured promissory notes in the amount of $5,000,000 each, plus estimated transaction costs of $125,000.

See accompanying notes to consolidated financial statements.

RICK'S CABARET INTERNATIONAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2009

(UNAUDITED)

The accompanying unaudited financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q of Regulation S-X.  They do not include all information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements.  However, except as disclosed herein, there has been no material change in the information disclosed in the notes to the financial statements for the year ended September 30, 2008 included in the Company's Annual Report on Form 10-KSB, as filed with the Securities and Exchange Commission.  The interim unaudited financial statements should be read in conjunction with those financial statements included in the Form 10-KSB for the year ended September 30, 2008.  In the opinion of management, all adjustments considered necessary for a fair presentation, consisting solely of normal recurring adjustments, have been made.  Operating results for the three and nine months ended June 30, 2009 are not necessarily indicative of the results that may be expected for the year ending September 30, 2009.  Certain prior period amounts in the accompanying consolidated financial statements have been reclassified to conform to the current presentation.

2.  RECENT ACCOUNTING STANDARDS AND PRONOUNCEMENTS

In December 2007, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 141R, “Business Combinations,” (“SFAS 141R”). SFAS 141R requires most identifiable assets, liabilities, noncontrolling interests, and goodwill acquired in a business combination to be recorded at full fair value. The Statement applies to all business combinations, including combinations among mutual entities and combinations by contract alone. Under SFAS 141R, all business combinations will be accounted for by applying the acquisition method. SFAS 141R is effective for fiscal years beginning on or after December 15, 2008 and will be effective for the Company beginning in fiscal 2010 for business combinations occurring after the effective date.

 

In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements – an amendment of ARB No. 51,” (“SFAS 160”). SFAS 160 will require noncontrolling interests (previously referred to as minority interests) to be treated as a separate component of equity, not as a liability or other item outside of permanent equity. The Statement applies to the accounting for noncontrolling interests and transactions with noncontrolling interest holders in consolidated financial statements. SFAS 160 is effective for fiscal years beginning on or after December 15, 2008 and is effective for the Company beginning in fiscal 2010. The Company does not expect that SFAS 160 will have a material impact on its consolidated financial statements.

 

In December 2006, the FASB issued SFAS No. 157, “Fair Value Measurements,” (“SFAS 157”). SFAS 157 clarifies the definition of fair value, describes methods used to appropriately measure fair value, and expands fair value disclosure requirements, but does not change existing guidance as to whether or not an instrument is carried at fair value. For financial assets and liabilities, SFAS 157 is effective for fiscal years beginning after November 15, 2007, which required the Company to adopt these provisions in fiscal 2009. For nonfinancial assets and liabilities, SFAS 157 is effective for fiscal years beginning after November 15, 2008, which will require the Company to adopt these provisions in fiscal 2010.  The adoption of SFAS 157 did not have a material effect on the Company’s consolidated financial statements.

SFAS 157 establishes a three-tier fair value hierarchy, which prioritizes the inputs used in the valuation methodologies in measuring fair value:

 o Level 1 – Observable inputs that reflect quoted prices (unadjusted) for identical assets or liabilities in active markets.

RICK'S CABARET INTERNATIONAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2009

(UNAUDITED)

2.   RECENT ACCOUNTING STANDARDS AND PRONOUNCEMENTS – continued

o  Level 2 – Include other inputs that are directly or indirectly observable in the marketplace.

o  Level 3 – Unobservable inputs which are supported by little or no market activity.

The fair value hierarchy also requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.

The Company’s derivative liabilities have been measured principally utilizing Level 2 inputs.

In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities,” (“SFAS 159”). SFAS 159 provides companies with an option to report selected assets and liabilities at fair value. This statement contains financial statement presentation and disclosure requirements for assets and liabilities reported at fair value as a consequence of the election and is effective for the Company beginning in fiscal 2009.  The initial adoption of SFAS 159 did not have a material effect on the Company’s consolidated financial condition or results of operations.

The Staff of the Securities and Exchange Commission issued Staff Accounting Bulletin ("SAB") 110 which expresses the views of the staff regarding the use of a "simplified" method, as discussed in SAB No. 107 ("SAB 107"), in developing an estimate of expected term of "plain vanilla" share options in accordance with Statement of Financial Accounting Standards No. 123 (revised 2004), “Share-Based Payment”. In particular, the staff indicated in SAB 107 that it will accept a company's election to use the simplified method, regardless of whether the company has sufficient information to make more refined estimates of expected term. At the time SAB 107 was issued, the staff believed that more detailed external information about employee exercise behavior (e.g., employee exercise patterns by industry and/or other categories of companies) would, over time, become readily available to companies. Therefore, the staff stated in SAB 107 that it would not expect a company to use the simplified method for share option grants after December 31, 2007. The staff understands that such detailed information about employee exercise behavior may not be widely available by December 31, 2007. Accordingly, the staff will continue to accept, under certain circumstances, the use of the simplified method beyond December 31, 2007. There were no option grants during the nine months ended June 30, 2009.

In May 2009, the FASB issued SFAS No. 165, “Subsequent Events” (“SFAS 165”), which establishes general standards of accounting for, and requires disclosure of, events that occur after the balance sheet date but before financial statements are issued or are available to be issued.  The Company adopted the provisions of SFAS 165 as of June 30, 2009.  The adoption of these provisions did not have a significant impact on the Company’s consolidated financial statements.

In June 2009, the FASB issued SFAS No. 168, “The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles” (“SFAS 168”).  SFAS 168 will become the single source of authoritative nongovernmental U.S. generally accepted accounting principles (“GAAP”), superseding existing FASB, American Institute of Certified Public Accountants (“AICPA”), Emerging Issues Task Force (“EITF”), and related accounting literature.  SFAS 168 reorganizes the thousands of GAAP pronouncements into roughly 90 accounting topics and displays them using a consistent structure.  Also included is relevant Securities and Exchange Commission guidance organized using the same topical structure in separate sections.  SFAS 168 will be effective for financial statements issued for reporting periods that end after September 15, 2009.  This will have an impact on the Company’s consolidated financial statements since all future references to authoritative accounting literature will be references in accordance with SFAS 168.

RICK'S CABARET INTERNATIONAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2009

 

Below is the summary of common stock options outstanding as of June 30, 2009:

The following is a summary of all stock option transactions for the nine months ended June 30, 2009:

RICK'S CABARET INTERNATIONAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2009

 

4. GOODWILL AND OTHER INTANGIBLES

Following are the changes in the carrying amounts of goodwill and licenses for the nine months ended June 30, 2009 and 2008:

During November 2008, $600,000 of related party debt matured and was paid in cash by the Company.  The Company also made additional payments of $1,556,374 on other long-term debt during the nine months ended June 30, 2009.

On April 29, 2009, the Company entered into a modification to its two secured promissory notes with the former owners of Tootsie’s Cabaret in Miami Gardens, Florida, whereby the due date for the $5 million of principal due and payable by the Company under each note (an aggregate of $10 million) was extended by two years from November 2010 to November 2012.  All other terms and conditions of the promissory notes remain the same.  The Company previously issued these notes in November 2007 to the former owners of Tootsie’s Cabaret in connection with a purchase agreement for the adult cabaret.  The Company paid a total of $150,000 to the holders of the notes as consideration for their agreement to extend the notes for two years through November 2012.  The $150,000 paid will be amortized as an adjustment of interest expense over the remaining life of the notes.  The Company accounted for this transaction in accordance with EITF 96-19, “Debtor’s Accounting for a Modification or Exchange of Debt Instruments”.

