RCI HOSPITALITY HOLDINGS, INC. 10-Q

Item 1. Financial Statements. 4 Table of Contents RCI HOSPITALITY HOLDINGS, INC. CONDENSED CONSOLIDATED BALANCE SHEETS (in thousands, except par value and number of shares) December 31, 2022 September 30, 2022 (unaudited) ASSETS Current assets Cash and cash equivalents $ 34,108 $ 35,980 Accounts receivable, net 6,016 8,510 Current portion of notes receivable 235 230 Inventories 4,051 3,893 Prepaid expenses and other current assets 8,611 1,499 Assets held for sale — 1,049 Total current assets 53,021 51,161 Property and equipment, net 246,536 224,615 Operating lease right-of-use assets, net 36,329 37,048 Notes receivable, net of current portion 4,631 4,691 Goodwill 70,189 67,767 Intangibles, net 143,949 144,049 Other assets 1,503 1,407 Total assets $ 556,158 $ 530,738 LIABILITIES AND EQUITY Current liabilities Accounts payable $ 5,182 $ 5,482 Accrued liabilities 18,864 11,328 Current portion of debt obligations, net 13,291 11,896 Current portion of operating lease liabilities 2,850 2,795 Total current liabilities 40,187 31,501 Deferred tax liability, net 30,562 30,562 Debt, net of current portion and debt discount and issuance costs 197,943 190,567 Operating lease liabilities, net of current portion 35,270 36,001 Other long-term liabilities 386 349 Total liabilities 304,348 288,980 Commitments and contingencies (Note 10) Equity Preferred stock, $ 0.10 par value per share; 1,000,000 shares authorized; none issued and outstanding — — Common stock, $ 0.01 par value per share; 20,000,000 shares authorized; 9,230,225 and 9,231,725 shares issued and outstanding as of December 31, 2022 and September 30, 2022, respectively 92 92 Additional paid-in capital 68,070 67,227 Retained earnings 183,726 173,950 Total RCIHH stockholders’ equity 251,888 241,269 Noncontrolling interests ( 78 ) 489 Total equity 251,810 241,758 Total liabilities and equity $ 556,158 $ 530,738 See accompanying notes to unaudited condensed consolidated financial statements. 5 Table of Contents RCI HOSPITALITY HOLDINGS, INC. CONDENSED CONSOLIDATED STATEMENTS OF INCOME (in thousands, except per share and number of share data) (unaudited) For the Three Months Ended December 31, 2022 2021 Revenues Sales of alcoholic beverages $ 29,650 $ 26,431 Sales of food and merchandise 10,347 10,894 Service revenues 25,563 20,876 Other 4,408 3,635 Total revenues 69,968 61,836 Operating expenses Cost of goods sold Alcoholic beverages sold 5,374 4,834 Food and merchandise sold 3,586 3,957 Service and other 49 100 Total cost of goods sold (exclusive of items shown separately below) 9,009 8,891 Salaries and wages 18,676 16,505 Selling, general and administrative 22,732 18,486 Depreciation and amortization 3,307 2,194 Other gains, net ( 654 ) ( 151 ) Total operating expenses 53,070 45,925 Income from operations 16,898 15,911 Other income (expenses) Interest expense ( 3,687 ) ( 2,604 ) Interest income 91 106 Non-operating gains, net — 84 Income before income taxes 13,302 13,497 Income tax expense 3,031 2,933 Net income 10,271 10,564 Net loss (income) attributable to noncontrolling interests ( 33 ) 11 Net income attributable to RCIHH common shareholders $ 10,238 $ 10,575 Earnings per share Basic and diluted $ 1.11 $ 1.12 Weighted average number of common shares outstanding Basic and diluted 9,230,258 9,407,519 Dividends per share $ 0.05 $ 0.04 See accompanying notes to unaudited condensed consolidated financial statements. 6 Table of Contents RCI HOSPITALITY HOLDINGS, INC. CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY (in thousands, except number of shares) (unaudited) Common Stock Additional Paid-In Capital Retained Earnings Treasury Stock Noncontrolling Interests Total Equity Number of Shares Amount Number of Shares Amount Balance at September 30, 2022 9,231,725 $ 92 $ 67,227 $ 173,950 — $ — $ 489 $ 241,758 Purchase of treasury shares — — — — ( 1,500 ) ( 98 ) — ( 98 ) Canceled treasury shares ( 1,500 ) — ( 98 ) — 1,500 98 — — Payment of dividends — — — ( 462 ) — — — ( 462 ) Stock-based compensation — — 941 — — — — 941 Share in return of investment by noncontrolling partner — — — — — — ( 600 ) ( 600 ) Net income — — — 10,238 — — 33 10,271 Balance at December 31, 2022 9,230,225 $ 92 $ 68,070 $ 183,726 — $ — $ ( 78 ) $ 251,810 Balance at September 30, 2021 8,999,910 $ 90 $ 50,040 $ 129,693 — $ — $ ( 600 ) $ 179,223 Issuance of common shares for business combination 500,000 5 30,357 — — — — 30,362 Payment of dividends — — — ( 380 ) — — — ( 380 ) Net income (loss) — — — 10,575 — — ( 11 ) 10,564 Balance at December 31, 2021 9,499,910 $ 95 $ 80,397 $ 139,888 — $ — $ ( 611 ) $ 219,769 See accompanying notes to unaudited condensed consolidated financial statements. 7 Table of Contents RCI HOSPITALITY HOLDINGS, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands, except number of shares) (unaudited) For the Three Months Ended December 31, 2022 2021 CASH FLOWS FROM OPERATING ACTIVITIES Net income $ 10,271 $ 10,564 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 3,307 2,194 Stock-based compensation 941 — Gain on sale of businesses and assets ( 686 ) ( 523 ) Unrealized loss on equity securities — 1 Amortization of debt discount and issuance costs 144 51 Gain on debt extinguishment — ( 83 ) Noncash lease expense 719 629 Gain on insurance ( 64 ) — Doubtful accounts expense on notes receivable — 17 Changes in operating assets and liabilities: Accounts receivable 1,447 1,344 Inventories ( 94 ) ( 445 ) Prepaid expenses, other current and other assets ( 7,208 ) ( 6,519 ) Accounts payable, accrued and other liabilities 6,118 9,034 Net cash provided by operating activities 14,895 16,264 CASH FLOWS FROM INVESTING ACTIVITIES Proceeds