RCI HOSPITALITY HOLDINGS, INC. 10-K

Item 1. Business. INTRODUCTION RCI Hospitality Holdings, Inc. is a holding company. Through our subsidiaries, we engaged in a number of activities in the hospitality and related businesses. As of September 30, 2020, our subsidiaries operated a total of 48 establishments that offer live adult entertainment and/or restaurant and bar operations. Together with its subsidiaries, RCI Hospitality Holdings, Inc. is collectively referred to as “RCIHH,” the “Company,” “we,” “us,” or “our” in this report. We also operate a leading business communications company serving the multibillion-dollar adult nightclubs industry. RCIHH was incorporated in the State of Texas in 1994 and became public in 1995. Our fiscal year ends on September 30. References to years 2020, 2019, and 2018 are for fiscal years ended September 30, 2020, 2019, and 2018, respectively. Our fiscal quarters chronologically end on December 31, March 31, June 30 and September 30. Our corporate website address is www.rcihospitality.com. Upon written request, we make available free of charge our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and all amendments to those reports as soon as reasonably practicable after such material is electronically filed with the SEC under the Securities Exchange Act of 1934, as amended (www.sec.gov). Information contained in the corporate website shall not be construed as part of this Form 10-K. COVID-19 PANDEMIC In March 2020, President Donald Trump declared the coronavirus disease 2019 (“COVID-19”) pandemic as a national public health emergency. The declaration resulted in a significant reduction in customer traffic in our clubs and restaurants due to changes in consumer behavior as social distancing practices, dining room closures and other restrictions were mandated or encouraged by federal, state and local governments. Since March 2020, we have temporarily closed and reopened several of our clubs and restaurants. The temporary closure of our clubs and restaurants caused by the COVID-19 pandemic has presented operational challenges. Our strategy is to open locations in accordance with local and state guidelines and it is too early to know when and if they will generate positive cash flows for us. Depending on the timing and number of locations we are allowed to open, and their ability to generate positive cash flow, we may need to borrow funds to meet our obligations or consider selling certain assets. The COVID-19 pandemic is adversely affecting the availability of liquidity generally in the credit markets, and there can be no guarantee that additional liquidity will be readily available or available on favorable terms, especially the longer the COVID-19 pandemic lasts. To augment an expected decline in operating cash flows caused by the COVID-19 pandemic, we instituted the following measures: ● Arranged and continue to arrange for deferment of principal and interest payment on certain of our debts; ● Furloughed employees working at our clubs and restaurants, except for a limited number of managers; ● Pay cut for all remaining salaried and hourly employees and deferral of board of director compensation; ● Deferred or modified certain fixed monthly expenses such as insurance, rent, and taxes, among others; ● Canceled certain non-essential expenses such as advertising, cable, pest control, point-of-sale system support, and investor relations coverage, among others. On May 8, 2020, the Company received approval and funding under the Paycheck Protection Program (“PPP”) of the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”) for its restaurants, shared service entity and lounge. See Notes 3, 10 and 11 to our consolidated financial statements. Ten of our restaurant subsidiaries received amounts ranging from $271,000 to $579,000 for an aggregate amount of $4.2 million; our shared-services subsidiary received $1.1 million; and one of our lounges received $124,000. None of our adult nightclub and other non-core business subsidiaries received funding under the PPP. The Company believes it has used the entire loan amount for qualifying expenses. Under the terms of the PPP, certain amounts of the loan may be forgiven if they are used for qualifying expenses as described in the CARES Act. The Company has currently utilized all of the PPP funds and has submitted its forgiveness applications. As of the filing of this report, we have received ten Notices of PPP Forgiveness Payment from the Small Business Administration out of the twelve of our PPP loans granted. All of the notices received forgave 100% of each of the ten PPP loans totaling the amount of $4.9 million. No assurance can be provided that the Company will in fact obtain forgiveness of the remaining two PPP loans in whole or in part. As of the release of