HIREQUEST, INC. The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our unaudited consolidated financial statements and the related notes included in Item 1 of Part I of this Quarterly Report on Form 10-Q and with our audited consolidated financial statements and related notes included in our Annual Report on Form 10-K for the fiscal year endedDecember 31, 2021 . The financial position, results of operations, cash flows and other information included herein are not necessarily indicative of the financial position, results of operations and cash flows that may be expected in future periods. See "Special Note Regarding Forward-Looking Statements" below for a discussion of uncertainties and assumptions that may cause actual results to differ materially from those expressed or implied in the forward-looking statements. Additionally, we use a non-GAAP financial measure and a key performance indicator to evaluate our results of operations. For important information regarding the use of such non-GAAP measure, including a reconciliation to the most comparable GAAP measure, see the section titled "Use of Non-GAAP Financial Measure: Adjusted EBITDA" below. For important information regarding the use of such key performance indicator, see the section titled "Key Performance Indicator: System-Wide Sales" below.
Special Note Regarding Forward-Looking Statements
This Quarterly Report on Form 10-Q and other documents incorporated herein by reference include, and our officers and other representatives may sometimes make or provide, certain estimates and other forward-looking statements within the meaning of the safe harbor provisions of theU.S. Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act, and Section 21E of the Exchange Act, including, among others, statements with respect to future revenue, franchise sales, system-wide sales, and the growth thereof; net income and Adjusted EBITDA (a Non-GAAP Financial Measure); the impact of any global pandemic including COVID-19; operating results; dividends and shareholder returns; anticipated benefits of mergers or acquisitions; intended office openings or closings; expectations of the effect on our financial condition of claims and litigation; strategies for customer retention and growth; strategies for risk management; and all other statements that are not purely historical and that may constitute statements of future expectations. Forward-looking statements can be identified by words such as: "anticipate," "intend," "plan," "goal," "seek," "believe," "project," "estimate," "expect," "strategy," "future," "likely," "may," "should," "will," and similar references to future periods. While we believe these statements are accurate, forward-looking statements are not historical facts and are inherently uncertain. They are based only on our current beliefs, expectations, and assumptions regarding the future of our business, future plans and strategies, projections, anticipated events and trends, the economy, and other future conditions. We cannot assure you that these expectations will materialize, and our actual results may be significantly different. Therefore, you should not place undue reliance on these forward-looking statements. Important factors that may cause actual results to differ materially from those contemplated in any forward-looking statements made by us include the following: the level of demand and financial performance of the temporary staffing industry; the financial performance of our franchisees; our and our franchisees' customers' ability to navigate successfully the challenges posed by current global supply disruptions and inflation, including with respect to energy prices; the impacts of COVID-19 or other diseases or pandemics; changes in customer demand; the extent to which we are successful in gaining new long-term relationships with customers or retaining existing ones, the level of service failures that could lead customers to use competitors' services; significant investigative or legal proceedings including, without limitation, those brought about by the existing regulatory environment or changes in the regulations governing the temporary staffing industry and those arising from the action or inaction of our franchisees and temporary employees; strategic actions, including acquisitions and dispositions and our success in integrating acquired businesses; disruptions to our technology network including computer systems and software whether resulting from a cyber-attack or otherwise; natural events such as severe weather, fires, floods, and earthquakes, or man-made or other disruptions of our operating systems or the economy including by war; the factors discussed in the "Risk Factors" section in our most recent Annual Report on Form 10-K, which we filed with theSEC onMarch 15, 2022 ; and the other factors discussed in this Quarterly Report and our Annual Report. Any forward-looking statement made by us in this Quarterly Report on Form 10-Q is based only on information currently available to us and speaks only as of the date on which it is made. The Company disclaims any obligation to update or revise any forward-looking statement, whether written or oral, that may be made from time to time, based on the occurrence of future events, the receipt of new information, or otherwise, except as required by law. 22
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Table of Contents Overview
