Greetings, and welcome to the HireQuest Inc. Second Quarter 2023 Earnings Conference Call. I will now turn the call over to your host, Mr. John Nesbett, Investor Relations. John, you may begin.

Thank you. I'd 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. I'd like to 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 and 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. These 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 periodic report filed with the Securities and Exchange Commission and the 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 Chief Executive Officer of HireQuest, Rick Hermanns. Go ahead, Rick.

Thank you, everyone, for joining today's call. I'll begin by providing an overview of our financial and strategic highlights from the second quarter and year-to-date. And then I'll turn the call over to David, who will share more details around our second quarter results. Our performance in the second quarter reflects our ability to deliver solid results despite what I think can accurately be described as a difficult economic environment. As I have frequently said, we have a unique model for the staffing industry, and the results this quarter reflect the strength of the franchise model. Our franchisees are entrepreneurial and incentivized to run a successful office no matter what the market environment, and we are seeing solid execution across the franchise base. This quarter also includes MRI Network and the over 200 franchise offices we onboarded as part of that acquisition at the end of last year. MRI is a top permanent placement and executive search and professional staffing network based in the United States and one of the largest executive recruiting networks in the world. The addition of MRI allowed us to immediately scale our presence in the Executive Search segment and is further enhanced and strengthened our broader franchise model. In the quarter, our total revenue grew 12.4% to $9 million, and franchise royalties increased 20.5% to $8.7 million compared to $7.2 million in the prior year period. System-wide sales for the quarter increased to $157 million compared to $120 million for the second quarter of 2022. While the majority of the growth in system-wide sales came from the addition of MRI, some of our small array offerings, such as DriverQuest and HireQuest Health, also contributed. I would also like to point out that both our HireQuest Direct and Snelling franchisees held their own despite the soft macro environment, with year-over-year declines of 4.4% and 9.2%, respectively. For the six months ended June 30, 2023, total revenue was $18.8 million, an increase of 25.3% compared to $15 million in the prior year period and franchise royalties increased 30.7% to $18 million compared to $13.8 million for the six months ended June 30, 2022. SG&A was $5.6 million in the second quarter of 2023, an increase of 74.5% compared to the second quarter of ’22. The increase was primarily related to ongoing costs related to the MRI acquisition and increased workers' compensation costs in the second quarter. MRI was a large acquisition for us. As we continue to integrate MRI and drive synergies across our business, we expect to bring expenses down over the balance of the year. In the second quarter, we continued to make progress and excluding the effect of workers' compensation insurance, Q2 SG&A was approximately $4.9 million compared to $5.7 million in Q1. We just want to make sure that we drive synergies thoughtfully and in a sustained fashion. Our positioning continues to improve, with an increasingly diverse mix of staffing options and a strong presence across key geographic areas. As we continue to drive organic growth, integrate acquisitions into our business, and drive synergies, we are confident that we will be able to drive growth and improve performance for the long term. With that, I'll pass it along to our CFO, David Burnett, who will provide a closer look at our second quarter results.

