UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

 

Form 10-K

 

 

Commission File Number: 001-32208

 

VCG HOLDING CORP.

(Exact Name of Registrant as Specified in its Charter)

 

 

Registrant’s telephone number, including area code:

(303) 934-2424

 

Securities registered pursuant to Section 12(b) of the Act:

 

 

Securities registered pursuant to Section 12(g) of the Act:

None

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes o     No þ

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes o     No þ

 

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 þ     No o

 

Indicate by a check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 229.405) of this chapter) during the preceding 12 months (or for such shorter period)  Yes o     No þ

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405) is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment of this Form 10-K.  o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o     No þ

 

The aggregate market value of the voting common equity held by non-affiliates of the registrant as of the last business day of the second fiscal quarter, June 30, 2009, was $25,955,857 (computed by reference to the average sale price as reported on the NASDAQ Global Market). As of March 12, 2010, there were 17,310,723 shares of the registrant’s Common Stock, par value of $.0001 per share, outstanding.

 

 

VCG HOLDING CORP.

 

FORM 10-K

 

TABLE OF CONTENTS

 

 

Forward-Looking Statement Disclaimer

 

In this report, references to “VCG Holding Corp,” “VCG”, the “Company,” “we,” “us,” and “our” refer to VCG Holding Corp. and its subsidiaries.

 

This Annual Report on Form 10-K contains certain forward-looking statements and, for this purpose, any statements contained herein that are not statements of historical fact are intended to be “forward-looking statements” with the meaning of the Private Securities Litigation Reform Act of 1995. Without limiting the foregoing, words such as “may,” “will,” “expect,” “believe,” “anticipate,” “intend,” “estimate,” “continue,” or comparable terminology, are intended to identify forward-looking statements. These statements by their nature involve substantial risks and uncertainties, and actual results may differ materially depending on a variety of factors, many of which are not within our control. These factors include, but are not limited, to, costs and liabilities associated with the proposed going private transaction and associated litigation and the proposed merger transaction, our inability to retain employees and members of management due to uncertainty about our future direction due to the proposed merger transaction, costs and liabilities associated with our inability to successfully close the proposed merger transaction or any other similar transaction, the possibility that we may be prohibited from closing the proposed merger transaction or forced to rescind it if it has been consummated and pay damages as a result of litigation, diversion of management’s attention caused by the proposed merger transaction and associated litigation, our limited operating history making our future operating results difficult to predict, the availability of, and costs associated with, potential sources of financing, disruptions in the credit markets, economic conditions generally and in the geographical markets in which we may participate, our inability to manage growth, difficulties associated with integrating acquired businesses into our operations, geographic market concentration, legislation and government regulations affecting us and our industry, competition within our industry, our failure to promote our brands, our failure to protect our brands, the loss of senior management and key personnel, potential conflicts of interest between us and Troy Lowrie, our Chairman of the Board and Chief Executive Officer (“CEO”), our failure to comply with licensing requirements applicable to our business, liability from unsanctioned, unlawful conduct at our nightclubs, the negative perception of our industry, the failure of our business strategy to generate sufficient revenues, liability from uninsured risks or risks not covered by insurance proceeds, claims for indemnification from officers and Directors, deterrence of a change of control because of our ability to issue securities or from the severance payment terms of certain employment agreements with senior management, our failure to meet the NASDAQ continued listing requirements, the failure of securities analysts to cover our common stock, our failure to comply with securities laws when issuing securities, our common stock being a penny stock, our intention not to pay dividends on our common stock, our future issuance of common stock depressing the sale price of our common stock or diluting existing stockholders, the limited trading market for, and volatile price of, our common stock, and our inability to comply with rules and regulations applicable to public companies.

 

We caution readers not to place undue reliance on any forward-looking statements, which speak only as of the date made and are based on certain assumptions and expectations which may or may not be valid or actually occur and which involve various risks and uncertainties.

 

Unless otherwise required by applicable law, we do not undertake, and specifically disclaim any obligation, to update any forward-looking statements to reflect occurrences, developments, unanticipated events or circumstances after the date of such statement.

 

 

General Information

 

Our Company was incorporated under the laws of the State of Colorado in 1998, but did not begin its operations until April 2002. The Company, through its subsidiaries, owns 20 adult nightclubs that offer quality live adult entertainment, restaurant and bar operations. Our nightclubs are located in Colorado, California, Florida, Illinois, Indiana, Kentucky, Minnesota, North Carolina, Maine, and Texas.

We believe maximum profitability and sustained growth in the industry is obtained by owning and operating upscale adult nightclubs. Our current strategy is to acquire upscale adult nightclubs in areas that are not market saturated and where the public is open to these types of establishments. Another part of our growth strategy is to achieve nightclub “clustering.” Adult nightclubs tend to group together in their respective markets. We believe that clustering our nightclubs leads to improved brand recognition, as well as some improvement in economies of scale as costs of marketing are spread over more nightclubs. Clustering also provides the Company with the ability to disperse management expertise to more locations under their responsibility.

 

Business

 

We operate the following nightclubs:

 

 

The Company classifies its clubs into three tiers called A, B, and C clubs. Type “A” club characteristics include larger facilities with a variety of entertainment and performers. “A” clubs include a restaurant with an onsite chef preparer. Furthermore, “A” type clubs offer high-label cigars, VIP facilities, and specialty suites. Type “B” clubs have smaller facilities. Food service is limited or not provided, but the facility serves alcohol. These clubs are a topless format. Type “C” clubs do not provide alcoholic beverages, except for Texas locations that follow the “Bring Your Own Bottle” (“B.Y.O.B”) format. These clubs are “all-nude.”

 

The Company owns International Entertainment Consultants, Inc. (“IEC”), which provides management services to our clubs. IEC was originally formed in 1980. At the time of acquisition in October 2003, IEC was owned by Troy Lowrie, our Chairman of the Board and CEO.

 

The day-to-day management of our clubs is conducted through IEC. IEC provides the clubs with management and supervisory personnel to oversee operations, hires and contracts all operating personnel, establishes club policies and procedures, handles compliance monitoring, purchasing, accounting and other administrative services, and prepares financial and operating reports, and income tax returns. IEC charges the clubs a management fee based on the Company’s common expenses that are incurred in maintaining these functions.

 

In June 2002, the Company formed VCG Real Estate Holdings, Inc. (“VCG-RE”), a wholly owned subsidiary that currently owns the land and buildings of two of our nightclubs. On July 31, 2009, VCG-RE sold another piece

of the real property located in Phoenix, Arizona to Black Canyon Highway LLC, a Texas limited liability company. As of December 31, 2009, VCG-RE owns both the real property on which PT’s^® Showclub in Indianapolis, IN and PT’s^® Brooklyn in Brooklyn, IL are located.

 

The Company has one reportable segment. Our clubs are distinguished by the following features:

 

 

Working Capital

 

We have historically reported negative working capital, where current liabilities exceed current assets. This is consistent with other businesses in our industry who report a working capital deficit, which increases net cash provided by operating activities. This is because we receive immediate cash payment for sales, while inventories, accrued expenses, and other current liabilities normally carry longer payment terms.

 

Advertising and Promotion

 

Our ability to attract patrons to a nightclub for the first time is critical to a nightclub’s success. Promotions, advertising, and special offers are the typical means to market a nightclub. We use a variety of highly targeted methods to reach our customers including local radio, billboard trucks, internet, newspaper and magazine ads, and professional sporting events.

 

We extensively utilize a marketing program developed by IEC. Our nightclubs are marketed as a safe and upscale environment for adult entertainment. The marketing strategy is to attract new customers, increase the frequency of visits by existing customers, and establish a higher level of name recognition. The target market is the business-convention traveler, local professionals, and business people. In addition, IEC conducts various promotional activities throughout the year to keep the nightclubs’ names before the public. In order to be good corporate citizens, the nightclubs actively sponsor and participate in local charitable events and make contributions to local charities.

 

Compliance Policies and Controls

 

IEC has developed comprehensive policies aimed at ensuring that the operation of each nightclub is conducted in conformance with local, state, and federal laws and they are designed to assure our clients a quality and enjoyable experience. We have a “no tolerance” policy on illegal drug use in or around the facilities. We continually monitor the actions of entertainers, employees, and customers to ensure that proper behavior standards are met.

We believe that operational and accounting controls are essential to the successful operation of a cash intensive nightclub and bar business. IEC has also developed and implemented internal operating and accounting controls to track cash, credit card transactions, and food and beverage inventory. We have installed an Aloha point of sale system, including restaurant fraud tracking software, in all our clubs. These controls also help to maintain the accuracy of our operating and accounting records. IEC has developed other special software programs to capture operating information and generate reports for efficient management and control of the nightclubs. We review all revenue information on a daily basis by club.

 

Patents, Trademarks, Licenses and Royalty Agreements

 

Under the terms of a 2005 Licensing Agreement and in consideration of royalty payments to General Media Communications, Inc., Penthouse granted us a five-year non-exclusive license, renewable in five years, for the use of the registered trademarks “Penthouse”, “Pet of the Month”, “Pet of the Year”, “Three-Key Logo” and “One-Key Logo” in our nightclub operations in Denver, Colorado and St. Louis, Illinois. The royalty payments are based on a percentage of revenue. We also have permission to use the name “Jaguar’s Gold Club” for our nightclubs located in Dallas and Ft. Worth, Texas without a fee.

 

The “Diamond Cabaret^®” name and “PT’s^®” name and logo are trademarks registered with the U.S. Patent and Trademark Office. We have an indefinite license from Club Licensing, LLC, which is controlled and majority-owned by Troy Lowrie, who is a significant stockholder and our Chairman of the Board and CEO, to use the “PT’s^®” trademark for a fee. Roxy’s is a service mark registered with the state of Illinois also owned by Club Licensing, LLC. The fee was established in 2006 and approved by the independent members of our Board of Directors (“Board”). The licensing fee amount has not changed for several years. The Men’s Club^® has a annually renewable license from the Texas Richmond Corporation.

 

Some of our nightclubs operate under owned trade names as opposed to licensed registered trademarks. The Company has three nightclubs that own trade names, which are used to market the nightclubs, set forth in the table below.

 

 

The Company does not pay royalties for the use of the owned trade names on its own products and services. The trade names are valuable in the operation of the nightclubs and their dealings with customers. We have valued the three trade names using the “income approach”. The income approach is based on the premise that free cash flow is a more valid criterion for measuring value than “book” or accounting profits. The after-tax nightclub free cash flows were discounted back to their net present value at an appropriate intangible rate of return to estimate the fair value of the trade names. All trade names have indefinite lives based on management’s expectations that we will continue using the trade names in the future.

 

Our nightclubs hold several licenses (including liquor, dance, and cabaret licenses) that are essential to the operation of our business. Dance or cabaret licenses are not salable, yet they can be transferred if a nightclub is transferred with approval. We estimated the fair value of cabaret licenses by using a variation of the income approach called the excess earnings method. This approach measures the present worth and anticipated future benefits of the license. The appropriate expenses were deducted from the sales attributable to the licenses and economic rents were charged for the use of other contributory assets. Economic rents are charges in the form of an expense to account for the assets’ reliance on other tangible and intangible assets in order to generate sales. The nightclub after-tax cash flows attributable to the assets were discounted back to their net present value at an appropriate intangible asset rate of return and summed to indicate a value for the licenses. All licenses have indefinite lives based on management’s expectations that we will continue using the licenses in the future.

 

Seasonality

 

We do not consider our business to be seasonal; however, severe winter weather can limit customers from visiting our nightclubs.

Customers

 

The business of the Company taken as a whole, or any individual club, is not dependent upon any single customer or a few customers.

 

Competition

 

The adult nightclub entertainment business is highly competitive with respect to price, location and quality of the facility, entertainment, service, and food and beverages. Due to the highly fragmented nature of the adult nightclub industry, exact industry details are sparse about the actual number of operating nightclubs in the United States. However, various sources state that there are approximately 3,000 to 4,000 adult nightclubs in the United States with no clear industry leader. We have many competitors in the metropolitan areas in which we are located and/or intend to expand. Our current nightclubs compete with locally owned nightclub owners. Three of our locations compete with nightclubs owned by Rick’s Cabaret International, Inc. (“Ricks”). Changes in customer preferences, economic conditions, demographic trends, and the location, number of, and quality of competing nightclubs could adversely affect our business, as could a shortage of experienced local management and hourly employees. We believe that our nightclubs enjoy a high level of repeat business and customer loyalty due to our upscale restaurant atmosphere, food quality, premium entertainment, perceived price-value relationship, and efficient service. 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.

 

Government Regulations

 

Our business is regulated by zoning, local and state liquor licensing, and local ordinances. Also, we are subject to state and federal time, place, and manner free speech restrictions. In the states in which we currently operate, state liquor licenses renew annually and are considered to be a “privileged” license that could be subject to suspension or revocation. The adult entertainment provided by our nightclubs has elements of free speech and expression and therefore, has some protection under the First Amendment to the U.S. Constitution. However, the protection is limited to expression, and not conduct. In addition to various regulatory requirements affecting the sale of alcoholic beverages in many cities where we operate, the location of a topless cabaret is subject to restriction by city ordinance. These ordinances affect the locations in which sexually oriented businesses may be operated by typically requiring minimum distances to schools, churches, and other sexually oriented businesses and containing 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; such a business permit must be granted if the proposed operation satisfies the requirements of the applicable ordinance.

 

In all states where we operate, management believes that we comply with applicable laws, regulations, and ordinances governing the sale of alcohol and the operation of sexually oriented businesses. While our nightclubs are generally well established in their respective markets, there can be no assurance that local, state, and/or federal licensing and other regulations will permit our nightclubs to remain in operation or be profitable in the future.

 

Employees and Independent Contractors

 

As of March 11, 2010, we had approximately 925 employees, of which 135 were full-time management employees including corporate and administrative operations, and approximately 790 who were engaged in entertainment, food, and beverage service, including bartenders and waitresses. None of our employees are represented by a union nor have we ever suffered a work stoppage. Our entertainers in Minneapolis, Minnesota act as commissioned employees. As of March 11, 2010, we had independent contractor relationships with approximately 2,000 entertainers in other states, who are self-employed and perform at our locations on a non-exclusive basis. Independent contractors/entertainers pay a fee to the nightclub to perform.

 

Potential Sale of the Company

 

As previously reported on the Company’s Current Reports on Form 8-K (filed with the Securities and Exchange Commission (“SEC”) on November 4, 2009, November 19, 2009, November 25, 2009, December 7, 2009 and December 17, 2009), on November 3, 2009, the Company received a non-binding letter of intent (the

“Proposal”) from the Company’s Chairman and CEO, Troy Lowrie, Lowrie Management, LLLP, an entity controlled by Mr. Lowrie, and certain other unidentified investors (collectively, the “Lowrie Investors”), to acquire all of the outstanding common stock of the Company for $2.10 per share in cash (the “Going Private Transaction”). The Proposal contemplated that the Company would no longer be a public reporting or trading company following the closing of the Going Private Transaction. In response to the Proposal, the Board formed a Special Committee consisting solely of directors who are independent under the NASDAQ Global Market (“NASDAQ”) independence rules to review and evaluate the Proposal. The Special Committee was formed in order to properly and fairly represent the best interests of the Company’s shareholders in a full and diligent evaluation of the Proposal and any alternatives thereto in order to maximize shareholder value. The members of the Special Committee are George Sawicki, Kenton Sieckman and Carolyn Romero. The Special Committee retained a financial advisor and independent legal counsel to assist the Special Committee in its evaluation of the Proposal and alternatives thereto. On December 16, 2009, the Special Committee informed the Lowrie Investors that it had determined, with input from its advisors, that the terms of the Proposal were currently inadequate, and the Special Committee directed its financial advisors to contact any parties that had either previously expressed an interest or might potentially be interested in pursuing a transaction with the Company.

