HireQuest, Inc. Q2 FY2022 Earnings Call

Good afternoon, everyone, and welcome to the HireQuest Incorporated Second Quarter 2022 Earnings Call. It is now my pleasure to hand it over to your host, Jennifer Belodeau. 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, David Burnett. I'll take a moment to read the safe harbor statement. This conference call contains forward-looking statements as defined within Section 27A of the Securities Act of 1933 as amended in Section 21E of the Securities Exchange Act of 1934 as amended. These forward-looking statements use terms such as anticipate, expect, intend, may, will, should or other comparable terms which involve risks and uncertainties because they relate to and depend on circumstances that will occur in the future. Those statements include statements regarding the intent, belief or current expectations of HireQuest and members of its management as well as assumptions on which such statements are based. Prospective investors are cautioned that any such forward-looking statements are not guarantees of future performance and involve risks and uncertainties, including those described in HireQuest's periodic reports filed with the SEC, and that actual results may differ materially from those contemplated by such forward-looking statements. Except as required by federal securities law, HireQuest undertakes no obligation to update or revise forward-looking statements to reflect changed conditions. With that out of the way, I'll now turn the call over to the CEO of HireQuest, Rick Hermanns. Go ahead, Rick.

Thank you for joining us for today's call. To begin with, I will provide an overview of financial and strategic highlights for the quarter, and then David will share more details surrounding our second quarter results. This was a very strong quarter for us across the board. We continue to see revenue growth both from recent acquisitions and organically from our existing franchisees. Franchise royalties grew 32.5% to $7.2 million, and organic franchise royalties grew 40.7% compared to the second quarter of 2021. Overall, total revenues increased by 62.8% to $9.3 million compared to the prior year period. Keep in mind that last year's Q2 was still impacted by the pandemic, making for a favorable comparison. But nonetheless, this was an exceptional quarter. This revenue growth resulted in another quarter of strong profitability for the business with adjusted EBITDA of $5.9 million, a 34.2% increase from the second quarter of 2021. Multiple factors drove our strong performance for the quarter. First, a number of the franchise locations that were opened within the past 12 months are starting to hit their stride and contributed to our results. A key component of our model is supporting our franchisees as they build their own businesses, and the strength of this model for the staffing sector continues to be reinforced. The economic recovery from the pandemic, as well as the addition of a strong commercial staffing offering with Snelling, provided expansion opportunities for franchisees; second, we are seeing the benefit of the strategic diversification of our geographic coverage and end markets. The three acquisitions we consummated in Q1 significantly advanced the strategy. Just to remind everyone, the staffing division of dmDickason expanded our franchise base in West Texas and New Mexico. The Dubin Group and Dubin Workforce Solutions marked our entry into Pennsylvania and Northbound Executive Search adds New York to our map and expands our franchise offerings into higher-margin executive placement vertical. With these acquisitions, we have substantially expanded our geographic and industry coverage and now have a foothold in a majority of the segments of the $168 billion staffing and recruiting marketplace. Third, the current economic backdrop of rising wages and labor shortages is creating a favorable demand environment. By utilizing HireQuest, companies are reducing the cost of permanent hiring while gaining access to quality workers in a supply-constrained environment. Fourth, the team here has become quite adept at executing and integrating acquisitions, utilizing the experience of our management team and asset-light platform we have in place. Our processes enable us to very quickly integrate acquisitions and provide the support and tools that help both new and experienced franchisees succeed. With that, I'll pass it along to our CFO, David Burnett for a closer look at our second quarter results. David?