from sale of businesses and assets 2,784 803 Proceeds from insurance 64 185 Proceeds from notes receivable 55 34 Payments for property and equipment and intangible assets ( 12,553 ) ( 9,850 ) Acquisition of businesses, net of cash acquired ( 4,000 ) ( 39,302 ) Net cash used in investing activities ( 13,650 ) ( 48,130 ) CASH FLOWS FROM FINANCING ACTIVITIES Proceeds from debt obligations, including related party proceeds of $ 0 and $ 650 , respectively 1,500 17,002 Payments on debt obligations ( 3,361 ) ( 2,488 ) Purchase of treasury stock ( 98 ) — Payment of dividends ( 462 ) ( 380 ) Payment of loan origination costs ( 96 ) — Share in return of investment by noncontrolling partner ( 600 ) — Net cash provided by (used in) financing activities ( 3,117 ) 14,134 NET DECREASE IN CASH AND CASH EQUIVALENTS ( 1,872 ) ( 17,732 ) CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 35,980 35,686 CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 34,108 $ 17,954 CASH PAID DURING PERIOD FOR: Interest $ 3,490 $ 2,330 Income taxes $ — $ 3 8 Table of Contents Noncash investing and financing transactions: Debt incurred in connection with acquisition of businesses $ 5,000 $ 22,200 Debt incurred in connection with purchase of property and equipment $ 5,584 $ — Note receivable from sale of property $ — $ 2,700 Issuance of shares of common stock for acquisition of businesses: Number of shares — 500,000 Fair value $ — $ 30,362 Adjustment to operating lease right-of-use assets and lease liabilities related to new and renewed leases $ — $ 18,243 Unpaid liabilities on capital expenditures $ 1,985 $ 626 See accompanying notes to unaudited condensed consolidated financial statements. 9 Table of Contents RCI HOSPITALITY HOLDINGS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) 1. Basis of Presentation The accompanying unaudited condensed consolidated financial statements of RCI Hospitality Holdings, Inc. (the “Company,” “RCIHH,” “we,” or “us”) have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP” or “U.S. GAAP”) 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 GAAP for complete financial statements. The September 30, 2022 consolidated balance sheet data were derived from audited financial statements but do not include all disclosures required by GAAP. However, except as disclosed herein, there has been no material change in the information disclosed in the notes to the consolidated financial statements for the year ended September 30, 2022 included in the Company’s Annual Report on Form 10-K, as filed with the Securities and Exchange Commission on December 14, 2022. The interim unaudited condensed consolidated financial statements should be read in conjunction with those consolidated financial statements included in the Form 10-K. In the opinion of management, all adjustments considered necessary for a fair statement of the financial statements, consisting solely of normal recurring adjustments, have been made. Operating results for the three months ended December 31, 2022 are not necessarily indicative of the results that may be expected for the year ending September 30, 2023 . 2. Recent Accounting Standards and Pronouncements In October 2021, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2021-08, Business Combinations (Topic 805): Accounting for Contract Assets and Contract Liabilities from Contracts with Customers . This ASU amends ASC 805 to require acquiring entities to apply ASC 606 to recognize and measure contract assets and contract liabilities in business combinations. The ASU is effective for public entities for fiscal years beginning after December 15, 2022, including interim periods within those fiscal years. We are still evaluating the impact of this ASU but we do not expect it to have a material impact on our consolidated financial statements. In June 2022, the FASB issued ASU 2022-03, Fair Value Measurement (Topic 820): Fair Value Measurement of Equity Securities Subject to Contractual Sale Restrictions . The amendments of this ASU clarify that an entity should measure the fair value of an equity security subject to contractual sale restriction the same way it measures an identical equity security that is not subject to such a restriction. The FASB said the contractual restriction on the sale of an equity security is not considered part of the unit of account of the equity security and, therefore, should not affect its fair value. The ASU is effective for public entities for fiscal years beginning after December 15, 2023, and interim periods within those fiscal years. Early adoption is permitted. We are still evaluating the impact of this ASU on our consolidated financial statements. 3. Current Operating Environment Our fiscal 2020 was the period hardest hit by the COVID-19 pandemic caused by 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. In fiscal 2021, our businesses started to recover from the initial effects of the pandemic when government restrictions eased. Stimulus money also flowed to the economy at that time which prompted increased discretionary spending. In fiscal 2022, several coronavirus variants threatened to bring back tight restrictions. Along with the pandemic, geopolitical and macroeconomic events started to affect the U.S. economy in general, with global inflation and supply chain disruption impacting our businesses the most. Geopolitical and macroeconomic events are still developing. In the event global inflation leads to a major economic downturn, our business operations and cash flow could be significantly affected. 