 

In connection with the Proposal, the Company has been served with three complaints (the “Complaints”) filed by various plaintiffs, alleging that they bring purported derivative and class action lawsuits against the Company and each of the individual members of the Board on behalf of themselves and all others similarly situated and derivatively on behalf of the Company, which previously have been reported in the Company’s Current Reports on Form 8-K (filed with the SEC on November 19, 2009, November 24, 2009 and December 7, 2009). The Complaints allege, among other things, that the consideration in the Proposal is inadequate, that Mr. Lowrie has conflicts of interest with respect to the Proposal and that in connection with the Board’s evaluation of the Proposal, the individual defendants have breached their fiduciary duties under Colorado law. The Complaints seek, among other things, certification of the individual plaintiffs as a class representative, either an injunction enjoining the defendants from consummating or closing the Going Private Transaction, or if the Going Private Transaction is consummated, rescission of the Going Private Transaction, an injunction directing the Board members to comply with their fiduciary duties, an award of damages in an amount to be determined at trial, an accounting to the Plaintiffs and the class for alleged damages suffered or to be suffered based on the conduct described in the Complaint, an award of reasonable attorneys’ and experts’ fees, and such other relief the court deems just and proper. As of the date hereof, the Company believes that the allegations set forth in the Complaints are baseless and the Company intends to vigorously defend itself in the lawsuits.

 

As reported on the Company’s Current Report on Form 8-K filed with the SEC on February 17, 2010, the Company, Rick’s, Mr. Lowrie, and Lowrie Management, LLLP (collectively with Mr. Lowrie, “Lowrie”), entered into a non-binding (except as to certain provisions, including exclusivity and confidentiality) letter of intent (the “Letter of Intent”). Pursuant to the Letter of Intent, Rick’s agreed to acquire all of the outstanding shares of common stock of the Company and the Company will merge with and into Rick’s or a wholly-owned subsidiary of Rick’s (the “Merger”). In the event the Merger is consummated, the Company will become a subsidiary of Rick’s and the Company’s shareholders will become shareholders of Rick’s. The parties intend that the Merger will be structured to qualify as a tax-free reorganization under the Internal Revenue Code of 1986, as amended.

 

Pursuant to the Letter of Intent, the Company’s shareholders will receive shares of common stock of Rick’s in exchange for their shares of the Company’s common stock based on an exchange ratio that values each share of the Company’s common stock between $2.20 and $3.80 per share. The applicable exchange ratio will be determined based on the weighted average closing price of Rick’s common stock on NASDAQ for the 20 consecutive trading days ending on the second trading day prior to the closing of the Merger. In the event the price per share of Rick’s common stock as determined by this formula is below $8.00, Rick’s may terminate the Merger agreement, subject to the payment to the Company of a termination fee to be negotiated by the parties in connection with the preparation of the Merger agreement. As of February 16, 2010 (assuming the Merger were to close on such date and the weighted average closing price per share of Rick’s common stock for the 20 consecutive trading days ending on February 11, 2010 was equal to the closing price of Rick’s common stock on February 11, 2010 of $11.76 per share), the value of each share of the Company’s common stock under this formula would be $2.66 per share.

Contemporaneously with the closing of the Merger, Rick’s has agreed to acquire 5,770,197 shares of the Company’s common stock held by Lowrie and its affiliates (the “Lowrie Common Stock”) for cash in an amount equal to the lesser of $2.44 per share or the per share value of the common stock received by the Company’s shareholders in the Merger. At Lowrie’s election, Lowrie may receive Rick’s common stock, at the same exchange ratio received by the Company’s shareholders in the Merger, for up to 30% of the Lowrie Common Stock. In addition, Mr. Lowrie will (i) refinance (at a lower interest rate) and continue to carry a $5.7 million note from the Company (as acquired by Rick’s), (ii) continue to personally guarantee certain Company obligations in exchange for a to-be-determined fair market value cash payment for such guarantees, (iii) sell to Rick’s the outstanding capital stock of Club Licensing, Inc., a wholly-owned subsidiary of Lowrie Management, LLLP that owns the trademarks “Diamond Cabaret” and “PT’s,” (the “Trademarks”), and (iv) enter into a three-year consulting agreement with Rick’s (collectively, the “Lowrie Transactions”). In exchange for the Lowrie Transactions, Lowrie will receive the following: (a) a to-be-determined amount equal to the fair market value of the restructuring of the $5.7 million note and continued personal guarantees (currently estimated to be $2 million); (b) a to-be-determined amount equal to the fair market value of the Trademarks (currently estimated to be $5 million); and (c) payment of $1.0 million over three years and a monthly expense allowance equal to $1,500 under the consulting agreement. Assuming Lowrie elects to be paid solely in cash at a price of $2.44 per share of the Company’s common stock and the fair market value of the Lowrie Transactions is as set forth above (totaling $7.0 million), Lowrie will receive aggregate payments of approximately $26.8 million (which amount includes the restructuring of the existing $5.7 million note held by Mr. Lowrie and excludes payments under the consulting agreement) in connection with the Merger, of which approximately $16.8 million will be payable in cash at the closing of the Merger and $10.0 million will be payable pursuant to a four-year promissory note from Rick’s bearing interest at 8.0% per annum.

 

The Letter of Intent provided for a binding exclusivity period through March 12, 2010, which the parties have extended to March 31, 2010, during which time the Company has agreed, on behalf of itself and its representatives, to negotiate exclusively with Rick’s and has further agreed not to solicit any offer or engage in any negotiations other than with Rick’s for the merger, sale of the business or assets of the Company or tender or exchange offer for the Company’s common stock. In the event the Company receives an unsolicited offer that is superior to the terms of the Merger (a “Superior Proposal”) and Rick’s does not amend its offer within five business days of the date on which it receives notice of such Superior Proposal to be superior to the Superior Proposal, then the Company may terminate the Letter of Intent. If the Company terminates the Letter of Intent due to its receipt of a Superior Proposal, it has agreed to reimburse Rick’s for its out-of-pocket expenses and fees incurred in evaluating and negotiating the Merger in an amount not to exceed $250,000 in the aggregate. If a definitive Merger agreement is not entered into by March 31, 2010, the Letter of Intent will automatically terminate, unless further extended by the parties.

 

The Merger agreement is expected to contain customary representations and warranties including the absence of a material adverse change in the business of Rick’s and the Company prior to closing and other customary closing conditions, including but not limited to, the receipt of material consents, the approval of the Merger by the shareholders of Rick’s and the Company and the effectiveness of a registration statement containing a joint proxy statement/prospectus filed with the SEC on Form S-4 to be filed by Rick’s, which, among other things, registers the shares of common stock to be issued to the Company’s shareholders in the Merger. There can be no assurance that the Company, Rick’s and Lowrie will enter into a definitive Merger agreement, that the entry into a definitive Merger agreement, if any, will result in the closing of any transaction or that the terms of any definitive Merger documents will reflect the terms of the proposed Merger as outlined in the Letter of Intent. See the discussion under the heading, “Risk Factors.”

 

Available Information

 

The Company’s website is www.vcgh.com. The Company’s periodic reports and all amendments to those reports required to be filed or furnished pursuant to Section 13(a) or Section 15(d) of the Securities Exchange Act of 1934 are available free of charge through its website. The Company will continue to post its periodic reports on Form 10-K and Form 10-Q and its current reports on Form 8-K and any amendments to those documents to our website as soon as reasonably practicable after those reports are filed with, or furnished to, the SEC. Material contained on the Company’s website is not incorporated by reference into this Report on Form 10-K.

 

Our business prospects are subject to various risks and uncertainties that impact our business. You should carefully consider the following discussion of risks, and the other information provided in this Annual Report on Form 10-K. The risks described below are not the only ones we face. Additional risks that are presently unknown to us or that we currently deem immaterial may also impact our business.

 

The process of negotiating and consummating the proposed merger transaction or any other transaction, as well as the failure to successfully consummate such a transaction, could adversely affect our business.

 

The process of analyzing, negotiating, documenting, and consummating (in each case, as necessary) the proposed merger or any other transaction resulting from the processes conducted by the legal and financial advisors to the Special Committee of our Board could cause disruptions in our business, which could have an adverse effect on our financial results. Among other things, uncertainty as to whether the proposed merger or any alternative transaction will be completed may cause current and prospective employees and members of management to become uncertain about their future roles with the Company if the transaction is completed. This uncertainty could adversely affect our ability to retain employees, members of management, and our relationships with customers and vendors. In addition, despite the fact that a Special Committee has been formed to manage and oversee any transaction and the Special Committee is being advised by outside professionals, the attention of management and other resources may be directed toward a potential transaction and diverted from day-to-day operations. Further, the costs associated with these processes are expected to be considerable, regardless of whether any transaction is approved or consummated. There is no assurance that the proposed merger or any other transaction will occur. If the proposed merger or any other transaction is not completed, the share price of our common stock may change to the extent that the current market price of our common stock reflects an assumption that a transaction will be completed. Finally, a failed transaction may result in negative publicity and/or a negative impression of us in the investment community. All of the foregoing could materially adversely affect our business, results of operations and financial condition.

 

We are subject to litigation related to the proposed going private transaction, which could affect our ability to consummate a transaction, force us to rescind a transaction if it is consummated before the conclusion of the litigation or otherwise adversely affect our business or stock price.

 

As previously disclosed in Current Reports on Form 8-K and Item 3 of this Annual Report, four complaints have been filed relating to the original going private transaction. The defendants in these lawsuits include varying combinations of the Company, the members of the Company’s Board, and Troy Lowrie, the Company’s Chairman and CEO. Among other things, the complaints seek to enjoin the Company, its directors, and certain of its officers from consummating the proposed going private transaction. The going private transaction offer made by Troy Lowrie was deemed inadequate by the Special Committee of the Board on December 16, 2009. On February 16, 2010, the Company signed a letter of intent to merge operations with Rick’s Cabaret International, Inc. as a wholly-owned subsidiary. Additional lawsuits pertaining to the proposed merger transaction could be filed in the future or the existing lawsuits could affect the proposed merger transaction.

 

If successful, the results of any lawsuits could be that the Company could be prohibited from consummating a proposed transaction, or, if it has been consummated, the Company could be forced to rescind it. The Company could also be required to pay damages to the plaintiffs. Any conclusion of these lawsuits or any other in a manner adverse to the Company could have a material adverse effect on the Company’s business, results of operations, financial condition, and cash flow. In addition, the cost to the Company of defending these or any other lawsuits, even if resolved in the Company’s favor, could be substantial. Such lawsuits could also substantially divert the attention of the Company’s management and other resources.

 

We have had limited operations which makes our future operating results difficult to predict.

 

Our Company was incorporated under the laws of the State of Colorado in 1998, but did not begin its operations until April 2002. The Company through its subsidiaries currently owns (in total or in partnerships) and operates 20 adult nightclubs that offer quality live adult entertainment, restaurant, and bar operations.

We have a limited operating history and face the risk and uncertainties of other early-stage companies. Because of our limited operating history, we may not be able to correctly estimate our future operating expenses, which could lead to cash shortfalls. Our budgeted expense levels are based in part on our expectations concerning future revenues. We may be unable to adjust our operations in a timely manner to compensate for any unexpected shortfall in revenues. Accordingly, a significant shortfall in demand for our services would decrease our revenues and could have an immediate and material adverse effect on our business, results of operations, and financial condition. To the extent that expenses precede or are not rapidly followed by increased revenue, our business, results of operations, and financial condition may be materially adversely affected.

 

Our inability to obtain capital, use internally generated cash, or use our securities or debt to finance future expansion efforts could impair the growth and expansion of our business.

 

Reliance on internally generated cash or debt to finance our operations or complete business expansion efforts could substantially limit our operational and financial flexibility. The extent to which we will be able or willing to issue securities to consummate expansions will depend on the market value of our securities from time to time and the willingness of potential investors, sellers, or business partners to accept it as full or partial payment. Using securities for this purpose also may result in significant dilution to our then existing stockholders. To the extent that we are unable to use securities to make future expansions, our ability to grow through expansions may be limited by the extent to which we are able to raise capital for this purpose through debt or equity financings. Raising external capital in the form of debt could require periodic interest payments that could hinder our financial flexibility in the future. No assurance can be given that we will be able to obtain the necessary capital to finance a successful expansion program or our other cash needs. If we are unable to obtain additional capital on acceptable terms, we may be required to reduce the scope of any expansion. In addition to requiring funding for expansions, we may need additional funds to implement our internal growth and operating strategies or to finance other aspects of our operations. Our failure to (a) obtain additional capital on acceptable terms, (b) use internally generated cash or debt to complete expansions because it significantly limits our operational or financial flexibility, or (c) use securities to make future expansions may hinder our ability to actively pursue any expansion program we may decide to implement. In addition, if we are unable to obtain necessary capital going forward, our ability to continue as a going concern would be negatively impacted.

 

Our business has been, and may continue to be, adversely affected by disruptions in the credit markets, including reduced access to credit and higher costs of obtaining credit.

 

Widening credit spreads, as well as significant declines in the availability of credit, have adversely affected our ability to borrow on a secured and unsecured basis and may continue to do so. Disruptions in the credit markets may make it harder and more expensive to obtain funding for our businesses. We often rely on access to the secured and unsecured credit markets to finance acquisitions of additional nightclubs. Additional nightclub acquisitions are also financed by promissory notes carried by the sellers and debt financed by company investors and related parties. If our available funding is limited or we are forced to fund our operations at a higher cost, these conditions may require us to curtail our business activities and increase our cost of funding, both of which could reduce our profitability and prevent or hamper our growth through acquisitions.

 

Our business has been, and may continue to be, adversely affected by conditions in the U.S. financial markets and economic conditions generally.

 

Our business is materially affected by conditions in the U.S. financial markets and economic conditions generally. In the past 24 months, these conditions have changed suddenly and negatively. The ongoing financial crisis and the loss of confidence in the stock market has increased our cost of funding and limited our access to some of our traditional sources of liquidity, including both secured and unsecured borrowings. Increases in funding costs and limitations on our access to liquidity could have a negative impact on our earnings and our ability to acquire additional nightclubs. In addition, the deteriorating general economic conditions in the United States has caused a drop in consumer spending in general, and discretionary spending in particular. This has caused a decline in the number of patrons at our nightclubs and the amount of money spent by them. Further, our nightclubs located in geographical areas suffering from proportionally worse economic conditions when compared to the United States in

general have experienced larger declines in operating revenues. Overall, the economic environment during our 2009 fiscal year has been slightly adverse for our business compared to the previous year and there can be no assurance that these conditions will improve in the near term. Until they do, we expect our results of operations to be slightly adversely affected.

 

Our nightclubs were acquired with a purchase price based on historical EBITDA. This results in each nightclub carrying a substantial amount of intangible value, mostly allocated to licenses and goodwill. Generally accepted accounting principles require an annual impairment review of these indefinite lived assets. For the fiscal year ended December 31, 2009, the annual impairment review resulted in an impairment loss of approximately $1.8 million, compared to the impairment loss of approximately $46 million in 2008. If difficult market and economic conditions continue over 2010 and/or we experience a decrease in revenue at one or more nightclubs, we could incur an additional decline in fair value of one or more of our nightclubs. This could result in another future impairment charge of up to the total value of the indefinite lived intangible assets.

 

Our acquisitions may result in disruptions in our business and diversion of management’s attention.

 

We have made, and may continue to make, acquisitions of complementary nightclubs, restaurants, or related operations. Any acquisitions will require the integration of the operations, products, and personnel of the acquired businesses and the training and motivation of these individuals. Such acquisitions may disrupt our operations and divert management’s attention from day-to-day operations, which could impair our relationships with current employees, customers, and partners. We may also incur debt or issue equity securities to pay for any future acquisitions. These issuances could be substantially dilutive to our stockholders. In addition, our profitability may suffer because of acquisition-related costs or amortization, or impairment costs for acquired goodwill and other intangible assets. If management is unable to fully integrate acquired business, products, or persons with existing operations, we may not receive the benefits of the acquisitions, and our revenues and stock trading price may decrease.

 

Our business is subject to risks associated with geographic market concentration.

 

One part of our growth strategy is nightclub “clustering.” Adult nightclubs tend to group together in their respective markets. We believe that clustering leads to improved brand recognition as well as some improvement in economics of scale as costs of marketing are spread over more nightclubs. Clustering also provides the Company with the ability to disperse management expertise to more locations under their responsibility. We are subject to risks associated with geographic market concentration in areas in which we own and operate multiple nightclubs, such as adverse changes in the local economy, the local regulatory environment, and our local reputation. If we are unable to successfully diminish the impact of these risks, our profitability and growth prospects may be materially and adversely affected.

 

Our business operations are subject to regulatory uncertainties which may affect our ability to acquire additional nightclubs, remain in operation or be profitable.

 

Our business is regulated by constantly changing zoning, local and state liquor licensing, local ordinances, and state and federal time, place and manner free speech restrictions. In states in which we currently operate, liquor licenses renew annually and are considered to be “privileged” licenses that could be subject to suspension or revocation. The adult entertainment provided by our nightclubs has elements of free speech and expression and, therefore, has some protection under the First Amendment to the U.S. Constitution. However, the protection is limited to the expression of our entertainers and not their conduct.