Thank you, Rick, and good afternoon, everyone. Thank you for joining us today. As Rick mentioned, total revenues for the second quarter were $9.3 million compared to $5.7 million for the same quarter last year, an increase of 62.8%. Our revenue is comprised of three components: franchise royalties, which is our primary source of revenue; service revenue, which is generated from fees for various optional services and interest charges to our franchisees on overdue accounts; and third is direct staffing revenue from owned locations. Franchise royalties and service revenue are derived from our franchise base. From time to time, we may have owned location staffing revenue from acquired businesses that are not converted to franchises. During Q2, owned revenue included the Dental Staffing Operations acquired in December of 2021. One of the two locations acquired as part of the Dubin transaction in February is also owned but is reported as discontinued operations while we continue to market it to prospective franchisees. Franchise royalties for the quarter were $7.2 million compared to $5.5 million last year, an increase of 32.5%. In addition to the contribution from acquired locations, royalties from our existing franchises saw a strong growth of 40.7% during the second quarter. System-wide sales for the quarter were $120 million compared to $89.7 million for the same period in 2021, an increase of 33.7%. Organic system-wide sales, which exclude the effect of acquisitions, grew 29.8% for the quarter. System-wide sales include sales in all offices, whether owned and operated by us or our franchisees. Selling, general and administrative expenses for the quarter were $3.5 million compared to $2 million in the same quarter last year. Most core operating expenses remained relatively flat as a percentage of system-wide sales. The increase in SG&A expenses is primarily related to higher compensation and headcount to keep pace with the immediate growth in system-wide sales stemming from recent acquisitions. This includes the additional headcount we carry from owned locations. In connection with the Q1 acquisitions, we recorded a $1.3 million accounting benefit in the second quarter related to adjustments in the fair value allocation after we completed independent valuations. In the first quarter of 2022, we had recorded a charge of $3.6 million related to the conversion of most of the assets acquired into franchise operations. The subsequent valuation adjustments included a $1.3 million decrease to that amount and the recognition of $1.1 million in goodwill. Converting acquisitions into franchises remains a cornerstone of our strategy, and these types of gains and losses should be expected following significant transactions. Net income from continuing operations for the quarter was $4.8 million, or $0.35 per basic and diluted share, compared to net income from continuing operations of $2.7 million, or $0.20 per basic and diluted share in the second quarter last year. Net income from discontinued operations, which is the available-for-sale franchise that we are currently operating, contributed another $0.01 per share. This quarter, we realized our second consecutive period of record adjusted EBITDA, generating $5.9 million, compared to $4.4 million in the second quarter of last year. We believe adjusted EBITDA is a relevant metric for us due to the size of non-cash operating expenses running through our income statement. Adjusted EBITDA is also exclusive of acquisition-related charges, including the $1.3 million benefit I mentioned a few moments ago. A detailed reconciliation of adjusted EBITDA to GAAP net income is provided in our latest 10-Q, which will be filed this afternoon. Moving on now to the balance sheet and cash flow. Our current assets at June 30, 2022, were $50.8 million compared to $42 million at December 31, 2021. Current assets at June 30 included $1.1 million of cash and $45.7 million of net accounts receivable, while current assets at December 31, 2021, included $1.3 million of cash and $38.2 million of net accounts receivable. Our current liabilities at June 30, 2022, were $28.7 million, resulting in net working capital of $22.2 million. At December 31, 2021, current liabilities were $21.5 million. We often provide financing to our franchisees for expansion or initial capital needs. Our franchisee notes receivable balance net of reserves was $4 million at June 30, 2022, and $3.9 million at December 31, 2021. At the end of the second quarter, we had approximately $27 million in availability under our credit facility, even after the three acquisitions completed in the first quarter. We believe that this facility, combined with our existing cash flow from operations, provides us with the flexibility and room for both organic growth as well as the capacity to capitalize on potential future acquisitions. Since the facility was finalized in the second quarter of 2021, we have closed five acquisitions with aggregate consideration of $27.1 million and finished the second quarter with just a modest balance of $2.8 million on the credit facility and $1.3 million in seller financing. We have paid a regular quarterly dividend since the third quarter of 2020. Continuing that pattern, we paid a $0.06 per common share dividend on June 15, 2022, to shareholders of record as of June 1. We expect to continue to pay a dividend for each subsequent quarter in 2022, subject to our Board of Directors' discretion. With that, I will turn the call back over to Rick for some closing comments.

Thanks, David. Our solid second quarter was very telling of the strength across the business and the success we've seen in acquiring companies that significantly broadened the scope of our offerings. I'd like to thank our team, our franchisees, and their workers for the continued excellence demonstrated throughout the quarter, especially given the challenging economic environment we are all currently facing. We have a long-established history, and this is not the first time we've experienced economic uncertainty. I'm confident that we are well positioned to handle any challenges that may come. As always, we remain focused on providing unparalleled support to our dedicated team of franchisees. Now I'll open the line to questions. Thank you.

Our first question is from Mike Baker, D.A. Davidson.