6.  EARNINGS PER SHARE

The Company computes earnings per share in accordance with SFAS No. 128, Earnings Per Share.  SFAS No. 128 provides for the calculation of basic and diluted earnings per share (“EPS”).  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 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).

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2009

(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, 2009 and 2008 totaling $691,165 and $2,410,000, respectively, were convertible into common stock at a price of $12 per share in 2009 and $3.00 to $25.32 per share in 2008, respectively, and resulted in additional common shares (based on average balances outstanding) in 2008.  Potential dilutive shares of 166,979 and 80,137 for the three and nine months ended June 30, 2008 have been excluded from earnings per share due to being anti-dilutive.

* EPS may not foot due to rounding.

During the nine months ended June 30, 2009, the Company purchased 269,549 shares of Company common stock for its treasury at an aggregate cost of $1,218,033.  These and all other treasury shares were cancelled during the three months ended June 30, 2009 in the amount of $2,511,813.

RICK'S CABARET INTERNATIONAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2009

On November 30, 2007, the Company entered into a Stock Purchase Agreement for the acquisition of 100% of the issued and outstanding common stock of Stellar Management Corporation, a Florida corporation (the "Stellar Stock") and 100% of the issued and outstanding common stock of Miami Garden Square One, Inc., a Florida corporation (the "MGSO Stock") which owns and operates an adult entertainment cabaret known as "Tootsie’s Cabaret" ("Tootsie’s") located at 150 NW 183rd Street, Miami Gardens, Florida 33169 (the "Transaction"). Pursuant to the Stock Purchase Agreement, the Company acquired the Stellar Stock and the MGSO Stock from Norman Hickmore ("Hickmore") and Richard Stanton ("Stanton") for a total purchase price of $25,486,000 (which includes inventory and other assets), payable to the sellers $15,486,000 in cash, $10,000,000 pursuant to two secured promissory notes in the amount of $5,000,000 each to Stanton and Hickmore (the "Notes"), plus estimated transaction costs of $175,000. The Notes will bear interest at the rate of 14% per annum with the principal payable in one lump sum payment on November 30, 2010 (extended to November 30, 2012 in April 2009). Interest on the Notes will be payable monthly, in arrears, with the first payment being due thirty (30) days after the closing of the Transaction. The Company cannot pre-pay the Notes during the first twelve (12) months; thereafter, the Company may prepay the Notes, in whole or in part, provided that (i) any prepayment by the Company from December 1, 2008 through November 30, 2009, shall be paid at a rate of 110% of the original principal amount and (ii) any prepayment by the Company after November 30, 2009, may be prepaid without penalty at a rate of 100% of the original principal amount. The Notes are secured by the Stellar Stock and MGSO Stock under a Pledge and Security Agreement.  As part of the Transaction, Hickmore and Stanton entered into five-year covenants not to compete with the Company. Additionally, as part of the Transaction, the Company entered into Assignment to Lease Agreements with the landlord for the property where Tootsie’s is located. The underlying lease agreements for the property provide for an original lease term through June 30, 2014, with two option periods which give the Company the right to lease the property through June 30, 2034.  The terms and conditions of the transaction were the result of extensive arm's length negotiations between the parties.

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

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.  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 results of operations of this acquired entity are included in the Company’s consolidated results of operations since December 1, 2007.

The following unaudited pro forma information presents the results of operations for the nine months ended June 30, 2008 as if the acquisition had occurred as of the beginning of the immediate preceding period.  The pro forma information is not necessarily indicative of what would have occurred had the acquisition been made as of such periods, nor is it indicative of future results of operations.  The pro forma amounts give effect to appropriate adjustments for the fair value of the assets acquired, amortization of intangibles and interest expense.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2009

 

On March 31, 2008, the Company’s wholly owned subsidiary, RCI Entertainment (Philadelphia), Inc. (the “Purchaser”) completed the acquisition of 100% of the issued and outstanding shares of common stock (the “TEZ Shares”) of The End Zone, Inc., a Pennsylvania corporation (the “Corporation”) which owns and operates “Crazy Horse Too Cabaret” (the “Club”) located at 2908 South Columbus Blvd., Philadelphia, Pennsylvania  19148 (the “Real Property”) from Vincent Piazza (the “Seller”).  As part of the transaction, the Company’s wholly owned subsidiary, RCI Holdings, Inc. (“RCI Holdings”) acquired from the Piazza Family Limited Partnership (the “Partnership Seller”) 51% of the issued and outstanding partnership interest (the “Partnership Interests”) in TEZ Real Estate, LP, a Pennsylvania limited partnership (the “Partnership”) and 51% of the issued and outstanding membership interest (the “Membership Interests”) in TEZ Management, LLC, a Pennsylvania limited liability company, which is the general partner of the Partnership (the “General Partner”).  The Partnership owns the Real Property where the Club is located.  At closing, the Company paid a purchase price of $3,500,000 in cash for the Partnership Interests and Membership Interests, and issued 195,000 shares of the Company’s restricted common stock (the “Rick’s Shares”) valued at $23 per share for the TEZ Shares.

As part of the transaction and as amended in April 2009, the Company entered into a Lock-Up/Leak-Out Agreement with the Seller pursuant to which, on or after one year after the closing date, the Seller shall have the right, but not the obligation, to have Rick’s purchase from Seller not more than 3,000 Rick’s Shares per month (the “Monthly Shares”), calculated at a price per share equal to $23.00 (“Value of the Rick’s Shares”) until March 31, 2010 and at the rate of 5,000 shares per month thereafter until the Seller has received  $4,485,000 from the sale of the shares.  At the Company’s election during any given month, the Company may either buy the Monthly Shares or, if the Company elects 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 Rick’s Shares shall be paid by the Company within three (3) business days of the date of sale of the Monthly Shares during that particular month.  The Company’s obligation to purchase the Monthly Shares from the Seller shall terminate and cease at such time as the Seller has received a total of $4,485,000 from the sale of the Rick’s Shares and any deficiency.  As of June 30, 2009, the 195,000 shares of restricted common stock were classified on the consolidated balance sheet as temporary equity in accordance with EITF Topic D-98, Classification and Measurement of Redeemable Securities.  In April 2009, the Company renegotiated the terms of these put options. Under the new terms, the Company has extended payback and reduced the number of shares that can be put back to the Company.  No consideration was required by the Company to renegotiate the terms of the put options.

JUNE 30, 2009

The full results of operations of this entity are included in the Company’s results of operations since March 31, 2008.

Additionally, at closing, the Seller and the Partnership Seller entered into a five-year agreement not to compete with the Company within a twenty mile radius of the Club. Finally, the Corporation entered into a new lease agreement with the Partnership giving it the right to lease the Real Property for twenty years (“Original Term”) with an option for an additional nine years eleven months (“Option Term”) with rent payable at the rate of (i) $50,000 per month, subject to adjustment for increases in the Consumer Price Index (CPI) every five years during the Original Term and the Option Term, or (ii) 8% of gross sales, whichever is higher.  The maximum increase in the CPI for any five year period shall be 15%.

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

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 results of operations of this acquired entity are included in the Company’s consolidated results of operations since June 30, 2008.  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.