We are a nationwide franchisor of offices providing direct-dispatch, executive search, and commercial staffing solutions primarily in the light industrial
and
blue-collar segments of the staffing industry. Our franchisees provide various types of temporary personnel through two business models operating under the trade names "HireQuest Direct", "HireQuest", "Snelling", "LINK Staffing", "DriverQuest", "HireQuest Health ", and "Northbound Executive Search".HireQuest Direct specializes primarily in unskilled and semi-skilled industrial and construction personnel.HireQuest , Snelling, and LINK specialize primarily in skilled and semi-skilled industrial personnel, clerical and administrative personnel, and permanent placement services. DriverQuest specializes in both commercial and non-CDL drivers serving a variety of industries and applications.HireQuest Health specializes in skilled personnel in the medical and dental industries. Northbound Executive Search specializes in executive placement and consultant services in the financial services industry. As ofSeptember 30, 2022 we had 225 franchisee-owned offices and 2 company owned offices in 38 states and theDistrict of Columbia . We provide employment for an estimated 75,000 temporary employees annually working for thousands of clients in many industries including construction, recycling, warehousing, logistics, auctioneering, manufacturing, hospitality, landscaping, and retail. The COVID-19 pandemic materially adversely impacted our business in 2020 and, to a much lesser extent, into 2021. Comparisons between 2022 and 2021 should be viewed through a COVID-19 lens with the understanding that for the nine-month period endedSeptember 30, 2021 our revenues and expenses were impacted by COVID and were lower than they otherwise would have been. A full economic recovery has been slow to occur, and it is uncertain if businesses will remain fully open, or another broad shutdown will occur due to a variant or new strain. The long-term effectiveness of economic stabilization efforts, including government payments to affected citizens and industries, and government vaccination efforts, is also uncertain. Also affecting comparisons between 2022 and 2021 were the acquisitions consummated in 2021 and 2022 as described below. Recent Developments The Snelling Acquisition OnMarch 1, 2021 , we completed our acquisition of certain assets ofSnelling Staffing ("Snelling") in accordance with the terms of the Asset Purchase Agreement datedJanuary 29, 2021 (the "Snelling Agreement"). At the time of acquisition,Snelling Staffing was an eminent staffing company headquartered inRichardson, TX. Pursuant to the Snelling Agreement,HQ Snelling Corporation ("HQ Snelling"), our wholly-owned subsidiary, acquired approximately 47 offices and substantially all of the operating assets, and assumed certain liabilities of the sellers for a purchase price of approximately$17.9 million (the "Snelling Acquisition"). Also onMarch 1, 2021 , HQ Snelling entered into the First Amendment to the Purchase Agreement, pursuant to whichHireQuest, Inc. agreed to advance$2.1 million to be paid to the sellers at closing to be used to pay accrued payroll liabilities that HQ Snelling assumed pursuant to the Snelling Agreement. We funded this acquisition with existing cash on hand and a draw on our existing line of credit withTruist Bank ("Truist").
The LINK Acquisition
OnMarch 22, 2021 , we completed our acquisition of the franchise relationships and certain other assets of LINK Staffing ("LINK") in accordance with the terms of the Asset Purchase Agreement datedFebruary 12, 2021 (the "LINK Agreement"). At the time of acquisition LINK was a family-owned staffing company headquartered inHouston, TX. Pursuant to the LINK Agreement,HQ Link Corporation ("HQ Link"), our wholly-owned subsidiary, acquired approximately 35 franchised offices, customer lists and contracts, and other assets of LINK for a purchase price of$11.1 million (the "LINK Acquisition"). We funded this acquisition with existing cash on hand.
The Recruit Media Acquisition
OnOctober 1, 2021 we completed our acquisition ofRecruit Media, Inc. ("Recruit Media") in accordance with the terms of the Stock Purchase Agreement datedOctober 1, 2021 (the "Recruit Agreement"). Pursuant to the Recruit Agreement, we purchased all of the outstanding shares of common stock of Recruit Media for approximately$4.4 million . Recruit Media is a tuck-in acquisition whose intellectual property compliments our technological structure, allowing us to accelerate improvements to our platform. We funded this acquisition with existing cash on hand and a draw on our existing line of credit with Truist. The Dental Power Acquisition OnDecember 6, 2021 we completed our acquisition of the Dental Power Staffing division ("Dental Power ") ofDental Power International, Inc. ("DPI") in accordance with the terms of a definitive agreement, datedNovember 2, 2021 , for approximately$1.9 million . DPI is a 46-year-old dental staffing company headquartered inCarrboro, North Carolina with long-standing client relationships in the dental industry. providing temporary, long-term contract, and direct-hire staffing services to dental practices across theU.S. As ofSeptember 30, 2022 , all of the operations acquired from DPI remain company owned. We funded this acquisition with existing cash on hand and a draw on our existing line of credit with Truist.