4. Acquisitions and Dispositions Lubbock Property On October 10, 2022, the Company purchased real estate in Lubbock, Texas amounting to $ 3.4 million for a future Bombshells location. The Company paid $ 1.1 million in cash at closing and entered into a bank financing for the $ 2.3 million remainder (see Note 7). The site includes extra land that will be listed for sale once the Bombshells unit is completed. 10 Table of Contents RCI HOSPITALITY HOLDINGS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) Non-Income-Producing Properties • On October 11, 2022, the Company purchased a hangar in Arcola, Texas amounting to $ 754,000 in cash. • On February 6, 2023, in view of the increasing business presence of the Company in the Denver, Colorado area, the Company acquired a non-income-producing corporate property for $ 458,000 in cash. Heartbreakers Gentlemen's Club On October 26, 2022, the Company completed the acquisition of a club in Dickinson, Texas for a total acquisition price of $ 9.0 million. The acquisition includes (1) $ 2.5 million for the adult entertainment business covered in a stock purchase agreement paid fully in cash at closing and (2) $ 6.5 million for the real estate property covered in a real estate purchase agreement paid $ 1.5 million in cash at closing and $ 5.0 million under a 6 % 15-year promissory note (see Note 7). In the stock purchase agreement, the Company acquired 100 % of the capital stock of the company which owned the adult entertainment business. The acquisition gives the Company its first adult club in the Galveston, Texas area market. As of the filing of this report, we have not completed our valuation analysis and related calculations in sufficient detail necessary to arrive at the fair values of the net assets acquired and the debt consideration, but we have preliminarily allocated the acquisition price $ 64,000 to current assets, $ 6.5 million to property and equipment, and $ 2.4 million to goodwill based on the negotiated purchase price. We believe that in this acquisition goodwill represents the existing customer base of the club in the area and the added synergy profitability expansion when we implement the Company's processes into the club. Since we do not have yet the fair value for the assets for the taxable portion of the business combination, we have not yet determined the amount of tax-deductible goodwill. In connection with the acquisition, we incurred approximately $ 23,000 in acquisition-related expenses, which is included in selling, general and administrative expenses in our unaudited condensed consolidated statement of income. From the date of acquisition until December 31, 2022, the club contributed revenue of $ 347,000 and income from operations of $ 57,000 , which are included in our unaudited condensed consolidated statement of income. The seller has not maintained historical U.S. GAAP financial data and it is impracticable to prepare them, therefore, we could not provide supplemental pro forma information of the combined entities. Aurora CO Property On November 8, 2022, the Company purchased real estate in Aurora, Colorado amounting to $ 850,000 in cash for a future Bombshells location. Central City CO Casino Property 1 On December 5, 2022, the Company purchased real estate in Central City, Colorado amounting to $ 2.4 million in cash for the development of a Rick's Cabaret Steakhouse and Casino business. Baby Dolls-Chicas Locas On December 12, 2022, the Company and certain of its subsidiaries entered into definitive agreements to acquire five gentlemen's clubs, five related real estate properties, associated intellectual properties, and certain automated teller machines for a total purchase price of $ 66.5 million, payable with a total of $ 25.0 million in cash, a total of $ 25.5 million in seller financing, and 200,000 restricted shares of common stock based on an $ 80 per share price, subject to lock-up, leak out restrictions. The five clubs, which are all located in Texas, are being purchased through four different asset purchase agreements and one stock purchase agreement, under which a newly formed wholly-owned subsidiary of the Company will acquire from each club-owning entity all of the tangible and intangible assets and personal property used in the business of that club, except for certain excluded assets. The transactions contemplated by these agreements have not yet closed as of the filing of this report. Closing is subject to certain closing conditions. Mark IV Property 11 Table of Contents RCI HOSPITALITY HOLDINGS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) On December 16, 2022, the Company purchased real estate in Fort Worth, Texas amounting to $ 2.4 million in cash. The property has two buildings, one of which the Company is leasing out to an existing tenant and the other building the Company is remodeling for future adult club operations. Grange Food Hall On December 20, 2022, the Company purchased a food hall property in Greenwood Village, Colorado for $ 5.3 million, including direct transaction costs and net of certain accrued taxes amounting to $ 102,000 . The purchase price was paid $ 1.9 million in cash at closing and $ 3.325 million under a 6.67 % five-year promissory note (see Note 7). The Company allocated $ 2.1 million to land, $ 2.6 million to building improvements, $ 98,000 to furniture, fixtures and equipment, and $ 565,000 to in-place leases based on their relative fair values. Tomball Parkway Property Sale On December 28, 2022, the Company sold a property classified as held-for-sale with a carrying value of $ 1.0 million for $ 1.7 million in cash. The Company used $ 1.2 million of the proceeds to pay off a loan related to the property. Central City CO Casino Property 2 On February 6, 2023, the Company purchased real estate in Central City, Colorado amounting