Thank you, Rick, and good afternoon, everyone. Thank you for joining us today. Expanding on some of the numbers Rick mentioned, let's start with total revenue, which for the second quarter of 2023 was $9 million compared to $8 million for the same quarter last year, an increase of 12.4%. Our total revenue was made up of two components: franchise royalties, which is our primary source of revenue, making up approximately 95% of total revenue; and service revenue, which is generated from certain services and interest charged to our franchisees. Other miscellaneous revenue is classified with service revenue. We did not report any revenue from company-owned operations, although at June 30, 2023, we owned one location classified as held for sale and reported below the line as discontinued operations. For continuing operations, franchise royalties for the second quarter were $8.7 million compared to $7.2 million for the same quarter last year, an increase of 20.5%. The MRI Network accounted for $1.9 million of the increase in royalties for the second quarter as royalties from pre-existing locations decreased by approximately $430,000. Underlying the growth in royalties are system-wide sales, which are not part of our revenue but can serve as a key performance indicator. System-wide sales reflect sales in all offices, including those classified as discontinued. It serves as a basis for most of our royalty revenue. System-wide sales for the second quarter were $157 million compared to $120 million for the same period in 2022, an increase of 30.8%. Similar to the growth in royalties, growth in system-wide sales was driven by the addition of MRI Network, which accounted for $43.5 million of the increase, and system-wide sales for the second quarter. Sales from preexisting locations decreased by approximately $6.6 million. Service revenue, which is generated from certain interest charged to our franchisees, service fees, and other miscellaneous revenues such as license fees, was $286,000 for the second quarter compared to $779,000 for the same quarter a year ago. Service revenue will fluctuate from quarter to quarter based on a number of factors, including changes in the volume and mix of system-wide sales, changes in accounts receivable, insurance renewals, and similar dynamics. Selling, general and administrative expenses for the second quarter were $5.6 million compared to $3.2 million in the prior year period. That is an increase of 74.5%. As Rick referenced earlier, the increase was primarily driven by a few large items. 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. Comp and benefits for the second quarter was $3.2 million versus $2.3 million in the prior year period. Since the acquisition, we have absorbed significant personnel costs as we integrate MRI Network into our preexisting operations. We are handling integration in a disciplined manner in hopes of creating an annuity-like payback from cost savings over the foreseeable future. Second, we had an $878,000 swing in workers' compensation expense. For the second quarter in 2023, workers' compensation expense was approximately $690,000 compared to a $188,000 benefit in workers' compensation in the second quarter of 2022. The increase primarily relates to changes in rates that we are unable to immediately pass along to our franchisees. 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. In the past, we have benefited from the runoff of older claims that were acquired in the Snelling acquisition from 2021, but those have now largely been realized. In addition to increased salaries and benefits, we also absorbed other MRI Network SG&A expenses, including marketing, IT, insurance, professional fees, and the like. These increases are evident in our SG&A costs for the second quarter and more so in the year-to-date results. As we communicated in our last earnings call, we expect to carry certain transition items and associated expenses well into 2023 to support our expanded operations. The increase in SG&A can be felt in income from operations, which is total revenue plus SG&A, depreciation, and amortization. Income from operations was $2.7 million in the second quarter versus $4.3 million in the prior year period, a decrease of 37.4%. Net income includes income from operations adjusted for miscellaneous items, interest, income taxes, and discontinued operations. All-in net income for the quarter was $2.0 million or $0.15 per diluted share compared to net income of $4.9 million or $0.36 per diluted share in the second quarter last year. Net income for the second quarter of 2022 includes $1.3 million of gains from the conversion of acquired operations into franchises. Adjusted EBITDA in the second quarter of 2023 was $3.9 million compared to $5.8 million in the second quarter of last year. We believe adjusted EBITDA is a relevant metric for us due to the size of certain noncash operating expenses running through our P&L. A detailed reconciliation of adjusted EBITDA to net income is provided in our 10-Q, which was filed this afternoon. Moving on now to the balance sheet. Our current assets at June 30, 2023, were $57.9 million compared to $51.9 million at December 31, 2022. Current assets as of June 30 included $2 million of cash and $51 million of accounts receivable, while current assets at December 31, 2022 included $3 million of cash and $45.3 million of accounts receivable. Current assets exceeded current liabilities by $17.3 million at June 30 versus year-end when working capital was $15.2 million. The increase in working capital is driven by the increase in accounts receivable, offset partially by a corresponding increase in the credit line. At June 30, we had $16.5 million drawn on our credit facility and another $23.2 million in availability, assuming continued covenant compliance. We believe our credit facility provides us with flexibility and room for short-term working capital needs as well as the capacity to capitalize on potential 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 June 15, 2023 to shareholders of record on June 1. We expect to continue to pay our shareholders 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. To conclude, we are very pleased with our performance this quarter, especially in the face of a more challenging economic environment. Our results are a testament to the innovative franchise model and the strength of our business initiatives that include a synergistic mix of strong organic growth and accretive M&A activity. As always, I would like to thank our employees for their hard work and dedication this quarter. As CEO of HireQuest, I look forward to continuing to drive operational success and value for our shareholders. With that, we can now open the line to questions. Thank you.

Your first question is coming from Mike Baker of D.A. Davidson.

Okay. So it sounds like you saw a little bit of organic growth slowdown. I presume that's a function of the slowing employment growth that we've seen over the last couple of months. But is that the right way to think about it? Or is there something else going on? And I guess, if you could help us sort of frame up how we should think about revenues for the third and fourth quarter.

