HireQuest, Inc. Q1 FY2021 Earnings Call

Good afternoon, ladies and gentlemen and welcome to the HireQuest, Inc. First Quarter 2021 Earnings Event. At this time, all participants have been placed on a listen-only mode and the floor will be opened for questions and comments after the presentation. It is now my pleasure to turn the floor over to your host, Brett Maas with Hayden IR. Sir, the floor is yours.

Thank you, operator. I would like to welcome everybody to the call. Hosting the call today are HireQuest’s CEO, Rick Hermanns and CFO, Cory Smith. Please be aware that some of the comments made during our call today may include forward-looking statements within the meaning of federal securities laws. Statements about our beliefs and expectations contain words such as may, could, would, will, should, believe, expect, anticipate and similar expressions constitute forward-looking statements. These statements involve risks and uncertainties regarding our operations and our future results that could cause HireQuest results to differ materially from management’s current expectations. We encourage you to review the Safe Harbor statements and risk factors contained in the company’s earnings release and its filings with the SEC, including without limitation, the most recent Annual Report on Form 10-K and other periodic reports, which identify specific risk factors that may also cause actual results or events to differ materially from those described in the forward-looking statements. Copies of the company’s most recent reports on Form 10-K and 10-Q may be obtained on the company’s website at hirequest.com or at the SEC’s website, sec.gov. The company does not undertake to publicly update or revise any forward-looking statements after the call or date of this call. I would also like to remind everyone that this call will be available for replay through May 31. A link to the replay on the website of the call was also provided in the earnings release and is available on the company’s website at hirequest.com. I would now like to turn the call over to CEO of HireQuest, Rick Hermanns. Rick?

Thank you for joining us. As most of you know, on March 1, we completed our acquisition of certain assets of Snelling, a 67-year-old staffing company headquartered in Richardson, Texas. On March 22, we completed our acquisition of the franchise relationships and certain other assets of LINK, a family-owned staffing company headquartered in Houston, Texas. These two acquisitions significantly increase our scale and accelerate our entrance into the traditional premier commercial staffing model, giving us an additional franchising model to sell and additional revenue streams. We were able to complete these acquisitions at favorable terms due to the challenge our industry is experiencing due to the pandemic and our unique position as a franchisor. To be sure, these challenges have impacted us as well, resulting in lower system-wide sales and lower royalty revenues. It’s been particularly challenging for our franchises, though they have responded admirably. But our model is structured to minimize the risk of events like these. While it has been challenging, others in our industry have fared much worse. As a result, we were able to take advantage of our balance sheet and our profitable business model and make these two highly strategic and accretive acquisitions. Because these were both completed late in the first quarter, the impact on our revenue and net income was minimal. However, $1.4 million in acquisition-related expenses have shown up in the first quarter, and we expect additional impact in the second quarter. Our efforts since closing these two acquisitions have focused on integrating the new franchisees and taking steps to de-risk the transactions, and we have made significant progress on both fronts. At this point, the operational integration of the new franchises is largely complete. Our franchisees and the corporate team put in substantial time and effort to accomplish this. As a result, we don’t have the financial or operational burden of running multiple systems. In our efforts to de-risk the transactions, first, we have signed the California-based franchise agreements of 6 LINK franchises and 1 Snelling branch to a third-party. This third-party will serve as the franchisor and will pay HireQuest a royalty of 9% of the gross profit of the offices in perpetuity. This royalty revenue represents yet another lucrative low-risk revenue stream for us. We also sold the 3 remaining California Snelling branches to the same third-party. These branches will also be part of the same royalty agreement in perpetuity once the buyer receives regulatory approval to franchise the offices. Finally, we sold 4 previously Snelling branches and 1 onsite location to a different third-party for consideration of approximately $1 million cash. This was a straight sale. The result is that after normal consolidation we have added a net 64 locations to our portfolio, including 36 Snelling branches and 28 LINK branches. The vast majority of these offices will operate as Snelling on a go-forward basis. We will see the full contribution of these branches in the second quarter, but our efforts continue to improve operations and efficiency at these acquired branches. As I stated previously, the two models: first on-demand staffing, where we have historically excelled, and second, traditional commercial staffing, which is the historical model of LINK and Snelling, are complementary, and they deliver several benefits for us, which include: one, they increase our national scale, making it easier to sell to national accounts and making our various trade names more recognizable; two, by adding commercial or weekly pay staffing models to our existing on-demand staffing operation, we significantly diversify our approach; three, we were able to meaningfully grow our system-wide sales that attract evaluations, taking advantage of the inherent leverage in our business model; four, as it relates to Snelling, we acquired a 67-year-old brand name that is well-regarded throughout the industry; five, they enable us to efficiently leverage our corporate resources and our workers’ compensation efforts, creating incremental profitability. Going forward, we will continue to evaluate additional strategic transactions screening for fit within our existing business structure and solid economics that contribute to our financial results in a positive and meaningful way. Deploying a disciplined approach to M&A, including taking steps to de-risk transactions as we have with the Snelling and LINK transactions, we are focused on accretive opportunities that open new geographies and lines of business, strengthen the presence of our existing franchisees, or provide access to targeted national accounts. Before I turn over the call to Cory to discuss the financial results further, I wanted to mention that the Board of Directors has decided to increase our regular quarterly dividend. We will pay a $0.06 per share dividend on June 15 to shareholders of record on June 1. Our expectation is that we will continue to pay a 6% dividend quarterly going forward. With that, I will turn the call over to Cory. Cory?