On March 31, 2008, the Company’s subsidiary, RCI Entertainment (Austin), Inc. (“RCI”), completed the acquisition of 49% of the membership interest of Playmates Gentlemen’s Club, LLC (“Playmates”) from Behzad Bahrami (“Seller”), resulting in 100% ownership by the Company of RCI.  Playmates owns an adult entertainment cabaret known as “Playmates” (the “Club”) located at 8110 Springdale Road, Austin, Texas 78724 (the “Premises”).  Under the terms of the Purchase Agreement, RCI paid a total purchase price of $1,401,711 which was paid $701,711 in cash and debt forgiveness at the time of closing and the issuance of 35,000 shares of the Company’s restricted common stock valued at $20.00 per share (the “Shares”).  For accounting purposes, the Company’s investment is only $751,000, due to the previous losses of the minority interest which have been expensed.  This acquisition was made to give the Company complete control over this entity.  Therefore, the investment has been assigned to goodwill as the operating license was acquired separately from the acquisition of the business.

Pursuant to the terms of the Purchase Agreement and as amended in April 2009, on or after one year after the closing date, the Seller shall have the right, but not the obligation to have the Company purchase from Seller not more than 2,500 Shares per month (the “Monthly Shares”), calculated at a price per share equal to $20.00 (“Value of the Shares”).  Seller shall notify the Company during any given month of its election to “Put” the Monthly Shares to the Company during that particular month.  At the Company’s election during any given month, the Company may either buy the Monthly Shares or, if the Company elects 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 the Company within three (3) business days of the date of sale of the Monthly Shares during that particular month.  The Company’s obligation to purchase the Monthly Shares from the Seller shall terminate and cease at such time as the Seller has received a total of $700,000 from the sale of the Shares.  As of June 30, 2009, the 35,000 shares of restricted common stock were classified on the consolidated balance sheet as temporary equity in accordance with EITF Topic D-98, Classification and Measurement of Redeemable Securities.  In April 2009, the Company renegotiated the terms of these and other put options.  No consideration was required by the Company to renegotiate the terms of these put options.  Under the new terms, the Company has extended payback and reduced the number of shares that can be put back to the Company.  In the event the Seller elects not to “Put” the Shares to the Company, the Seller shall not sell more than 10,000 Shares during any 90-day period in the open market, provided that Seller complies with Rule 144 of the Securities Act of 1933, as amended, in connection with his sale of the Shares.  The full results of operations of this entity are included in the Company’s results of operations since March 31, 2008.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2009

 

In April 11, 2008, the Company’s wholly owned subsidiary, RCI Entertainment (Dallas), Inc., completed the acquisition of 100% of the issued and outstanding partnership interest (the "Partnership Interest") of Hotel Development - Texas, Ltd, a Texas limited partnership (the "Partnership") and 100% of the issued and outstanding membership interest (the "Membership Interest") of HD-Texas Management, LLC, a Texas limited liability company, the general partner of the Partnership (the "General Partner") from Jerry Golding, Kenneth Meyer, and Charles McClure (the "Sellers"). The Partnership owns and operates an adult entertainment cabaret known as "The Executive Club" (the "Club"), located at 8550 North Stemmons Freeway, Dallas, Texas 75247 (the "Real Property"). As part of the transaction, the Company’s wholly owned subsidiary, RCI Holdings, Inc. ("RCI"), also acquired the Real Property from DPC Holdings, LLC, a Texas limited liability company ("DPC"). At closing, the Company paid a total purchase price of $3,590,609 for the Partnership Interest and Membership Interest, which was paid through the issuance of 50,694 shares of the Company’s restricted common stock to each of Messrs. Golding, Meyer and McClure, for an aggregate total of 152,082 shares (collectively, the "Rick's Club Shares") to be valued at $23.30 per share ($3,544,119) and $46,490 in cash. As consideration for the purchase of the Real Property, RCI paid total consideration of $5,599,721, which was paid (i) $4,250,000, payable $610,000 in cash and $3,640,000 through the issuance of a five year promissory note (the "Promissory Note") and (ii) the issuance of 57,918 shares of the Company’s restricted common stock (the "Rick's Real Property Shares") to be valued at $23.30 per share ($1,349,721). The Promissory Note bears interest at a varying rate at the greater of (i) two percent (2%) above the Prime Rate or (ii) seven and one-half percent (7.5%), and is guaranteed by Rick's and Eric Langan, individually. At Closing, the Parties entered into an Amendment to Purchase Agreement solely to provide for the Sellers to set aside 10,500 Rick's Club Shares under an Escrow Agreement for the offset of certain liabilities of the Partnership.  The Company also incurred costs in the amount of $37,848, which was paid in cash.

At Closing and as amended in May 2009, the Sellers entered into Lock-Up/Leak-Out Agreements pursuant to which on or after one year after the closing date, the Sellers shall have the right, but not the obligation to have Rick's purchase from Sellers not more than an aggregate of 2,172 Shares per month (the "Monthly Club Shares"), calculated at a price per share equal to $25.00 per share ("Value of the Rick's Club Shares") from April 11, 2009 until April 11, 2010, at the rate of 4,347 shares per month from April 11, 2010 until April 11, 2012 and thereafter at the rate of 3,621 shares per month until each of the individual Sellers has received a total of $1,267,350 from the sale of the Rick's Club Shares. At the Company’s election during any given month, the Company may either buy the Monthly Club Shares or, if the Company elects not to buy the Monthly Club Shares from the Sellers, then the Sellers shall sell the Monthly Club Shares in the open market. Any deficiency between the amount, which the Sellers receive from the sale of the Monthly Club Shares and the Value of the Rick's Club Shares shall be paid by the Company within three (3) business days of the date of sale of the Monthly Club Shares during that particular month.  The Company’s obligation to purchase the Monthly Club Shares from the Sellers shall terminate and cease at such time as the Sellers have received an aggregate total of $3,802,050 from the sale of the Rick's Club Shares and any deficiency.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2009

 

Additionally, at Closing and as amended in May 2009, DPC entered into a Lock-Up/Leak-Out Agreement pursuant to which on or after one year after the closing date, DPC shall have the right, but not the obligation to have Rick's purchase from DPC not more than 828 Shares per month (the "Monthly Real Estate Shares"), calculated at a price per share equal to $25.00 per share ("Value of the Rick's Real Estate shares") from April 11, 2009 until April 11, 2010, at the rate of 1,653 shares per month from April 11, 2010 until April 11, 2012 and thereafter at the rate of 1,379 shares per month until DPC has received a total of $1,447,950 from the sale of the Rick's Real Estate Shares. At the Company’s election during any given month, the Company may either buy the Monthly Real Estate Shares or, if the Company elects not to buy the Monthly Real Estate Shares from DPC, then DPC shall sell the Monthly Real Estate Shares in the open market. Any deficiency between the amount which DPC receives from the sale of the Monthly Real Estate Shares and the Value of the Rick's Real Estate Shares shall be paid by the Company within three (3) business days of the date of sale of the Monthly Real Estate Shares during that particular month. The Company’s obligation to purchase the Monthly Real Estate Shares from DPC shall terminate and cease at such time as DPC has received an aggregate total of $1,447,950 from the sale of the Rick's Real Estate Shares and any deficiency.

The only consideration required by the Company in the amendment of the terms of these put options was the granting of a second lien on the related club property in Dallas, Texas.  The granting of the second lien for the “Dallas sellers” put options necessitates derivative liability accounting, as required by paragraph 32 of EITF 00-19 and SFAS 133.  These put options have been transferred from temporary equity to derivative liabilities, measured at fair value, effective as of the date of the modifications.  The liabilities will continue to be recognized each quarter at fair value and the change in fair value recognized in the statement of income.

