Summary
- Shares of RCI continue to fall after its auditor, BDO, resigned.
- There's no way to spin this as a positive event.
- Meanwhile, the business is not performing that well.
- Shares could be attractive, but at a much lower price.
Shares of RCI Hospitality (RICK) plunged about 13% on news that its auditor, BDO, submitted its resignation over a disagreement with how the company was handling its internal investigation regarding matters raised by an SEC inquiry and anonymous internet articles containing potential SEC violations, including the failure to disclose related-party transactions, document and report use of the company’s aircraft for personal reasons, and hidden conflicts of interest. After a reviewing the situation with BDO, the findings of the report, as well as Q2 results that were disclosed in the past few weeks, I believe investors should continue to avoid RICK, even at its current price.
The BDO Resignation Does Not Sound Great
When an auditor resigns over a disagreement with a company, it usually does not portend great things to come. Such is the case with BDO’s resignation. While the 8-K attempts to convey RCI as a company that simply complied with its internal investigation led by a qualified Special Counsel, BDO thought otherwise. Per the 8-K:
Specifically, BDO stated that it believes the company has not performed sufficient investigatory procedures and has not taken timely and appropriate remedial action in response to certain deficiencies that BDO thinks exist in the way the internal review has been conducted, including: (I) undue restriction on the scope of the internal review; (II) failure to initiate certain forensic procedures; (III) refusal to provide BDO access to pertinent interview summaries and other documents; (iv) lack of assessment as to the impact of the matters identified to date on existing and future regulatory filings, including financial statements related footnotes; and (V) restrictions, based on privilege, hindering BDO’s ability to properly shadow and evaluate the adequacy of the internal review."
In short, BDO believes RCI led a fairly limited review lacking transparency with its auditor and preventing the company from accessing the results of its findings. Of note, RCI disclosed that BDO elected not to receive a final report from the investigation before resigning. This signals to me that BDO was skeptical of the quality of the report and likely viewed it as insufficient to insulate the firm from any risk associated with signing off on the findings. BDO submitted its resignation even after RCI nearly doubled its auditor spend in FY18 to $1.23 million from $0.65 million.
This should be viewed as a negative sign.
The Special Committee Review Validates Previous Reporting
While I originally penned this update on Friday, I wanted to update my thoughts to capture the findings that were disclosed in the Special Committee 8-K review this morning.
As noted here on Seeking Alpha, Ed Anakar is the brother of Nourdean Anakar, audit committee and board member. Ed Anakar's salary was disclosed. Additionally, management disclosed compensation for personal aircraft usage, which were "inadvertently" left out of the 2017 and 2016 10-K reports.
Although the committee provided no updates on the relationship between CEO Eric Langan and Tannos Construction, management did disclose related party transactions between Langan and his father and brother. Per the 8-K:
During the last three fiscal years we utilized the services of Sherwood Forest Creations, LLC and its predecessor, Creative Steel Designs, furniture fabrication companies that manufacture tables, chairs and other furnishings for our Bombshells locations, as well as providing ongoing maintenance. Sherwood Forest is owned by a brother of Eric Langan, our president and chief executive officer, and Creative Steel was owned by his father. Amounts billed to us for goods and services provided by Sherwood Forest were $321,353 in fiscal 2018, an aggregate of $135,322 by Sherwood Forest and Creative Steel in fiscal 2017, and $176,864 by Creative Steel in fiscal 2016. Sherwood Forest Creations continues to provide services to the company."
Although I did not uncover these transactions, I think it further underscores the underwhelming level of disclosure from RCI.
The Special Committee also proposed next steps for improving governance that also address multiple issues found in the short report, including the three residential houses the company owns, "Adopt an amended related party transaction policy strengthening the review process by the audit committee with respect to related party transactions, employment of family members and charitable contributions," appointing a chief compliance officer that reports directly to the committee, the appointment of a new independent board member to sit on the audit committee, and enhanced protocols for transactions requiring SEC disclosure.
In aggregate, these seem like the beginning of good next steps. However, keep in mind that BDO resigned over the investigation, so there is a possibility that more landmines are left to be publicly disclosed.