 

In all states where we operate, management believes that we comply with applicable laws, regulations, and ordinances governing the sale of alcohol and the operation of sexually oriented businesses. However, changes in these laws, regulations, and ordinances may increase our cost of compliance therewith, or cause us to be unable to renew them, thereby reducing our profitability or preventing our nightclubs to remain in operation. There can be no assurance that local, state and/or federal licensing, and other regulations will permit our nightclubs to remain in operation or profitable in the future. Further, if we are involved in costly administrative or legal proceedings to

renew our licenses or defend against claims involving non-protected free speech, it may result in negative publicity and decreased profitability.

 

Beginning January 1, 2008, our two Texas nightclubs became subject to a new state law requiring each nightclub to collect a five dollar surcharge for every nightclub visitor. We have filed a tax protest suit against this “patron tax,” and the suit has been stayed by agreement until the Texas Supreme Court resolves the underlying case. This trend is spreading to other states to enact similar surcharges or admission fee taxes. Currently, the Company is not passing this surcharge on to our customers and we are absorbing this expense. Our profitability could be negatively impacted if this surcharge continues in Texas and spreads to other states in which the Company operates.

 

There is substantial competition in the nightclub entertainment industry, which may affect our ability to operate profitably or acquire additional nightclubs.

 

Our ability to increase or sustain revenues is impacted by our ability to compete effectively with our competitors, both for nightclub acquisitions and patrons. Our ability to compete depends on many factors, many of which are outside of our control. These factors include the quality and appeal of our competitors’ nightclubs relative to our offerings, the strength of our competitors’ brands, the effectiveness of our competitors’ sales, marketing efforts and the attractiveness of their product offerings, and general consumer behaviors and preferences regarding how they choose to spend their discretionary income. Further, our competitors may have significantly greater financial and management resources than our Company. In addition, the industry is especially sensitive to ever-changing and unpredictable competitive trends and competition for general entertainment dollars which cannot be easily predicted and which are beyond our control. If we are unable to compete effectively in the market, we may be unable to attract patrons to our existing nightclubs or complete acquisitions of new nightclubs, which may prevent us from sustaining or increasing our revenues or growing our business.

 

If we are unable to effectively promote our brands and establish a leading position in the marketplace, our business may fail.

 

We believe that we may attract more patrons to our nightclubs and distinguish ourselves from our competition by increasing the awareness of our brands and that the importance of brand recognition will increase over time. In order to gain brand recognition, we believe that we must increase our marketing and advertising budgets to create and maintain brand name loyalty through the promotion and development of our affiliation with the PT’s^®, Diamond Cabaret^®, and Penthouse^® names. We do not know whether these efforts will lead to greater brand recognition. If we are unable to effectively promote our brand and establish a leading position in the marketplace, we may be unable to attract patrons or new nightclubs for acquisitions, which may prevent us from sustaining or increasing our revenues or growing our business.

 

Our failure to protect our brands may undermine our competitive position and litigation to protect our brands or defend against third-party allegations of infringement may be costly.

 

We believe that it is important for our business to achieve brand recognition. We rely primarily on trademarks and trade names to achieve this. Third parties may infringe or misappropriate our trademarks, trade names, and other intellectual property rights, which could have a material adverse effect on our business, financial condition, or operating results. In addition, policing unauthorized use of our trademarks, trade names, and other intellectual property can be difficult and expensive. Litigation may be necessary to enforce our intellectual property rights or determine the validity and scope of the proprietary rights of others. We cannot give assurance that the outcome of such potential litigation will be in our favor. Such litigation may be costly and may divert management attention as well as expend our other resources away from our business. An adverse determination in any such litigation will impair our intellectual property rights and may harm our business, prospects, and reputation.

 

Our business is dependent upon management and employees for continuing operations and expansion.

 

Our success will depend, to a significant extent, on the efforts and abilities of Troy Lowrie, our Chairman of the Board and CEO, Micheal Ocello, a Director and our President and Chief Operating Officer and Courtney Cowgill, our Chief Financial and Accounting Officer. The loss of the services of Messrs. Lowrie and/or Ocello or our

inability to recruit and train additional key personnel in a timely fashion could have a material and continuing adverse effect on our business and future prospects. A loss of one or more of our current officers or key personnel could severely and negatively impact our operations. Messrs. Lowrie and Ocello have limited experience managing a public company subject to the SEC’s periodic reporting obligations.

 

Hiring qualified management is difficult due to the limited number of qualified professionals in the industry in which we operate. We have in the past experienced difficulty in recruiting qualified personnel and there can be no assurance that we will be successful in attracting and retaining additional members of management if our business continues to grow. Failure to attract and retain personnel, particularly management personnel, would continue to materially harm our business, financial condition and results of operations.

 

Troy Lowrie, our Chairman of the Board and CEO, may have potential conflicts of interest with the Company, which may adversely affect our business. He beneficially owns a significant number of shares of our common stock, which will have an impact on all major decisions on which our stockholders may vote and which may discourage an acquisition of our Company.

 

We have engaged in several transactions with Lowrie Management LLLP, which is controlled and majority owned by Troy Lowrie, who is a significant stockholder, and our Chairman of the Board and CEO. Additionally, Mr. Lowrie and Lowrie Management LLLP is one of several parties that have submitted a proposal to the Company’s Board to acquire all of the Company’s common stock in a going private transaction. Further, in the proposed merger transaction as currently proposed, Mr. Lowrie will receive different consideration than the Company’s other shareholders, due in part to his continued guaranty of certain Company obligations, the sale of certain trademarks owned by Mr. Lowrie’s affiliates, the refinancing of his promissory note with the Company, and his consulting agreement with Rick’s Cabaret International, Inc. The Special Committee of the Board rejected the proposed going private transaction as inadequate on December 16, 2009. Conflicts of interest may arise between Mr. Lowrie’s duties to our Company and his duties to Lowrie Management LLLP, or his interest as an owner of Lowrie Management LLLP or as a potential acquirer of the Company’s common stock in the proposed going private transaction. Because Mr. Lowrie is a Director and the CEO of our Company, he has a duty of loyalty and care to us under Colorado law when there are any potential conflicts of interest between our Company and Lowrie Management LLLP. We cannot give you assurance that when conflicts of interest arise, Mr. Lowrie will act completely in our interests or that conflicts of interest will be resolved in our favor. In addition, Mr. Lowrie could violate his legal duties by diverting business opportunities from us to others. If we cannot resolve any conflicts of interest between Mr. Lowrie and us, we would have to rely on legal proceedings which could disrupt our business.

 

Several of our landlords and lenders have required Mr. Lowrie’s continued management role with our Company in order to avoid a default or acceleration of our obligations under certain of our leases or loan agreements.

 

As of March 12, 2010, Mr. Lowrie owns approximately 28% of our issued and outstanding common stock. In addition, he is our Chairman of the Board and CEO. The interests of Mr. Lowrie may differ from the interests of other stockholders. Because of his significant ownership of our common stock, Mr. Lowrie will have the ability to significantly influence virtually all corporate actions requiring stockholder approval, including the following actions:

 

 

Mr. Lowrie’s beneficial stock ownership may discourage potential investors from investing in shares of our common stock due to the lack of influence they could have on our business decisions, which in turn could reduce our stock price.

We must comply with all licenses and permits relating to the sale of alcohol.

 

We derive a significant portion of our revenues from the sale of alcoholic beverages. States in which we operate may have laws which may limit the availability of a permit to sell alcoholic beverages or which may provide for suspension or revocation of a permit to sell alcoholic beverages in certain circumstances. The temporary or permanent suspension or revocations of any such permits would have a material adverse effect on the revenues, financial condition, and results of operations of the Company. In all states where we operate, management believes that we comply with applicable city, county, state, or other local laws governing the sale of alcohol.

 

Activities or conduct at our nightclubs may cause us to lose necessary business licenses, expose us to liability, or result in adverse publicity, which may increase our costs, divert management’s attention from our business, and cause our stockholders to lose confidence in us, thereby lowering our profitability and our stock price.

 

We are subject to risks associated with activities or conduct at our nightclubs that are illegal or violate the terms of necessary business licenses. Our nightclubs operate under licenses for sexually oriented businesses and some protection under the First Amendment to the U.S. Constitution. While we believe that the activities at our nightclubs comply with the terms of such licenses, and that the element of our business that constitutes an expression of free speech under the First Amendment to the U.S. Constitution is protected, activities and conduct at our nightclubs may be found to violate the terms of such licenses or be unprotected under the U.S. Constitution. This protection is limited to the expression and not the conduct of an entertainer. An issuing authority may suspend or terminate a license for a nightclub found to have violated the license terms. Illegal activities or conduct at any of our nightclubs may result in negative publicity or litigation. Such consequences may increase our cost of doing business, divert management’s attention from our business, and make an investment in our securities unattractive to current and potential investors, thereby lowering our profitability and our stock price.

 

IEC has developed comprehensive policies aimed at ensuring that the operation of each nightclub is conducted in conformance with local, state and federal laws. We have a “no tolerance” policy on illegal drug use in or around the facilities. We continually monitor the actions of entertainers, waitresses, and customers to ensure that proper behavior standards are met. However, such policies, no matter how well designed and enforced, can provide only reasonable, but not absolute, assurance that the policies’ objectives are being achieved. Because of the inherent limitations in all control systems and policies, there can be no assurance that our policies will prevent deliberate acts by persons attempting to violate or circumvent them. Notwithstanding the foregoing limitations, management believes that our policies are reasonably effective in achieving their purposes.

 

Our industry is viewed negatively by many for moral, religious, women’s rights, and other reasons, therefore, the market for our securities is smaller than for other securities and an investor may find it hard to sell our securities.

 

We operate in an industry that is viewed negatively by many. People may object to sexually oriented entertainment for moral, religious, women’s rights, or other reasons. As a result, we are exposed to risks associated with societal attitudes towards our business, both locally and nationally. Local attitudes may disproportionally affect our nightclubs in areas in which we are operating while national attitudes may affect our business generally or our stock price specifically. Because of the negative perception of our industry, the market for our securities is smaller than for securities without such negative perception. Therefore, an investor in our securities may be unable to sell our securities at an acceptable time and price, or at all.

 

Our business plan and proposed strategy has not been independently evaluated.

 

We have not obtained any independent evaluation of our business plan and proposed business strategy. There can be no assurance that our nightclubs or proposed strategy will generate sufficient revenues to maintain profitability.

We may be subject to uninsured risks which, if realized, could expose us to money damages, which we may be unable to pay.

 

We maintain insurance in amounts we consider adequate for personal injury and property damage to which our nightclubs may be subject. We also currently have personal injury liquor liability coverage in place. However, there can be no assurance that we will not be exposed to potential liabilities for money damages in excess of the coverage provided by insurance, including, but not limited to, liabilities which may be imposed pursuant to state “dram shop” statutes or common law theories of liability. In general, “dram shop” statutes provide that a person injured by an intoxicated person has the right to recover damages from an establishment that wrongfully served alcoholic beverages to such person if it was apparent to the server that the individual being sold, served, or provided with an alcoholic beverage was obviously intoxicated to the extent that he presented a clear danger to himself and others. If our insurance coverage is not sufficient to pay for any money damages that we may be found liable for, we will have to pay such excess damages using the funds needed for operation of our business, if available, thereby increasing our costs and reducing our profitability.

 

Our Directors and Officers have limited liability and are entitled to indemnification that could encourage derivative lawsuits and require us to direct funds away from our business.

 

Our Articles of Incorporation provide that our Directors shall not be liable to the Company or our stockholders for monetary damages for breaches of fiduciary duties as a Director to the fullest extent permitted by Colorado law.

 

Further, we are obligated to indemnify and advance expenses to our Directors and Executive Officers in certain circumstances. Our Articles of Incorporation provide that the Company shall indemnify and advance expenses to a Director or Officer in connection with a proceeding to the fullest extent permitted or required by and in accordance with Colorado law. We have also entered into separate, but substantively identical, indemnification agreements with all of our Directors and named executive officers. The indemnification agreements provide that the Company will indemnify each Director and Executive Officer against claims arising out of events or occurrences related to such individual’s service on the Company’s Board or as an Executive Officer, as applicable, (i) when such indemnification is expressly required to be made by law, or (ii) after a determination has been made that such indemnification is permissible. Pursuant to these arrangements, we may be required to advance costs incurred by an Officer or Director and to pay judgments, fines, and expenses incurred by an Officer or Director, including reasonable attorneys’ fees, as a result of actions or proceedings in which our Officers and Directors may become involved by reason of being or having been an Officer or Director of our Company. Funds paid in satisfaction of judgments, fines, and expenses may be funds we need for the operation of our business, thereby affecting our ability to maintain profitability.

 

These provisions in the Company’s Articles of Incorporation and the stand-alone indemnification agreements may have the effect of reducing the likelihood of derivative litigation against Directors and Executive Officers, and may discourage or deter stockholders or management from bringing a lawsuit against Directors and Executive Officers even though such an action, if successful, might otherwise have benefited our stockholders. We also note that our Directors and Troy Lowrie, the Company’s Chairman of the Board and CEO, are currently defendants in one or more lawsuits in connection with the proposed going private transaction, as further discussed in another risk factor and elsewhere in this Annual Report on Form 10-K. The Company may be required to advance expenses to and indemnify the Directors and Mr. Lowrie from expenses involved in defending against such lawsuits. Any amount we are required to pay or advance to a Director or Executive Officer pursuant to these provisions will be diverted from the Company’s operating capital and will have an adverse effect on the Company’s cash flow and results of operation. While the Company has obtained directors’ and officers’ insurance to protect against this occurrence, there can be no assurance that our directors’ and officers’ insurance will cover a claim made for indemnification or be sufficient to cover the entire amount claimed for indemnification.

 

We have been informed that the Securities and Exchange Commission has the opinion that indemnification of liabilities to Executive Officers or Directors under the Securities Act of 1933, as amended (the “Securities Act”) to be against public policy as expressed in the Securities Act and therefore are unenforceable.

We could use the issuance of additional shares of our authorized stock to deter a change in control.

 

As of March 12, 2010, we have 17,310,723 shares of common stock outstanding, out of a total of 50,000,000 shares of common stock authorized, and zero shares of Series A preferred stock, out of a total of 1,000,000 shares authorized for future issuance under our Articles of Incorporation. This does not include 224 shares of common stock reserved for issuance under our 2002 Stock Option and Stock Bonus Plan, 2,708 shares of common stock reserved for issuance under our 2003 Stock Option and Stock Bonus Plan, and 906,667 shares of common stock reserved for issuance under our 2004 Stock Option and Appreciation Rights Plan. In addition, our Board is authorized to issue “blank check” preferred stock, with designations, rights, and preferences as they may determine. Accordingly, our Board may, without stockholder approval, issue shares of preferred stock with dividend, liquidation, conversion, voting, or other rights that could adversely affect the voting power or other rights of the holders of our common stock. This type of preferred stock could also be issued to discourage, delay, or prevent a change in our control. The ability to issue “blank check” preferred stock is a traditional anti-takeover measure. These provisions in our charter documents make it difficult for a majority stockholder to gain control of the Board and of our Company. The issuance of additional shares would make it more difficult for a third party to acquire us, even if its doing so would be beneficial to our stockholders.

 

We have employment agreements with Troy Lowrie and Micheal Ocello that contain features that may discourage a change of control.

 

On December 4, 2008, we entered into five-year employment agreements with Troy Lowrie, our Chairman of the Board and CEO, and Micheal Ocello, one of our Directors and our President and Chief Operating Officer. Pursuant to the terms of the employment agreements, if we terminate either of them other than for “cause,” “death,” or “disability” (as such terms are defined therein), or either of them terminates his employment for “good reason” (as such term is defined therein, which term includes termination of the officer following a change of control), we must pay the officer a severance payment equal to three times the sum of the officer’s base salary in effect upon termination plus an amount equal to the highest bonus the officer received in the three years before termination, if any.

 

Further, the employment agreements provide that if such an officer’s employment is terminated for any reason, we must, at the officer’s election, promptly pay all outstanding debt owed to the officer and his family or issue to the officer, with his approval, the number of shares of our common stock determined by dividing (a) the outstanding principal and interest owed to the officer (b) 50% of the last sale price of our common stock on the date of termination.