Thanks, Mike. Our results are generally consistent with those of other companies that have reported so far. For instance, PeopleReady was down by about 16%, and most companies in perm placement are seeing declines of 25% to 30%. This reflects the current state of the staffing and recruiting industry. On our side, particularly in staffing, we have performed better than what our peers have reported. However, in recruiting and perm placement, our performance is about average compared to others. As I mentioned previously, our geographic mix is benefiting us in staffing. While the overall economy is seeing some job softness, particularly affecting temporary staffing, we are experiencing a somewhat lesser impact due to our strong presence in Texas and Florida. I do not anticipate any changes this quarter or signals from the Fed that would suggest relief before the year's end. I believe internal growth recovery will be tied to overall economic recovery, and I remember stating in a previous call that predicting economic trends is challenging, and we are certainly influenced by them. That said, I do not expect improvement in our same-store sales before the year ends. However, if the economy improves, we will be in a good position to benefit. I want to highlight that the 6% blended decline observed in our existing staffing offices is a solid comparison to our peers. I hope that answers your question.

Yes. No, that definitely helps. And I guess, if I could ask one more, moving down the P&L, we understand, I think, the sticky costs and MRI, which should come down over time, but it might take a while anyway, how should we sort of think about the expense rate in the coming quarters, excluding workers' comp, which I understand is volatile.

So the good news is during the second quarter, we were able to reduce our permanent staffing costs by close to $900,000 on an annualized basis, mainly through attrition. This fits within our pattern of aligning staff size with our revenues. Additionally, there were several other costs that diminished during the second quarter. Therefore, while Q2 still incurred some expenses, many of those costs are no longer present. I anticipate that Q3 might still include some extra expenses from the MRI acquisition, but I expect that legacy costs will largely be resolved by the end of the quarter, making Q3 a relatively straightforward period. By Q4, we should reach a stable point. However, this could change if the Fed continues to raise rates and our revenues soften, which may require us to make further unplanned cuts. I want to emphasize that we have already implemented many of the cuts we intended. There are still some additional cuts available, but they will likely relate to what I consider investments. For instance, in terms of franchise sales, as long as we are selling new units, we'll continue to allocate resources there. However, if we feel we are going against the Fed, that would be an area where we could reduce costs. Ultimately, the situation will dictate our decisions. I can't guarantee that SG&A will drop another $2 million annually, as it will depend on demand. While there are still a few cuts we can make, the majority have already been executed, though they weren't fully evident in Q2.

Your next question is coming from Kevin Steinke of Barrington Research.

Regarding the revenue outlook, I understand that it’s a changing situation. Historically, the third quarter has performed stronger sequentially compared to the second quarter. However, the impact of MRI might reduce that effect. Is there any reason to think that this historical trend will continue, or could it be disrupted by the economy? I’m not sure if you have any insights on this at the moment.

So that's a great question, Kevin. The reality is that Q3 is generally our best quarter. You're absolutely right. The state of the economy is going to affect whether, let's say, Q3 is better than Q2. It will probably be but will it be, let's say, as good as it's supposed to be? Hard to completely say because even back in April, our comparisons were, let's say, our year-over-year comparisons were probably stronger in early April than what they were, let's say, in late June. And so Q3 may be, let's say, not as pronounced of an increase is what we would normally expect to see if that answers your question.

Yes, that's helpful. Good insight. You mentioned some growth-related costs associated with MRI, including franchise sales and training costs. While it's still early, have you noticed any benefits from these costs so far? Additionally, do you think the economy might affect the returns from these expenses in the near term? Would you consider holding onto them a bit longer to see their impact as the economy improves, or how are you approaching this situation?

There are three types of investments. First, there are those that are only pursued in a strong economy, which we have eliminated. Second, some investments can be adversely affected by the economy but can be easily revived when conditions improve, such as franchise sales. In a recession, franchise sales would decline, making it difficult to justify significant spending on them. Third, there are investments like IT that yield long-term benefits rather than short-term gains. Unless our cash flow is severely impacted, we plan to continue those investments even if they initially hurt our earnings, as they are essential for maintaining our competitive edge, supported by our strong balance sheet. We will be careful about the cuts we make as the environment is challenging, but we need to maintain reasonable performance. While I wish we were doing better, certain sectors are facing significant difficulties, especially in IT, where a large number of job losses have occurred. Our MRI IT-related franchisees are experiencing these challenges. However, I did speak with someone recently who mentioned signs of improvement. My point is that we won't cut long-term investments unless our cash flow situation worsens, but we will reduce spending on areas that can be easily revived or that should only be maintained in a thriving economy. I'm not sure if that fully answers your question.