Thank you, Rick, and good afternoon everyone. Thanks for joining us. Our total revenue is made up of two components: franchise royalties, which make up roughly 90% of total revenue and service revenue. Total revenue for the first quarter of 2021 was $3.4 million compared to $4.1 million for the same quarter last year, a decrease of 17.4%. Franchise royalties for the quarter were $3.3 million compared to $3.7 million last year, a decrease of 12%. This decrease was primarily due to the economic shutdown caused by COVID-19. Service revenue, which is generated from interest charges to our franchisees on overdue accounts receivable and fees for various optional services, was $144,000 compared to $415,000 last year, a decrease of 65.3%. This decrease was largely due to a decrease in miscellaneous fees charged for optional services. Selling, general, and administrative expenses were $3.8 million in the first quarter of 2021 compared to $3.3 million in the first quarter of 2020. This increase was primarily due to $1.4 million in non-recurring expenses related to our two acquisitions, a relative increase in charges related to workers’ compensation costs of approximately $892,000, and an increase in computer-related costs of approximately $89,000. These increases were partially offset by a decrease in professional fees of $130,000 and the absence of the $1.4 million note impairment incurred last year. As Rick mentioned, there will be additional transaction-related expenses recognized in the second quarter. Net income for the quarter was $3.7 million or $0.27 per diluted share compared to net income of $875,000 or $0.06 per diluted share last year. Net income this year included miscellaneous income of approximately $3.9 million related to the transaction surrounding the LINK and Snelling acquisitions. Also included in net income is approximately $1.4 million in non-recurring acquisition-related expenses. Moving on to the balance sheet, our current assets at March 31, 2021, were $34.5 million compared to $39 million at December 31, 2020. Current assets at March 31, 2021, included $2 million of cash and $29.7 million of accounts receivable, while current assets at December 31, 2020, included $13.7 million of cash and $21.3 million of accounts receivable. Our notes receivable balance, net of reserve at March 31, 2021, was $3.3 million compared to $5.9 million at December 31, 2020. We collected approximately $5.5 million in cash from these notes during the first quarter, which included approximately $5.3 million related to the sale of specific notes and payments of approximately $249,000. Beginning in the third quarter of 2020, our Board approved and the company paid its first quarterly dividend of $0.05 per common share. Subsequently, the Board approved a $0.05 cash dividend for payments in December and again in March. As Rick mentioned, the Board increased the dividend to $0.06 per share, which will be paid on June 15 to shareholders of record as of June 1. We expect to pay this increased quarterly dividend each quarter in 2021 subject to our Board’s discretion. And with that, I will turn the call back over to the operator for Q&A.

Thank you. Our first question today is from Aaron Edelheit at Mindset Capital. Your line is live.

Hi. I wanted to ask you what conditions you are seeing? When I think about the first quarter and I think about lots of lockdowns and the surges and we are in a very different place, thanks to the vaccines today. Can you just describe what you are seeing business condition-wise and the demand for your services now versus what was going on in the first quarter?

Sure and good to talk to you, Aaron. Recognizing the first quarter, as the first quarter progressed, demand became progressively stronger. Throughout the first quarter, especially once it got to about March, things definitely were picking up. We are at a point now where, if you compared us to, let’s say, the first quarter of 2019 at least on a comparable store basis, we are probably getting close to being within 5% to 10% of what we were in 2019. To sort of take a trip down memory lane, in the fourth quarter of last year, we were typically running 18% to 20% behind. And so, we are now running 5%, 7% behind 2019, not 2020. We are way ahead of 2020. But of course, April and May of last year were the 2 worst months. So that’s not surprising. As far as the vaccine, there is no question, things have opened up. Although, again, stadiums still are not full, not everything is back to normal. I would anticipate further strengthening of revenues. The single biggest challenge we face right now is the lack of ability to find workers, which is a real challenge for our franchisees and for us. Our typical employees are around the $9 to $13 an hour range, and those are people who, in particular, the attraction of the $300 federal bonus for unemployment puts a true disincentive on working because basically, you really make more money staying on unemployment than you do working. This has been a real challenge. Our revenues could probably be, I would say, 12% to 15% higher were we able to find people. Last week, it came out that there are about 7.5 million job openings in the United States, and I think we have about 7.4 million of them. I’m being facetious. We’re obviously selling 7.4 million open jobs. We have a lot. And that’s really the biggest challenge we have right now. It’s not demand; it’s finding workers.