this report, we do not know the future extent and duration of the impact of COVID-19 on our businesses. Lower sales, as caused by local, state and national guidelines, could lead to adverse financial results. However, we will continually monitor and evaluate the situation and will determine any further measures to be instituted, including refinancing several of our debt obligations. We continue to adhere to state and local government mandates regarding the pandemic and, since March 2020, have closed and reopened several of our locations depending on changing government mandates. As of the release of this report, we have reopened many of our club and Bombshells locations with certain operating hour restrictions and with limited occupancy. OUR BUSINESS We operate several businesses, which we aggregate for financial reporting purposes into two reportable segments – Nightclubs and Bombshells. Businesses not included as Nightclubs or Bombshells are combined as “Other.” Nightclubs Segment We operate our adult entertainment nightclubs through several brands that target many different demographics of customers by providing a unique, quality entertainment environment. Our clubs do business as Rick’s Cabaret, Jaguars Club, Tootsie’s Cabaret, XTC Cabaret, Club Onyx, Hoops Cabaret and Sports Bar, Scarlett’s Cabaret, Temptations Adult Cabaret, Foxy’s Cabaret, Vivid Cabaret, Downtown Cabaret, Cabaret East, The Seville, Silver City Cabaret, and Kappa Men’s Club. We also operate one dance club under the brand name Studio 80. We generate revenue from our nightclubs through the sale of alcoholic beverages, food and merchandise items; service in the form of cover charge, dance fees, and room rentals; and through other related means such as ATM commissions and vending income, among others. During fiscal 2020, our Nightclub segment sales mix was 46% service revenue; 36% alcoholic beverages; and 18% food, merchandise and other. Segment gross margin (revenues less cost of goods sold, divided by revenues) was approximately 89%. During the COVID-19 pandemic, our Nightclubs segment revenue declined by 41% and income from operations declined by 74% from the prior year. Same-stores sales for Nightclubs in 2020 was -9.0% with the impact of the pandemic excluded from comparable sales. With the impact of the pandemic included in comparable sales (see Adjusted Same-Store Sales on page 23), same-store sales would be -41.7%. 4 Our Nightclubs segment continues to be heavily affected by the COVID-19 pandemic as most states have reissued directives for lockdowns and stricter safety restrictions in the fall of 2020 due to the resurgence of cases. On November 5, 2019, the Company announced that its subsidiaries had signed definitive agreements to acquire the assets and related real estate of a well-established, top gentlemen’s club located in the Northeast Corridor for $15.0 million. The agreements terminated prior to closing. We provided the sellers notice of the termination in April 2020. A list of our nightclub locations is in Item 2— “Properties.” Bombshells Segment Our Bombshells segment operates a restaurant and bar concept that sets itself apart with décor that pays homage to all branches of the U.S. military. Locations feature local DJs, large outdoor patios, and more than 75 state-of-the-art flat screen TVs for watching your favorite sports. All food and drink menu items have military names. Bombshell Girls, with their military-inspired uniforms, are a key attraction. Their mission, in addition to waitressing, is to interact with guests and generate a fun atmosphere. Bombshells is also open to franchising under our subsidiary, BMB Franchising Services, Inc., which has been approved to sell franchises in all 50 states. As of September 30, 2020, we operated ten Bombshells locations, all in Texas with one in Dallas, one in Austin, and eight in the Greater Houston area. During fiscal 2020, Bombshells sales mix was 63% alcoholic beverages and 37% food, merchandise and other. Segment gross margin (revenues less cost of goods sold, divided by revenues) was approximately 77%. We grew Bombshells segment revenue by 40% and income from operations by 300% from prior year despite the COVID-19 pandemic. This was a result of being able to open the Bombshells locations as restaurants while bars were closed and the contribution of two new locations that opened in fiscal 2020. Same-stores sales for Bombshells in 2020 was +18.3% with the impact of the pandemic excluded from comparable sales. With the impact of the pandemic included in comparable sales (see Adjusted Same-Store Sales on page 23), same-store sales would be +6.5%. We opened the first Bombshells in March 2013 in Dallas, quickly becoming one of the most popular restaurant destinations in the area. Within six years, eight more