The Temporary Alternatives Acquisition
OnJanuary 24, 2022 we completed our acquisition of certain assets of Temporary Alternatives in accordance with the terms of the Asset Purchase Agreement datedJanuary 10, 2022 , including three locations inWest Texas andNew Mexico for approximately$7.0 million , inclusive of a prescribed amount of working capital. Temporary Alternatives is a staffing division of dmDickason Personnel Services, a family-owned company based inEl Paso, TX. The acquisition of Temporary Alternatives will expand our national footprint intoWest Texas and grow our franchise base, and we immediately entered into a franchise agreement and sold the non-working capital assets acquired. We funded this acquisition with existing cash on hand and a draw on our existing line of credit with Truist. The Dubin Acquisition OnFebruary 21, 2022 we completed our acquisition of the staffing operations ofThe Dubin Group, Inc. , andDubin Workforce Solutions, Inc. (collectively "Dubin") in accordance with the terms of an Asset Purchase Agreement datedJanuary 19, 2022 for approximately$2.5 million , inclusive of a prescribed amount of working capital. Dubin provides executive placement services and commercial staffing in thePhiladelphia metro area. The acquisition of Dubin will help expedite growth into a new staffing vertical, expand our national footprint, and grow our franchise base. We funded this acquisition with existing cash on hand, deferred purchase payments, and a draw on our existing line of credit with Truist. We divided Dubin into separate businesses and sold certain customer related assets of one of the acquired locations to a new franchisee. The remaining assets related to the operations of the other acquired locations have not been sold and as ofSeptember 30, 2022 are classified as available-for-sale. In the meantime, we operate the Philadelphia Snelling franchise as company-owned. The Northbound Acquisition OnFebruary 28, 2022 we completed our acquisition of certain assets ofNorthbound Executive Search, LTD ("Northbound") in accordance with the terms of an Asset Purchase Agreement datedJanuary 25, 2022 , for approximately$11.4 million , inclusive of a$1.5 million note payable and a prescribed amount of working capital. Northbound provides executive placement and short-term consultant services primarily to blue chip clients in the financial services industry. The acquisition of Northbound will help expedite growth into a new staffing vertical, expand our national footprint, and grow our franchise base, and we immediately entered into a franchise agreement and sold the customer-related assets acquired. We funded this acquisition with existing cash on hand, seller financing of$1.5 million , and a draw on our existing line of credit with Truist. 23
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Table of Contents Results of Operations Financial Summary The following table displays our consolidated statements of operations for the interim periods endedSeptember 30, 2022 andSeptember 30, 2021 . Percentages reflect the line item as a percentage of total revenue (in thousands, except percentages). Three months ended Nine months ended September 30, 2022 September 30, 2021 September 30, 2022 September 30, 2021 Franchise royalties$ 7,433 79.4 %$ 6,540 95.0 %$ 21,226 79.2 %$ 15,250 95.4 % Staffing revenue, owned locations 1,499 16.0 % - 0.0 % 3,891 14.5 % - 0.0 % Service revenue 429 4.6 % 341 5.0 % 1,677 6.3 % 741 4.6 % Total revenue 9,361 100.0 % 6,881 100.0 % 26,794 100.0 % 15,991 100.0 % Cost of staffing revenue, owned locations 1,123 12.0 % - 0.0 % 2,832 10.6 % - 0.0 % Gross profit 8,238 88.0 % 6,881 100.0 % 23,962 89.4 % 15,991 100.0 % Selling, general and administrative expenses 2,395 25.6 % 3,044 44.2 % 8,763 32.7 % 8,927 55.8 % Depreciation and amortization 601 6.4 % 366
5.3 % 1,777 6.6 % 1,065 6.7 % Income from operations 5,242 56.0 % 3,471 50.4 % 13,422 50.1 % 5,999 37.5 % Other miscellaneous income
(99 ) (1.1 )% 36 0.5 % (2,020 ) (7.5 )% 3,847 24.1 % Interest income
51 0.5 % 54 0.8 % 198 0.7 % 285 1.8 %
Interest and other
financing expense (100 ) (1.1 )% (42 ) (0.6 )% (256 ) (1.0 )% (67 ) (0.4 )%
Net income before
income taxes 5,094 54.4 % 3,519 51.1 % 11,344 42.3 % 10,064 62.9 % Provision for income taxes
946 10.1 % 325 4.7 % 1,880 7.0 % 408 2.6 %
Net income from
continuing operations 4,148 44.3 % 3,194 46.4 % 9,464 35.3 % 9,656 60.4 %
Income from
discontinued
operations, net of tax 98 1.0 % - 0.0 % 277 1.0 % - 0.0 %
Net income $ 4,246 45.4 % $ 3,194 46.4 %
$ 6,629 70.8 %$ 5,294 76.9 %$ 17,849 66.6 %$ 9,598 60.0 %
Use of Non-GAAP Financial Measure: Adjusted EBITDA
Earnings before interest, taxes, depreciation and amortization, and non-cash
compensation, or Adjusted EBITDA, is a non-GAAP measure that represents our net
income before interest expense, income tax expense, depreciation and
amortization, non-cash compensation, compliance costs related to the work
opportunity tax credit ("WOTC") and other charges we consider unusual and/or
non-recurring. We utilize Adjusted EBITDA as a financial measure as management
believes investors find it a useful tool to perform more meaningful comparisons
and evaluations of past, present, and future operating results. We believe it is
a complement to net income and other financial performance measures. Adjusted
EBITDA is not intended to represent or replace net income as defined by U.S.