to $ 2.2 million in cash for the development of another casino and restaurant business. BMB San Antonio On February 7, 2023, the Company completed the acquisition of a previously franchised Bombshells location in San Antonio, Texas for a total acquisition price of $ 3.2 million. The transaction was effected through a membership interest purchase agreement under which a subsidiary of the Company purchased 100 % of the issued and outstanding membership interests of the target limited liability company that owns and operates the Bombshells location from the six previous owners of the entity (the "Sellers"). At acquisition date, the Sellers were paid $ 1.2 million in cash and were issued six seller-financed promissory notes totaling $ 2.0 million (see Note 7). Due to the proximity of the acquisition date to the filing date of this report, we have not completed our valuation analysis and related calculations to arrive at the fair values of the net assets acquired, any liabilities assumed, and the debt consideration, along with the determination of any goodwill or gain on the transaction. The Company is not providing supplemental pro forma disclosures to this acquisition as it does not materially contribute to the consolidated operations of the Company. 12 Table of Contents RCI HOSPITALITY HOLDINGS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) 5. Revenues Revenues, as disaggregated by revenue type, timing of recognition, and reportable segment (see also Note 11), are shown below (in thousands): Three Months Ended December 31, 2022 Three Months Ended December 31, 2021 Nightclubs Bombshells Other Total Nightclubs Bombshells Other Total Sales of alcoholic beverages $ 22,098 $ 7,552 $ — $ 29,650 $ 18,167 $ 8,264 $ — $ 26,431 Sales of food and merchandise 4,594 5,753 — 10,347 4,589 6,305 — 10,894 Service revenues 25,533 30 — 25,563 20,684 192 — 20,876 Other revenues 4,100 96 212 4,408 3,341 10 284 3,635 $ 56,325 $ 13,431 $ 212 $ 69,968 $ 46,781 $ 14,771 $ 284 $ 61,836 Recognized at a point in time $ 55,918 $ 13,428 $ 211 $ 69,557 $ 46,344 $ 14,770 $ 283 $ 61,397 Recognized over time 407 * 3 1 411 437 * 1 1 439 $ 56,325 $ 13,431 $ 212 $ 69,968 $ 46,781 $ 14,771 $ 284 $ 61,836 * Lease revenue (included in Other Revenues) as covered by ASC 842. All other revenues are covered by ASC 606. The Company does not have contract assets with customers. The Company’s unconditional right to consideration for goods and services transferred to the customer is included in accounts receivable, net in our unaudited condensed consolidated balance sheet. A reconciliation of contract liabilities with customers is presented below (in thousands): Balance at September 30, 2022 Consideration Received Recognized in Revenue Balance at December 31, 2022 Ad revenue $ 82 $ 161 $ ( 126 ) $ 117 Expo revenue 8 321 — 329 Franchise fees 115 — ( 3 ) 112 Other 29 4 ( 29 ) 4 $ 234 $ 486 $ ( 158 ) $ 562 Contract liabilities with customers are included in accrued liabilities as unearned revenues in our unaudited condensed consolidated balance sheets (see also Note 6), while the revenues associated with these contract liabilities are included in other revenues in our unaudited condensed consolidated statements of income. 6. Selected Account Information The components of accounts receivable, net are as follows (in thousands): December 31, 2022 September 30, 2022 Credit card receivables $ 3,229 $ 2,687 Income tax refundable — 2,979 ATM in-transit 1,310 819 Other (net of allowance for doubtful accounts of $ 55 and $ 30 , respectively) 1,477 2,025 Total accounts receivable, net $ 6,016 $ 8,510 13 Table of Contents RCI HOSPITALITY HOLDINGS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) Notes receivable consist primarily of secured promissory notes executed between the Company and various buyers of our businesses and assets with interest rates ranging from 6 % to 9 % per annum and having original terms ranging from 1 to 20 years. The components of prepaid expenses and other current assets are as follows (in thousands): December 31, 2022 September 30, 2022 Prepaid insurance $ 7,301 $ 191 Prepaid legal 46 61 Prepaid taxes and licenses 171 391 Prepaid rent 222 296 Other 871 560 Total prepaid expenses and other current assets $ 8,611 $ 1,499 A reconciliation of goodwill as of December 31, 2022 and September 30, 2022, which is substantially all in Nightclubs segment, is as follows (in thousands): Gross Accumulated Impairment Net Balance at September 30, 2022 $ 88,921 $ 21,154 $ 67,767 Acquisitions (see Note 4) 2,422 — 2,422 Balance at December 31, 2022 $ 91,343 $ 21,154 $ 70,189 The components of intangible assets, net are as follows (in thousands): December 31, 2022 September 30, 2022 Indefinite-lived: Licenses $ 103,972 $ 103,972 Trademarks 13,119 13,119 Domain names 23 23 Definite-lived: Licenses 25,371 25,962 Leases acquired in-place 664 117 Noncompete agreements 40 55 Discounted leases 76 78 Software 684 723 Total intangible assets, net $ 143,949 $ 144,049 14 Table of Contents RCI HOSPITALITY HOLDINGS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) The components of accrued liabilities are as follows (in thousands): December 31, 2022 September 30, 2022 Insurance $ 7,050 $ 30 Sales and liquor taxes 2,095 2,227 Payroll and related costs 3,520 3,186 Property taxes 2,876 2,618 Interest 552 499 Patron tax 517 467 Unearned revenues 562 234 Income taxes 99 — Lawsuit settlement 115 246 Other 1,478 1,821 Total accrued liabilities $ 18,864 $ 11,328 The components of selling, general and administrative expenses are as follows (in thousands): For the Three Months Ended December 31, 2022 2021 Taxes and permits $ 2,684 $ 2,236 Advertising and marketing 2,670 