HireQuest, Inc. Q1 FY2023 Earnings Call

Good afternoon everybody. And welcome to the HireQuest Incorporated First Quarter 2023 Earnings Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. Please note that this conference is being recorded. I will now turn the conference over to your host, John Nesbett, Investor Relations. John, over to you.

Thank you. And good afternoon. I would like to welcome everyone to the call. Hosting the call today are HireQuest’s Chief Executive Officer, Rick Hermanns; and Chief Financial Officer, David Burnett. Let’s 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 and Section 21E of the Securities Exchange Act of 1934 as amended. These forward-looking statements in terms, such as anticipate, expect, intend, may, will, should, or other comparable terms involve risks and uncertainties because they relate to events 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 the 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 Securities And Exchange Commission 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. I would now like to 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 the financial and strategic highlights for the quarter, and then David will share more details surrounding our first quarter results. Our first quarter results were driven by strong performance at our organic locations in the integration of strategic, accretive acquisitions into our business. Total revenue grew 40% to $9.9 million with franchise royalties increasing 41.8% to $9.3 million. System-wide sales for the quarter increased to $153.5 million compared to $101 million in the first quarter of 2022. And net income from continuing operations increased 372.1% to $2.3 million or $0.17 per diluted share. Last quarter, we announced that we had completed our acquisition of MRI Network, a top permanent placement and executive search firm and professional staffing network based in the United States and the third largest executive recruiting network in the world. This was a transformative acquisition for us, adding over 200 franchise offices both in the United States and internationally to our staffing network. Our acquisition of MRI Network is a perfect example of our broader M&A strategy. We are intently focused on identifying, evaluating, and executing accretive acquisitions that we believe will further enhance the organic growth of our business. MRI Network allows us to add immediate scale in a brand new service focused on the executive search and professional staffing market, and in a way that supports our existing HireQuest Direct and Snelling offerings. As is the case with any acquisition, we also incurred certain expenses related to our purchase of MRI Network that are reflected in this quarter’s results, particularly in our SG&A. These are near-term, one-off expenses that we planned for as part of the acquisition and we expect them to be largely phased out by the end of the third quarter. We will note here that certain expenses related to MRI have been a bit more difficult to eliminate as quickly as we would have hoped. That said, we are pleased with the progress we’ve made this quarter, particularly our ability to efficiently integrate large acquisitions into our business to have a near-term positive impact on our results. This is especially true in the current economic environment where many staffing companies have been reporting declining revenues year-over-year for their U.S. and North American businesses. With the first quarter now closed and a little more visibility into 2023, I’m confident that we are well positioned to continue driving our growth strategy to deliver consistent, improved results as we move through the balance of the year. With that, I will pass it along to our CFO, David Burnett, who will provide a closer look at our first quarter results. David?