GAAP and should not be considered as an alternative to net income or any other
measure of performance prescribed by U.S. GAAP. We use Adjusted EBITDA to
measure our financial performance because we believe interest, taxes,
depreciation and amortization, non-cash compensation, WOTC-related costs and
other non-recurring charges bear little or no relationship to our operating
performance. By excluding interest expense, Adjusted EBITDA measures our
financial performance irrespective of our capital structure or how we finance
our operations. By excluding taxes on income, we believe Adjusted EBITDA
provides a basis for measuring the financial performance of our operations
excluding factors that are beyond our control. By excluding depreciation and
amortization expense, Adjusted EBITDA measures the financial performance of our
operations without regard to their historical cost. By excluding non-cash
compensation, Adjusted EBITDA provides a basis for measuring the financial
performance of our operations excluding the value of our restricted stock and
stock option awards. By excluding WOTC related costs, Adjusted EBITDA provides a
basis for measuring the financial performance of our operations excluding the
costs associated with qualifying for this tax credit. In addition, by excluding
certain non-recurring charges, Adjusted EBITDA provides a basis for measuring
financial performance without such items. In addition, our Credit Agreement
requires us to comply with a fixed charge coverage ratio and a leverage ratio,
both of which include Adjusted EBITDA substantially as defined above. For all of
these reasons, we believe that Adjusted EBITDA provides us, and investors, with
information that is relevant and useful in evaluating our business.
However, because Adjusted EBITDA excludes depreciation and amortization, it does
not measure the capital we require to maintain or preserve our fixed and
intangible assets. In addition, because Adjusted EBITDA does not reflect
interest expense, it does not take into account the total amount of interest we
pay on outstanding debt, nor does it show trends in interest costs due to
changes in our financing or changes in interest rates. Adjusted EBITDA, as
defined by us, may not be comparable to Adjusted EBITDA as reported by other
companies that do not define Adjusted EBITDA exactly as we define the term.
Because we use Adjusted EBITDA to evaluate our financial performance, we
reconcile it to net income, which is the most comparable financial measure
calculated and presented in accordance with U.S. GAAP below (in thousands).
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Table of Contents
Three months ended Nine months ended
September 30, September September 30, September
2022 30, 2021 2022 30, 2021
Net income $ 4,246 $ 3,194 $ 9,741 $ 9,656
Interest expense 100 42 256 67
Provision for income taxes 946 325 1,880 408
Depreciation and amortization 601 366 1,777 1,065
WOTC related costs 156 175 451 414
EBITDA 6,049 4,102 14,105 11,610
Non-cash compensation 584 851 1,194 1,420
Acquisition related charges, net (4 ) 34 2,317 (3,739 )
Impairment of notes receivable - 307 233 307
Adjusted EBITDA $ 6,629 $ 5,294 $ 17,849 $ 9,598 Three Months Ended
Gross Profit Our total revenue consists of franchise royalties, staffing revenue with respect to our owned locations, and service revenue. Gross profit includes total revenue less the cost of staffing services at owned locations. Once a company-owned office is sold, disposed of, or otherwise classified as available-for-sale, it would not be reflected in gross profit and instead reported as "Income from discontinued operations, net of tax." Gross profit for the three months endedSeptember 30, 2022 was approximately$8.2 million compared to$6.9 million for the three months endedSeptember 30, 2021 , an increase of 19.7%. Gross profit as a percentage of system-wide sales was 6.7% for the three months endedSeptember 30, 2022 versus 6.8% for the three months endedSeptember 30, 2021 . The increase in gross profit is consistent with the 21.0% increase in underlying system-wide-sales for the quarter endedSeptember 30, 2022 compared to the prior year quarter.