opened in the Austin and Houston, Texas areas, including two that were opened in fiscal 2019. In September 2016, we closed one Bombshells location in Webster, Texas. We opened one Bombshells on Interstate 10 (BMB I-10), east of Houston in December 2018, and another one on State Highway 249 (BMB 249), northwest of Houston in March 2019. In the current fiscal 2020, we opened one Bombshells in Katy, Texas (BMB Katy) in October 2019, and another on Southwest Freeway (BMB 59) in Houston, Texas in January 2020. Of the ten active Bombshells as of September 30, 2020, eight are freestanding pad sites and two are inline locations. For a list of our Bombshells locations, refer to Item 2—“Properties.” Other Segment We group together all businesses not belonging to either Nightclubs and Bombshells as Other reportable segment. This is made up of several wholly-owned subsidiaries composed primarily of our Media Group and Drink Robust. Our Media Group is the leading business communications company serving the multibillion-dollar adult nightclubs industry and the adult retail products industry. It owns a national industry convention and tradeshow; two national industry trade publications; two national industry award shows; and more than a dozen industry and social media websites. Included in the Media Group is ED Publications, publishers of the bimonthly ED Club Bulletin, the only national business magazine serving the 2,200-plus adult nightclubs in North America, which collectively have annual revenues in excess of $5 billion, according to the Association of Club Executives. ED Publications, founded in 1991, also publishes the Annual VIP Guide of adult nightclubs, touring entertainers and industry vendors; produces the Annual Gentlemen’s Club Owners EXPO, a national convention and tradeshow; and offers the exclusive ED VIP Club Card, honored at more than 850 adult nightclubs. The Media Group produces two nationally recognized industry award shows for the readers of both ED Club Bulletin and StorErotica magazines, and maintains a number of B-to-B and consumer websites for both industries. Drink Robust is licensed to sell Robust Energy Drink in the United States. 5 OUR STRATEGY Our overall objective is to create value for our shareholders by developing and operating profitable businesses in the hospitality and related space. We strive to achieve that by providing an attractive price-value entertainment and dining experience; by attracting and retaining quality personnel; and by focusing on unit-level operating performance. Aside from our operating strategy, we employ a capital allocation strategy. Capital Allocation Strategy Our capital allocation strategy provides us with disciplined guidelines on how we should use our free cash flows; provided however, that we may deviate from this strategy if other strategic rationale warrants. We calculate free cash flow as net cash flows from operating activities minus maintenance capital expenditures. Using the after-tax yield of buying our own stock as baseline, management believes that we are able to make better investment decisions. Based on our current capital allocation strategy: ● We consider acquiring or developing our own clubs or restaurants that we believe have the potential to provide a minimum cash on cash return of 25%-33%, absent an otherwise strategic rationale; ● We consider disposing of underperforming units to free up capital for more productive use; ● We consider buying back our own stock if the after-tax yield on free cash flow is above 10%; ● We consider paying down our most expensive debt if it makes sense on a tax-adjusted basis, or there is an otherwise strategic rationale. COMPETITION The adult entertainment and the restaurant/sports bar businesses are highly competitive with respect to price, service and location. All of our nightclubs compete with a number of locally owned adult clubs, some of whose brands may have name recognition that equals that of ours. The names “Rick’s” and “Rick’s Cabaret,” “Tootsie’s Cabaret,” “XTC Cabaret,” “Scarlett’s,” “Silver City,” “Club Onyx,” “Downtown Cabaret,” “Temptations,” “The Seville,” “Jaguars,” “Hoops Cabaret,” and “Foxy’s Cabaret” are proprietary. In the restaurant/sports bar business, “Bombshells” is also proprietary. We believe that the combination of our existing brand name recognition and the distinctive entertainment environment that we have created allows us to compete effectively in the industry and within the cities where we operate. Although we believe that we are well positioned to compete successfully, there can be no assurance that we will be able to maintain our high level of name recognition and prestige within the marketplace. GOVERNMENTAL REGULATIONS We are subject to various federal, state and local laws affecting our business