Great quarter. You mentioned it in the press release and prepared remarks, but could you provide more insight on the current labor market? It’s tight, as indicated by last Friday's numbers. However, we are also hearing about increasing layoffs and a slowdown in hiring. Can you share your perspective on the market from your position and how it is affecting your business?

Thank you, Mike. At this point, we haven't really seen much of a change for the better or for the worse as far as striking an equilibrium. What I'm getting at is basically we are still more short of workers than we are orders, and that hasn't really changed. That said, we probably aren't as far behind in filling orders as we were a quarter ago. So, this quarter, I think, and the fourth quarter will be very critical in determining aggregate demand compared to what the workforce is available. I was just reading today how there are nearly twice as many open jobs as there are people employed seeking to fill them. So I think that it will take quite a few layoffs or cutbacks in planned hiring before we get to a point that our overall demand will be affected.

Okay. Makes sense. The idea of the higher wage reminds us how that helps you because I presume you have to pay people more, but I suppose you passed that right through to your customers?

Yes. So, don't misunderstand me. I don't think that high wages to the extent that they make us less competitive with Mexico, China, or Vietnam helps the overall economy, and in the long run, will hurt demand for us. That said, in the short run, obviously, to the extent that wages go up, our aggregate billings go up and our royalties increase. So, in the short run, it's certainly good for us when wages increase.

Last quarter, you mentioned something regarding M&A and the integration of a couple of acquisitions. You indicated that if we experienced another quarter of negative GDP, companies would be eager to sell, which could benefit you. Now that we have seen another quarter of negative GDP, I’m curious about what trends you observe in terms of potential M&A and sellers. What should we anticipate for deal-making this year?

Great question. We have a steady supply of deals that we're considering. However, I wouldn’t say it’s significantly different from what we've experienced over the past year. There is definitely a good supply available, but we are being cautious about our spending due to some uncertainties. When evaluating potential acquisitions, we're looking at trailing twelve months results; if we enter a deeper recession – it’s debatable whether two consecutive quarters of negative GDP growth counts as a recession, although traditionally it does. In any case, with unemployment at 3.6%, it doesn't feel like a typical recession. To summarize, we haven't seen a large increase in distressed companies looking to sell, but that influences how we approach acquisitions going forward. We want to avoid buying at a peak, so we will continue with our disciplined acquisition strategy. The opportunity is definitely there, as there are around 44,000 staffing companies in the United States, meaning there will always be plenty of acquisition options regardless of unemployment rates. It's simply a matter of whether the pricing is right. As I mentioned in the last call, tougher economic conditions tend to make sellers more reasonable about prices, which increases our chances of closing deals.

I have a follow-up to that previous question. Given that you've made five acquisitions recently, since the first quarter, could this be a challenge because of the need to integrate them? I know you integrate quickly, but I'm curious if the current economic uncertainty is making you more cautious. Does this busy period in your operations affect your decision-making, or are those acquisitions fully integrated and not posing any challenges?

No, I would say not really at all with the acquisitions we have completed in the last five transactions. They are integrated as well as they are going to be, so it's not holding us back. We just narrowly missed out on what would have been a good deal, but it will come. It’s not hindering us; it’s just a matter of finding new opportunities. There has been a slight impact because we were only wrapping up the last of those deals in March, which caused us to ease off as we looked for new deals in April and May. Many of these take a few months to materialize. So, while there has been a bit of an impact on what’s currently available, nothing from the integration of prior deals is affecting our potential opportunities.

Yes. Understood. Foot can now be back on the gas, I guess, is the point. if it weren't.

Yes, that's right.

Our next question is coming from Aaron Edelheit of Mindset Capital.

Rick, great quarter again. I wanted to confirm that this is not your strongest quarter seasonally; your strongest quarter is Q3. That's correct, right?

That is correct.

Okay. Last quarter during our conference call, you mentioned that business was going strong and everything was fine. Do you still feel the same way as you did at the end of the call in May, or is there any update on how you see the business progressing?

So, fair question. If you look at it, we had almost $120 million of system-wide sales in the quarter. So just annualizing it puts you at a run rate of $480 million. That's really pretty exceptional for us, and that's really exceptional for us. Thus far, I don't see anything stopping that momentum that we have. Now I always want to be a little cautious because I can look at two quarters of negative GDP growth, a new tax increase coming, all these are things that aren't good for the economy. So we're not going in there without an appropriate level of caution. That said, business has been really strong, obviously, as indicated by $120 million of system-wide sales in the second quarter.