Finally, at Closing each of the Sellers entered a five year Non-Competition Agreement with the Company pursuant to which they agreed not to compete with the Company in Dallas County or any adjacent county.

The following information summarizes the allocation of fair values assigned to the assets and liabilities at the acquisition date based on a preliminary valuation.  Subsequent adjustments may be recorded upon the completion of the valuation and the final determination of the purchase price allocation.

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 results of operations of this entity are included in the Company’s consolidated results of operations since April 11, 2008. 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.

On June 18, 2008, the Company’s wholly owned subsidiary RCI Entertainment (Northwest Highway), Inc. (the “Purchaser”) completed the acquisition of certain assets (the “Purchased Assets”) of North by East Entertainment, Ltd., a Texas limited partnership (the “Seller”) by and through its general partner, Northeast Platinum, LLC, a Texas limited liability company (the “General Partner”) pursuant to an Asset Purchase Agreement dated May 10, 2008.  The Seller owned and operated an adult entertainment cabaret known as “Platinum Club II” (the “Club”), located at 10557 Wire Way (at Northwest Highway), Dallas, Texas  75220 (the “Real Property”).

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2009

8.  ACQUISITIONS AND DISPOSITIONS - continued

 

At closing, the Company paid a total purchase price of $1,500,000 cash for the Purchased Assets.  At Closing, the principal of the Seller entered into a five-year agreement not to compete with the Club by operating an establishment with an urban theme that both serves liquor and provides live female nude or semi-nude adult entertainment in Dallas County, Tarrant County, Texas or any of the adjacent counties thereto.

As part of the transaction, the Company’s wholly owned subsidiary RCI Holdings, Inc. (“RCI”) also acquired the Real Property from Wire Way, LLC, a Texas limited liability company (“Wire Way”).  Pursuant to a Real Estate Purchase and Sale Agreement (the “Real Estate Agreement”) dated May 10, 2008, RCI paid total consideration of $6,000,000, which was paid $1,650,000 in cash and $4,350,000 through the issuance of a five (5) year promissory note (the “Promissory Note”).  The Promissory Note bears interest at a varying rate at the greater of (i) two percent (2%) above the Prime Rate or (ii) seven and one-half percent (7.5%), which is guaranteed by the Company and by Eric Langan, the Company’s Chief Executive Officer, individually.  The Company also incurred $77,599 in costs, which was paid in cash.

The following information summarizes the allocation of fair values assigned to the assets and liabilities at the acquisition date based on a preliminary valuation.  Subsequent adjustments may be recorded upon the completion of the valuation and the final determination of the purchase price allocation.

The main factor that contributes to goodwill in the transaction is the Company’s ability to rebrand this operation as a Club Onyx to produce more revenues.  The results of operations of this entity are included in the Company’s consolidated results of operations since June 18, 2008.  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.

On September 5, 2008, the Company’s wholly owned subsidiary RCI Entertainment (Las Vegas), Inc. (the “Purchaser”) completed the acquisition of certain assets (the “Purchased Assets”) of DI Food & Beverage of Las Vegas, LLC, a Nevada limited liability company (the “Seller”)  pursuant to a Third Amended Asset Purchase Agreement (the “Third Amendment”) between Purchaser,

Rick’s Cabaret International, Inc. (“Rick’s”), Seller, and Harold Danzig (“Danzig”), Frank Lovaas (“Lovaas”) and Dennis DeGori (“DeGori”) who are all members of Seller.  The Seller owned and operated an adult entertainment cabaret known as “Scores” (the “Club”), located at 3355 Procyon Street, Las Vegas, Nevada  89102 (the “Real Property”).

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2009

8.  ACQUISITIONS AND DISPOSITIONS - continued

 

At Closing, Purchaser paid Seller an aggregate amount as follows (the “Purchase Price”):

 

As part of the transaction and as amended in April 2009, the Company entered into a Lock-Up/Leak-Out Agreement with the Seller pursuant to which, on or after seven (7) months after the closing date, the Seller shall have the right, but not the obligation, to have Rick’s purchase from Seller a total of 150,000 of the Rick’s Shares (“Rick’s Put Share”) in an amount and at a rate of not more than the following number of the Rick’s Put Shares per month (the “Monthly Shares”) calculated at a price per share equal to $20.00 per share (“Value of the Rick’s Shares”):

At the Company’s election during any given month, the Company may either buy the Monthly Shares or, if the Company elects 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 Rick’s Shares shall be paid by us within three (3) business days of the date of sale of the Monthly Shares during that particular month.  The Company’s obligation to purchase the Monthly Shares from the Seller shall terminate and cease at such time as the Seller has received a total of $3,000,000 from the sale of the Rick’s Shares and any deficiency.  Under the terms of the Lock-Up/Leak-Out Agreement, Seller may not sell more than 25,000 Rick’s Shares per 30- day period, regardless of whether the Seller “Puts” the Rick’s Put Shares to Rick’s or sells them in the open market or otherwise.  No consideration was required by the Company to renegotiate the terms of these put options.

Upon closing of the transaction, the Company entered a two-year Non-Compete Agreement with DeGori (the “DeGori Non-Compete Agreement”) pursuant to which DeGori agreed not to compete with the Club by operating an establishment serving liquor and providing live female nude or semi-nude adult entertainment in Clark County, Nevada or in a radius of 25 miles of Clark County, Nevada; provided, however, that the Non-Competition Agreement specifically excluded the Penthouse Club and the Bada Bing Club located in Clark County, Nevada.   The Company agreed to pay DeGori cash consideration of $66,667 for entering into the Non-Competition Agreement.   Additionally, at Closing, the Company also entered into a 12-month Consulting Agreement with DeGori (the “Consulting Agreement”) for a total aggregate of $133,333 in consulting fees payable in eighteen (18) equal monthly payments of $7,407.38 per month with the first payment due October 15, 2008.  Upon closing of the transaction, the Company entered a one-year Non-Compete Agreement with Lovaas (the “Lovaas Non-Compete Agreement”) pursuant to which Lovaas agreed not to compete with the Club by operating an establishment serving liquor and providing live female nude or semi-nude adult entertainment in Clark County, Nevada, or any of its surrounding counties; provided, however, that this Non-Competition Agreement shall specifically exclude the Penthouse Club and the Bada Bing Club located in Clark County, Nevada. The Company incurred $367,580 in costs in connection with the acquisition.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2009

8.  ACQUISITIONS AND DISPOSITIONS - continued

 

The following information summarizes the allocation of fair values assigned to the assets and liabilities at the acquisition date based on a preliminary valuation.  Subsequent adjustments may be recorded upon the completion of the valuation and the final determination of the purchase price allocation.

The main factor that contributes to goodwill in the transaction is the Company’s ability to rebrand this operation as a Rick’s Cabaret to produce more revenues.  The results of operations of this acquired entity are included in the Company’s consolidated results of operations since September 5, 2008.  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.

The following unaudited pro forma information presents the results of operations as if the acquisition had occurred as of the beginning of the immediate preceding period.  The pro forma information is not necessarily indicative of what would have occurred had the acquisition been made as of such periods, nor is it indicative of future results of operations.  The pro forma amounts give effect to appropriate adjustments for the fair value of the assets acquired, amortization of intangibles and interest expense.