Franchise Royalties
Franchise royalties for the three months endedSeptember 30, 2022 were approximately$7.4 million , an increase of 13.7% from$6.5 million for the three months endedSeptember 30, 2021 . Approximately$240 thousand of this increase in royalties was due to the Snelling, LINK, Northbound, Temporary Alternatives and Dubin acquisitions and approximately$653 thousand was due to organic growth. Our net effective royalty rate (as a percentage of external system-wide sales) was 6.2% for the three-month period endedSeptember 30, 2022 compared to 6.4% for the three months endedSeptember 30, 2021 . Our net effective royalty rate will generally fluctuate due to mix of business among the various royalty models we operate under, as well as incentives we offer during the year. A summary of franchise royalties for the three months endedSeptember 30, 2022 andSeptember 30, 2021 are as follows (in thousands): Three months ended September 30, September 30, 2022 2021 Franchise royalties from pre-existing locations $ 4,907$ 4,254 Franchise royalties from 2021 acquisitions 2,112 2,286 Franchise royalties from 2022 acquisitions 414 - Franchise royalties $ 7,433$ 6,540 Service Revenue Service revenue consists of interest we charge our franchisees on overdue customer accounts receivable and other miscellaneous fees for optional services we provide. Direct costs to provide certain services are reflected as a reduction in service revenue. As accounts receivable age over 42 days, our franchisees pay us interest on these accounts equal to 0.5% of the amount of the uncollected receivable each 14-day period. All accounts that age beyond 84 days are charged back to the franchisee and no longer incur interest, although some of our franchisees elect to charge back accounts that age over 42 days in order to avoid the interest charge. In addition to royalty fees, we also charge a license fee to some locations that utilize our intellectual property that are not franchisees. License fees are 9% of the gross margin for the location. We have no employees and provide no services at the licensed locations. Service revenue for the three months endedSeptember 30, 2022 was approximately$429 thousand , an increase of$88 thousand from the three months endedSeptember 30, 2021 , when service revenue was approximately$341 thousand . This increase was largely due to the growth in the number of franchisee locations and corresponding service-related fees. Due to the timing of how we charge for certain services and the related costs to provide them, service revenue is expected to fluctuate from quarter-to-quarter. Included in service revenue is interest income of$252 thousand for the three months endedSeptember 30, 2022 and$151 thousand for the three months endedSeptember 30, 2021 . The increase in interest generally follows our overall balance in accounts receivable, although relatively few age over 42 days and result in service revenue for us. Many of our franchisees have elected to charge back accounts early in order to avoid or reduce the interest charge. Therefore, there will not be a proportionally large increase in service revenue even when there is a large increase in accounts receivable. We pride ourselves on maintaining quality, creditworthy customerswho pay timely. We do not strive to increase interest on aged accounts receivable.
Staffing Revenue, Owned Locations
Following theDecember 2021 acquisition ofDental Power , we have a platform to build a customer base in the medical and dental-oriented sector of the staffing industry, which we expect will benefit our entire network by increasing revenue opportunities under the HireQuest Health brand. As ofSeptember 30, 2022 , all of the operations acquired from DPI remain company-owned, but franchisees in 8 locations are operating under theHireQuest Health banner. Although we may franchiseDental Power operations in the future, we currently have no firm plans in place to do so. For the three months endedSeptember 30, 2022 , staffing revenue from owned locations was$1.5 million . We had no company owned locations during the three months endedSeptember 30, 2021 .
Selling, General, and Administrative Expenses
SG&A expenses for the three months endedSeptember 30, 2022 were approximately$2.4 million , a decrease of$649 thousand from the three months endedSeptember 30, 2021 when SG&A expenses were$3.0 million . The decrease in SG&A was primarily driven by a$982 thousand decrease in net workers compensation expense. During the current year quarter we reduced our reserves based on recent claims resolution and experience. Most of the workers compensation benefit relates to the Snelling reserve assumed at the time of acquisition and will run off as claims are resolved. This decrease was offset by an increase in salaries and benefits, which increased$824 thousand as a result of additional headcount to keep pace with growth in system-wide sales as a result of the 2021 and 2022 acquisitions, plus organic growth. In addition, Compensation expense in the three months endedSeptember 30, 2022 includes an accrual of approximately$393 thousand for performance bonuses. There was no such accrual in the three months endedSeptember 30, 2021 . Stock-based compensation decreased by$267 thousand . Compensation-related expenses remain by far the largest component of SG&A. 25
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Table of Contents Other Income and Expense
Other income and expense consists of depreciation, amortization, interest income, rent received from sub-tenants, and other non-operating income and expense.