Yes. I would say, absolutely yes. That answers the question. That's great insight. Lastly, I wanted to ask about how you're thinking about acquisitions in the current environment? If this environment might present you with more opportunities as other competitors struggle, maybe more than you are in this environment? And what you're seeing on deal flow and pricing and those sorts of dynamics?

So first, I'll reiterate something I've mentioned before: one advantage of a recession is that it usually creates more opportunities for us and better pricing. I believe there are currently more opportunities than there were six months ago. However, I'm not suggesting that we're overwhelmed with offers from businesses wanting to be acquired; that's not the case. But we do see more serious opportunities. In terms of our approach to acquisitions, we are definitely looking to buy for a couple of reasons. For one, we’ve been doing this strategically for five years and plan to continue. This is part of our normal business operations. Given our current situation with HQD and Snelling being down, pursuing an acquisition will be more feasible now. We have some capacity in our permanent staff, which means we can take on an acquisition without needing to hire as many new employees as in the past. We're currently operating at approximately $30 million to $50 million below what I had anticipated before the economy slowed down. If we were to acquire a business valued around $30 million or $40 million, we haven't really adjusted our permanent payroll for HQD and Snelling yet. Thus, we could reasonably take on a $25 million or $30 million acquisition without significantly increasing our staff. From this standpoint, it would be more advantageous than usual, so we are eager to find an appropriate acquisition. However, we must also be mindful of the current economic climate. We need to manage sellers' expectations since they might base their pricing on 2022's figures while we’re looking at the present situation in mid-2023, which has changed. This discrepancy could complicate closing a deal. On the positive side, we now have a clearer understanding of the market dynamics in an economy that's not buoyed by post-COVID demand. This provides us a more accurate picture of what we are purchasing and greater potential upside, given the uncertain economy. We remain optimistic about this and our VP of Corporate Development is actively working on identifying potential acquisitions.

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

Rick, I wanted to ask you about last quarter when we discussed the earnings call, you mentioned that this quarter might be challenging. Now, with the increase in workers' compensation and the way you're thoughtfully managing SG&A, I am looking ahead to next quarter. Based on what I'm hearing, and I hope I'm not setting unrealistic expectations, it seems that we should experience a sequential increase in revenue due to seasonal strength, assuming nothing unusual occurs. You are addressing expenses, so we could anticipate higher revenue and lower expenses, indicating that the third quarter might yield a significantly better EPS. Is this an accurate interpretation, or should I consider that this is potentially the messy low point along with the economic slowdown?

The main concern is the economy itself. I am cautious about what I say because I don't know how the Federal Reserve's actions will impact businesses, especially if regional banks start to cut back on lending for commercial projects. Many factors could influence my statements, and everything I say could change in a week. That being said, the third quarter is typically our strongest, and it should show sequential improvement. However, if the economy continues to weaken, any gains we see from a better quarter may be offset by economic challenges. From a sales perspective, it should not be worse than the second quarter. At worst, it should remain stable. We have eliminated some costs that affected us in the second quarter, and we should benefit from that in the third quarter. I believe SG&A expenses will be lower, except for workers' compensation, which is unpredictable. In the past, our workers' comp performance has been negatively impacted by old claims that are no longer affecting us. Ideally, those unfavorable comparisons should decrease. For three consecutive quarters, workers' comp has negatively impacted earnings, but this should stabilize as we move past the impact of old claims. Other expenses that we reduced in the second quarter will also be fully accounted for in the third quarter. Overall, I expect things to improve. However, I am not suggesting we celebrate just yet; there are still economic uncertainties to consider. Compared to our peers, we are performing quite well.

That's very helpful.

I don't want to be overly celebratory right now because there are still factors outside of our control that could arise.

I understand. My perspective aligns with yours, considering the significant acquisition you made and your careful approach to managing expenses to foster long-term growth. We're facing a short-term impact on shareholders due to the increase in SG&A expenses, but that should gradually ease. Workers' compensation costs are higher than usual, compounded by a slowing economy. However, looking at the brighter side, I want to ensure I’m viewing this correctly as a long-term shareholder. I see HireQuest as developing a steady stream of cash flows. After acquiring MRI and utilizing that line of credit, it's evident that you're able to pay it down each quarter, and your accounts receivable should reach its peak in Q3. Following that peak, due to seasonal factors, you should be able to reduce the line of credit further, independent of any new acquisitions. It seems like you’re also positioned for a full pipeline ahead. Given the current economic slowdown, I believe that while short-term results might be somewhat affected, the likelihood of securing future acquisitions increases. You're now in a much stronger position financially, generating cash flow to facilitate this. I would like to know your thoughts on the current acquisition landscape—specifically, how the asking prices from sellers compare to your acquisition targets. Do you believe they are more aligned now than before? Additionally, what are your thoughts on the possibility of making another acquisition before the end of the year?