2,383 Supplies and services 2,424 1,980 Insurance 2,582 2,395 Legal 985 1,060 Lease 1,762 1,640 Charge card fees 1,897 1,331 Utilities 1,271 935 Security 1,164 1,087 Stock-based compensation 941 — Accounting and professional fees 1,518 1,346 Repairs and maintenance 1,164 725 Other 1,670 1,368 Total selling, general and administrative expenses $ 22,732 $ 18,486 The components of other gains, net are as follows (in thousands): For the Three Months Ended December 31, 2022 2021 Gain on disposal of businesses and assets ( 590 ) ( 342 ) Settlement of lawsuits — 192 Gain on insurance ( 64 ) ( 1 ) Other gains, net $ ( 654 ) $ ( 151 ) 15 Table of Contents RCI HOSPITALITY HOLDINGS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) 7. Debt On October 10, 2022, in relation to a real estate purchase (see Note 4), the Company borrowed $ 2.3 million from a bank lender. The 18-month promissory note bears an initial interest rate of 6 % per annum to be adjusted daily to a rate equal to the Wall Street Journal prime rate plus 0.5 % with a floor of 6 %. The promissory note is payable in 17 monthly interest-only installments with the full principal and accrued interest payable at maturity. The Company paid approximately $ 26,000 in debt issuance cost at closing. This promissory note is secured by the purchased real estate property. On October 26, 2022, in relation to a club acquisition (see Note 4), the Company executed a promissory note for $ 5.0 million with the seller. The 6 % 15-year promissory note is payable in 180 equal monthly payments of $ 42,193 in principal and interest. This promissory note is secured by the purchased real estate property. On November 18, 2022, in relation to a real estate purchase on September 12, 2022, the Company borrowed $ 1.5 million from a bank lender. The 18-month promissory note bears an initial interest rate of 6 % per annum to be adjusted daily to a rate equal to the Wall Street Journal prime rate plus 0.5 % with a floor of 6 %. The promissory note is payable in 17 monthly interest-only installments with the full principal and accrued interest payable at maturity. This promissory note is secured by the purchased real estate property. On December 20, 2022, the Company executed a promissory note for $ 3.325 million with a bank lender in relation to a purchase of a food hall property (see Note 4). The 6.67 % five-year promissory note is payable in 59 equal monthly installments of $ 22,805 in principal and interest, with the balance of principal and accrued interest payable at maturity. There are certain financial covenants with which the Company is to be in compliance related to this loan. Future maturities of long-term debt as of December 31, 2022 are as follows: $ 13.9 million, $ 29.4 million, $ 14.7 million, $ 10.3 million, $ 13.9 million and $ 132.5 million for the twelve months ending December 31, 2023, 2024, 2025, 2026, 2027, and thereafter, respectively. Of the maturity schedule mentioned above, $ 4.4 million, $ 19.4 million, $ 4.8 million, $ 0 , $ 3.0 million and $ 75.0 million, respectively, relate to scheduled balloon payments. Unamortized debt discount and issuance costs amounted to $ 3.3 million and $ 3.4 million as of December 31, 2022 and September 30, 2022, respectively. On February 7, 2023, in relation to the acquisition of a franchised Bombshells location in San Antonio, Texas (see Note 4), the Company entered into six separate seller-financing promissory notes totaling $ 2.0 million. Each of the promissory notes has an interest rate of 7 % per annum, has a term of 24 months, and is payable in monthly installments totaling $ 39,602 of principal and interest for the first 23 months based on a 60-month amortization schedule with the remaining unpaid principal and interest paid at maturity. 8. Stock-based Compensation On February 7, 2022, our board of directors approved the 2022 Stock Option Plan (the “2022 Plan”). The board’s adoption of the 2022 Plan was approved by the shareholders during the annual stockholders' meeting on August 23, 2022. The 2022 Plan provides that the maximum aggregate number of shares of common stock underlying options that may be granted under the 2022 Plan is 300,000 . The options granted under the 2022 Plan may be either incentive stock options or non-qualified options. The 2022 Plan is administered by the compensation committee of the board of directors. The compensation committee has the exclusive power to select individuals to receive grants, to establish the terms of the options granted to each participant, provided that all options granted shall be granted at an exercise price not less than the fair market value of the common stock covered by the option on the grant date, and to make all determinations necessary or advisable under the 2022 Plan. On February 9, 2022, the board of directors approved a grant of 50,000 stock options each to six members of management subject to the approval of the 2022 Plan. Stock-based compensation for the three months ended December 31, 2022, which is included in corporate segment selling, general and administrative expenses, amounted to $ 941,000 . As of December 31, 2022, we had unrecognized compensation cost amounting to $ 6.1 million related to stock-based compensation awards granted, which is expected to be recognized over a weighted average period of 3.1 years. The February 9, 2022 stock options vest over four years with the first 20 % having vested on the approval of the 2022 Plan at the 2022 annual stockholders' meeting on August 23, 2022, and 20 % vesting on February 9 of each year thereafter, 16 Table of Contents RCI HOSPITALITY HOLDINGS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) provided