 

Finally, Mr. Lowrie’s employment agreement provides that if Mr. Lowrie’s employment is terminated for any reason, we must also take all necessary steps to remove Mr. Lowrie as a guarantor of any of our (or our affiliates’) obligations to any third party. In the event that we are not successful in doing so, we must pay to Mr. Lowrie a cash amount equal to five percent per year of the aggregate amount he is continuously guaranteeing until such time when Mr. Lowrie no longer guarantees the obligations.

 

A change of control may trigger the payments set forth above and the resulting costs may prevent or deter a potential acquirer from buying the Company. Even if doing so could be beneficial to our stockholders.

 

We must meet the NASDAQ Global Market continued listing requirements or we risk delisting, which may decrease our stock price and make it harder for our stockholders to trade our stock.

 

Our common stock is currently listed for trading on the NASDAQ Global Market. We must continue to satisfy NASDAQ’s continued listing requirements or risk delisting of our securities. That would likely have an adverse effect on the price of our common stock and our business. There can be no assurance that the Company will meet the continued listing requirements for the NASDAQ Global Market, or that the Company’s common stock will not be delisted from the NASDAQ Global Market in the future. If our common stock is delisted from NASDAQ, it may trade on the over-the-counter market, which may be a less liquid market. In such case, our stockholders’ ability to trade, or obtain quotations of the market value of, shares of our common stock would be severely limited because of lower trading volumes and transaction delays. These factors could contribute to lower prices and larger spreads in the bid and ask prices for our securities.

In the event the make-up of our Board or Audit Committee were not, or are not in the future, in compliance with the SEC and NASDAQ independence requirements, we face a number of risks that could materially and adversely affect our stockholders and our business.

 

The SEC rules and the NASDAQ Stock Market’s continued listing requirements require, among other things, that a majority of the members of our Board are independent and that our Audit Committee consists entirely of independent directors. We know that we currently comply with the SEC and NASDAQ requirements regarding director independence. However, in the event that we do not remain in compliance with these requirements, our Executive Officers could establish policies and enter into transactions without the requisite independent review and approval. This could present the potential for a conflict of interest between us and our stockholders generally and our Executive Officers, stockholders, or Directors.

 

Further, our failure to comply with these requirements may limit the quality of the decisions that are made by our Board and Audit Committee, such that the risk of material misstatements or omissions caused by errors or fraud with respect to our financial statements or other disclosures that may occur and not be detected in a timely manner or at all; or the payment of inappropriate levels of compensation to our executive officers. In the event there are deficiencies or weaknesses in our internal controls, we may misreport our financial results or lose significant amounts due to misstatements caused by errors or fraud. Finally, if the composition of our Board or Audit Committee fails to meet NASDAQ’s independence requirements in the future and we fail to regain compliance with NASDAQ’s continued listing requirements, the Company’s common stock will be delisted from the NASDAQ Global Market, as further described in the previous risk factor.

 

Securities analysts may not initiate coverage or continue to cover our common stock, and this may have a negative impact on our common stock’s market price.

 

The trading market for our common stock depends, in part, on the research and reports that securities analysts publish about us and our business. We do not have any control over these analysts. Currently, one analyst firm covers us but there is no guarantee that this securities analyst will continue to cover our common stock in the future. If securities analysts do not cover our common stock, the lack of research coverage may adversely affect its market price. If we are covered by securities analysts, and our stock is downgraded, our stock price would likely decline. If the analyst ceases to cover us or fails to publish regular reports on us, we could lose visibility in the financial markets, which could cause our stock price or trading volume to decline.

 

In the past, we have raised substantial amounts of capital in private placements, and if we fail to comply with the applicable securities laws, ensuing rescission rights or lawsuits would severely damage our financial position.

 

Our 2004 private placement consisted of securities that were not registered under the Securities Act, as amended (the “Securities Act”), or under any state “blue sky” law as a result of exemptions from such registration requirements. Such exemptions are highly technical in nature and if we inadvertently failed to comply with any of such exemptive provisions, investors could have the right to rescind their purchase of our securities and sue for damages. If any investors were to successfully seek such rescission or prevail in any such suit, we could face severe financial demands that could have significant, adverse affects on our financial position. Future financings may involve sales of our common stock at prices below prevailing market prices, as well as the issuance of warrants or convertible securities at a discount to market price.

 

The application of the “penny stock” rules could adversely affect the market price of our common stock and increase the transaction costs to sell those shares.

 

The SEC has adopted regulations which generally define a “penny stock” as an equity security that has a market price of less than $5.00 per share or an exercise price of less than $5.00 per share, subject to specific exemptions. Because the last reported trade of our company stock on the NASDAQ Global Market was at a price below $5.00 per share, our common stock is currently considered a penny stock. The SEC’s penny stock rules require a broker-dealer, before a transaction in a penny stock not otherwise exempt from the rules, to deliver a standardized risk disclosure document that provides information about penny stocks and the risks in the penny stock

market. The broker-dealer must also provide the customer with current bid and offer quotations for the penny stock, the compensation of the broker-dealer and the salesperson in the transaction, and monthly account statements showing the market value of each penny stock held in the customer’s account. In addition, the penny stock rules generally require that before a transaction in a penny stock occurs, the broker-dealer must make a special written determination that the penny stock is a suitable investment for the purchaser and receive the purchaser’s agreement to the transaction. If applicable in the future, these rules may restrict the ability of brokers-dealers to sell our common stock and may affect the ability of investors to sell their shares, until our common stock no longer is considered a penny stock.

 

Because we do not intend to pay any dividends on our common stock, purchases of our common stock may not be suited for investors seeking dividend income.

 

Since our inception, we have not paid any dividends on our common stock and we do not anticipate paying any dividends on our common stock in the foreseeable future. The Board has elected not to pay dividends in the future. We expect that future earnings applicable to the common stockholders, if any, will be used for working capital and to finance growth.

 

Future sales of our common stock may depress our stock price. A significant amount of common stock is subject to issuance upon exercise of securities to purchase common stock. The exercise and sale of these financial instruments could depress the market price of our common stock.

 

A significant amount of our common stock may be eligible for sale under Rule 144 promulgated under the Securities Act at different times in the future and its sale could depress the market price of our common stock. Provided that all applicable Rule 144 conditions are satisfied, we believe that stockholders holding 17,310,723 shares of our issued and outstanding shares of common stock are currently eligible to sell their shares. The Company issued no stock in 2009.

 

We also have issued stock options convertible into an aggregate of 262,500 shares of our common stock at an exercise price of between $6 and $13 per share. None of the options are currently vested or exercisable but they vest and become exercisable between April 2010 and June 2015. All option exercise prices substantially exceed the market price of our common stock on March 12, 2010.

 

The market price of our common stock could decline as a result of sales of substantial amounts of our common stock in the public market, or as a result of the perception that these sales could occur. In addition, these factors could make it more difficult for us to raise funds through future offerings of common stock. As of March 12, 2010, we have 50,000,000 authorized shares of which 17,310,723 shares of common stock are issued and outstanding.

 

Ownership could be diluted by future issuances of our stock, options, warrants or other securities.

 

Ownership in the Company may be diluted by future issuances of capital stock or the exercise of outstanding or to be issued options, warrants or convertible notes to purchase capital stock. In particular, we may sell securities in the future in order to finance operations, expansions, or particular projects or expenditures.

 

There is a limited public trading market for our common stock.

 

Our stock is currently traded on the NASDAQ Global Market under the trading symbol “VCGH.” There is a limited public trading market for our common stock. Without an active trading market, there can be no assurance of any liquidity or resale value of our common stock, and stockholders may be required to hold shares of our common stock for an indefinite period of time.

 

Our stock price has been volatile and may fluctuate in the future.

 

The trading price of our securities may fluctuate significantly. This price may be influenced by many factors, including:

 

 

 

Public stock markets have experienced and are currently experiencing substantial price and trading volume volatility. These broad market fluctuations may adversely affect the market price of our securities. Further, if the proposed merger transaction or any alternative transaction is not completed, the share price of our common stock may change, to the extent that the current market price of our common stock reflects an assumption that a transaction will be completed. Fluctuations in our stock price may have made our stock attractive to momentum, hedge, or day-trading investors who often shift funds into and out of stocks rapidly, exacerbating price fluctuations in either direction particularly when viewed on a quarterly basis.

 

Other Risk Factors May Adversely Affect Our Financial Performance.

 

Other risk factors that could cause our actual results to differ materially from those indicated in the forward-looking statements by affecting, among many things, pricing, consumer spending, and consumer confidence, include, without limitation, changes in economic conditions and financial and credit markets, credit availability, increased fuel costs and availability for our employees, customers and suppliers, health epidemics or pandemics or the prospects of these events (such as reports on avian flu), consumer perceptions of food safety, changes in consumer tastes and behaviors, governmental monetary policies, changes in demographic trends, terrorist acts, energy shortages and rolling blackouts, and weather (including, major hurricanes and regional snow storms) and other acts of God.

 

 

Not applicable.

 

 

Our corporate office is located at 390 Union Boulevard, Suite 540, Lakewood, Colorado 80228. This office space is used by IEC, our wholly-owned subsidiary. We occupy approximately 5,500 square feet under a lease with an unrelated third party that expires in February 2017. Additional administrative offices are located inside various nightclub locations or rented on a month-to-month basis without a formal lease.

 

Each of our adult entertainment nightclubs is held in separately owned subsidiary corporations, limited liability companies, or limited partnerships. We currently lease the real estate for a majority of our company-owned adult entertainment nightclubs under operating leases with remaining terms ranging from five years to just over 50 years. These leases generally contain options which permit us to extend the lease term at an agreed rent or at prevailing market rates.

 

We own the real property on which we operate four company-owned adult entertainment nightclubs located in Texas (2), Illinois (1) and Indiana (1).

The table contains specifics about our leased and owned adult nightclub locations:

 

 

 

Other than as set forth below, we are not aware of any pending legal proceedings against the Company, individually or in the aggregate, that would have a material adverse affect on our business, results of operations, or financial condition.

 

Thee Dollhouse Productions Litigation

 

On or around July 24, 2007, VCG Holding Corp. was named in a lawsuit filed in District Court, 191 Judicial District, of Dallas County, Texas. This lawsuit arose out of a VCG acquisition of certain assets belonging to Regale, Inc. (“Regale”) by Raleigh Restaurant Concepts, Inc. (“RRC”), a wholly owned subsidiary of VCG, in Raleigh, N.C. The lawsuit alleges that VCG tortiously interfered with a contract between Michael Joseph Peter and Regale and misappropriated Mr. Peter’s purported trade secrets. On March 30, 2009, the United States District Court for the Eastern District of North Carolina entered an Order granting Summary Judgment to VCG and dismissed Mr. Peter’s claims in their entirety. The Court found that as a matter of law, VCG did not tortiously interfere with Mr. Peter’s contract with Regale and further found that VCG did not misappropriate trade secrets. Mr. Peters did not appeal that ruling and as such, the federal proceedings have concluded.

 

Ancillary to this litigation, Thee Dollhouse filed a claim in arbitration on June 2008 against Regale as a result of this transaction, asserting that Regale, by selling its assets to RRC, breached a contract between Thee Dollhouse and Regale. In addition, an assertion was made that one of Regale’s principals tortiously interfered with the contract between Regale and Thee Dollhouse. Regale filed a Motion to Stay Arbitration which was granted in part and denied in part, with the Court staying arbitration as to Regale’s principal and denying the stay as to Regale. As a result, the arbitration as to Regale is proceeding. VCG is indemnifying and holding Regale harmless from this claim pursuant to their contract. The arbitration was originally scheduled for late October 2009, however due to illness of one of the principals of the claimant, the arbitration has been adjourned to April 26, 2010. The Company has not accrued any funds for the settlement of this litigation, as the outcome of this dispute cannot be predicted. The Company’s or a successor entity’s, indemnification obligation to Regale will continue even if any of the proposed sale transactions or an alternative transactions is consummated.

 

Zajkowski, et. al. vs VCG and Classic Affairs Litigation

 

In December 2007, a former employee of VCG’s subsidiary Classic Affairs, Eric Zajkowski, filed a lawsuit in Hennepin County District Court, Minneapolis, Minnesota against VCG following his termination from employment alleging that, in connection with his employment, he was subject to certain employment practices which violated Minnesota law. The initial action and subsequent pleading asserted that the matter was filed as a purported class action. Subsequent to the filing of Zajkowski’s Complaint, Zajkowski moved to amend his Complaint to name additional Plaintiffs and later, to name Classic Affairs as a party defendant. VCG and Classic Affairs have answered this complaint denying all liability. Classic Affairs has also filed a Counter-Complaint against Mr. Zajkowski based upon matters relating to his termination from employment with Classic Affairs.

 

In December 2008 and early January 2009, the parties filed cross-motions for Summary Judgment and Zajkowski filed a Motion for Class Certification. Following the motions, the Court issued a series of rulings on those Motions. In these rulings, the Court has dismissed VCG as a party Defendant — having determined that VCG is not directly liable to Zajkowski or the other Plaintiffs on their claims. The Court granted Summary Judgment to Zajkowski as to one issue, but did not determine the scope or extent, if any, of the alleged damages, ruling this issue,

like the others, are questions for a jury, and the Court dismissed two other claims asserted by Zajkowski. In all other respects, the Court has denied the parties respective Summary Judgment motions.

 

On July 21, 2009, the Court denied Zajkowski’s and the other Plaintiffs’ Motion for Class Certification. Zajkowski appealed that decision to the Minnesota Court of Appeals and on September 22, 2009, the Court of Appeals denied Plaintiffs request for discretionary review. Plaintiffs have indicated that they do not intend to seek leave to appeal from the Minnesota Supreme Court. The parties have held mediation in November 2009 and the case was resolved. The settlement terms, including the amounts, are confidential. The lawsuit has now been dismissed, with prejudice. All related costs have been accrued or paid as of December 31, 2009.

 

Texas Patron Tax Litigation

 

Beginning January 1, 2008, VCG’s Texas clubs became subject to a new state law requiring the Company to collect a five dollar surcharge for every club visitor. A lawsuit was filed by the Texas Entertainment Association, an organization in which the Company is a member, alleging that the fee is an unconstitutional tax. On March 28, 2008, the Judge of the District Court of Travis County, Texas ruled that the new state law violates the First Amendment to the U.S. Constitution and, therefore, the District Court’s order enjoined the state from collecting or assessing the tax. The State of Texas has appealed the District Court’s ruling. When cities or the State of Texas give notice of appeal, the State supersedes and suspends the judgment, including the injunction. Therefore, the judgment of the Travis County District Court cannot be enforced until the appeals are completed.

 

The Company has filed a lawsuit to demand repayment of the paid taxes. On June 5, 2009, the Court of Appeals for the Third District (Austin) affirmed the District Court’s judgment that the Sexually Oriented Business Fee violated the First Amendment to the U.S. Constitution. The State of Texas appealed the Court of Appeals ruling to the Texas Supreme Court. On August 26, 2009, the Texas Supreme Court ordered both sides to submit briefs on the merits. The State’s brief was filed on September 25, 2009 and the Texas Entertainment Association’s brief was filed on October 15, 2009. On February 12, 2010 the Texas Supreme Court granted the State’s Petition for Review and set oral arguments for March 25, 2010.

 

The Company has expensed approximately $290,000 for the year ended December 31, 2009 and $203,000 for the year ended December 31, 2008 for the Texas Patron Tax. The Company accrued, but did not pay the fourth quarter estimated tax liability of $71,000. The Company has paid, under protest, approximately $422,000 to the State of Texas for the two year period.

 

Department of Labor and Immigration and Customs Enforcement Reviews

 

United States Department of Labor (“DOL”) Audit (PT’s Showclub)

 

In October 2008, PT’s^® Showclub in Louisville, KY was required to conduct a self-audit of employee payroll by the DOL. After an extensive self-audit, it was determined that (a) the club incorrectly paid certain employees for hours worked and minimum wage amounts and (b) the club incorrectly charged certain minimum wage employees for their uniforms. As a result, the DOL required that the club issue back pay and refund uniform expenses to qualified employees at a total cost of $14,439.