Depreciation and amortization Depreciation and amortization for the three months endedSeptember 30, 2022 was approximately$601 thousand compared to$366 thousand for the three months endedSeptember 30, 2021 . We own our corporate headquarters, a building of approximately 15,000 square feet, inGoose Creek, South Carolina . This building serves as our base of operations for nearly all of the employeeswho provide franchisee support functions. In late 2021, we completed the construction of a 10,000 square foot building adjacent to our corporate headquarters and a supporting parking lot. Depreciation increased by approximately$20 thousand in the three months endedSeptember 30, 2022 due to this addition. The remaining increase of$215 thousand was primarily due to additional amortization stemming from acquisitions. We acquired$21.9 million of franchise agreements and$9.0 million of other intangibles in acquisitions during 2021 and$14.9 million of other intangibles in acquisitions during 2022 (excludingGoodwill ). Of the$23.9 million in other intangibles over the two years, only$3.6 million are indefinite lived and not amortized. Future years will continue to have significant amortization expense until the underlying intangibles are disposed of, impaired or fully amortized. Future acquisitions are expected to further increase tangible and intangible assets on our balance sheet, and correspondingly increase depreciation and amortization. Other income and expense For the three months endedSeptember 30, 2022 , other miscellaneous expense was approximately$99 thousand , compared to other miscellaneous income of$36 thousand for the three months endedSeptember 30, 2021 . In the three months endedSeptember 30, 2022 , we recognized approximately$150 thousand for non-royalty based incentives given to a franchisee during an expansion and acquisition of one of their competitors. This incentive is to help offset integration charges such as signage, branding, marketing, etc. The remaining other miscellaneous income for the three months endedSeptember 30, 2022 , and income for the three months endedSeptember 30, 2021 , is primarily gross rents from leasing excess space at our corporate headquarters to third parties. We lease approximately 9,220 square feet of office space in our headquarters campus to unaffiliated companies. These leases are at the market rate. Rental income for the three months endedSeptember 30, 2022 is higher than the three months endedSeptember 30, 2021 after completion of the new building adjacent to our corporate headquarters. Interest income and expense Interest income for the three months endedSeptember 30, 2022 was approximately$51 thousand compared to$54 thousand for the three months endedSeptember 30, 2021 . Interest income represents interest related to the financing of franchised locations, and one note to the California Purchaser. The small decrease is consistent with a small decrease in underlying principal. Interest and other financing expense relates primarily to the Revolving Credit and Term Loan Agreement with Truist. Interest and other financing expense increased from$42 thousand atSeptember 30, 2021 to$99 thousand atSeptember 30, 2022 . Interest and other financing expense will fluctuate as we utilize the line of credit for acquisitions or other short-term liquidity needs. Due to the acquisitions in the first quarter of 2022, coupled with the working capital needs associated with organic growth, we carried a larger balance on our line of credit for most of the quarter endedSeptember 30, 2022 . Provision for income tax Income tax expense was approximately$946 thousand for the three months endedSeptember 30, 2022 . We estimate an annual projected effective tax rate ("ETR") for the year to determine income tax expense or benefit in the interim periods. The estimated annual ETR does not include tax effects from significant unusual or infrequently occurring items. Such items are accounted for discretely during the period in which they occur. The ETR is primarily driven by the federal Work Opportunity Tax Credit, which is included as part of income tax expense because it can be claimed only on the income tax return and can be realized only through the existence of taxable income. Other significant items affecting our tax rate are and windfall tax deductions related to stock-based compensation, overall limits on executive compensation. Our net ETR for the three months endedSeptember 30, 2022 was 18.6%. Income tax expense for the three months endedSeptember 30, 2021 was approximately$325 thousand . The annual ETR included the non-taxable bargain purchase gain recognized in 2021. Bargain purchase gains are recorded net of deferred taxes, and are treated as permanent differences, resulting in a lower ETR in the period recorded. Our net ETR for the three months endedSeptember 30, 2021 was 9.2%. 26
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Table of Contents
Nine Months Ended
Gross Profit Our total revenue consists of franchise royalties, staffing revenue with respect to our owned locations, and service revenue. Gross profit includes total revenue less the cost of staffing services at owned locations. Once a company-owned office is sold, disposed of, or otherwise classified as available-for-sale, it would not be reflected in gross profit and instead reported as "Income from discontinued operations, net of tax." Gross profit for the nine months endedSeptember 30, 2022 was approximately$24.0 million compared to$16.0 million for the nine months endedSeptember 30, 2021 , an increase of 49.9%. This increase is consistent with the 39.0% increase in underlying system-wide-sales for the nine months endedSeptember 30, 2022 compared to the nine months endedSeptember 30, 2021 . In addition, the net effective royalty rate was higher in the nine months endedSeptember 30, 2022 than it was in the nine months endedSeptember 30, 2021 . Gross profit as a percentage of system-wide sales was 7.0% for the nine-month period endedSeptember 30, 2022 versus 6.5% for the nine months endedSeptember 30, 2021 . The 50-basis point improvement was primarily due to increased service revenue and the Gross Profit from the company-owned location. Franchise Royalties Franchise royalties for the nine months endedSeptember 30, 2022 were approximately$21.2 million , an increase of 39.2% from$15.2 million for the nine months endedSeptember 