10-Q: Scores Holding Co. Faces Steep Revenue Decline and 'Going Concern' Doubts Amidst Internal Control Weaknesses

Scores Holding Company, Inc. reported a dramatic 82% drop in Q1 2023 royalty revenue and a shift to net loss, raising substantial doubt about its ability to continue as a going concern, compounded by identified material weaknesses in internal financial controls.

Summary

• Scores Holding Company, Inc., a trademark licensing company for adult entertainment clubs, reported a significant financial downturn for the three months ended March 31, 2023.
• Royalty revenue plummeted by 82.2% to $73,500 in Q1 2023, down from $414,000 in Q1 2022.
• The company swung from a net income of $311,442 in Q1 2022 to a net loss of $(22,900) in Q1 2023.
• As of March 31, 2023, the company's accumulated deficit reached $6,899,498, and its working capital deficit worsened to $233,195 from $205,795 at December 31, 2022.
• Net cash provided by operating activities drastically decreased to $5,645 in Q1 2023, compared to $385,779 in Q1 2022.
• Management has concluded that the company's disclosure controls and procedures are not effective, citing material weaknesses in internal control over financial reporting related to financial statement review, close processes, journal entries, and account reconciliations.
• The company's ability to continue as a going concern is in substantial doubt due to accumulated losses, working capital deficit, and the results of litigation.

Sentiment

Score: 2

Explanation: The company's financial performance shows a severe decline in revenue and a shift to net loss. The 'going concern' warning, coupled with identified material weaknesses in internal controls, indicates significant operational and financial instability. While management expresses some optimism about post-COVID recovery and brand interest, the current financial health is highly concerning.

Positives

• Cash and cash equivalents increased to $13,245 as of March 31, 2023, from $7,600 at December 31, 2022.
• Management believes the worst effects of the COVID-19 pandemic on the adult entertainment industry are over, with all royalty-paying licensees having reopened.
• The company has observed a recent increase in interest from establishments looking to utilize the SCORES brand trademarks.
• Several significant legal proceedings against the company, including the 'Voronina Matter' and 'Jane Doe v. Scores Holding Company, Inc.', have been settled or dismissed, with the company no longer a defendant in the latter.

Negatives

• Royalty revenue experienced a severe decline of 82.2%, falling from $414,000 in Q1 2022 to $73,500 in Q1 2023.
• The company reported a net loss of $(22,900) in Q1 2023, a significant reversal from the net income of $311,442 in Q1 2022.
• The accumulated deficit grew to $6,899,498 as of March 31, 2023.
• The working capital deficit worsened to $233,195, indicating increasing short-term liquidity challenges.
• Net cash provided by operating activities decreased substantially from $385,779 in Q1 2022 to $5,645 in Q1 2023.
• Management identified material weaknesses in internal control over financial reporting, deeming disclosure controls and procedures ineffective.

Risks

• Substantial doubt exists about the company's ability to continue as a going concern within one year due to accumulated losses, working capital deficit, and litigation results.
• The company requires additional working capital to develop business operations and there are no assurances that additional financing will be available or on acceptable terms.
• If adequate working capital is not available, the company may not be able to continue its operations.
• Material weaknesses in internal control over financial reporting, specifically regarding the effectiveness and timeliness of the financial statement review process, policies and procedures governing the financial statement close process, and control in the preparation, documentation, and review of journal entries and account reconciliations, could adversely affect the company's ability to record, process, summarize, and report financial information accurately.
• Forward-looking statements involve risks and uncertainties, and actual results may differ significantly from projections.

Future Outlook

The company intends to raise additional working capital through continued licensing of its brand with current and new operators. Management believes the financial effects of the COVID-19 pandemic will not have a substantial or long-term detrimental impact on the adult entertainment industry, noting a recent increase in interest from establishments in utilizing the SCORES brand trademarks. The company will continue to evaluate possible acquisitions or investments in complementary businesses, products, and technologies.

Management Comments

• "Upon managements evaluation of relevant hospitality industry conditions and events known as of the date that these financial statements are issued it is their belief the financial effects of the Covid 19 pandemic will not have a substantial or long term effect on the financial viability of the adult entertainment industry."
• "There will be operational changes to be certain but not a consequentially detrimental impact on the industry."
• "Although there are fewer licensees and some of the licensing fees have been re-negotiated management believes the worst of the effects the Covid 19 pandemic are over."
• "The lifting of many, if not all, gathering restrictions imposed by local government has vastly improved the appeal of adult entertainment-oriented establishments. Consequently, the Company has seen a recent increase in the number of such establishments interested in utilizing the SCORES brand trademarks."
• "Management has taken or will take steps to remediate the control deficiencies identified above, which include creating formal policies and procedures governing our financial statement close process, and control in the preparation, documentation, and review of journal entries and account reconciliations."

Industry Context

Scores Holding Company, Inc. operates in the adult entertainment industry, specifically through trademark licensing to gentlemens clubs. The industry experienced significant disruption due to COVID-19 related closures in 2020, which materially impacted the company's royalty revenues. However, management expresses optimism that the industry is recovering, with all licensees having reopened and an observed increase in interest for the 'SCORES' brand, suggesting a broader rebound in the hospitality and adult entertainment sectors as pandemic restrictions ease.