Got it. It’s amazing how your accompanying business model has performed in the last year, considering all these crosswinds and crosscurrents from either COVID or when you describe disincentives for encouraging people to get out. I wanted to go to another thing that’s hitting all the headlines, which is inflation. If I understand correctly, you’re a cost-plus business; how should I think about the impact of inflation or higher wages, or how should I think about it for HireQuest?

That’s a good question. Higher wages, frankly, the answer defies a simple explanation. Any time you have to go to your client and ask for a price increase, it’s just an opportunity for them to potentially leave. I would rather not have to do it. Stability in wages is better. But it really depends on whether the client realizes that they are short of people and are willing to raise the pay wage high enough to make recruiting easier. Some clients refuse to raise the pay rate, even if they end up getting short-filled orders every day. Others do because they recognize that the market is a lot different than it was a year ago. The largest clients are typically paying on a markup basis, so it is somewhat of a cost-plus. The issue gets more to whether they are being cautious when it comes to raising their rates. Occasionally, a client may say they can’t get us people at $10 an hour anymore, so they need to find a new staffing company. In reality, $10 an hour is probably $2 beneath the going rate for that type of worker in that market. This can create risks for losing clients, but there are certain opportunities for us as well because, even to the extent that if we have a 45% markup on a $10 pay rate, if that pay rate goes up to $11 an hour, our franchisees will make more money at that constant markup. That can be beneficial for the franchisee, so long as they can retain the client despite the higher pay rate.

Yes. So it sounds like there might be some short-term issues as the labor market kind of normalizes, but in the long run, it will all get settled out, right?

Yes. Presumably, I mean, there is a fairly defined market price for, let’s say, warehouse labor in Indianapolis. It will reach its equilibrium. I do foresee that, that equilibrium rate will be certainly higher than it was in, say, 2019, which was already significantly higher than it was in, say, 2017. There has been a strong increase in wages at the blue-collar level in the country, which is beneficial for the American public, our workers. To the extent that our clients allow us to offer market pay to our employees, it makes it easier for our franchisees to recruit as well.

No, great. That’s very helpful. When I think about this upcoming quarter and your seasonally strongest quarter, which is normally Q3, and I think about last year, obviously, the full effects of COVID, and you now have added these two acquisitions. Can you talk about what to expect or what you expect to see in the next two quarters in terms of whether it’s going to be a slow ramp-up or are you still fixing selling? Or is there stuff you have to do? Or are we just going to see the full impact? It feels like it’s going to be pretty dramatic when you report in, I guess, in August and then for Q3 would be later in the year.

I think that essentially, as GDP grows, so will our revenues. Regarding whether we are fixing, selling, it’s not necessarily the pieces are all in place. It’s really more a question of does the economy fully recover by the third quarter. For example, one particular office I have in mind has been heavily hospitality-oriented and is still running 70% below last year. So, any dramatic improvement I see would still be primarily confined to those markets that are still dramatically behind. There are pockets of those. Fortunately, the rest of our offices should gradually improve as schools and universities fully open in the fall, and conventions start occurring again. I have to note that the number of states have moved to become stricter on job-seeking activities prior to getting continued unemployment benefits. Even if every stadium, every auto auction, every convention center, every hotel were at 100% capacity in August, if we can’t find people, we are still not going to see what we could have.

Yes. No, that’s really helpful. Just understanding what the short-term will look. Last question on monopolizing for the time. In the last conference call, you talked about organic growth. We talked about new verticals expansion. I was just wondering if you have any additional thoughts on what you are seeing for organic store growth or new verticals or expanding on verticals?

I would say not to quote me, because it’s not necessarily set yet. But we have opened probably already maybe 5 or 6 new offices and have commitments from people to open probably another 8 or 9 more. I would like to think that we should be in somewhere in the 10 to 15 new organic office openings through this year, which, considering it’s still a pandemic and particularly given how we are almost halfway through the year, is really nice. That represents probably a 6% to 7% increase in our number of units, and I’m pleased with that. We continue to seek accretive acquisitions, and those do not necessarily just mean in the traditional staffing environment or on-demand staffing. We are looking for those opportunities, but we are not going to chase something that doesn’t make economic sense either.

Got it. Thank you so much and congrats to you and the team for just navigating this and just thanks for the good stewardship.

Thank you.

Thank you. We have no further questions in the queue at this time.

Alright. Well, I want to thank everybody for having joined us. As you watch over the next couple of quarters, I hope you are as excited as we are about the future with the new Snelling and LINK additions to the company. Again, I thank you for your continued support. Have a good day.

Thank you. Ladies and gentlemen, this does conclude today’s event. You may disconnect your lines at this time and have a wonderful day. Thank you for your participation.