30, 2021 . Approximately$3.0 million of this increase in royalties was due to th e Snelling and LINK acquisitions and approximately$3.0 million was due to organic growth. Our net effective royalty rate (as a percentage of external system-wide sales) increased from 6.2% for the nine months endedSeptember 30, 2021 to 6.3% for the nine months endedSeptember 30, 2022 . Our net effective royalty rate will fluctuate due to mix of business among the various royalty models we offer and will generally be higher in the early portion of the year until volume related discounted rates become effective. A summary of franchise royalties for the nine months endedSeptember 30, 2022 andSeptember 30, 2021 are as follows (in thousands): Nine months ended September 30, September 30, 2022 2021 Franchise royalties from pre-existing locations $ 13,580$ 10,618 Franchise royalties from 2021 acquisitions 6,569 4,632 Franchise royalties from 2022 acquisitions 1,077 - Franchise royalties $ 21,226$ 15,250 Service Revenue Service revenue consists of interest we charge our franchisees on overdue customer accounts receivable and other miscellaneous fees for optional services we provide. Direct costs to provide certain services are reflected as a reduction in Service revenue. As accounts receivable age over 42 days, our franchisees pay us interest on these accounts equal to 0.5% of the amount of the uncollected receivable each 14-day period. All accounts that age beyond 84 days are charged back to the franchisee and no longer incur interest, although some of our franchisees elect to charge back accounts that age over 42 days in order to avoid the interest charge. In addition to royalty fees, we also charge a license fee to some locations that utilize our intellectual property that are not franchisees. License fees are 9% of the gross margin for the location. We have no employees and provide no services at the licensed locations. These license fees are included in service revenue. Service revenue for the nine months endedSeptember 30, 2022 was approximately$1.7 million , an increase of approximately$936 thousand from the nine months endedSeptember 30, 2021 , when service revenue was approximately$741 thousand . This increase was partially due to the introduction of trademark license fees after theMarch 2021 Acquisitions. In addition, we experienced strong growth in the number of franchisee locations and the related service-related fees. Due to the timing of how we charge for certain services and the related costs to provide them, service revenue is expected to fluctuate from quarter-to-quarter. Included in service revenue is interest income of$709 thousand for the nine months endedSeptember 30, 2022 and$420 thousand for the nine months endedSeptember 30, 2021 . The increase in interest generally follows the overall increase in accounts receivable, although relatively few age over 42 days and result in service revenue for us. In addition, for the nine months endedSeptember 30, 2022 , several franchisees elected to charge back accounts early in order to avoid the interest charge. Therefore, there will not be a proportionally large increase in service revenue even when there is a large increase in accounts receivable. The Company does not strive to increase interest on aged accounts receivable. Staffing Revenue, Owned Locations Following theDecember 2021 acquisition ofDental Power , we have a platform to build a customer base in the medical and dental-oriented sector of the staffing industry, which we expect will benefit our entire network by increasing revenue opportunities under the HireQuest Health brand. As of September 30, 2022, all of the operations acquired from DPI remain company owned. Although we may franchise these operations in the future, we currently have no firm plans in place to do so. For the nine months endedSeptember 30, 2022 , staffing revenue from owned locations was approximately$3.9 million . We had no company owned locations during the nine months endedSeptember 30, 2021 . Selling, General, and Administrative Expenses SG&A expenses for the nine months endedSeptember 30, 2022 were approximately$8.8 million , a decrease of 1.8% from$8.9 million for the nine months endedSeptember 30, 2021 . The decrease in SG&A was primarily driven by a$1.6 million decrease in net workers compensation expense. During the current year we have reduced our reserves based on recent claims resolution and experience. Most of the workers compensation benefit relates to the Snelling reserve assumed at the time of acquisition and will run off as claims are resolved. This decrease was offset by an increase in salaries and benefits, which increased$1.6 million as a result of additional headcount to keep pace with growth in system-wide sales as a result of the 2021 and 2022 acquisitions, plus organic growth. In addition, compensation expense in the nine months endedSeptember 30, 2022 includes an accrual of approximately$1.1 million for performance bonuses. There was no such accrual in the nine months endedSeptember 30, 2021 , although the nine months endedSeptember 30, 2021 includes the entire 2020 executive bonus of$1.1 million . We have historically recognized discretionary bonuses in the first quarter of the fiscal year following the year to which the bonus related. Beginning in the fourth quarter of 2021, we changed our methodology and now recognize the expense during the year to which the bonus relates, resulting in the accrual described in the preceding sentence. For the nine months endedSeptember 30, 2022 , SG&A also includes a$233 thousand impairment charge related to notes receivable due from non-franchisees. During 2020, the California Purchaser experienced significant economic hardships due to the impacts of COVID-19 and the related government mandates in the state. As a result, we restructured a portion of the notes receivable in an effort to increase the probability of repayment. We granted near-term payment concessions in 2021 to help the debtor attempt to improve its financial condition so it may eventually be able to repay the amount due . After reviewing the potential outcomes, we recorded an additional impairment of approximately$233 thousand inJune 2022 .
Other income and expense Other income and expense consists of depreciation, amortization, interest income, rent received from sub-tenants, and other non-operating income and expense.