Corporate Governance

Legal Proceedings

• **Luisa Santos de Oliveira v. Scores Holding Company, Inc. et al. (FLSA/NYLL)**: Plaintiff voluntarily dismissed the complaint against the Company with prejudice on March 25, 2021. A related case was discontinued against the Company and its officers on March 26, 2021. A stipulation of voluntary dismissal without prejudice for Club Azure LLC was pending court approval on May 12, 2023.
• **Scores Alabama (Trademark Infringement)**: A civil action filed on September 5, 2019, was settled on April 11, 2023, for $45,000, which was paid on May 23, 2023. The licensee agreed to cease using the Scores brand by March 31, 2023.
• **Voronina Matter (Unauthorized Image Use)**: A civil suit filed on April 3, 2016, by 50 individuals was settled confidentially in July 2018 for $1,310,000. The Company received loans from Metropolitan (a related party) to make payments. A Settlement and Offset Agreement on December 1, 2018, offset past due royalties owed to the Company ($382,259) against the amount owed to Metropolitan, reducing the net amount owed to Metropolitan to $399,139. The remaining balance of $373,068.40 was paid in full on March 28, 2022.
• **Jane Doe v. Scores Holding Company, Inc. et al. (Sex Trafficking Allegations)**: Plaintiff alleged sex trafficking through Scores Tampa. An arbitrator found in favor of the Company and its subsidiary SLC. Plaintiff filed an Amended Complaint on July 19, 2023, that did not include the Company or SLC as defendants, thus this legal proceeding is no longer pending against them.
• **Jeremy Green v. Scores Holding Co., Inc. et al. (Breach of Contract)**: A lawsuit filed on July 15, 2019, by a former consultant was settled on October 6, 2022, for $10,000, payable in two $5,000 installments. The second payment had not been made as of the filing date.
• **Jessica Hall v. Scores Holding Company, Inc. et al. (Discrimination/Retaliation)**: A settlement in principle was reached on July 21, 2023, for SCRH and Harvey to each pay Jessica B Hall $6,000. A settlement agreement was signed on October 2, 2023, and paid on October 5, 2023.

Related Party Transactions

• The Company has a related party payable of $90,000 as of March 31, 2023, up from $67,500 at December 31, 2022.
• The Company previously leased office space from Westside Realty of New York, Inc. (WSR), majority-owned by Robert M. Gans (CEO). The lease terminated on December 31, 2020, but the Company still owed WSR $22,500 in unpaid rents as of March 31, 2023, and December 31, 2022.
• The Company has a management services agreement with Metropolitan Lumber Hardware and Building Supplies, Inc. (Metropolitan), solely owned by Robert M. Gans. Metropolitan provides management services, including those of Robert M. Gans and Howard Rosenbluth (CFO). The annual fee was increased to $90,000 effective May 5, 2015. The Company incurred $22,500 in management fees for Q1 2023 and Q1 2022, and owed $67,500 in unpaid management services as of March 31, 2023.
• Royalty Settlement Agreements were entered into on February 28, 2017, with three licensees (IMO, Star Light, Swan) controlled by Robert M. Gans. The Company forgave a portion of unpaid royalties in return for promissory notes. Robert M. Gans guaranteed these payments, but the licensees were not current, and the Company did not call upon the guarantees.
• Metropolitan made loans totaling $770,000 to the Company to help fund the $1,310,000 Voronina settlement.
• On December 1, 2018, a Settlement and Offset Agreement was executed to offset $382,259 in past due royalties owed to the Company from related parties against the $781,399 owed to Metropolitan, reducing the net amount owed to Metropolitan to $399,139. This amount was paid in full on March 28, 2022.

Stakeholder Impact

• **Shareholders**: Face significant risk of dilution if the company pursues equity financing to address its working capital needs. The substantial decline in financial performance, accumulated deficit, and 'going concern' warning negatively impact shareholder value.
• **Creditors**: The worsening working capital deficit and 'going concern' warning indicate increased risk for creditors regarding the company's ability to meet its short-term and long-term obligations.
• **Customers (Licensees)**: While some licensing fees were renegotiated due to the pandemic, the reopening of clubs and increased interest in the Scores brand suggest a potentially more stable operating environment for licensees going forward.

Next Steps

• Continue efforts to improve internal control over financial reporting, including creating formal policies and procedures for the financial statement close process, and control in the preparation, documentation, and review of journal entries and account reconciliations.
• Management and the Board of Directors will continue to monitor remedial measures and the effectiveness of internal controls and procedures.
• Evaluate possible acquisitions of or investments in businesses, products, and technologies that are complementary to the company's operations.
• Seek additional working capital through continued brand licensing, and potentially through the sale of equity or debt securities or securing credit facilities.

Key Dates

Recommendation

Keywords

Trademark licensing, Adult entertainment, Royalty revenue, Going concern, Internal controls, SEC filing, 10-Q, Financial performance, Liquidity, Legal proceedings