however that the options will be subject to earlier vesting under certain events set forth in the Plan, including without limitation a change in control. All of the options will expire, if not vested, at the end of five years . The weighted average grant-date fair value of the stock options was $ 31.37 . No stock options were exercised during the three months ended December 31, 2022. As of December 31, 2022, 60,000 stock options were vested and exercisable. For the three months ended December 31, 2022, we excluded 60,000 stock options from the calculation of diluted earnings per share because their effect was anti-dilutive. There were no stock options outstanding during the three months ended December 31, 2021. Aside from the outstanding stock options, there were no other potentially dilutive securities for inclusion in the calculation of diluted earnings per share. 9. Income Taxes Income tax expense was $ 3.0 million and $ 2.9 million during the three months ended December 31, 2022 and 2021, respectively. The effective income tax expense rate was 22.8 % and 21.7 % for the three months ended December 31, 2022 and 2021, respectively. Our effective income tax rate is affected by state taxes, permanent differences, and tax credits, including the FICA tip credit, for both years, as presented below. For the Three Months Ended December 31, 2022 2021 Federal statutory income tax expense 21.0 % 21.0 % State income taxes, net of federal benefit 4.0 % 2.9 % Permanent differences 0.5 % 0.4 % Tax credits ( 2.8 ) % ( 2.0 ) % Other 0.1 % ( 0.6 ) % Total income tax expense 22.8 % 21.7 % The Company or one of its subsidiaries files income tax returns in the U.S. federal jurisdiction, and various states. Fiscal year ended September 30, 2019 and subsequent years remain open to federal tax examination. The Company ordinarily goes through various federal and state reviews and examinations for various tax matters. 10. Commitments and Contingencies Legal Matters Texas Patron Tax A declaratory judgment action was brought by five operating subsidiaries of the Company to challenge a Texas Comptroller administrative rule related to the $ 5 per customer Patron Tax Fee assessed against Sexually Oriented Businesses. An administrative rule attempted to expand the fee to cover venues featuring dancers using latex cover as well as traditional nude entertainment. The administrative rule was challenged on both constitutional and statutory grounds. On November 19, 2018, the Court issued an order that a key aspect of the administrative rule is invalid based on it exceeding the scope of the Comptroller’s authority. On March 6, 2020, the U.S. District Court for the Western District of Texas, Austin Division, ruled that the Texas Patron Tax is unconstitutional as it has been applied and enforced by the Comptroller. The State of Texas appealed to the Fifth Circuit Court of Appeals, who affirmed that the Texas Patron Fee is unconstitutional as applied. The State of Texas next sought review from the Supreme Court, but the high court declined to take the case. That lawsuit is now back before the trial court for post-trial proceedings but is final for purposes of determining the Texas Patron Fee is unconstitutional as applied to clubs featuring dancers using latex cover. Indemnity Insurance Corporation As previously reported, the Company and its subsidiaries were insured under a liability policy issued by Indemnity Insurance Corporation, RRG (“IIC”) through October 25, 2013. The Company and its subsidiaries changed insurance companies on that date. 17 Table of Contents RCI HOSPITALITY HOLDINGS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) On November 7, 2013, the Court of Chancery of the State of Delaware entered a Rehabilitation and Injunction Order (“Rehabilitation Order”), which declared IIC impaired, insolvent and in an unsafe condition and placed IIC under the supervision of the Insurance Commissioner of the State of Delaware (“Commissioner”) in her capacity as receiver (“Receiver”). The Rehabilitation Order empowered the Commissioner to rehabilitate IIC through a variety of means, including gathering assets and marshaling those assets as necessary. Further, the order stayed or abated pending lawsuits involving IIC as the insurer until May 6, 2014. On April 10, 2014, the Court of Chancery of the State of Delaware entered a Liquidation and Injunction Order With Bar Date (“Liquidation Order”), which ordered the liquidation of IIC and terminated all insurance policies or contracts of insurance issued by IIC. The Liquidation Order further ordered that all claims against IIC must have been filed with the Receiver before the close of business on January 16, 2015 and that all pending lawsuits involving IIC as the insurer were further stayed or abated until October 7, 2014. As a result, the Company and its subsidiaries no longer had insurance coverage under the liability policy with IIC. The Company has retained counsel to defend against and evaluate these claims and lawsuits. We are funding 100 % of the costs of litigation and will seek reimbursement from the bankruptcy receiver. The Company filed the appropriate claims against IIC with the Receiver before the January 16, 2015 deadline and has provided updates as requested; however, there are no assurances of any recovery from these claims. It is unknown at this time what effect this uncertainty will have on the Company. As previously stated, since October 25, 2013, the Company has obtained general liability coverage from other insurers, which have covered and/or will cover any claims arising from actions after that date. As of December 31, 2022, we have 1 remaining unresolved claim out of the