The following unaudited pro forma information presents the results of as if the acquisitions of Miami Gardens Square One, Inc. and DI Food and Beverage of Las Vegas, LLC had occurred as of the beginning of the immediate preceding period.  The pro forma information is not necessarily indicative of what would have occurred had the acquisition been made as of such periods, nor is it indicative of future results of operations.  The pro forma amounts give effect to appropriate adjustments for the fair value of the assets acquired, amortization of intangibles and interest expense.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2009

8.  ACQUISITIONS AND DISPOSITIONS - continued

 

Media Acquisitions

On April 15, 2008, the Company’s wholly owned subsidiary, RCI Entertainment (Media Holdings), Inc., a Texas corporation ("RCI Media"), acquired 100% of the issued and outstanding common stock (the "ED Stock") of ED Publications, Inc., a Texas corporation ("ED"), 100% of the issued and outstanding common stock (the "TEEZE Stock") of TEEZE International, Inc., a Delaware corporation ("TEEZE") and 100% of the issued and outstanding membership interest (the "Membership Interest") of Adult Store Buyers  Magazine, LLC, a Georgia limited liability company.

Under the terms of a Purchase Agreement between Don Waitt ("Waitt"), RCI Media and Rick's Cabaret International, Inc. ("Rick's") dated April 15, 2008 (the "ED Purchase Agreement"), the Company agreed to pay Waitt the following consideration for the purchase of the ED Stock:

(i) $300,000 cash at closing;

(ii) $200,000 cash payable in 6 months (paid); and

(iii) The issuance of 8,696 shares of restricted common stock valued at $23.00 per share (the "Closing Shares").   (See the explanation below of the subsequent renegotiation of these terms).

Additionally, during the three (3) year period following the Closing Date (the "Earn Out Period"), Waitt shall be entitled to earn additional consideration (the "Additional Consideration") of up to $2,000,000 (the "Maximum Amount") consisting of $500,000 cash (the “Cash”) and 65,217 shares of restricted common stock valued at $23.00 per share (the "Earn Out Shares"), based upon the earnings before income tax, depreciation and amortization ("EBITDA") of RCI Media. RCI Media will pay the Maximum Amount of the Additional Consideration to the Seller if RCI Media's EBITDA during the three (3) year period following the Closing Date totals an aggregate of $2,400,000. At the end of each twelve (12) month period after the Closing Date, RCI Media shall determine its EBITDA and shall pay to Waitt any such portion of the Additional Consideration as has been earned. The Closing Shares and Earn Out Shares are collectively referred to as the "Rick's Shares".

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2009

At Closing, Waitt entered into a Lock-Up/Leak-Out Agreement with the Company pursuant to which on or after one year after the closing date with respect to the Closing Shares, or on or after seven (7) months from the date of issuance with respect to the Earn Out Shares, if any, Waitt shall have the right, but not the obligation to have with respect to the Earn Out Shares, if any, Waitt shall have the right, but not the obligation to have Rick's purchase from Waitt 5,000 Rick's Shares per month (the "Monthly Shares"), calculated at a price per share equal to $23.00 per share ("Value of the Rick's Shares") until Waitt has received an aggregate of $1,700,000 (i) from the sale of the Rick's Shares sold in the open market or in a private transaction or otherwise, and (ii) the payment of any deficiency (as defined in the ED Purchase Agreement) by Rick's. At the Company’s election during any given month, the Company may either buy the Monthly Shares or, if the Company elects not to buy the Monthly Shares from Waitt, then Waitt shall sell the Monthly Shares in the open market. Any deficiency between the amount which Waitt receives from the sale of the Monthly Shares and the Value of the Rick's Shares shall be paid by the Company within three (3) business days of the date of sale of the Monthly Shares during that particular month. The Company’s obligation to purchase the Monthly Shares from Waitt shall terminate and cease at such time as Waitt has received an aggregate total of $1,700,000 from the sale of the Rick's Shares and any deficiency (as defined in the ED Purchase Agreement).

At Closing, Waitt also entered a three (3) year Employment Agreement with RCI Media (the "Employment Agreement") pursuant to which he will serve as President. The Employment Agreement extends through April 15, 2011, and provides for an annual base salary of $250,000. Pursuant to the Employment Agreement, Mr. Waitt is also eligible to participate in all benefit plans maintained by the Company for salaried employees. Under the terms of the Employment Agreement, Mr. Waitt is bound to a confidentiality provision and cannot compete with the Company upon the expiration of the Employment Agreement.

Under the terms of a Purchase Agreement between John Cornetta ("Cornetta"), Waitt, RCI Media and Rick's dated April 15, 2008 (the "TEEZE/ASB Purchase Agreement"), the Company agreed to pay the following consideration to Cornetta and Waitt for the purchase of the TEEZE Stock and the Membership Interest:

Pursuant to the TEEZE/ASB Purchase Agreement, on or after one year after the closing date, each of Messrs. Waitt and Cornetta shall have the right, but not the obligation to have Rick's purchase the Rick's TEEZE Shares calculated at a price per share equal to $23.00 per share ("Value of the Rick's TEEZE Shares") until Messrs. Waitt and Cornetta have each received $150,000 (i) from the sale of the Rick's TEEZE Shares sold by them, regardless of whether sold to Rick's, sold in the open market or in a private transaction or otherwise, and (ii) the payment of any deficiency (as defined in the TEEZE/ASB Purchase Agreement) by Rick's. At the Company’s election during any given month, the Company may either buy the Rick's TEEZE Shares or, if the Company elects not to buy the Rick's TEEZE Shares, then Cornetta and/or Waitt shall sell the Rick's TEEZE Shares in the open market. Any deficiency between the amount which Cornetta or Waitt receives from the sale of the Rick's TEEZE Shares and the Value of the Rick's TEEZE Shares shall be paid by the Company within three (3) business days of the date of sale of the Rick's TEEZE Shares during that particular month. The Company’s obligation to purchase the Rick's TEEZE Shares shall terminate and cease at such time as Waitt and Cornetta have each received $150,000 from the sale of the Rick's TEEZE Shares and any deficiency.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2009

In April 2009, the Company renegotiated the terms of its purchase agreements with the former owners of ED Publications, Teeze and Adult Store Buyer publications. The new agreement with the former owner of ED Publications provides for the execution of a $200,000 promissory note payable over two years with interest at 4% per annum in lieu of the issuance of 8,696 shares. The Company simultaneously purchased 6,522 shares that had been issued in connection with the Teeze transaction by means of a $150,000 promissory note payable over two years with interest at 4% per annum.

At Closing, Cornetta entered a five year Non-Competition Agreement with the Company pursuant to which he agreed not to compete with the Company either directly or indirectly with TEEZE, ASB, RCI Media, Rick's or any of their affiliates by publishing any sexually oriented industry trade print publications, with the exception of a publication known as "Xcitement" which is currently owned and operated by Cornetta.

The following information summarizes the initial allocation of fair values assigned to the assets and liabilities at the acquisition date based on a preliminary valuation for the ED Publications, Inc., Adult Store Buyers Magazine LLC, and TEEZE International, Inc. acquisitions.  Subsequent adjustments may be recorded upon the completion of the valuation and the final determination of the purchase price allocation.

The results of operations of these entities are included in the Company’s results of operations since April 15, 2008.  This acquisition was made to create new marketing synergies with major industry product suppliers and new national advertising opportunities and also provides the Company with additional diversification of revenue and income streams while remaining within the Company’s core competency.  The ability to create additional cash flows from the marketing synergies is the main factor contributing to goodwill in the transaction.  Proforma results of operations have not been provided, as the amounts were not deemed material to the consolidated financial statements.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2009

9.  INCOME TAXES

Income tax expense 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, including discontinued operations, for the three and nine months ended June 30, as a result of the following:

Included in the Company’s deferred tax liabilities at June 30, 2009 is approximately $13,150,000 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.