There’s a lot to unpack here. Let me address the first part. Your long-term assessment aligns closely with my own perspective. We're actively working to grow organically while pursuing strategic acquisitions. Regardless of market conditions, we continue to build our revenue stream, although this means our growth may be inconsistent due to ongoing acquisitions. We're not waiting long periods before moving on to the next opportunity. I also want to clarify regarding the MRI acquisition. While we've experienced some challenges due to economic factors, it has still proven to be a profitable investment for us. Although its sales and revenues have decreased, impacting potential growth, it has nevertheless been beneficial for our shareholders, especially considering the current economic climate. Once the economy stabilizes, we anticipate further growth. Regarding your second question about the bid-ask dynamics, there are multiple ways we can take advantage of the current market conditions. I often mention the term recession, but the reality is that some regions aren’t experiencing it. For instance, Florida and Texas are performing well, particularly on the HireQuest Direct and Snelling fronts. Therefore, calling it a recession doesn't accurately represent several markets we're involved in. However, in other areas facing economic distress, we can find opportunities as companies look to sell, potentially lowering prices. An example of this is the Snelling acquisition, where we negotiated a bargain purchase agreement of $5.6 million, along with additional savings from managing their workers' compensation costs. Such deals significantly benefit us when we identify companies that have overextended themselves. However, we’re not solely focused on distressed sales; we’re also open to fair-priced acquisitions that fit our geographical needs. Our criteria for acquisitions remain rigorous, and an uncertain economic climate often pushes sellers to be more open to negotiation, especially if they've recently enjoyed higher profits and now see them declining. While the number of opportunities has not dramatically increased, there are still more deals available compared to previous years. Our approach remains the same, and I want to emphasize that our borrowing levels have been higher than in the past. However, those borrowings are decreasing. A year ago, our borrowing rates were around 3.25%, now they are approximately 6.5% to 7% on larger amounts, which has affected our earnings. Even without significant acquisitions, we’ll see a reduction in interest expenses over the next few quarters, which will improve our income. I anticipate another acquisition soon, as we have made significant progress with MRI, putting us in a strong operational position to pursue the right deal at the right price.

Your next question is coming from Mike Albanese of EF Hutton.

Rick. Lot of great insight on the call as usual. I just got a quick one for you, kind of returning back to the macro, I guess. Obviously, demand is softening, but can you just tell me what you're seeing generally speaking regarding wages?

So wages have continued to go up. Part of it is in many of the states that we operate in have minimum wage escalators. And while we don't typically pay minimum wage, it definitely impacts, particularly in the HireQuest Direct and the Snelling divisions, it impacts even people who are making more than minimum wage. And so there has definitely been a fair bit of pressure on wages, again, just simply because legally, the minimum wage keeps going up.

Got it. Would you say that when comparing to the growth you've seen in wages over the previous quarters, is it slowing down, speeding up, or is it just a continuation of the same trend?

I would say there's still a lot of pressure upwards. Maybe not. That said, it's certainly not like the second quarter of 2021, when there was a lot of upward pressure. I'm not suggesting it's the same now, but there continues to be a consistent shortage. For example, I was flying through Minneapolis recently, and a restaurant in the middle of the airport was closed until 2:00 because they didn't have enough staff.

We have now reached the end of our question-and-answer session, and I will now turn the call back over to the management for closing comments.

Thank you all for joining us on the call. We wish the economy was stronger and that our results were better. However, when comparing our results to our peers and considering the challenges we've faced with workers' compensation, I believe we have performed well under the circumstances. As we consistently emphasize, we are focused on the long term, and while our results may fluctuate, we maintain a conservative balance sheet to seize opportunities as they arise. Thank you for your time and interest, and we look forward to what the future holds. Have a good night.

Thank you very much. This does conclude today's conference, and you may disconnect your phone lines at this time. Thank you for your participation.