original 71 claims. Shareholder Derivative Action On January 21, 2022, Shiva Stein and Kevin McCarty filed a shareholder derivative action in the Southern District of Texas, Houston Division against former director Nourdean Anakar, Yura Barabash, former director Steven L. Jenkins, Eric Langan, Luke Lirot, former CFO Phillip K. Marshall, Elaine J. Martin, Allan Priaulx, and Travis Reese as defendants, as well as against RCI Hospitality Holdings, Inc. as nominal defendant. The action, styled Stein v. Anakar, et al., No. 4:22-mc-00149 (S.D. Tex.), alleges claims for breach of fiduciary duty based on alleged dissemination of inaccurate information, alleged failure to maintain internal controls, and alleged failure to properly manage company property. This action is in its preliminary phase, and a potential loss cannot yet be estimated. These allegations are substantively similar to claims asserted in the class action and a prior derivative action that was dismissed in June of 2021. RCI intends to vigorously defend against the action. On April 2, 2022, the Company and its current and former officers and directors named in the shareholder derivative complaint filed their Motions to Dismiss and the derivative plaintiffs have responded. The Motions now have been fully briefed for the Court's consideration. Other On June 23, 2014, Mark H. Dupray and Ashlee Dupray filed a lawsuit against Pedro Antonio Panameno and our subsidiary JAI Dining Services (Phoenix) Inc. (“JAI Phoenix”) in the Superior Court of Arizona for Maricopa County. The suit alleged that Mr. Panameno injured Mr. Dupray in a traffic accident after being served alcohol at an establishment operated by JAI Phoenix. The suit alleged that JAI Phoenix was liable under theories of common law dram shop negligence and dram shop negligence per se. After a jury trial proceeded to a verdict in favor of the plaintiffs against both defendants, in April 2017 the Court entered a judgment under which JAI Phoenix’s share of compensatory damages is approximately $ 1.4 million and its share of punitive damages is $ 4 million. In May 2017, JAI Phoenix filed a motion for judgment as a matter of law or, in the alternative, motion for new trial. The Court denied this motion in August 2017. In September 2017, JAI Phoenix filed a notice of appeal. In June 2018, the matter was heard by the Arizona Court of Appeals. On November 15, 2018 the Court of Appeals vacated the jury’s verdict and remanded the case to the trial court. It is anticipated that a new trial will occur at some point in the future. JAI Phoenix will continue to vigorously defend itself. As set forth in the risk factors as disclosed in this report, the adult entertainment industry standard is to classify adult entertainers as independent contractors, not employees. While we take steps to ensure that our adult entertainers are deemed independent contractors, from time to time, we are named in lawsuits related to the alleged misclassification of entertainers. Claims are brought under both federal and where applicable, state law. Based on the industry standard, the manner in which the independent contractor entertainers are treated at the clubs, and the entertainer license agreements governing the entertainer’s work at the clubs, the Company believes that these lawsuits are without merit. Lawsuits are handled by attorneys with an expertise in the relevant law and are defended vigorously. 18 Table of Contents RCI HOSPITALITY HOLDINGS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) General In the regular course of business affairs and operations, we are subject to possible loss contingencies arising from third-party litigation and federal, state, and local environmental, labor, health and safety laws and regulations. We assess the probability that we could incur liability in connection with certain of these lawsuits. Our assessments are made in accordance with generally accepted accounting principles, as codified in ASC 450-20, and is not an admission of any liability on the part of the Company or any of its subsidiaries. In certain cases that are in the early stages and in light of the uncertainties surrounding them, we do not currently possess sufficient information to determine a range of reasonably possible liability. In matters where there is insurance coverage, in the event we incur any liability, we believe it is unlikely we would incur losses in connection with these claims in excess of our insurance coverage. Settlements of lawsuits for the three months ended December 31, 2022 and 2021 amount to approximately $ 0 and $ 192,000 , respectively. As of December 31, 2022 and September 30, 2022, the Company has accrued $ 115,000 and $ 246,000 in accrued liabilities, respectively, related to settlement of lawsuits. 19 Table of Contents RCI HOSPITALITY HOLDINGS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) 11. Segment Information The Company owns and operates adult nightclubs and Bombshells Restaurants and Bars. The Company has identified such segments based on management responsibility and the nature of the Company’s products, services and costs. There are no major distinctions in geographical areas served as all operations are in the United States. The Company measures segment profit (loss) as income (loss) from operations. Segment assets are those assets controlled by each reportable segment. The Other category below includes our media and energy drink divisions that are not significant to the unaudited condensed consolidated financial statements. Below is the financial information related to the Company’s segments (in thousands): For the Three Months Ended December 31, 2022 2021 Revenues (from external