10. DISCONTINUED OPERATIONS

The accompanying financial statements reflect the following as discontinued operations as of and for the period ended June 30, 2009.

The Company sold one of its nightclubs, Encounters in San Antonio, on March 1, 2009 for $40,000, including $5,000 in cash and a $35,000 note payable monthly for one year.  The Company recognized an impairment of $221,563 for this club during the quarter ended December 31, 2008.  The actual loss at date of sale was $226,175.

The Company also has put its Rick’s Cabaret nightclub in Austin, Texas up for sale.  A sale of the club was scheduled in May 2009, but the sale was never closed.  The Company recognized an impairment of the net assets of the club of $823,090 as of June 30, 2009, recognized in the consolidated statement of income as loss from sale of discontinued operations.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2009

Following is summarized information regarding these discontinued operations:

 

Major classes of assets and liabilities included as assets and liabilities of discontinued operations as of:

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2009

11. SEGMENT INFORMATION

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

RICK'S CABARET INTERNATIONAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2009

12. COMMITMENTS AND CONTINGENCIES

Sexually Oriented Business Ordinance of Houston, Texas

In 1997, the City of Houston passed a comprehensive new ordinance regulating the location of and the conduct within sexually oriented businesses (the “Ordinance”), which became the subject of litigation which affects our Sexually Oriented Business licenses in Houston, Texas. After extensive litigation, the Trial Court in Houston rendered its judgment in favor of the City of Houston in January, 2007.  After a lengthy series of court battles, the Fifth Circuit Court of Appeals ruled in favor of the City of Houston in September 2007.  Despite efforts for further appeal, the United States Supreme Court refused to hear the matter.

Additionally, on behalf of three of our club locations in Houston, we filed state court lawsuits seeking judicial review of the results of the amortization process contained within the Ordinance.  At the conclusion of the trial for this matter, the Court ruled that the amortization awards were proper and requested that findings of fact and conclusions of law be submitted to the Court as well as a judgment in the case. A stay sought by the clubs during the appeal was denied.  As a result, we, as well as every other similarly situated sexually oriented business located within the incorporated area of Houston, Texas, has either ceased providing nude or semi-nude entertainment or developed alternate methods of operating.  We have already taken steps to clothe our entertainers in a manner to eliminate the need for licenses and not to be subject to the Ordinance.  Approximately 1.9% of our club operation’s revenues for the nine months ended June 30, 2009 were in Houston, Texas and those clubs lost approximately 1.4% of the Company’s income before taxes for that period.

Other Legal Matters

Beginning January 1, 2008, our 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 we are 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.  In June 2009, the Texas Third Court of Appeals upheld the judgment that the surcharge is unconstitutional.  The State has appealed the judgment to 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 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 quarter ended June 30, 2009, as a result of the Third Court’s decision, the Company accrued the fee, but did not pay the State. 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.

For all the above legal matters, no contingent reserves for liabilities have been recorded in the accompanying consolidated balance sheets as such potential losses are not deemed probable or estimable.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2009

13. 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 Emerging Issues Task Force (“EITF’) No. 00-19, “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, EITF No. 00-19 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 EITF No. 00-19 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.

The fair value of the derivative liabilities when the securities became derivatives were estimated to be $3,751,192 in accordance with SFAS No. 157, using a Black-Scholes option-pricing model using the following weighted average assumptions:

The fair value of the derivative liabilities as of June 30, 2009 were estimated to be $3,765,666 in accordance with SFAS 157, using a Black-Scholes option-pricing model using the following weighted average assumptions:

The loss for the three months ended June 30, 2009, recognized in earnings amounted to $121,904.

14. SUBSEQUENT EVENTS

The following events have occurred after June 30, 2009, which the Company considers necessary to disclose in order to keep these financial statements from being misleading.  Subsequent events have been evaluated through August 12, 2009, the date the financial statements were issued.

The Company’s Board of Directors approved the issuance of stock options to the Board of Directors and the Company’s General Counsel on July 22, 2009.  Each non-officer Director and the General Counsel received 10,000 options (total of 50,000 options) and the two Officer Directors received 5,000 each.  The options vest in one year, expire after two years and are exercisable at $8.75 per share.

On August 6, 2009, the Company completed the sale of an aggregate of $7.2 million in 10% convertible debentures that will be used to make future acquisitions. The three-year debentures bear interest at 10 percent and can be convertible into common shares of the Company’s stock at $8.75 per share. The debentures are redeemable by the Company at any time if the closing price of the Company’s stock is at least $11.50 for 20 consecutive days. Other terms of the debentures are available in the Company’s 8-K filing with the SEC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2009

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:

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

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect certain reported amounts in the financial statements and accompanying notes. Estimates and assumptions are based on historical experience, forecasted future events and various other assumptions that we believe to be reasonable under the circumstances. Estimates and assumptions may vary under different assumptions or conditions. We evaluate our estimates and assumptions on an ongoing basis. We believe the accounting policies below are critical in the portrayal of our financial condition and results of operations.

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 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 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 31 to 40 years. Furniture, equipment and leasehold improvements have estimated useful lives between five and ten 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.

In June 2001, the FASB issued SFAS No. 142, Goodwill and Other Intangibles Assets, which addresses the accounting for goodwill and other intangible assets. Under SFAS No. 142, goodwill and intangible assets with indefinite lives are no longer amortized, but reviewed on an annual basis for impairment. All of the Company’s goodwill and intangible assets relate to the nightclub segment, except for $567,000 related to the media segment.  Definite lived intangible assets are amortized on a straight-line basis over their estimated lives.  Fully amortized assets are written-off against accumulated amortization.

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 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, 2008, 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. The Company determined that there is no goodwill impairment at September 30, 2008.

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.

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 Emerging Issues Task Force (“EITF’) No. 00-19, “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, EITF No. 00-19 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 EITF No. 00-19 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.

The fair value of the derivative liabilities when the securities became derivatives were estimated to be $3,751,192 in accordance with SFAS No. 157, using a Black-Scholes option-pricing model using the following weighted average assumptions:

The fair value of the derivative liabilities as of June 30, 2009 were estimated to be $3,765,666 in accordance with SFAS 157, using a Black-Scholes option-pricing model using the following weighted average assumptions:

The loss for the three months ended June 30, 2009, recognized in earnings amounted to $121,904.

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 revenue for VIP memberships in accordance with Staff Accounting Bulletin No. 104, Revenue Recognition, by deferring membership revenue and recognizing over the estimated membership usage period. Management estimates that the weighted average useful lives for memberships are 12 and 24 months for annual and lifetime memberships, respectively. The Company does not track membership usage by type of membership, however it believes these lives are appropriate and conservative, based on management’s knowledge of its client base and membership usage at the clubs.

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.

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.

Deferred income taxes are determined using the liability method in accordance with SFAS No. 109, “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.

In June 2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes, an Interpretation of FASB Statement No. 109, Accounting for Income Taxes” (“FIN 48”), to create a single model to address accounting for uncertainty in tax positions. FIN 48 clarifies the accounting for income taxes by prescribing a minimum recognition threshold a tax position is required to meet before being recognized in the financial statements. FIN 48 also provides guidance on derecognition, measurement, classification, interest and penalties, accounting in interim periods, disclosure and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006. The Company has adopted FIN 48 as of October 1, 2007, as required.  The adoption of FIN 48 has had no effect on the Company's consolidated financial position, results of operations or cash flows. There are no unrecognized tax benefits to disclose in the notes to the consolidated financial statements.