 

In March 2009, VCG was placed under a similar nationwide DOL audit for all nightclub locations and its corporate office. All locations completed the self-audit in August 2009 and are currently working with the DOL to determine what, if any, violations may have occurred. This case is still in the investigatory state and no final determination can be made at this time of an unfavorable outcome or any potential liability. After discussion with outside legal counsel on this case, the Company has accrued $200,000 as of December 31, 2009 for potential wage/hour violations. A summary meeting has tentatively been scheduled with the DOL and counsel on March 15, 2010 to finalize the liability. The Company believes it has corrected all processes that resulted in the potential violations.

 

Immigration and Customs Enforcement (“ICE”) Reviews

 

On June 30, 2009, PT’s^® Showclub in Portland, Maine was served a subpoena by ICE requesting documents to conduct an I-9 audit. ICE requested all original I-9’s for both current and past employees from September 14, 2007 (club acquisition date) to June 30, 2009. ICE conducted the audit to ensure proper use of the I-9 form to confirm that

the club verified employees’ right to work in the United States. The club complied with the subpoena submitting all requested documents by July 16, 2009. As of March 12, 2010, ICE is still reviewing the requested documents. This matter is still in its investigatory stage and no determination of potential violations or liability has been made. No amounts have been accrued related to this audit. While ICE initially discussed taking this audit to all clubs, no formal actions have been taken by ICE to begin that process. This audit is still isolated to Maine.

 

Internal Revenue Service

 

The IRS audited PT’s^® Showclub in Denver for the years 2006, 2007, and 2008 to determine tip reporting compliance. Every business with customary tipping must report annually on Form 8027 the total sales from food and beverage operations, charge sales, total tips reported, and charge tips reported. The audit was based upon this Form to determine compliance with the amended Section 3121(q) of the Internal Revenue Code. The audit was conducted by an examining agent in Denver in August and September 2009. The audit focused on the data reported on Form 8027 and related underlying documentation. It included the agent examining information contained in the daily sales packages generated by the club.

 

The audit resulted in a determination that cash tips for that club were under-reported in the three years examined. The tax assessed as a result of this under-reporting was $61,500. Penalties and interest were not assessed. The IRS auditor indicated that all other clubs would be audited and recommended that a Point of Sale (“POS”) system should be installed in every club to ensure compliance with IRS regulations. Upon completion of this audit, the Company began an intensive self-audit for the three year period using the same procedures followed by the IRS agent. This resulted in an initial accrual of $386,000 in estimated taxes to cover the estimated liability as of September 30, 2009. Subsequent discussions with the IRS agent removed 2006 from the audit period, replacing that year with 2009. The Company has submitted workpapers prepared for the self-assessment to the IRS agent for the periods 2007, 2008, and 2009. The agent has tentatively indicated that these workpapers and test period could be used to determine the ultimate tip reporting rate by club. As a result of the completion of the self-assessment process for the three years under examination, the Company has reduced the estimated liability by $179,000 to approximately $207,000 as of December 31, 2009.

 

Litigation Associated with the Proposed Going Private Transaction

 

In connection with the Proposal concerning the proposed Going Private Transaction, the Company has been served with three complaints filed by various plaintiffs, alleging that they bring purported derivative and class action lawsuits against the Company and each of the individual members of the Board on behalf of themselves and all others similarly situated and derivatively on behalf of the Company, which previously have been reported in the Company’s Current Reports on Form 8-K (filed with the SEC on November 19, 2009, November 24, 2009 and December 7, 2009).

 

On November 13, 2009, the Company was served with a complaint filed by David Cohen in the District Court in Jefferson County, Colorado. In the complaint, Mr. Cohen alleges that he brings the purported class action lawsuit against the Company and each of the individual members of the Board on behalf of the Company’s stockholders. The complaint alleges, among other things, that Troy Lowrie, the Company’s Chairman of the Board and Chief Executive Officer, has conflicts of interest with respect to the Proposal and that in connection with the Board’s evaluation of the Proposal, the individual defendants have breached their fiduciary duties under Colorado law. The complaint seeks, among other things, certification of Mr. Cohen as class representative, either an injunction enjoining the defendants from consummating or closing the Going Private Transaction, or if the Going Private Transaction is consummated, rescission of the Going Private Transaction, an award of damages in an amount to be determined at trial and an award of reasonable attorneys’ and experts’ fees.

 

On November 20, 2009, the Company was served with a complaint filed by Gene Harris and William C. Steppacher, Jr. in the District Court in Jefferson County, Colorado. In the complaint, the plaintiffs purport to bring a derivative and class action lawsuit against the Company and each of the individual members of the Board on behalf of themselves and all others similarly situated and derivatively on behalf of the Company. The complaint alleges, among other things, that Mr. Lowrie has conflicts of interest with respect to the Proposal and that the individual defendants have breached their fiduciary duties under Colorado law in connection with the Proposal. The complaint

seeks, among other things, certification of the plaintiffs as class representatives, an injunction directing the Board members to comply with their fiduciary duties, an accounting to the plaintiffs and the class for alleged damages suffered or to be suffered based on the conduct described in the complaint, an award of the costs and disbursements of maintaining the action, including reasonable attorneys’ and experts’ fees, and such other relief the court deems just and proper.

 

On December 3, 2009, the Company was served with a complaint filed by David J. Sutton and Sandra Sutton in the District Court in Jefferson County, Colorado. In the complaint, the plaintiffs purport to bring a class action lawsuit against the Company and each of the individual members of the Board on behalf of themselves and all others similarly situated. The complaint alleges, among other things, that Mr. Lowrie has conflicts of interest with respect to the Proposal and that the individual defendants have breached their fiduciary duties under Colorado law in connection with the Proposal. The complaint seeks, among other things, certification of the plaintiffs as class representatives, an injunction directing the Board to comply with their fiduciary duties and enjoining the Board from consummating the Proposal, imposition of a constructive trust in favor of the plaintiffs and the class upon any benefits improperly received by the defendants, an award of the costs and disbursements of maintaining the action, including reasonable attorneys’ and experts’ fees, and such other relief the court deems just and proper.

 

The plaintiffs in the three lawsuits have moved to consolidate all three of the lawsuits (the “Class Action and Derivative Suits”) into one suit together with a fourth lawsuit arising out of the Proposal for the proposed Going Private Transaction, in which the Company was not named as a defendant, filed on December 11, 2009 by Brandon Ostry in the District Court in Jefferson County, Colorado against Mr. Lowrie and Lowrie Management, LLLP. The Company provided additional details on the Ostry lawsuit in its Current Report on Form 8-K filed with the SEC on December 17, 2009. The court has indicated that it will consider the consolidation motion if and when the plaintiffs move for class certification. As of the date hereof, the plaintiffs have not yet moved for class certification.

 

As of the date hereof, the Company believes that the allegations made in each of the Class Action and Derivative Suits are baseless and the Company intends to vigorously defend itself. The Company has not accrued any reserves for damages or for the settlement of these lawsuits as the outcome of the disputes cannot be predicted. Further, the uncertainty over the potential outcome of the Class Action and Derivative Suits has increased in light of subsequent events. As described elsewhere in this Annual Report on Form 10-K, on December 16, 2009, the Special Committee of the Company’s Board rejected the Proposal concerning the proposed Going Private Transaction as then-currently inadequate and, as previously disclosed in the Company’s Current Report on Form 8-K filed with the SEC on February 17, 2010, on February 17, 2010, the Company entered into the Letter of Intent with Rick’s concerning the proposed Merger. Currently, the Class Action and Derivative Suits only pertain to the Proposal for the proposed Going Private Transaction and not the proposed Merger. However, it is possible that the plaintiffs in the Class Action and Derivative Suits will attempt to amend their complaints to make claims related to the proposed Merger or that these plaintiffs or others persons may file one or more new lawsuits related to it.

 

Pursuant to the terms of the Company’s Articles of Incorporation and stand-alone indemnification agreement the Company has entered into with its Directors and executive officers, the Company may be required to advance expenses to and indemnify the Directors and Mr. Lowrie from expenses involved in defending against the lawsuits described above. The Company has discussed the risks and costs associated with such indemnification under the heading “Risk Factors.”

 

The Company is involved in various other legal proceedings that arise in the ordinary course of business. The Company believes the outcome of any of these proceedings will not have a material effect on the consolidated operations of the Company.

 

The Company is involved in various other legal proceedings that arise in the ordinary course of business. The Company believes the outcome of any of these proceedings will not have a material effect on the consolidated operations of the Company.

 

 

Market Information

 

The Company’s common stock, $0.0001 par value per share, is currently traded on the NASDAQ Global Market under the symbol “VCGH.” The market for our common stock is limited and volatile.

 

The following table sets forth the range of high and low bid prices for our common stock for each quarterly period indicated, as reported on the NASDAQ Global Market:

 

 

The high and low bid prices per share as reported on the NASDAQ Global Market on March 11, 2010, were $2.88 and $2.73, respectively.

 

Holders

 

As of March 12, 2010, there were approximately 2,232 stockholders of record of our common stock, excluding shares held by objecting beneficial owners.

 

Dividends

 

The Company has never declared or paid any dividends on our common stock. We do not intend to pay cash dividends on our common stock. We plan to retain our future earnings, if any, to finance our operations and for expansion of our business. The decision whether to pay cash dividends on our common stock will be made by our Board, in its discretion, and will depend on our financial condition, operating results, capital requirements, and other factors that our Board consider relevant.

 

Recent Sales of Unregistered Securities

 

None.

 

Transfer Agent and Registrar

 

The transfer agent and registrar for our common stock is Transfer Online, Inc., 512 SE Salmon Street, Portland, OR 97214.

 

Purchases of Equity Securities by the Issuer and Affiliated Purchasers

 

During 2009, the Company repurchased an aggregate of 444,655 shares of common stock for an aggregate purchase price of $869,393. As a result, as of December 31, 2009, up to 787,721 shares of common stock or shares of common stock with an aggregate purchase price of approximately $8,046,000 (whichever is less) remain available for repurchase under the Company’s repurchase program.

The following table provides additional information about the Company’s purchases under the repurchase program during the fourth quarter of 2009.

 

 

 

 

On November 3, 2009, the Company’s Board terminated the stock repurchase program approved on July 26, 2007, to allow the Company to evaluate the proposed going private transaction by Troy Lowrie, our Chairman of the Board and CEO, among other parties.

 

 

The following table sets forth certain of the Company’s historical financial data. The selected historical consolidated financial data as of December 31, 2009 and 2008 and for the years ended December 31, 2009 and 2008 have been derived from the Company’s audited consolidated financial statements and the related notes included elsewhere herein. The selected historical consolidated financial data as of December 31, 2007, 2006, and 2005 and for the years ended December 31, 2007, 2006, and 2005 have been derived from the Company’s audited financial statements for such years, which are not included in this Annual Report on Form 10-K. The selected historical consolidated financial data set forth are not necessarily indicative of the results of future operations and should be read in conjunction with the discussion under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and the historical consolidated financial statements and accompanying notes included herein. The historical results are not necessarily indicative of the results to be expected in any future period.

 

 

Please read the following selected consolidated financial data in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and the related notes appearing elsewhere in this Annual Report on Form 10-K for a discussion of information that will enhance understanding of this data.

 

 

 

 

 

Forward-Looking Statement Disclaimer

 

In this report, references to “VCG Holding Corp,” “VCG,” the “Company,” “we,” “us,” and “our” refer to VCG Holding Corp. and its subsidiaries.

 

This Annual Report on Form 10-K contains certain forward-looking statements and, for this purpose, any statements contained herein that are not statements of historical fact are intended to be “forward-looking statements” with the meaning of the Private Securities Litigation Reform Act of 1995. Without limiting the foregoing, words such as “may,” “will,” “expect,” “believe,” “anticipate,” “intend,” “estimate,” “continue,” or comparable terminology, are intended to identify forward-looking statements. These statements by their nature involve substantial risks and uncertainties, and actual results may differ materially depending on a variety of factors, many of which are not within our control. These factors include, but are not limited, to, costs and liabilities associated with the proposed going private transaction and associated litigation and the proposed merger transaction, our inability to retain employees and members of management due to uncertainty about our future direction due to the proposed merger transaction, costs and liabilities associated with our inability to successfully close the proposed merger transaction or any other similar transaction, the possibility that we may be prohibited from closing the proposed merger transaction or forced to rescind it if it has been consummated and pay damages as a result of litigation, diversion of management’s attention caused by the proposed merger transaction and associated litigation, our limited operating history making our future operating results difficult to predict, the availability of, and costs associated with, potential sources of financing, disruptions in the credit markets, economic conditions generally and in the geographical markets in which we may participate, our inability to manage growth, difficulties associated with integrating acquired businesses into our operations, geographic market concentration, legislation and government regulations affecting us and our industry, competition within our industry, our failure to promote our brands, our failure to protect our brands, the loss of senior management and key personnel, potential conflicts of interest between us and Troy Lowrie, our Chairman of the Board and Chief Executive Officer (“CEO”), our failure to comply with licensing requirements applicable to our business, liability from unsanctioned, unlawful conduct at our nightclubs, the negative perception of our industry, the failure of our business strategy to generate sufficient revenues, liability from uninsured risks or risks not covered by insurance proceeds, claims for indemnification from officers and Directors, deterrence of a change of control because of our ability to issue securities or from the severance payment terms of certain employment agreements with senior management, our failure to meet the NASDAQ continued listing requirements, the failure of securities analysts to cover our common stock, our failure to comply with securities laws when issuing securities, our common stock being a penny stock, our intention not to pay dividends on our common stock, our future issuance of common stock depressing the sale price of our common stock or diluting existing stockholders, the limited trading market for, and volatile price of, our common stock, and our inability to comply with rules and regulations applicable to public companies.

 

We caution readers not to place undue reliance on any forward-looking statements, which speak only as of the date made and are based on certain assumptions and expectations which may or may not be valid or actually occur and which involve various risks and uncertainties.

 

Unless otherwise required by applicable law, we do not undertake, and specifically disclaim any obligation, to update any forward-looking statements to reflect occurrences, developments, unanticipated events or circumstances after the date of such statement.

Overview

 

The Company is in the business of acquiring, owning and operating nightclubs, which provide premium quality live adult entertainment, restaurant and beverage services in an up-scale environment. As of December 31, 2009, the Company, through its subsidiaries, owns and operates 20 nightclubs in Indiana, Illinois, Colorado, Texas, North Carolina, Minnesota, Kentucky, Maine, Florida, and California. The Company operates in one reportable segment.

 

Critical Accounting Estimates

 

The preparation of financial statements and related disclosures in conformity with accounting principles generally accepted in the United States (“U.S. GAAP”) requires us to make judgments, assumptions, and estimates that affect the amounts reported in the Consolidated Financial Statements and accompanying notes, Note 2. Summary of significant accounting policies, to the Consolidated Financial Statements describes the significant accounting policies and methods used in preparation of the Consolidated Financial Statements. The accounting positions described below are significantly affected by critical accounting estimates. Such accounting positions require significant judgments, assumptions, and estimates to be used in the preparation of the Consolidated Financial Statements, and actual results could differ materially from the amounts reported based on variability in factors affecting these estimates.

 

Our management has discussed the development and selection of these critical accounting estimates with the Audit Committee of our Board of Directors, and the Audit Committee has reviewed our disclosures to it in this Management’s Discussion and Analysis.

 

Assignment of Fair Values upon Acquisition of Licenses, Goodwill and Other Intangibles

 

In accordance with the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 805, Business Combinations (“ASC 805”), and ASC Topic 350, Intangibles - Goodwill and Other (“ASC 350”), when the Company acquires a nightclub, we assign fair values to all identifiable assets and liabilities, including intangible assets such as licenses, goodwill, identifiable trade names, and covenants not to compete. We also determine the useful life for the amortizable identifiable intangible assets acquired. These determinations require significant judgment, estimates, and projections. The remainder of the purchased cost of the acquired nightclub that is not assigned to identifiable assets or liabilities is then recorded as goodwill. As a result of our acquisitions, each nightclub has recorded a significant amount of intangibles, including licenses and goodwill. The Company has not had an acquisition since July 2008.

 

The assumptions and estimates used in determining the current value of a nightclub includes operating cash flows, market and market share, sales volume, prices, and working capital changes. Historical experience, project performance, and any other available information is also used at the time that the fair value of the nightclub is estimated.

 

In estimating the fair values of our nightclubs, we used a combination of the income approach and the market-based approach. The income approach is a valuation technique, which involves discounting estimated future cash flows of each nightclub to their present value to calculate fair value. The discount rate used varies by nightclub and represents the estimated weighted average cost of capital, which reflects the overall level of inherent risk involved in our operations and cash flows. To estimate future cash flows, we applied a multiple to EBITDA. The market-based approach uses a comparable public company, and then compares specific parts of our operations such as rent expense.