Thank you, Rick. Good afternoon everyone. Thanks for joining us today. Expanding on some of the numbers Rick mentioned, let’s start with total revenue, which for the first quarter of 2023 was $9.9 million compared to $7.0 million for the same quarter last year, an increase of 40%. Our total revenue is made up of two components, franchise royalties, which is our primary source of revenue; and service revenue, which is generated from certain services and interest charges to our franchisees and other miscellaneous revenue. On occasion, we will report a third component, company-owned revenue, which would be related to company-owned locations that are not marketed as a potential franchise and are managed by us instead of a franchisee. At March 31, 2023, we owned one location but it did not meet this criteria and instead is classified as held for sale and reported below the line as discontinued operations. Those operations are not included in the revenue I just mentioned, but it is important to keep in mind that we are still benefiting from this location and once it is franchised out, we will retain a royalty stream. For continuing operations, franchise royalties for the quarter were $9.3 million compared to $6.6 million for the same quarter last year, an increase of 41.8%. Almost all of the increase in royalties relates to acquisitions. Although organic sales grew modestly, we are proud to be able to maintain organic sales in an uncertain and declining market. Underlying the growth in royalties are system-wide sales, which for the quarter were $153.5 million compared to $101 million for the same period in 2022. System-wide sales reflect sales at all offices including those classified as discontinued. Similar to the growth in royalties, growth in system-wide sales is primarily related to acquisitions completed in 2022, but unlike many of our competitors, we did not lose organic sales year-over-year. Service revenue, which is generated from interest charged to our franchisees on overdue accounts receivable, service fees, and other miscellaneous revenues such as license fees was $534,000 for the quarter compared to $468,000 for the same quarter a year ago. Changes in service revenue are generally related to growth in system-wide sales and the resulting increase in accounts receivable. Selling, general and administrative expenses for the quarter were $5.8 million compared to $2.7 million in the prior year period, an increase of 120.1%. The increase was primarily driven by two large items. First, we had a tough comparable for our workers’ compensation expense. For the first quarter in 2023, workers’ compensation expense was approximately $185,000 compared to a $613,000 benefit in network of compensation expense in the first quarter of 2022. That is a $798,000 swing in worker’s compensation expense from Q1 2022 to Q1 2023. This benefit in the prior year included a $365,000 reduction related to the Snelling workers’ compensation reserves assumed at the time of acquisition that have been winding down. There was no such adjustment in 2023. Generally, workers’ compensation expense will fluctuate quarter-to-quarter based on the mix of worker classifications, the level of payroll and claims resolution both recent and historical. The predominant item driving the increase in SG&A is compensation and benefits. Compensation-related expenses have always been the largest component of SG&A. There was a $1.6 million increase in compensation-related expenses from Q1 2022 to Q1 2023. When we acquired MRI Network in December 2022, we took on over 30 new corporate employees. During the first quarter, we absorbed significant costs as we integrate MRI Network into our operations. We are handling the integration in a disciplined manner in the hopes of creating an annuity-like payback from cost savings for the foreseeable future. Because high costs often creep back in over the near term, it is critical for us to be patient and secure cost synergies that will hold for several years. In addition to increased salaries and benefits, we have also absorbed other MRI Network SG&A expenses including marketing, IT, insurance, professional fees, and the like. As we communicated in our last earnings call, we expect to carry certain transition items and associated expenses through at least the first half of this year and into the third quarter. The increase in SG&A can be felt in income from operations, which is total revenue less SG&A, depreciation and amortization. Income from operations was $3.3 million in the first three months of 2023 versus $3.9 million in the first three months of 2022, a decrease of 14.7%. Net income includes income from operations adjusted for miscellaneous items, interest, income taxes, and discontinued operations. Interest in financing expense included a $318,000 loss on debt extinguishment related to the refinance of our line of credit. This was largely offset by a $340,000 gain on the conversion of our Dental Power business into a franchise, which is reflected net of tax in discontinued operations. Net income for the first quarter of 2022 included $3.6 million of losses resulting from the conversion of acquired operations into franchises. All in net income for the quarter was $2.6 million or $0.19 per diluted share compared to net income of $603,000 or $0.04 per diluted share in the first quarter last year. Adjusted EBITDA in the first quarter of 2023 was $4.6 million compared to $5.3 million in the first quarter of 2022. We believe adjusted EBITDA is a relevant metric for us due to the size of non-cash operating expenses running through our P&L. A detailed reconciliation of adjusted EBITDA-to-net income is provided in our 10-Q. Moving on now to the balance sheet. Our current assets at March 31, 2023 were $59.6 million compared to $51.9 million at December 31, 2022. Current assets as of March 31st included $8.2 million of cash and $48.1 million of accounts receivable. While current assets at December 31, 2023 included $3 million of cash and $45.3 million of accounts receivable. The elevated cash balance reflects some cash management inefficiencies as we change banks from Truist to Bank of America. Current assets exceeded current liabilities by $14.7 million at March 31 versus year-end when working capital was $15.2 million. The decrease in working capital reflects a larger balance on the credit line following the acquisition of MRI Network. At year-end, we had $21.2 million drawn on our credit facility and another $19.1 million in availability, assuming continued covenant compliance. In February of 2023, we replaced a line of credit facility at Truist Bank, plus a term loan we had at Truist Bank with a new $50 million line of credit from Bank of America. We believe that this new facility provides us with the flexibility and room for short-term working capital needs, as well as the capacity to capitalize on potential future acquisitions. 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 March 15, 2023 to shareholders of record as of March 1st. We expect to continue to pay a dividend each quarter subject to the Board’s discretion. With that, I will turn the call back over to Rick for some closing comments.