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 EITF Topic D-98 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.

Effective October 1, 2006, the Company adopted the fair value recognition provisions of SFAS No. 123R, “Share-Based Payments”, using the modified prospective application method.

 

The compensation cost recognized for the nine months ended June 30, 2009 and 2008 was $60,132 and $117,810, respectively.  There were no stock options exercises for the nine months ended June 30, 2009.

RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED JUNE 30, 2009 AS COMPARED TO THE THREE MONTHS ENDED JUNE 30, 2008

For the three months ended June 30, 2009, we had consolidated total revenues of $20,934,833 compared to consolidated total revenues of $15,940,006 for the three months ended June 30, 2008, an increase of $4,994,827 or 31.3%.  The increase in total revenues was primarily attributable to the increase in revenues generated by our new media division and new clubs in Dallas, Texas (two clubs), Philadelphia, Pennsylvania, and Las Vegas, Nevada, in the amount of  approximately $6 million.  Total revenues for same-location-same-period of club continuing operations decreased 0.9% to $14,894,316 for the three months ended June 30, 2009 from $15,034,144 for the same period ended June 30, 2008.

Income taxes, as a percentage of income before taxes was 36.1% and 38.3% for the quarters ended June 30, 2009 and 2008, respectively.

Net income decreased from $1,829,204 to $1,784,493, primarily due to the increase in expenses detailed below and losses in our new operations in Las Vegas.   Income before income taxes (exclusive of corporate overhead) for same-location-same-period of club continuing operations decreased to $4,486,515 for the three months ended June 30, 2009 from $4,689,659 for same period ended June 30, 2008, or by 4.3%.

Following is a comparison of the Company’s income statement for the quarters ended June 30, 2009 and 2008 with percentages compared to total revenue:

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

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, media postage and internet traffic purchases and webmaster payouts.  The cost of goods sold for the club operations for the three months ended June 30, 2009 was 10.7% compared to 11.2% for the three months ended June 30, 2008.  The cost of goods sold from our internet operations for the three months ended June 30, 2009 was 0.3% compared to 2.3% for the three months ended June 30, 2008.  The cost of goods sold from our media operations for the three months ended June 30, 2009 was 32.0%, compared to 34.9% for the three months ended June 30, 2008.  The cost of goods sold for same-location-same-period of club continuing operations for the three months ended June 30, 2009 was 11.8%, compared to 11.2% for the same period ended June 30, 2008.

The increase in payroll and related costs, stated as “Salaries & Wages” above, was primarily due to the addition of the new clubs.   The decrease in percentage to total revenues is principally due to management’s continued monitoring of payroll costs in 2009 during these tougher economic times.   Payroll for same-location-same-period of club continuing operations decreased to $2,656,706 for the three months ended June 30, 2009 from $2,773,853 for the same period ended June 30, 2008.  Management currently believes that its labor and management staff levels are appropriate.

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.  Patron taxes amounted to $443,000 for each of the quarters ended June 30, 2009 and 2008.

The increase in the percentage of advertising and marketing to total revenue is principally due to the addition of our new club in Las Vegas and its marketing campaign.

The increase in the percentage to revenues of credit card fees relates to increased chargebacks from certain credit card companies in 2009.

Rent expense increased principally due to significant new leases in Las Vegas and Philadelphia.

Depreciation and amortization increased approximately $225,000 from the three months ended June 30, 2008, due to the new clubs purchased during the 2008 fiscal year.

The increase in interest expense was attributable to our obtaining new debt during the year ended September 30, 2008 to finance the purchase of the new clubs and related real estate.  As of June 30, 2009, the balance of long-term debt was $31,768,115 compared to $33,557,406 a year earlier, but a substantial portion of the new debt was entered into during the quarter ended June 30, 2008.

See “Derivative Financial Instrument” above for information on the Company’s derivative financial instrument at June 30, 2009.

Losses, before income taxes, at clubs losing money during the quarter ended June 30, 2009 exceeded $520,000, compared to $900,000 for the quarter ended March 31, 2009.  The significant losing club was Rick’s Cabaret in Las Vegas.  Subsequent to December 31, 2008, the Company took the following steps to remedy losses in certain clubs:

The Rick’s Cabaret in Dallas lost $323,000 before income taxes during the quarter ended December 31, 2008.  In January 2009, we converted the location to XTC Cabaret Dallas.  Early results are very encouraging.  This location, as XTC Dallas, made a $124,000 profit for the quarter ended June 30, 2009 and we expect ongoing profits in this location although there can be no assurance.

The Rick’s Cabaret in Philadelphia lost $276,000 before income taxes during the quarter ended December 31, 2008.  We have converted the location to Club Onyx Philadelphia in January 2009 and the club made a profit of $195,000 for the quarter ended June 30, 2009.  We expect continued profitability in 2009 going forward although there can be no assurance.

Club Onyx Dallas did not have a liquor license during the quarter ended December 31, 2008 until December 5, 2008 and lost $188,000 before income taxes during the quarter.  This location was at virtual breakeven for the quarter ended June 30, 2009, and we expect ongoing profits in this location, of which there can be no assurance.

Rick’s Cabaret Las Vegas lost approximately $300,000 before income taxes for the quarter ended June 30, 2009.   Due to the economy in Las Vegas, we expect to continue to lose money at this location until the Las Vegas economy improves, but we have made expense reductions and modifications to our marketing campaign in this location subsequent to March 31, 2009 and we have seen a large improvement in operations in the quarter.

The accompanying consolidated financial statements reflect the following as discontinued operations as of and for the period ended June 30, 2009.

The Rick’s Cabaret in Austin is currently held for sale and is included in discontinued operations in the accompanying statement of income.  A sale of the club was scheduled in May 2009, but the sale was never closed.  The Company recognized an impairment of the net assets of the club of $823,090 as of March 31, 2009, recognized in the consolidated statement of income as loss from sale of discontinued operations.

The Company sold one of its nightclubs, Encounters in San Antonio, on March 1, 2009 for $40,000, including $5,000 in cash and a $35,000 note payable monthly for one year.  The Company recognized an impairment of $221,563 for this club during the quarter ended December 31, 2008.  The actual loss at date of sale was $226,175.

Following is summarized information regarding the discontinued operations:

RESULTS OF OPERATIONS FOR THE NINE MONTHS ENDED JUNE 30, 2009 AS COMPARED TO THE NINE MONTHS ENDED JUNE 30, 2008

For the nine months ended June 30, 2009, we had consolidated total revenues of $56,301,613 compared to consolidated total revenues of $41,775,763 for the nine months ended June 30, 2008, an increase of $14,525,850 or 34.8%.  The increase in total revenues was primarily attributable to the increase in revenues generated by our new media division and new clubs in Miami Gardens, Florida, two clubs in Dallas, Texas, Philadelphia, Pennsylvania, and Las Vegas, Nevada, in the amount of $15 million.  Total revenues for same-location-same-period of club continuing operations decreased to $24,603,662 for the nine months ended June 30, 2009 from $26,059,704 for same period ended June 30, 2008, a 5.6% decrease.  Same-location-same-period information for the nine months does not include our club in Miami Gardens, although that club is included in the information for the three month periods ended June 30, 2009 and 2008.

Income taxes, as a percentage of income before taxes was 36.6% and 31.0% for the nine months ended June 30, 2009 and 2008, respectively.  The increase in 2009 is due to the lack of significant permanent differences in 2009 compared to 2008, principally related to exercised stock options and also to the increased significance of state taxes in 2009.