And nothing so far into the current quarter; you don't see any change to that?

No. But this quarter and the fourth quarter will be really good indicators for us regarding the overall status of the economy. Staffing companies are excellent barometers of economic activity, and if we start to see some weaknesses, that would indicate that the overall economy might be beginning to decline. It's challenging to make strong predictions with so many people wanting to purchase something as basic as a car. While manufacturing cars is not straightforward, it's puzzling how a recession can coincide with a supply shortage, especially given how long cars have been produced in the United States. This is the strangest situation I've encountered in 31 years of running this company, and it's difficult to understand. However, I believe that things remain strong.

Yes. Okay. That was what I was thinking. Now another and maybe this is kind of a rough way to think about it. But if I think about that Q3 is typically the strongest quarter, followed by Q2 and then Q1 and Q4 are weak. Is that a rough rule of thumb, assuming there was no change to the economy and labor compared to what it is today? Could you just as a rule of thumb annualize this quarter's numbers? Or how would you have investors think about, I guess, annualized results? You just mentioned something on system-wide sales in terms of where the company sits versus this quarter.

So, and I'm going to caveat the living daylights out of this statement, right? It means no acquisitions, no weird charges, no special items, no big change in workers' compensation, etcetera. The way I would think would be to say Q2 and Q4 should be similar; Q3 should be 10% to 15% better; and Q1 should be 10% to 15% less. That would be the way I would frame it. So personally, I would just use as a sort of a metric, I would say, well, Q2 times 4 equals the annual result in a static environment. Now static environments almost never happen. So just again, I want to caveat that statement.

I joined the call a bit late, so I apologize if this has already been discussed. You mentioned that the economic situation of rising wages and labor shortages is creating a favorable demand environment. Can you elaborate on the labor shortages and any constraints they are causing on your ability to meet demand? Has the situation improved at all? Have more workers returned to the workforce, or what is the current status?

Demand has remained very strong and exceeds our capacity to fulfill it. Our order fulfillment capabilities are improving somewhat, but not enough to bridge the gap between orders and supply. The more specialized a position is, the harder it is to fill, which is a common situation in the staffing industry. Filling a role that requires numerous specific skills will always be more challenging than that of a general warehouse worker. However, we could definitely place many more people if they were available. Regarding your question about workers returning to the job market, I wouldn't say that is happening yet. Nevertheless, as other companies reduce their hiring plans and some begin layoffs, I anticipate an increase in traffic and a greater ability to fulfill our outstanding orders.

Okay. Understood. And what are you seeing from your franchisee base in terms of appetite for opening new locations and leveraging the commercial staffing platform and just some of the other kind of specialties that you're providing for your franchisee base to grow their businesses?

I appreciate that question. I always want to sell more and open more offices than we currently do. We have begun to see an increase in openings, although it took some time for our franchisees to recover from the pandemic. That experience has made everyone cautious, especially those running physical businesses as opposed to online retailers. We have expanded our offices significantly, but I wouldn’t go as far as to say we are opening new ones every week. Over the last year, we have entered a few key markets that I believe will eventually provide us with positive momentum. For example, we recently opened a location in the Boston area and one in Chicago, both of which are among the largest metropolitan areas in the U.S. These markets hold great potential for us, especially since our franchisees have experience in those locations. We are focused on organic growth, though it will take some time. Previously, the decision to open new branches was closely tied to the cash flow from existing operations. In the next couple of years, many of our franchisees from the Command Center merger will have paid off their acquisition debt. This could enable them to invest more in sales or consider expanding with their newfound cash flow. I feel optimistic about our chances of increasing our number of locations in the next two to three years.

Okay, that's helpful. That's an interesting dynamic you brought up. I guess the focus is still on having existing franchisees open new locations. But has there been any change in your efforts to attract new franchisees from outside the current network to increase that location count?

Yes, it's interesting that you asked that. I was hesitant to mention it because it's quite new, but we actually hired someone this quarter who will work at least part-time on selling franchises to new clients. So we are beginning to enhance those efforts as well.

Congratulations on the good result here.

As there are no questions in the queue, this concludes our Q&A session today. We want to thank you for your interest and participation in the conference, and you may disconnect your lines at this time.