activities. Particularly in Texas, the authority to issue a permit to sell alcoholic beverages is governed by the Texas Alcoholic Beverage Commission (“TABC”), which has the authority, in its discretion, to issue the appropriate permits. We presently hold a Mixed Beverage Permit and a Late Hour Permit at numerous Texas locations. Minnesota, North Carolina, Louisiana, Arizona, Pennsylvania, Florida, New York, and Illinois have similar laws that may limit the availability of a permit to sell alcoholic beverages or that may provide for suspension or revocation of a permit to sell alcoholic beverages in certain circumstances. It is our policy, prior to expanding into any new market, to take steps to ensure compliance with all licensing and regulatory requirements for the sale of alcoholic beverages, as well as the sale of food. 6 In addition to various regulatory requirements affecting the sale of alcoholic beverages, in many cities where we operate, the location of an adult entertainment cabaret is subject to restriction by city, county or other governmental ordinance. The prohibitions deal generally with distance from schools, churches and other sexually oriented businesses, and contain restrictions based on the percentage of residences within the immediate vicinity of the sexually oriented business. The granting of a sexually oriented business permit is not subject to discretion; the permit must be granted if the proposed operation satisfies the requirements of the ordinance. In all states where we operate, management believes we are in compliance with applicable city, county, state or other local laws governing the sale of alcohol and sexually oriented businesses. TRADEMARKS Our rights to the trade names “RCI Hospitality Holdings, Inc.,” “Rick’s,” “Rick’s Cabaret,” “Tootsie’s Cabaret,” “Club Onyx,” “XTC Cabaret,” “Temptations,” “Jaguars,” “Downtown Cabaret,” “Cabaret East,” “Bombshells Restaurant and Bar,” and “Vee Lounge” are established under common law, based upon our substantial and continuous use of these trade names in interstate commerce, some of which have been in use at least as early as 1987. We have registered our service mark, “RICK’S AND STARS DESIGN,” and the “BOMBSHELLS RESTAURANT & BAR” logo design with the United States Patent and Trademark Office. We have also obtained service mark registrations from the Patent and Trademark Office for “RICK’S AND STARS DESIGN” logo, “RCI HOSPITALITY HOLDINGS, INC.,” “RICK’S,” “RICK’S CABARET,” “CLUB ONYX,” “XTC CABARET,” “SCARLETT’S CABARET,” “SILVER CITY CABARET,” “BOMBSHELLS RESTAURANT AND BAR,” “THE SEVILLE CLUB,” “DOWN IN TEXAS SALOON,” “CLUB DULCE,” “THE BLACK ORCHID,” “HOOPS CABARET,” “VEE LOUNGE,” “STUDIO 80,” “FOXY’S CABARET,” “EXOTIC DANCER,” and “TOYS FOR TATAS” are registered through service mark registrations issued by the United States Patent and Trademark Office. As of this date, we have pending registration applications for the names “TOOTSIES CABARET,” “In The Biz,” and “Bombshells Officer’s Club.” We also own the rights to numerous trade names associated with our media division. There can be no assurance that these steps we have taken to protect our service marks will be adequate to deter misappropriation of our protected intellectual property rights. EMPLOYEES AND INDEPENDENT CONTRACTORS Our people are employed by the parent company or by any of its subsidiaries. Executive officers are employed by the parent company; shared services personnel and managers responsible for multiple clubs or restaurants are employed by RCI Management Services, Inc.; and the rest are employed by the individual operating entities. As of September 30, 2020, we had the following employees: Operations Managers Non-Managers Corporate Total Hourly 17 1,735 20 1,772 Salaried 228 21 53 302 245 1,756 73 2,074 Additionally, as of September 30, 2020, we had independent contractor entertainers who are self-employed and conduct business at our locations on a non-exclusive basis. Our entertainers at Rick’s Cabaret in Minneapolis, Minnesota and at Jaguars Club in Phoenix, Arizona act as commissioned employees. All employees and independent contractors sign arbitration non-class-action participation agreements where allowed by federal and state laws. None of our employees are represented by a union. We consider our employee relations to be good. We believe that the adult entertainment industry standard of treating entertainers as independent contractors provides us with safe harbor protection to preclude payroll tax assessment. We have prepared plans that we believe will protect our profitability in the event that the sexually oriented business industry is required in all states to convert entertainers, who are now independent contractors, into employees. See related discussion in “Risk Factors” below. 7