Net income decreased from $6,217,856 to $3,414,796, primarily due to the increase in expenses detailed below and losses in our new operations in Dallas, Philadelphia and Las Vegas.   Income before income taxes (exclusive of corporate overhead) for same-location-same-period of club continuing operations decreased to $5,930,711 for the nine months ended June 30, 2009 from $7,333,146 for same period ended June 30, 2008, or by 19.1%.

Following is a comparison of the Company’s income statement for the nine months ended June 30, 2009 and 2008 with percentages compared to total revenue:

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

Other revenues include ATM commissions earned, video games and other vending and certain promotion fees charged to our entertainers.

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.  The increase in the cost of goods sold as a percentage of revenues for the nine months ended June 30, 2009 was due primarily to two factors: (1) the addition of several new alcohol-selling clubs and their related cost of goods which is significantly higher as a percentage of revenues compared to the cost of sales of the XTC clubs which are BYOB, and (2) the addition of the media division which has a higher cost of sales than club operations.  The cost of goods sold for the club continuing operations for the nine months ended June 30, 2009 was 11.7% compared to 11.1% for the nine months ended June 30, 2008.  The cost of goods sold from our internet operations for the nine months ended June 30, 2009 was 1.23% compared to 2.8% for the nine months ended June 30, 2008.  The cost of goods sold from our media operations for the nine months ended June 30, 2009 was 36.2%.  The cost of goods sold for same-location-same-period of continuing club operations for the nine months ended June 30, 2009 was 11.8%, compared to 11.7% for the same period ended June 30, 2008.

The increase in payroll and related costs, stated as “Salaries & Wages” above, was primarily due to the addition of the new clubs.   The decrease in percentage to total revenues is principally due to management’s continued monitoring of payroll costs in 2009 during these tougher economic times.   Payroll for same-location-same-period of club operations decreased to $5,075,696 for the nine months ended June 30, 2009 from $5,309,490 for the same period ended June 30, 2008.  Management currently believes that its labor and management staff levels are appropriate.

The increase in the percentage of taxes and permits to total revenues is principally due to the patron tax in Texas which was not in effect until January 1, 2008.

The increase in the percentage to revenues of credit card fees relates to increased chargebacks from certain credit card companies in 2009.

The increase in the percentage of advertising and marketing to total revenue is principally due to the addition of our new club in Las Vegas and its marketing campaign.

Rent expense increased principally due to significant new leases in Las Vegas and Philadelphia.

The increase in legal and professional expense is principally due to contesting of labor lawsuits in Minnesota and New York.

Depreciation and amortization for the nine months ended June 30, 2009 increased approximately $800,000 from the nine months ended June 30, 2008, due to the new clubs purchased in 2008.  Maintenance capital expenditures amounted to $268,000 for the nine months ended June 30, 2009.  We anticipate that depreciation will exceed maintenance capital expenditures for the year ending September 30, 2009 by approximately $2.5 million.

The increase in interest expense was attributable to our obtaining new debt during the year ended September 30, 2008 to finance the purchase of the new clubs and related real estate.  As of June 30, 2009, the balance of long-term debt was 31,768,115 compared to $33,557,406 a year earlier, but a substantial portion of the new debt was entered into during the quarter ended June 30, 2008.

See “Derivative Financial Instrument” above for information on the Company’s derivative financial instrument at June 30, 2009.

The significant change in minority interests is due to the purchase, effective June 30, 2008, of the remaining 49% of our Austin Rick’s Cabaret location and the purchase, effective the same day, of 51% of the partnership owning the real estate for our Philadelphia location.

Losses, before income taxes, at clubs losing money during the nine months ended June 30, 2009 exceeded $2.5 million.  The significant losing club for the nine months was Rick’s Cabaret in Las Vegas, which lost $1.6 million.  Losses, before income taxes, at clubs losing money during the three months ended December 31, 2008 exceeded $1.9 million.  During the quarter ended December 31, 2008, the significant losing clubs included Rick’s Cabaret in Las Vegas, Dallas, Philadelphia and Club Onyx in Dallas.  Subsequent to December 31, 2008, the Company took the following steps to remedy losses in certain clubs:

XTC Cabaret in Dallas (converted from Rick’s Cabaret in January 2009) earned $171,000 before income taxes during the six months ended June 30, 2009,  and we expect ongoing profits in this location although there can be no assurance.

Club Onyx in Philadelphia (converted from Rick’s Cabaret in January 2009) lost $276,000 before income taxes during the quarter ended December 31, 2008. The club made a profit of $410,000 for the six months ended June 30, 2009.  We expect continued profitability in 2009 going forward although there can be no assurance.

Club Onyx Dallas did not have a liquor license during the quarter ended December 2008 until December 5, 2008 and lost $188,000 before income taxes during the quarter.  This location made a profit of $61,000 for the six months ended June 30, 2009, and we expect ongoing profits in this location, of which there can be no assurance.

Rick’s Cabaret Las Vegas lost approximately $935,000 before income taxes for the six months ended June 30, 2009.   Due to the economy in Las Vegas, we expect to continue to lose money at this location until the Las Vegas economy improves, but we have made expense reductions and modifications to our marketing campaign in this location subsequent to March 31, 2009 and we have seen a large improvement in operations in the third quarter.

LIQUIDITY AND CAPITAL RESOURCES

At June 30, 2009, we had working capital of $3,690,921 compared to $3,410,445 at September 30, 2008.

Net cash provided by operating activities of continuing operations in the nine months ended June 30, 2009 was $6,032,429 compared to $10,260,790 for the nine months ended June 30, 2008.  The decrease in cash provided by operating activities was primarily due to the decrease in net income and the payment of income taxes and accounts payable during the nine months ended June 30, 2009.

We used $1,359,367 of cash in investing activities from continuing operations during the nine months ended June 30, 2009 compared to $25,358,196 during the nine months ended June 30, 2008.  The decrease was principally due to the acquisition of the new club in Miami Gardens, Florida on November 30, 2007.  Cash of $4,361,692 was used by financing activities of continuing operations during the nine months ended June 30, 2009 compared to $26,577,205 cash provided during the nine months ended June 30, 2008.  The decrease in cash provided by financing activities is primarily the result of common stock issuances to raise capital for acquiring the new Florida club in November 2007.

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.

On April 29, 2009, the Company entered into a modification to its two secured promissory notes with the former owners of Tootsie’s Cabaret in Miami Gardens, Florida, whereby the due date for the $5 million of principal due and payable by the Company under each note (an aggregate of $10 million) was extended by two years from November 2010 to November 2012.  All other terms and conditions of the promissory notes remain the same.  The Company previously issued these notes in November 2007 to the former owners of Tootsie’s Cabaret in connection with a purchase agreement for the adult cabaret.  The Company paid a total of $150,000 to the holders of the notes as consideration for their agreement to extend the notes for two years through November 2012.  The $150,000 paid will be amortized as an adjustment of interest expense over the remaining life of the notes.

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.

During April and May 2009, we completed renegotiation of terms of certain of our long term debt and a significant portion of outstanding put options.  Before the renegotiation, the maximum obligation that could be owed if our stock were valued at zero is $13,935,020 and is recorded in our consolidated balance sheet as Temporary Equity.   After the renegotiation, the maximum obligation that could be owed if our stock were valued at zero is $12,433,000.  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 as explained in Note 13 of Notes to Consolidated Financial Statements. 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 August 3, 2009 of $7.81 per share, of which there can be no assurance: (This includes the derivative financial instruments recognized in our balance sheet at June 30, 2009.)