Thanks, David. As I said before, I am confident in HireQuest’s ability to drive sustainable growth across our business and generate positive operational results in 2023 and beyond. As I always like to extend my sincerest thanks to our team, our franchisees, and their workers for their excellent work and dedication. I’m very encouraged by the progress we’ve made in expanding our franchising network and offerings to address a broad spectrum of staffing needs, and I look forward to leveraging our network to drive growth and value for our shareholders. With that, we’ll now open the line for questions. Thank you.

Thank you very much. Operator Instructions. Okay. Your first question is coming from Kevin Steinke of Barrington. Kevin, your line is live.

Hey. Kevin Steinke with Barrington Research. So yes, I wanted to start off, I guess by asking about organic sales growth. You noted they grew modestly while other competitors were maybe reporting declines. What’s your feel for organic growth outlook as we continue to progress through 2023 in terms of the pipeline and overall demand? Is that softening and what’s labor supply availability, just any comments on that as we move forward in the year?

Sure. So we are definitely seeing a continued slight slowing in demand. It’s noticeable without being appreciable, if that makes sense. Obviously, it depends on whether the Fed keeps increasing interest rates, as that may accelerate even further. As far as workforce supply, it’s definitely based on industry and that’s even true of the declines. Oddly enough, anything that touches upon tech, particularly with the MRINetwork, there’s a full-on recession for those offices that focus on IT, at least in our experience. There are certain geographic regions as well that are definitely performing poorly. Whereas, frankly, and probably why we are outperforming from an organic standpoint, is we’re heavy in Texas, Georgia, Florida, and South Carolina—states that have not been nearly as negatively impacted as certain others. And where we are experiencing the most softening are in certain, again, certain states.

Okay. That’s a helpful commentary. Yes, just in terms of the cost items related to MRI and you mentioned that maybe some of the costs are rolling off a little more slowly than you might have hoped. And so you also talked about the compensation and benefits increase of $1.6 million, I believe you said related to MRI. So can you just maybe talk about a little bit more about what’s maybe taken a little longer there? And did you actually, or have you achieved all the synergies out of the gate from MRI that you would’ve thought of or is there still more to come or I guess they are coming more slowly?

So that’s right. There’s where your finger is on maybe why they’re going down a bit slower than hoped for—some of the synergies have been slower. What I want to caution really anybody who’s listening as far as who’s an investor is that this is a marathon. In buying MRI, we took over a company that has, let’s say, system-wide sales more than 50% of what we had. This was a very significant acquisition. While in my optimism, I had maybe hoped that we were going to be able to digest it faster than it’s turned out to be. Some of the expenses are sticking around longer because we want to make sure we gather all of those efficiencies and synergies that we know will ultimately benefit us. So yes, it’s taking a little bit longer, and I’ll own it. Earlier, I had been hoping and thinking that by the end of the second quarter all the expenses would be gone. They’ll definitely drag a bit into the third quarter. This is where obviously, I’ve only been the CEO of the public company since the middle of 2019. I hope I’ve developed a track record of where I’m not going to try to over-promise anything, and I certainly did it prior to that when we were a private company. I know when we’re overstaffed, and I know when we’re overspending on something. On the other hand, we bought MRI with some very specific goals in mind. Yes, it’s taking a little more patience. We’re still only five months into this thing, so it’s not like we’ve been struggling with this for years. But certain things we absolutely know will generate synergies. Like I said, we’re well aware of where we need to be and what our costs realistically need to be. We’re interested in what happens to the company three years from now and five years from now far more than we are interested in what happens over the next three months.

Great. That’s helpful commentary. And that makes sense, obviously with an acquisition of this size to take the time to get it right even if maybe it takes a little bit longer. So completely understood there. So maybe just lastly here you enumerated a number of costs in the press release and your comments here, and I think you said some of those would be coming off by the third quarter, or maybe by the end of the third quarter. What costs should we think about rolling off there? You mentioned IT expenses, license fees, third-party services for contract staffing, obviously the salary and benefits costs and advertising marketing. So just wondering what kind of should be coming out as we get to that third quarter timeframe?