 

Testing for Impairment of Intangible Assets

 

ASC Topic 350 requires an annual reassessment of the carrying value of indefinite lived assets at the reporting unit or nightclub level, or even more frequently, if certain circumstances occur, for impairment of that value. The evaluation of impairment involves comparing the current fair value of the reporting units to the recorded value. If the recorded value of a nightclub exceeds its current fair value, then an impairment loss is recognized to the extent that the book value of the intangible assets exceeds the implied fair value of the nightclub’s intangible assets. Accordingly, the fair value of a reporting unit is allocated to all of the assets and liabilities of that nightclub,

including any unrecognized intangible assets and the excess becomes the implied value of the goodwill. This is done in relation to the nightclub’s respective forecasted cash flows and other relevant assumptions

 

In performing the Company’s annual impairment assessment at December 31, 2009 in accordance with ASC Topic 350, the Company recorded a non-cash impairment charge for licenses of $1,574,000 and trade names of $167,000. In addition, the Company evaluated its goodwill at December 31, 2009 and recorded a non-cash impairment charge of approximately $17,000. The total impairment charge was approximately $1,758,000.

 

The fair value of the licenses, trade names, and reporting units was based on estimated discounted future net cash flows at the club level. The impairment charge is a result of a continued weak economy. We computed an estimate of our company-wide weighted average cost of capital of 12.0%. The long-term growth rate of 3% was estimated by using the Gordon Growth Model. These processes are subjective and require significant estimates. These estimates include judgments about future cash flows that are dependent on internal forecasts, growth rates, company specific risk premiums and estimates of weighted average cost of capital used to discount future cash flows. Changes in these assumptions and estimates could materially affect the results of our reviews for impairment.

 

Impairment of Real Estate

 

ASC Topic 360, Property Plant and Equipment requires a fair market valuation of assets, including land and buildings, in the event of triggering events including adverse changes in the business climate or decline in market value. In December 2008, the Company ordered an appraisal of the land and building owned in Phoenix, Arizona. The appraisal was performed by an independent third party real estate appraiser who valued the land and building at $2,600,000, resulting in an impairment of approximately $1,886,000 at December 31, 2008. This building was rented by the individual who purchased the operations and ownership interest in our subsidiary Epicurean Enterprises in January 2007. The lessee defaulted on the lease in August 2008 and an impairment charge of $268,000 was recorded at June 30, 2009. On July 31, 2009, the Company sold the building and land for approximately $2,300,000. The Company recognized a non-cash loss of approximately $69,000 upon the sale. The Company does not have any real property held for sale or vacant as of December 31, 2009.

 

Stock Options

 

In 2007 and 2008, the Company issued stock option grants to key employees and officers. The two officer grants vest one-third on the 3^rd, 5th and 7th anniversary of the grant date. Key employee grants vest 20% on the 3^rd anniversary and 40% each on the 5th and 7th anniversary of the grant date. The options are cancelled upon termination of employment and expire ten years from the date of grant. All options were granted at an exercise price significantly above the fair market value of the common stock covered by the option on the grant date. All option exercise prices substantially exceed fair market value on December 31, 2009 and March 12, 2010.

 

The Company accounts for stock-based compensation by measuring and recognizing as compensation expense the fair value of all options as of the grant date. The determination of fair value involves a number of significant estimates. We use the Black-Scholes Option Pricing Model to estimate the fair value of option grants using assumptions which are described in Note 11 to the consolidated financial statements. These include the expected volatility of our stock and employee exercise behavior. These variables make estimation of fair value of stock options difficult. A key assumption is the number of options ultimately expected to vest. Since no options were granted during 2009, the only estimate which affected the 2009 financial statements was the forfeiture assumption. Forfeitures were estimated at the time of the grant in 2007 and 2008 of 16% over the seven year option vesting period based upon limited historical experience and were revised to 25% during 2009 based upon actual forfeitures. This resulted in a reduction of stock-based compensation expense of approximately $46,000 for 2009.

 

Any subsequent revisions to the forfeiture assumptions adjusts the prior period compensation expense in the period of the change on a cumulative basis for unvested options for which compensation expense has already been recognized and in subsequent periods for unvested options for which the expense has not yet been recognized. Actual forfeitures could differ materially as a result of voluntary employee actions and involuntary actions which may result in significant changes in our stock-based compensation expense amounts in the future. In addition, the value, if any, an employee ultimately receives from stock-based compensation awards will likely not correspond to the expense amounts recorded by the Company.

Legal and Other Contingencies

 

As discussed in Note 12 to the consolidated financial statements, legal proceedings are pending or threatened. The outcomes of legal proceedings and claims brought against us and other loss contingencies are subject to significant uncertainty. We accrue a charge against income when our management determines that it is probable that an asset has been impaired or a liability has been incurred and the amount of loss can be reasonably estimated. We regularly evaluate current information available to us to determine whether an accrual should be established or adjusted. Due to the inherent uncertain nature of litigation, the ultimate outcome or actual cost of defense or settlement may vary materially from estimates.

 

IRS Tip Audit

 

The IRS audited PT’s^® Showclub in Denver for the years 2006, 2007, and 2008 to determine tip reporting compliance. Every business with customary tipping must report annually on Form 8027 the total sales from food and beverage operations, charge sales, total tips reported, and charge tips reported. The audit resulted in a determination that cash tips for that club were under-reported in the three years examined. The tax assessed, without penalties and interest, as a result of this under-reporting was $61,500. The Company performed an intensive self-audit for 2007, 2008 and 2009 using the same procedures followed by the IRS agent. As a result of the completion of the self-assessment process for the three years under examination, the Company has accrued a tip liability of $207,000 as of December 31, 2009. This estimate involves significant judgment and the actual tax liability may differ materially.

 

DOL Audit

 

In October 2008, PT’s^® Showclub in Louisville, KY was required to conduct a self-audit of employee payroll by the DOL. After an extensive self-audit, the DOL required that the Club issue back pay and refund uniform expenses to qualified employees at a total cost of $14,439.

 

In March 2009, VCG was placed under a similar nationwide DOL audit for all nightclub locations and its corporate office. All locations completed the self-audit in August 2009 and are currently working with the DOL to determine what, if any, violations may have occurred. This case is still in the investigatory state and no final determination can be made at this time of an unfavorable outcome or any potential liability. The Company has accrued $200,000 as of December 31, 2009 for potential wage/hour violations; however this estimate involves significant judgment and the actual liability may vary materially from this estimate. A summary meeting has tentatively been scheduled with the DOL and counsel on March 15, 2010 to finalize the liability. The Company believes it has corrected all processes that resulted in the potential violations.

 

Self-Insured Health Insurance

 

The Company is partially self-insured for group health insurance. The accrual is regularly evaluated and adjusted for claims incurred but not reported. Due to the inherent uncertain nature of medical claims, the actual cost may materially differ from the $200,000 accrued liability as of December 31, 2009.

 

Income Taxes

 

We are subject to income in the United States. Tax law requires items to be included in the tax return at different times than when the same items are reflected in the consolidated financial statements. Permanent differences result when either deductible items for U.S. GAAP purposes are not deductible for tax purposes or income recognized for U.S. GAAP purposes is not recognized for tax. Temporary differences reverse over time, such as depreciation, amortization, and net operating loss carry-forwards. As of December 31, 2009, we have an estimated tax net operating loss carry-forward of approximately $2,608,000 which is classified as non-current deferred tax asset. Significant judgment is used in determining the timing of utilizing the net operating loss carry-forward, some of which may be utilized in 2010. Based on the evaluation of all available information, the Company recognizes future tax benefits, such as net operating loss carry-forwards, to the extent that realizing these benefits is considered “more likely than not” to be sustained in accordance with FASB guidance issues in accounting for uncertainty in income taxes recognized.

The timing differences create either deferred tax assets or liabilities. Deferred tax assets and liabilities are determined based on temporary differences between the financial reporting and tax bases of assets and liabilities. The tax rates used to determine deferred tax assets or liabilities are enacted tax rates in effect for the year and manner in which the differences are expected to reverse. Our effective rates differ from the statutory rate primarily due to 2009 permanent differences of approximately $351,000 (tax affected) and tax credits of approximately $582,000.

 

During the course of ordinary business, there are some transactions and calculations for which the ultimate tax determination is uncertain. We establish reserves for tax-related uncertainties based on estimates of whether, additional tax will be due. The reserves are established when we believe that certain positions are likely to be challenged and may not be fully sustained on review by tax authorities. We evaluate our ability to realize the tax benefits associated with deferred tax assets by analyzing our future taxable income using both historical and projected future operating results, reversing the existing taxable temporary differences, taxable income in prior carry-back years (if permitted) and the availability of tax planning strategies. In the event that we change our determination as to the amount of deferred tax assets that can be realized, we will adjust our valuation allowance with a corresponding impact to the provision for income taxes in the period in which such determination is made.

 

As of December 31, 2009, the current portion of the deferred income tax asset was determined to be $76,920 attributable to the company’s partially self insured health insurance reserve and $3,841,673 non-current deferred income tax asset attributable to other temporary differences.

 

Results of Operations

 

Year Ended December 31, 2009 Compared to Year Ended December 31, 2008

 

Revenues

 

Total revenue, net of sales taxes, decreased from approximately $57,693,000 for the year ended December 31, 2008 to approximately $55,040,000 for the year ended December 31, 2009. The decrease in revenue of approximately $2,653,000 or 4.6% was primarily due to the weak economy and a reduction in business and convention travel. The high-end A clubs had a decline in revenue of approximately $1,552,000 or 7.3%. These clubs are the most susceptible to the economic recession because of their business clientele. Because of the weak economy the B format clubs also experienced an overall decline in revenue of approximately $2,462,000 or 8.8%. The Jaguar’s Gold Club in Dallas, Texas and Imperial Showgirls Gentlemen’s Club in Anaheim, California were included in operations for all of 2009, but only for a part of 2008. These acquisitions generated approximately $1,720,000 of additional income in 2009 that was not included in 2008 results.

 

Rental income received from unrelated third parties, included in other income, totaled approximately $179,000 for the year ended December 31, 2009 and approximately $288,000 in 2008. This was due to the Company not receiving rental income in 2009 on the Arizona property which was sold in July 2009. Rental income in 2008 was less than 0.5% of total income and decreased to approximately 0.3% in 2009.

 

Cost of Goods Sold

 

Cost of Goods sold includes the cost of the alcohol, food, and merchandise we sell to customers. We track cost of goods sold as a percentage of the attributable revenues. Costs of goods sold decreased in 2009 to approximately $5,921,000 or 23.9% of attributable revenue. This compares to approximately $6,980,000 in 2008, or approximately 24.3% of attributable revenue. The decrease is a result of operating two additional all nude nightclubs (C clubs) for the full year of 2009 as compared to 2008. The all nude clubs do not sell alcohol and have a lower cost of goods sold percentage. In addition, the A and B clubs better managed their inventories, reducing the cost of sales percentage by more than the decrease in attributable revenue.

Salaries and Wages

 

Salaries and wages increased by approximately $320,000 or 2.4% in 2009, from $13,461,000 for the year ended December 31, 2008 to approximately $13,781,000 for the year ended December 31, 2009. This slight change can be attributable to the following:

 

 

In November 2007, the Company’s Compensation Committee hired an independent consulting firm to determine proper compensation levels for our CEO and President. The study’s results were used to determine the compensation of our President, Micheal Ocello, after he changed his status from consultant to employee in October 2007. Mr. Ocello’s annual salary has remained consistent, without an increase for the twelve months ended December 31, 2009 and 2008.

 

Our CEO and principal stockholder, Troy Lowrie, elected to not receive a salary from the Company’s inception in 2002 until March 2008. At that time, Mr. Lowrie elected to receive a salary of approximately $300,000 annually, only 40% of the salary recommended by the independent salary survey and approved by the Board. In November 2008, Mr. Lowrie elected to increase his salary to $700,000, the full amount approved by the Board. Mr. Lowrie has been paid that salary, without an increase, through 2009.

 

The percentage of salary to total revenue for the year ended December 31, 2009 was 25.0%. The same percentage for the previous year was 23.3%, an increase of 1.7%. We expect the ongoing percentage of salary to total revenue to continue to be approximately 25% of total revenues.

 

Other General and Administrative Expenses

 

Taxes and permits expenses increased by approximately $585,000 for the year ended December 31, 2009, compared to the same period in 2008. This 20.2% increase was a result of:

 

 

Charge card and bank fees decreased by approximately $72,000 to a total of approximately $797,000 for the year ended December 31, 2009. This is an 8.3% decrease over the same period in 2008. This decrease is attributable to a change in several cities to banks with lower service charges, closing of many bank accounts with little or nominal activity, sharp decrease in wiring funds to avoid wire fees and the use of electronic funds transfers and online banking. Chargeback losses are also down in 2009 by approximately $37,000 due to changes in procedures in processing and fighting customer chargebacks.

 

Annual rent increased slightly in 2009, to approximately $5,855,000 as of December 31, 2009 compared to $5,798,000 for the same period ending December 31, 2008. This increase of approximately $57,000 or 1.0% is for

scheduled rent increases plus rents for full year on Manana Entertainment, Inc. and VCG-IS, LLC, the two clubs acquired during 2008.

 

Legal fees increased by 33.1% to approximately $1,466,000 for the year ended December 31, 2009 compared to the same period in 2008. This increase is due to litigation involving the Classic Affairs nightclub (see Item 3 Legal Proceedings). The lawsuit has now been dismissed, with prejudice. All related costs have been accrued or paid as of December 31, 2009.

 

Other professional fees decreased by approximately $572,000 or 20.5% in 2009 to approximately $2,216,000 at December 31, 2009, from the previous amount of $2,788,000 in 2008. These fees include charges for appraisals, broker commissions for renting company real estate, lobbying fees, and environment assessments. Other professional fees in 2009 included the following approximate amounts:

 

 

Approximately $954,000 in expenses were incurred by the Company and the Special Committee in relation to the proposed going private transaction and proposed merger with Rick’s Cabaret International, Inc. See Footnote 3 to the Financial Statements. These costs represent expenses of the Special Committee, legal costs billed by the legal counsel to the Special Committee, legal costs incurred by the Company in relation to both the proposed going private transaction and proposed merger, and costs billed and accrued from the financial advisor to the Special Committee.

 

Advertising and marketing expenses decreased by approximately $116,000 or 3.9% over the year ended December 31, 2008. This decrease is mostly attributable to more efficient methods of advertising, including using billboard trucks for mobile advertising versus leasing fixed billboard signs. Advertising and marketing expenses were approximately 5.1% of total revenues in 2009 and 2008. The Company’s senior management uses this metric to monitor and control advertising expenses.

 

Insurance expenses decreased by approximately $57,000 for the year ended December 31, 2009, a 3.3% decrease over the prior year. This decrease is due to insurance premium savings related to economies of scale and lower rates resulting from a reduction in claims. Insurance premiums represented approximately 3.0% of total revenues in 2009 and 2008. This percentage is a metric that Company senior management uses to monitor and control insurance expenses.

 

Utilities expenses slightly decreased in 2009 over the same period in 2008. The decrease of approximately $72,000 or 6.5% was a result of milder weather in 2009 versus the very cold winter in the central and northeast United States in 2008.

 

Repair and maintenance expenses increased from approximately $1,022,000 in 2008 to $1,242,000 in 2009. This increase of $220,000 or 21.5% resulted from repairs and stepped up maintenance on several nightclubs, including repairs to heating/air conditioning systems in Minnesota, Kentucky, Illinois and Colorado. Sprinkler systems were repaired and updated in Raleigh and sewer and drains were repaired in Denver. Electrical wiring and lighting systems were repaired in several clubs as well.