customers) Nightclubs $ 56,325 $ 46,781 Bombshells 13,431 14,771 Other 212 284 $ 69,968 $ 61,836 Income (loss) from operations Nightclubs $ 22,740 $ 18,736 Bombshells 1,847 2,802 Other ( 185 ) ( 43 ) Corporate ( 7,504 ) ( 5,584 ) $ 16,898 $ 15,911 Depreciation and amortization Nightclubs $ 2,485 $ 1,547 Bombshells 458 429 Other 63 6 Corporate 301 212 $ 3,307 $ 2,194 Capital expenditures Nightclubs $ 4,144 $ 9,228 Bombshells 8,319 304 Other 37 189 Corporate 53 129 $ 12,553 $ 9,850 20 Table of Contents RCI HOSPITALITY HOLDINGS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) December 31, 2022 September 30, 2022 Total assets Nightclubs $ 444,362 $ 428,104 Bombshells 65,584 62,021 Other 2,758 2,635 Corporate 43,454 37,978 $ 556,158 $ 530,738 Excluded from revenues in the table above are intercompany rental revenues of the Nightclubs and Corporate segments for the three months ended December 31, 2022 amounting to $ 3.7 million and $ 231,000 , respectively, and intercompany sales of Robust Energy Drink included in Other segment amounting to $ 37,000 . Excluded from revenues in the table above are intercompany rental revenues of the Nightclubs and Corporate segments for the three months ended December 31, 2021 amounting to $ 3.2 million and $ 168,000 , respectively, and intercompany sales of Robust Energy Drink included in Other segment amounting to $ 69,000 . These intercompany revenue amounts are eliminated upon consolidation. General corporate expenses include corporate salaries, health insurance and social security taxes for officers, legal, accounting and information technology employees, corporate taxes and insurance, legal and accounting fees, depreciation and other corporate costs such as automobile and travel costs. Management considers these to be non-allocable costs for segment purposes. Certain real estate assets previously wholly assigned to Bombshells have been subdivided and allocated to other future development or investment projects. Accordingly, those asset costs have been transferred out of the Bombshells segment. 12. Related Party Transactions Presently, our Chairman and President, Eric Langan, personally guarantees all of the commercial bank indebtedness of the Company. Mr. Langan receives no compensation or other direct financial benefit for any of the guarantees. The balance of our commercial bank indebtedness, net of debt discount and issuance costs, as of December 31, 2022 and September 30, 2022, was $ 120.1 million and $ 115.1 million, respectively. Included in the $ 17.0 million borrowing on October 12, 2021 are notes borrowed from related parties—one note for $ 500,000 (Ed Anakar, an employee of the Company and brother of our former director Nourdean Anakar) and another note for $ 150,000 (from a brother of Company CFO, Bradley Chhay) in which the terms of the notes are the same as the rest of the lender group. We used the services of Nottingham Creations, and previously Sherwood Forest Creations, LLC, both furniture fabrication companies that manufacture tables, chairs and other furnishings for our Bombshells locations, as well as providing ongoing maintenance. Nottingham Creations is owned by a brother of Eric Langan (as was Sherwood Forest). Amounts billed to us for goods and services provided by Nottingham Creations and Sherwood Forest were $ 0 and $ 24,037 during the three months ended December 31, 2022 and 2021, respectively. As of December 31, 2022 and September 30, 2022, we owed Nottingham Creations and Sherwood Forest $ 13,174 and $ 92,808 , respectively, in unpaid billings. TW Mechanical LLC provided plumbing and HVAC services to both a third-party general contractor providing construction services to the Company, as well as directly to the Company during fiscal 2023 and 2022. A son-in-law of Eric Langan owns a 50 % interest in TW Mechanical. Amounts billed by TW Mechanical to the third-party general contractor were $ 0 and $ 0 for the three months ended December 31, 2022 and 2021, respectively. Amounts billed directly to the Company were $ 0 and $ 80,996 for the three months ended December 31, 2022 and 2021, respectively. As of December 31, 2022 and September 30, 2022, the Company owed TW Mechanical $ 0 and $ 9,338 , respectively, in unpaid direct billings. 21 Table of Contents RCI HOSPITALITY HOLDINGS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) 13. Leases Total lease expense included in selling, general and administrative expenses in our unaudited condensed consolidated statements of income for the three months ended December 31, 2022 and 2021 is as follows (in thousands): Three Months Ended December 31, 2022 2021 Operating lease expense – fixed payments $ 1,259 $ 1,131 Variable lease expense 427 334 Short-term and other lease expense (includes $ 64 and $ 72 recorded in advertising and marketing, and $ 127 and $ 83 recorded in repairs and maintenance for the three months ended December 31, 2022 and 2021, respectively; see Note 6) 267 330 Sublease income — ( 2 ) Total lease expense, net $ 1,953 $ 1,793 Other information: Operating cash outflows from operating leases $ 1,910 $ 1,749 Weighted average remaining lease term – operating leases 11.2 years 12.4 years Weighted average discount rate – operating leases 5.6 % 5.7 % Future maturities of operating lease liabilities as of December 31, 2022 are as follows (in thousands): Principal Payments Interest Payments Total Payments January - December 2023 $ 2,850 $ 2,060 $ 4,910 January - December 2024 3,068 1,895 4,963 January - December 2025 3,331 1,717 5,048 January - December 2026 3,583 1,523 5,106 January - December 2027 3,345 1,325 4,670 Thereafter 21,943 4,933 26,876 $ 38,120 $ 13,453 $ 51,573 22 Table of Contents