Yes. So let me make sure I clarify that statement, and I’ll go back to my point. Part of it isn’t necessarily just reducing costs; it’s making sure that the costs are in line with what the revenues are. So I want to go back to the franchise salespeople. I’d hire 50 more franchise salespeople if they were producing enough new franchises to justify the cost. I’m not saying to you that we’re going to get rid of it because that’ll reduce our cost so that our SG&A goes down. That’s not really the point. The point is more that we’re going to make sure that we’re selling enough franchises to justify a fairly heavy investment. There are certain software licenses where we’re running—let’s say—we have two different copies of our accounting software. Well, it takes a while to integrate those even though they’re two copies of the exact same software. These are good examples. The other part is we had a holdover of their Chief Financial Officer—the MRINetwork CFO. That expense will roll off partially captured in the second quarter and be completely gone in the third quarter. Additionally, keep in mind our effective tax rate. The effect of a higher effective tax rate was about $170,000 of net income. I want to draw attention to that. Overall, there are just certain things we had hoped we could get through faster than we did. We’ve been really focused on relationships within the franchise community because ultimately what we bought was a series of 220 relationships. The success of this deal in the long run will depend on how well we build relationships with those 220 franchises.

Okay. Well thanks for all the insight. That was helpful. I will turn it over.

Thank you, Kevin.

Thank you very much. Your next question is coming from Matthew Hayes from D.A. Davidson. Matthew, your line is live.

Hi, thank you for taking my question. Weekly jobless claims just came in at $264,000 hitting a 1.5 year high last week. Could you comment on how this development impacts your business?

I think that where it affects us most is it’s an indicator that demand is softening. It’s just another indicator. It hasn’t really impacted us from a job fill standpoint, other than what I would say is, clients are being a bit more selective. A year ago or a year and a half ago, many clients were desperate enough that they were less choosy than they are now. Now they’re back to a more normal way of being choosy. That’s one aspect of it. As I said before in response to one of Kevin’s questions, there are certain industries and areas that are being impacted. I would love to be able to see the details of that 264,000 new jobless claims. My guess is they probably fall into certain industries and not necessarily overall. Anytime you start seeing that and if the jobless rate starts going up, clearly that’s what’s driving that softness. That’s why some of our competition are showing revenue declines of 14%, 15%, or 16%.

That makes sense. And a follow-up for you, Rick. You’ve built this business from scratch, and it seems like a real differentiator to this story is your deep understanding of both the franchise staffing model and incentivizing entrepreneurs from having been in this business for over 30 years. How much longer do you plan on running the business?

You know what? I have no—all I do is work out five days a week. I feel great. So I have no intention of going anywhere.

Thank you very much. Your next question is coming from Mike Albanese of EF Hutton. Mike, your line is live.

Rick, David, how are you guys?

David, how are you?

Good, Mike.

Yes. First off, glad to hear that you have no intentions of leaving and continuing to build upon your previous successes here at HireQuest. You pretty much answered my question in your responses to Kevin, but I’d like to just go back to his original question, and maybe we can dig into it just a little bit deeper. And the question relates to the divergence in organic growth rate between you and your competitors, and I’m wondering if you get the sense at all that you are stealing market share from them, and what that could be attributable to. Is it the difference in business model or is it simply your exposure to different end markets and different geographies? I’m really just wondering if there’s more under the hood there.

I would love to sit here and say we’re just so much better than everybody else that we’re crushing them. Right? If I said that, I’d be lying. Generically, I think we are better; I’d say that to any client because of our model. I would always take a franchisee on average over a corporate-run store every time. I believe in that. That being said, that has been baked into our numbers for literally decades. So I can’t really claim that as why we did so much better from a revenue standpoint this quarter. I think it’s a hundred percent just based on where we are. Fortunately, I live in Florida, and you would never confuse this place with someplace that is in a recession. It’s booming. House prices are up, everything is up. Fortunately, like I said, we are heavy in Texas, Florida, Georgia, South Carolina, and Tennessee. I just think that’s really what it is, and call that strategy or call it luck—it’s just a fact.