 

General and administrative (“G&A”) expenses include common office and nightclub expenses such as janitorial, supplies, security, cast and employee relations, education and training, travel and automobile, telephone, and internet expenses. Total G&A expenses totaled $5,023,000 for the twelve months ended December 31, 2009 compared to $4,777,000 for the same time period in 2008. Janitorial expenses were the largest item in the G&A

category, totaling approximately $870,000 for the twelve months ended December 31, 2009. This is an increase of approximately $126,000 over the same time period in 2008. The primary reason for this increase is that the two clubs acquired in 2008 were included in a full year’s expenses in 2009. In addition, upholstery and carpet cleaning are included in this account and this has been done semi-annually in most clubs in 2009. Office and nightclub supplies totaled $694,000 for the 12 months ended December 31, 2009, an increase of approximately 9.5% over the same time period for 2008. Automobile and travel also increased by approximately $51,000 for the year ended December 31, 2009 compared to the same period in 2008. Employee education and travel was higher for club personnel, where classes on non-violent security training, club management and classes on the new point of sales POS system were offered to personnel in all clubs. G&A expenses for being a public company included SEC filing fees, investor relations and transfer agent charges totaled approximately $218,000 for the fiscal year ending in 2009. Other unusual and previously disclosed expenses are included in the G&A total, including abandoned acquisition totaling approximately $52,000 in 2009.

 

Depreciation and Amortization

 

Depreciation and amortization expenses increased by $13,507 or 0.8%, during the year ended December 31, 2009, compared to the same period in 2008. This small increase is a result of the point of sale (“POS”) system being installed in November and December 2009. Depreciation on other asset additions earlier in 2009 were offset by the end of depreciation expense on the Arizona building that was sold in July 2009.

 

Amortization of non-compete agreements entered into in connection with nightclub acquisitions, is included in depreciation and amortization in the statement of consolidated operations. For the year ended December 31, 2008 amortization of non-competes was $20,761 and $17,035 for the year ended December 31, 2009. All non-compete agreements were included in the acquisition valuation analysis and adjusted accordingly. These adjusted values are being amortized ratably over the life of the agreement.

 

Interest Expense

 

Total interest expense decreased by approximately $305,000 or approximately 8.1%, during the year ended December 31, 2009, compared to the same period in 2008. The decrease in interest expense was a result of the Company paying down over approximately $4,700,000 in total debt, during 2009, including one promissory note with an annual interest rate of 12%.

 

Interest Income

 

Interest income decreased by almost $16,000 or 68.4% for the year ended December 31, 2009, when compared to the same period in 2008. This is because the Company made a decision to spend virtually all free cash on paying down debt or buying back the Company’s stock, and because of interest earned in 2008 on a federal tax refund.

 

Loss on Sale of Assets

 

The Company recorded losses on the sale or write-off of assets totaling approximately $75,000 for the year ended December 31, 2009. The previously disclosed loss on the sale of the Arizona property totaled almost $69,000 of that loss. The remaining $6,000 was the write-off of miscellaneous small assets at the clubs.

 

Income Taxes

 

For 2009, the current income tax benefit of approximately $127,000 represents the net of a Federal benefit of approximately $274,000 offset by state income tax expense of $147,000. Since a tax net operating loss of $2,529,111 was generated during 2009, there is no Federal income tax owed for 2009. The Federal benefit resulted from the amendment of 2007 tax returns during 2009 and the reconciliation of the 2008 book provision to the tax returns. State income tax expense primarily represents taxes payable for those states which do not allow consolidated tax filings, as well as minimum taxes due in various states.

 

Deferred tax expense in 2009 included approximately $466,000 of deferred income taxes expense as compared to a deferred income tax benefit of $11,831,550 for the prior year which was substantially attributable to asset

impairments of $48,006,241. Our non-current portion of deferred income tax asset increased by $1,017,181 during 2009 due to the tax net operating loss generated. This was partially offset by the sale of the Arizona land and building during 2009 which reduced our non-current portion of deferred income tax asset by approximately $780,000.

 

Net income was $735,691 for the year ended December 31, 2009 as compared with a net loss of $30,710,794 for 2008.

 

Liquidity and Capital Resources

 

The amount of cash flow generated and the working capital needs of the nightclub operations does not materially fluctuate and is predictable. We expect to meet our liquidity needs for the next year from existing cash balances and cash flows from operations. We intend to use our cash flows for principal and interest payments on debt, capital expenditures in certain clubs, and repairs and maintenance in other clubs.

 

Working Capital

 

At December 31, 2009 and December 31, 2008, the Company had cash of approximately $2,677,000 and $2,209,000 respectively. Our total current assets were approximately $4,884,000 and $4,220,000 for the same time period. Current liabilities totaled approximately $8,004,000 at December 31, 2009 and $7,128,000 at December 31, 2008. The Company’s current liabilities exceed its current assets resulting in a negative working capital of approximately $3,120,000 at December 31, 2009 and $3,108,000 at December 31, 2008. The working capital deficit decreased by approximately $12,000 between the two years. Our requirement for working capital is not significant since we receive payment for food and beverage purchases in cash or credit cards at the time of the sale. So we receive the cash revenue before we are required to pay our suppliers for these purchases.

 

Of the current liabilities at December 31, 2009, none is due to Lowrie Management LLLP. A total of approximately $1,309,000 of current liabilities are guaranteed by Mr. Lowrie and secured by his personal assets. Of that, the Company paid $1,400,000 in full on January 4, 2010. At December 31, 2009, the Company still had $1,280,000 of available and unused funding on its revolving line of credit with one bank and consolidated two loans into one loan with the same bank. The proposed merger transaction and current economic conditions have temporarily suspended the process of negotiating a larger line of credit. We have loans and a line of credit with our lead bank and have no reason to believe that these will not be renewed, when they come due in 2010 to 2014.

 

In 2009, we made payments on debt totaling approximately $5,175,000, including payments of high-interest rate debt. The Company renegotiated terms on many loans during the fourth quarter of 2008 and first quarter of 2009, extending maturity dates by 12 to 14 months or more. In all instances but one loan, the interest rate and principal amounts did not change, making the extension a modification of the loan, not an extinguishment.

 

On August 17, 2009, the Company modified the terms of two existing long-term debt obligations totaling $3,872,426 with Citywide Banks. The promissory notes that were consolidated included:

 

(i) a promissory note executed on May 16, 2006 with a current outstanding principal balance of $1,770,286, bearing interest at 8.5% per annum, with monthly principal and interest payments of approximately $36,156 and with a maturity date of May 16, 2010; and

 

(ii) a promissory note executed on June 30, 2008 with a current outstanding principal balance of $2,102,140, bearing interest at 6% per annum, with monthly principal and interest payments of approximately $50,403 and with a maturity date of June 30, 2013.

 

The consolidated replacement promissory note (the “Replacement Note”) in the amount of $3,872,426 bears interest at the rate of 7% per annum, with monthly principal and interest payments of approximately $76,865 and with a maturity date of August 15, 2014. The Replacement Note contains two new covenants. The first new covenant requires acquisitions or additional indebtedness of equal to, or in excess, of $1,000,000 be pre-approved by Citywide Banks. The second new covenant is a financial ratio covenant. This covenant requires the quarterly calculation of net cash flow to debt service in a ratio greater than, or equal to, 1.2 to 1.0. Net cash flow is defined as

income attributable to the Company plus depreciation, amortization, and interest expense. Net profit excludes any intangible impairments and related tax effects. The Company is currently in compliance with all debt covenants.

 

The Company also extended its revolving line of credit with Citywide Banks. The original line of credit (the “Original Line of Credit”) was executed on June 29, 2008, had a maturity date of June 29, 2010, a maximum principal amount of $4,000,000, and a variable interest rate calculated on the Prime Rate as published in the Wall Street Journal, subject to change daily with a floor of six percent. The replacement line of credit (the “Replacement Line of Credit”) has the identical maximum principal amount and interest terms as stated in the Original Line of Credit. Monthly payments vary based on principal outstanding. The maturity date of the Replacement Line of Credit is August 15, 2011. The following is a description of material changes in the terms of the Replacement Line of Credit compared to the Original Line of Credit: (i) The Original Line of Credit and the Replacement Line of Credit have the same collateral, but have been cross collateralized with the collateral for the Replacement Note: the Whole Life Insurance Policy on the life of Troy Lowrie, plus the P&A Select Strategy Fund, LP and the P&A Multi-Sector Fund II, LP, owned by Lowrie Management LLLP, and (ii) The Original Line of Credit covenants required that all advances on the Original Line of Credit be fully repaid for one day every 180 days. That covenant was replaced with the same new covenants as indicated for the Replacement Note above.

 

On September 22, 2009, the Company prepaid a promissory note issued to Bryan S. Foster (“Foster”) in connection with VCG’s purchase of Manana Entertainment, Inc. (“Manana”) from Foster in the following manner:

 

(a) a cash payment of $1,600,000 made by VCG and Manana to Foster, and

 

(b) an offset of the amount owed by Black Canyon Highway LLC, the purchaser of the Phoenix, Arizona property to VCG totaling $263,544 against the balance owed by VCG and Manana to Foster under the Foster note.

 

After the application of the offset and note payments, the outstanding principal balance owed by Black Canyon to VCG at December 31, 2009 under the Black Canyon note is $56,132. The unpaid balance on the Black Canyon note will continue to accrue interest at eight percent per annum. No other terms of the Black Canyon note were changed.

 

As previously disclosed, in August 2009, the Company renegotiated due dates on five promissory notes, totaling $1,984,612 with original maturity dates from January to November 2010. In all instances, the loans were extended twelve months from their original maturity dates into 2011. No other changes were made to these notes. The Company has shown these promissory notes as long-term debt on the balance sheet. Please see Note 9 in the consolidated financial statements for additional detail on the Company’s debt. The Company is not currently considering any immediate acquisitions because of the proposed merger transaction.

 

Cash flows generated from operations was $7,081,000, and we had a net increase in cash at the end of the fiscal year ended December 31, 2009. We have been able to satisfy our needs for working capital and capital expenditures through a combination of cash flow from nightclub operations and debt. We expect that operations will continue with the realization of assets and payment of current liabilities in the ordinary course of business.

 

While we can offer no assurances, we believe that our existing cash and expected cash flow from operations will be sufficient to fund our operations and necessary capital expenditures and to service our debt obligations for the foreseeable future. If the proposed merger does not occur and if we are unable to achieve our planned revenues, costs and working capital objectives, we believe that we have the ability to curtail stock repurchases and capital expenditures and will reduce costs to levels that will be sufficient to enable us to meet our cash requirement needs in the upcoming year.

 

Capital Resources

 

We had stockholders’ equity of $28,482,530 at December 31, 2009 and $28,386,742 at December 31, 2008. The $95,789 increase in stockholders’ equity is primarily a result of the stock buybacks that occurred and are described elsewhere in this document. We had stockholders’ equity of $28,482,530 at December 31, 2009 and $28,386,742 at December 31, 2008. The stock buybacks described elsewhere in this document resulted in an

approximate reduction in stock and additional paid-in capital of $625,000. This was offset by net income attributable to VCG of $735,691 for the year ended December 31, 2009.

 

Net cash provided by operating activities was approximately $7,081,000 in 2009 compared to approximately $11,752,000 in 2008. The major non-cash activities in 2009 were the impairment of indefinite life intangible assets (licenses, goodwill and trademarks) of $1,758,000; the non-cash impairment of the Phoenix, Arizona land and building of $268,000 and the provisions of depreciation of approximately $1,695,000; non-compete amortization of approximately $17,000 and net amortization of favorable lease rights and unfavorable lease liabilities of approximately $212,000. The amortization of loan fees included an additional approximately $37,000 related to the extinguishment and replacement of a bank debt, with a new note including an extended due date and modified interest rate. Accounts payable and accrued expenses also increased by approximately $576,000. There was also a decrease in the deferred income tax benefit of $739,000 due to the income tax effect of the sale of the Arizona property offset by the impairment losses.

 

Net cash used by investing activities totaled approximately $1,236,000 for the year ended December 31, 2009. The Company purchased approximately $1,454,000 of property and equipment, mostly in club remodels and the POS system.

 

Net cash used by financing activities was approximately $5,380,000 for 2009. During 2009, we paid approximately $79,000 in loan fees, compared to approximately $268,000 paid to lenders in 2008. We received approximately $1,212,000 in proceeds from new debt, and paid approximately $5,175,000 in debt in 2009. We repurchased approximately $869,000 of common stock, which was immediately cancelled according to Colorado state law.

 

The following table reconciles net income or (loss) to EBITDA by quarter. EBITDA is normally a presentation of “earnings before interest, taxes, depreciation, and amortization.” EBITDA is a non-GAAP calculation that is frequently used by our investors to measure operating results. EBITDA data is included because the Company understands that such information is considered by investors as an additional basis on evaluating our ability to pay interest, repay debt, and make capital expenditures. Management cautions that this EBITDA may not be comparable to similarly titled calculations reported by other companies. Because it is non-GAAP, EBITDA should not be considered an alternative to operating or net income in measuring company results.

 

 

EBITDA (excluding non-cash impairment charges) decreased $3,404,500 in fiscal year 2009, primarily because of the reduction in income tax benefits from the impairment charges.

 

Another non-GAAP financial measurement used by the investment community is free cash flow. The following table calculated free cash flow for the Company for the twelve months ended December 31, 2009 and 2008. We use free cash flow calculations as one method of cash management to anticipate available cash, but

cautions investors that this free cash flow calculation may not be comparable to similarly titled calculations reported by other companies. Because this is non-GAAP, free cash flow should not be considered as an alternative to the consolidated statement of cash flows.

 

 

Contractual Obligations and Commercial Commitments

 

The Company has long-term contractual obligations primarily in the form of operating leases and debt obligations. The following table summarizes our contractual obligations and their aggregate maturities as well as future minimum rent payments. Future interest payments related to variable interest rate debt were estimated by using the interest rate in effect at December 31, 2009.

 

 

Potential Sale of the Company

 

On November 3, 2009, the Company received a non-binding letter of intent (the “Proposal”) from the Company’s Chairman and CEO, Troy Lowrie, Lowrie Management, LLLP, an entity controlled by Mr. Lowrie, and certain other unidentified investors (collectively, the “Lowrie Investors”), to acquire all of the outstanding common stock of the Company for $2.10 per share in cash (the “Going Private Transaction”). The Proposal contemplated that the Company would no longer be a public reporting or trading company following the closing of the Going Private Transaction. In response to the Proposal, the Board formed a Special Committee to review and evaluate the Proposal and to recommend to the Board whether or not to approve or decline the Proposal. On December 16, 2009, the Special Committee informed the Lowrie Investors that it had determined, with input from its advisors, that the terms of the Proposal were currently inadequate, and the Special Committee directed its financial advisors to contact any parties that had either previously expressed an interest or might potentially be interested in pursuing a transaction with the Company.

 

On February 16, 2010, the Company, Rick’s Cabaret International, Inc. (“Rick’s”), Mr. Lowrie, and Lowrie Management, LLLP (collectively with Mr. Lowrie, “Lowrie”), entered into a non-binding (except as to certain provisions, including exclusivity and confidentiality) letter of intent (the “Letter of Intent”). Pursuant to the Letter of Intent, Rick’s agreed to acquire all of the outstanding shares of common stock of the Company and the Company will merge with and into Rick’s or a wholly-owned subsidiary of Rick’s (the “Merger”). In the event the Merger is consummated, the Company will become a subsidiary of Rick’s and the Company’s shareholders will become shareholders of Rick’s. The parties intend that the Merger will be structured to qualify as a tax-free reorganization under the Internal Revenue Code of 1986, as amended.

 

 

Not applicable to smaller reporting companies.

 

 

To the Board of Directors and Stockholders of VCG Holding Corp.

 

We have audited the accompanying consolidated balance sheets of VCG Holding Corp. as of December 31, 2009 and 2008, and the related consolidated statements of operations, stockholders’ equity, and cash flows for each of the years in the two-year period ended December 31, 2009. We also have audited VCG Holding Corp.’s internal control over financial reporting as of December 31, 2009, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). VCG Holding Corp.’s management is responsible for these financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Annual Report on Internal Control over Financial Reporting (Item 9A.). Our responsibility is to express an opinion on these financial statements and an opinion on the company’s internal control over financial reporting based on our audits.

 

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.

 

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

 

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of VCG Holding Corp. as of December 31, 2009 and 2008, and the consolidated results of its operations and its cash flows for each of the years in the two-year period ended December 31, 2009 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, VCG Holding Corp. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2009, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).

 

/s/ Causey Demgen & Moore Inc.

Denver, Colorado

March 12, 2010

VCG Holding Corp.

 

Consolidated Balance Sheets

 

 

The accompanying notes are an integral part of the consolidated financial statements.

VCG Holding Corp.

 

Consolidated Statements of Operations

For the years ended

 

 

The accompanying notes are an integral part of the consolidated financial statements.

VCG Holding Corp.

 

Consolidated Statements of Equity

For the years ended December 31, 2009 and 2008

 

 

The accompanying notes are an integral part of the consolidated financial statements.