Yes, well said. That’s fair. I think I like to give you a little more credit than it’s just dumb luck, right? I mean, it’s certainly built by design. I wonder if the softening labor market and the weakening demand are exposing a better business model, and if that’s starting to show in the numbers. I know it’s hard to dissect that.

Even in the places where we’re down, there’s one particular market I’m thinking we’re way down, related to one single client. They have had a big slowdown and they consolidated their operations. There’s nothing we could do. If we were in certain other states, it’s just—where it’s softer, you can tell. I mean, you could see it, probably even where you look at real estate prices, and it’s almost a harbinger for us as well. If interest rates increase significantly, ultimately that will choke off commercial real estate demand; that’s sort of the longer term, where it starts to create broader problems.

Yes, that makes sense. Okay, thank you very much. That’s really all I have for you today.

All right.

Thank you very much. Your next question is coming from Aaron Edelheit of Mindset Capital. Aaron, your line is live.

Thank you. Just for the record, Rick, you’re not allowed to leave HireQuest. That’s a new shareholder rule we’re implementing. I don’t know if you know about it.

Thank you for that.

I really appreciate the candor and you sharing open and not glossing over any of the tougher things that you go through. My question, just to clarify, and I really appreciate all the detail that you’ve shared and your commentary in answering the questions. It sounds like you believe the synergies are still there; it just may take an extra quarter, and when we’re looking in Q4, obviously no one can control or predict where the economy is going. Absent that, by Q4, things should be normalized to where you want them to be. Is that an accurate assessment?

No, I would say that’s somewhat inaccurate, but maybe not in the way you think. I never went in—we never went in thinking that we were going to get all these synergies in the first or second quarter. A lot of these are literally three- to five-year propositions in a lot of cases. For example, utilizing MRI has a great training program. We’re co-opting that into also working with our Snelling branches. Now what’s the payoff on that? In the current quarters, it’s nothing really; it’s something that develops over time. I do expect that both MRI Network and HireQuest Direct, Snelling—all three frequently sell to the same companies—but those synergies have been slower to develop than I thought. Those are the ones that definitely should bloom by the third and fourth quarter. There are still synergies on just how we deliver our services that we just have to work through. They are starting, but have more to go.

Yes. When you highlighted those costs, like $700,000, $800,000 outside of the worker’s compensation, which I understand fluctuates up and down, I just want to clarify so that I fully understand, are those some of the costs, are those all of the costs? Are there even more synergies that you fully expect? How should I think about those specific extra costs that you highlighted in the press release versus kind of a more normalized position for Q4?

I’m a builder, not a burner. We didn’t buy MRI Network just to strip out whatever we could and then feed off of a corpse. That would make no sense. We looked at MRI Network as something that would be accretive to what we do, expand our product offerings to a broader segment of the overall staffing industry, and it brought in 220 franchisees, many of whom have the talent to do more than what they’re doing. It is absolutely our intention, goal, and expectation that there are—I mean, within that group of 220 MRI franchises, there are a good number we can help double or triple their business. We’re focused on the long-term growth. You are right; the costs need to align with revenues as we balance those investments. We begin to have green shoots with new franchises, and we expect that to benefit us in the longer term.

Thank you very much, and keep up the great work.

Thank you.

Thank you very much. There appears to be no further questions in the queue. I’m going to hand back over to management for any closing remarks.

Well, I want to thank everybody for listening in. I hope that you will agree that the quarter was momentous in that again, we took on an entity that represented almost 50% of what HireQuest was previously, and that there are a lot of opportunities out there that we are working towards. Admittedly little—the opportunities are in some ways bigger and therefore the investments are bigger. Anyway, I do want to thank you for joining us. And look forward to continuing the success as we go through 2023. Thank you very much.

Thank you, everybody. This concludes today’s conference. You may disconnect your phone lines at this time and have a wonderful rest of the day. Thank you for your participation.