VCG Holding Corp.

 

Consolidated Statements of Cash Flows

For the years ended

 

 

The accompanying notes are an integral part of the consolidated financial statements.

VCG Holding Corp.

 

Notes to Consolidated Financial Statements

 

Index

 

VCG Holding Corp.

 

Notes to Consolidated Financial Statements

 

 

VCG Holding Corp. (the “Company”) is in the business of acquiring, owning, and operating nightclubs, which provide premium quality live adult entertainment, restaurant, and beverage services in an up-scale environment. As of December 31, 2009, the Company, through its subsidiaries, owns and operates twenty nightclubs in Indiana, Illinois, Colorado, Texas, North Carolina, Minnesota, Kentucky, Maine, Florida, and California. The Company operates in one reportable segment.

 

 

Principles of Consolidation

 

The Consolidated Financial Statements include the accounts of the Company and its wholly-owned and majority-owned subsidiaries and a consolidated variable interest entity. All inter-company balances and transactions are eliminated in consolidation.

 

Use of Estimates

 

The preparation of financial statements in conformity with principles generally accepted in the United States (“U.S. GAAP”) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, as well as the reported amounts of revenues and expenses during the reporting period and certain financial statement disclosures. As discussed below, the Company’s most significant estimates include those made in connection with the valuation of property and equipment, intangible assets, goodwill, and the accrual of certain liabilities. Actual results could differ materially from these estimates.

 

Cash

 

Substantially all of the Company’s cash is held by one bank located in Colorado. The Company does not believe that, as a result of this concentration, it is subject to any financial risk beyond the normal risk associated with commercial banking relationships.

 

Asset Held for Sale

 

Asset held for sale in 2008 consisted of an employee house, purchased by the Company when the employee was transferred to a new nightclub in a new state. The house was sold in 2009 for $107,326.

 

Other Receivables

 

Other receivables at December 31, 2009 consist of approximately $151,000 deposit due from a cancelled acquisition, $56,000 from the sale of the Arizona land and building, various small receivable amounts due from property insurance damage claims, credit card fees, and employee advances. The December 31, 2008 balance includes small receivable amounts for property taxes, credit card fees, and employee advances.

 

Income Tax Receivable

 

Income tax receivable is the amount due from the IRS for overpayment of estimated income tax deposits made during the year shown. This amount is applied against the first estimated tax deposit due in the next fiscal year.

 

Inventories

 

Inventories include alcoholic beverages, food, and Company merchandise. Inventories are stated at the lower of cost or market, where cost is determined by using first-in, first-out method.

 

VCG Holding Corp.

 

Notes to Consolidated Financial Statements — (Continued)

 

Prepaid Expenses

 

Prepaid expenses represent expenses paid prior to the receipt of the related goods or services. The balance consists primarily of prepaid rent, liquor and other license fees, prepaid memberships and prepaid insurance premiums for the corporate office, and various nightclubs.

 

Property and Equipment

 

Property and equipment is recorded at cost and depreciated using the straight-line method over the estimated life, listed below.

 

 

Expenditures for maintenance and repairs are charged to expense as incurred. When an asset is sold or otherwise disposed of, the cost and accumulated depreciation are removed from the accounts and the resulting gain or loss is recognized in the consolidated statement of operations for the respective period.

 

Property and equipment are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. An impairment loss is recognized if the carrying amount of the asset exceeds its fair value (see Note 5).

 

Goodwill

 

The excess of the purchase over the fair value of assets acquired and liabilities assumed in purchase business combinations is classified as goodwill. In accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 350, Intangibles — Goodwill and Other (“ASC 350”), the Company does not amortize goodwill, but performs impairment tests of the carrying value at least annually. The Company tests goodwill for impairment at the “nightclub” or “reporting unit” level, which is one level below the operating segment.

 

Intangible Assets

 

Indefinite life intangible assets, which are stated at cost, are composed of liquor and cabaret or sexually oriented business licenses and trade names. Finite lived assets include non-compete agreements, which are stated at cost less accumulated amortization. Amortization is computed on the straight-line method over term of the non-compete agreement. Intangible assets with finite lives are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable.

 

Indefinite life intangible assets are tested annually and individually for impairment in accordance with ASC 350, for impairment. An impairment loss is recognized if the carrying amount of the asset exceeds its fair value.

 

Favorable Lease Rights and Unfavorable Lease Rights

 

Favorable lease rights and unfavorable lease liabilities resulted from the fair value analysis of nightclub acquisitions. A favorable lease right occurs when the acquired lease is below market at the time of acquisition. An

 

VCG Holding Corp.

 

Notes to Consolidated Financial Statements — (Continued)

 

unfavorable lease right occurs when the acquired lease payments are above market. The balance is amortized ratably into rent expense over the expected lease term, which includes expected renewals.

 

Deferred Revenue

 

Deferred revenue consists of the unearned portion of VIP room memberships. VIP room memberships are amortized into revenues ratably over the one-year life of membership from the date of purchase.

 

Deferred Rent

 

In accordance with FASB ASC Topic 840, Leases (“ASC 840”), the Company expenses rent on a straight-line basis over the expected lease term, which includes expected renewals.

 

Revenue Recognition

 

The Company’s revenues from nightclubs include funds received from the sale of alcoholic beverages, food, and merchandise, service and other revenues. The Company recognizes sales revenue at point-of-sale upon receipt of cash, check, or charge card. Service revenues include entertainer payments to perform at the Company’s nightclubs, customer admission fees, customer payments for tabs and tip charges, dance dollar payments, and suite rental fees. Service revenue is collected and recorded as revenue on a daily basis when received and earned.

 

Other income is comprised of fees charged for usage of ATM machines located in nightclubs, credit card charges, VIP memberships, valet parking fees, various fees at nightclubs for services and special events, and rental income from third party tenants at certain nightclubs. Other Income also includes non-club revenue of rent received from unrelated third parties in Indianapolis and Phoenix.

 

Advertising Cost

 

Advertising costs are expensed as incurred and are included in selling, general, and administrative expense.

 

Stock-Based Compensation

 

At December 31, 2009, the Company had stock options outstanding, which are described in Note 11. The Company recognizes stock-based compensation in accordance with FASB ASC Topic 718, Compensation-Stock Compensation (“ASC 718”), which requires the Company to measure the cost of services to be rendered based on the grant-date fair value of the equity award. The compensation expense is recognized over the period an employee is required to provide service in exchange for the award, referred to as the requisite service period.

 

Income Taxes

 

Income taxes are recorded in accordance with the provisions of FASB ASC Topic 740, Income Taxes (“ASC 740”). Pursuant to ASC 740, deferred tax assets and liabilities are determined based on the differences between the financial reporting and tax bases of assets and liabilities using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. A valuation allowance is established when necessary to reduce deferred tax assets to the amounts expected to be realized.

 

ASC 740 clarified the accounting for uncertainty in income taxes recognized in a company’s financial statements and prescribed a recognition threshold and measurement attributes for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. As a result, the Company has applied a more-likely-than-not recognition threshold for all tax uncertainties. ASC 740 only allows the recognition of those tax benefits that have a greater than 50% likelihood of being sustained upon examination by the various taxing authorities.

 

VCG Holding Corp.

 

Notes to Consolidated Financial Statements — (Continued)

 

The company files tax returns in the U.S. Federal and various state jurisdictions. The company is no longer subject to U.S. Federal income tax examinations for years prior to 2006 and state and local income tax examinations by tax authorities for years prior to 2005. Penalties, if any, related to unrecognized tax liabilities are in other general and administrative on the Statement of Operations. Interest expense, if any, related to unrecognized tax liabilities are in interest expense on the Statement of Operations.

 

Earnings per Share

 

In accordance with FASB ASC Topic 260, Earnings per Share (“ASC 260”), basic earnings (loss) per share is computed by dividing net income (loss) attributable to common shares by the weighted average number of common shares outstanding during the period. Diluted earnings (loss) per share is computed by dividing net income (loss) attributable to common shares by the weighted average number of common and potential common shares outstanding during the period. Potential common shares, composed of the incremental common shares issuable upon the exercise of stock options and warrants, are included in the calculation of diluted earnings (loss) per share calculation to the extent such shares are dilutive.

 

The following table sets forth the computation of basic and diluted weighted average shares outstanding:

 

 

The Company has excluded 262,500 and 300,500 stock options from its calculation of the effect of dilutive securities in 2009 and 2008, respectively, as they represent anti-dilutive stock options.

 

The Company has also excluded 325,376 warrants from its calculation of the effect of dilutive securities in 2009, as they represent anti-dilutive warrants.

 

Reclassifications

 

Certain and significant prior year amounts have been reclassified to conform to the current period presentation.

 

Fair Value of Financial Instruments

 

The carrying value of cash, accounts receivable, and accounts payable approximates fair value due to the short-term nature of these instruments. The carrying amount of the notes payable approximates fair value as the individual borrowings bear interest at rates that approximate market interest rates for similar debt instruments.

 

Recently Issued Accounting Pronouncements

 

In June 2009, the Financial Accounting Standards Board (“FASB”) established the FASB Accounting Standards Codification^tm (the “Codification”) as the single source of authoritative U.S. GAAP recognized by

 

VCG Holding Corp.

 

Notes to Consolidated Financial Statements — (Continued)

 

the FASB to be applied by nongovernmental entities. Rules and interpretive releases of the Securities and Exchange Commission (“SEC”) under authority of federal securities laws are also sources of authoritative U.S. GAAP for SEC registrants. We have conformed the references in the notes to our financial statements to the new Codification.

 

In April 2009, the FASB issued an update to FASB ASC Topic 820, Fair Value Measurements and Disclosures (“ASC 820”), to provide additional guidance on estimating fair value when the volume and level of transaction activity for an asset or liability have significantly decreased in relation to normal market activity for the asset or liability. Additional disclosures are required regarding fair value in interim and annual reports. These provisions are effective for interim and annual periods ending after June 15, 2009.

 

In April 2009, the FASB issued an update to FASB ASC Topic 805, Business Combinations (“ASC 805”) authoritative guidance to require that assets acquired and liabilities assumed in a business combination that arise from contingencies be recognized at fair value if fair value can be reasonably determined. If the fair value of such assets or liabilities cannot be reasonably determined, then they would generally be recognized in accordance with certain other pre-existing accounting standards. This guidance also amends the subsequent accounting for assets and liabilities arising from contingencies in a business combination and certain other disclosure requirements. This guidance became effective for assets or liabilities arising from contingencies in business combinations that are consummated on or after October 1, 2009. Accordingly, the Company will record and disclose assets acquired and liabilities assumed in a business combination that arises from contingencies under the revised standard for transactions consummated, if any, after October 1, 2009.

 

In May 2009, the FASB issued ASC Topic 855, Subsequent Events (“ASC 855”), which provides guidance on events that occur after the balance sheet date but prior to the issuance of the financial statements. ASC 855 distinguishes between events requiring recognition in the financial statements from those that may require disclosure in the financial statements. This guidance is effective for interim and annual periods after June 15, 2009. We adopted this guidance for the quarter ended June 30, 2009. The adoption had no impact on our consolidated financial statements.

 

In August 2009, the FASB issued Accounting Standard Update (“ASU”) No. 2009-05, Fair Value Measurements and Disclosure Topic 820, Measuring Liabilities at Fair Value authoritative guidance to provide clarification on measuring liabilities at fair value when a quoted price in an active market is not available. In these circumstances, a valuation technique should be applied that uses either the quote of the liability when traded as an asset, the quoted prices for similar liabilities or similar liabilities when traded as assets, or another valuation technique consistent with existing fair value measurement guidance, such as an income approach or a market approach. The new guidance also clarifies that when estimating the fair value of a liability, a reporting entity is not required to include a separate input or adjustment to other inputs relating to the existence of a restriction that prevents the transfer of the liability. This guidance was adopted effective July 1, 2009. The adoption had no impact on our consolidated financial statements.

 

In January 2010, the FASB issued ASU No. 2010-04, Accounting for Various Topics — Technical Corrections to SEC Paragraphs. This update provides updates/corrections to various topics of the codification with regards to the SEC’s position on various matters. There is no new guidance, but it includes adjustments to the SEC’s position on already issued updates. Some of the main topics covered are as follows: 1) Requirements for using push down accounting in an acquisition 2) appropriate balance sheet presentation of unvested, forfeitable equity instruments, which are issued to nonemployees as consideration for future services, and 3) intangible assets arising from insurance contracts acquired in a business combination. The corrections are applicable for 2009 since the updates relate to already issued guidance. The adoption had no impact on our consolidated financial statements.

 

Issued but not yet effective accounting standards

 

In June 2009, the FASB issued ASC Topic 810, Consolidation authoritative guidance to require an analysis to determine whether a variable interest gives the entity a controlling financial interest in a variable interest entity. This

 

VCG Holding Corp.

 

Notes to Consolidated Financial Statements — (Continued)

 

guidance requires an ongoing reassessment and eliminates the quantitative approach previously required for determining whether an entity is the primary beneficiary. It requires an analysis to determine whether a variable interest gives the entity a controlling financial interest in a variable interest entity. This guidance is effective for fiscal years beginning after November 15, 2009. VCG is currently assessing the impact that this guidance may have on its Consolidated Financial Statements.

 

In June 2009, the FASB issued ASC Topic 860, Transfers and Servicing authoritative guidance to improve information and disclosures related to the transfers of financial assets, including securitization transactions, and the continuing risk exposures related to transferred financial assets. The concept of a “qualifying special-purpose entity” is eliminated and the requirements for derecognizing financial assets have been modified. This guidance will be effective for fiscal years beginning after November 15, 2009. We do not expect the adoption of this new guidance will have a significant impact on our Consolidated Financial Statements.

 

Management has reviewed and continues to monitor the pronouncements of the various financial and regulatory agencies and is currently not aware of any other pronouncements that could have a material impact on the Company’s consolidated financial position, results of operations, or cash flows.

 

Consolidation of Variable Interest Entities

 

During 2007, the Company became the .01% General Partner of 4th Street Limited Partnership LLLP (“4th Street”), a limited liability limited partnership that owns a building in Minneapolis, MN that is rented by the Minneapolis nightclub operated by the Company. The land and building, which had a net book value of approximately $2,844,000 and $2,896,000 at December 31, 2009 and 2008, respectively, represent the only assets held by 4th Street. The lease term is for 17 years. The majority of the 99.9% limited partner interests are held by related parties, ranging from note holder, to stockholders and Directors. Under the terms of the 4th Street partnership agreement, profits and losses and cash flows are allocated between the General and the Limited Partners based on their respective ownership percentages.

 

The Company has considered the provisions of FASB ASC Topic 810, Consolidation (“ASC 810”) and has determined the following:

 

 

The Company has reviewed the provisions of FASB ASC Topic 360-20, Real Estate Sales (“ASC 360-20”) as it relates to accounting for the noncontrolling interest attributable to the Limited Partners and has determined that the interest should not be accounted for using the financing method.

 

 

Inventories consist of beverages, food, tobacco products and merchandise. All are valued at the lower of cost or market.

 

 

VCG Holding Corp.

 

Notes to Consolidated Financial Statements — (Continued)

 

 

 

On April 14, 2008, the Company acquired 100% of the common stock of Manana Entertainment, Inc. (“Manana”) and the building in which Manana operates Jaguar’s Gold Club of Dallas for total cash consideration of $4,093,525 and a 12% promissory note in the amount of $2,500,000. The total purchase price of $6,593,525, including direct acquisition costs of $307,914, was allocated to the acquired assets and liabilities as set forth in the following table:

 

 

Goodwill is not amortizable for tax purposes.

 

On July 28, 2008, the Company acquired the assets of VCG-IS LLC (“VCG-IS”) for cash consideration of $4,005,000 and an 8% promissory note in the principal amount of $3,293,027. VCG-IS operates Imperial Showgirls Gentlemen’s Club in Anaheim, CA. The total purchase price of $7,293,027, including direct acquisition costs of $321,643, was allocated to the acquired assets and liabilities as set forth in the following table:

 

 

The total amount of goodwill amortizable over 15 years for tax purposes is $380,000.

 

The following pro forma financial information includes the consolidated results of operations as if the 2008 acquisitions had occurred at January 1, 2008, but do not purport to be indicative of the results that would have occurred has the acquisitions been made as of that date or of results which may occur in the future.

 

 

VCG Holding Corp.

 

Notes to Consolidated Financial Statements — (Continued)