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Depreciation and amortization Depreciation and amortization for the nine months endedSeptember 30, 2022 was approximately$1.8 million , compared to$1.1 million for the nine months endedSeptember 30, 2021 . We own our corporate headquarters, a building of approximately 15,000 square feet, inGoose Creek, South Carolina . This building serves as our base of operations for nearly all of the employeeswho provide franchisee support functions. In late 2021, we completed the construction of a 10,000 square foot building adjacent to our corporate headquarters and a supporting parking lot. Depreciation increased by approximately$58 thousand in the nine months endedSeptember 30, 2022 due to this addition. The remaining increase of$654 thousand was primarily due to additional amortization stemming from acquisitions. We acquired$21.9 million of franchise agreements and$9.0 million of other intangibles in acquisitions during 2021 and$14.9 million of other intangibles in acquisitions during the nine months endedSeptember 30, 2022 . Of the$14.9 million in other intangibles, only$3.7 million are indefinite lived and not amortized. Future years will continue to have significant amortization expense until the underlying intangibles are disposed of, impaired or fully amortized. Future acquisitions are expected to further increase tangible and intangible assets on our balance sheet, and correspondingly increase depreciation and amortization. Other income and expense For the nine months endedSeptember 30, 2022 , other miscellaneous expense was approximately$2.0 million , compared to other miscellaneous income of$3.8 million for the nine months endedSeptember 30, 2021 . In the nine months endedSeptember 30, 2022 , we recognized approximately$2.2 million in losses resulting from the conversion of the Temporary Alternatives, Dubin and Northbound acquisitions to franchises, and a$150 thousand non-royalty based incentive given to a franchisee during an expansion and acquisition of one of their competitors. Other miscellaneous income in the nine months endedSeptember 30, 2021 includes a bargain purchase gain of approximately$4.9 million from the Snelling acquisition (adjusted to$5.6 million in later quarters), which is recorded net of deferred taxes. This gain was partially offset by losses during the nine months endedSeptember 30, 2021 on the transfer of unwanted assets acquired in the LINK transaction of approximately$1.9 million . The remaining items of other miscellaneous income consist of small gains and losses resulting from the conversion of Snelling owned stores to franchises, and gross rents from leasing excess space at our corporate headquarters to third parties. The remaining increase of other miscellaneous income during the nine months endedSeptember 30, 2022 represents gross rents from leasing excess space at our corporate headquarters to third parties. We lease approximately 9,220 square feet of office space in our headquarters campus to unaffiliated companies. These leases are at the market rate. Rental income for the nine months endedSeptember 30, 2022 is higher than the nine months endedSeptember 30, 2021 after completion of the new building adjacent to our corporate headquarters. Interest income and expense Interest income for the nine months endedSeptember 30, 2022 was approximately$198 thousand compared to$285 thousand for the nine months endedSeptember 30, 2021 . Interest income represents interest related to the financing of franchised locations, and one note to the California Purchaser. The decrease is consistent with a decrease in principal related to the financing of franchised locations. InMarch 2021 , we sold approximately$5.3 million of notes receivable to Bass for no gain or loss in order to mitigate credit risk and potential future losses. In addition, during the nine months endedSeptember 30, 2022 we stopped accruing interest on the impaired notes receivable from non-franchisees. Interest and other financing expense relates primarily to the Revolving Credit and Term Loan Agreement with Truist. Interest and other financing expense increased from$67 thousand atSeptember 30, 2021 to$256 thousand atSeptember 30, 2022 . Interest and other financing expense will fluctuate as we utilize the line of credit for acquisitions or other short-term liquidity needs. Due to the acquisitions in the nine months endedSeptember 30, 2022 , coupled with the working capital needs associated with organic growth, we carried a larger balance on our line of credit for most of the period. Provision for income tax Income tax expense was approximately$1.9 million for the nine months endedSeptember 30, 2022 . We estimate an annual projected effective tax rate (ETR) for the year to determine income tax expense (benefit) in the interim periods. The estimated annual ETR does not include tax effects from significant unusual or infrequently occurring items. Such items are accounted for discretely during the period in which they occur. The ETR is primarily driven by the federal Work Opportunity Tax Credit, which is included as part of income tax expense because it can be claimed only on the income tax return and can be realized only through the existence of taxable income. Other significant items affecting our tax rate are and windfall tax deductions related to stock-based compensation, overall limits on executive compensation. Our net ETR for the nine months endedSeptember 30, 2022 was 16.6%. Income tax expense for the nine months endedSeptember 30, 2021 was approximately$408 thousand . The tax expense includes the non-taxable bargain purchase gain recognized in 2021. Bargain purchase gains are recorded net of deferred taxes, and are treated as permanent differences, resulting in a lower ETR in the period recorded. We do not expect that benefit to reoccur, but generally expect that our effective tax rate will be significantly lower than statutory rates due to ongoing Work Opportunity Tax Credits and stock-based compensation.
Liquidity and Capital Resources
Overview
Our major source of liquidity and capital is cash generated from our ongoing operations consisting of royalty revenue, staffing revenue from owned locations, and service revenue. We also receive principal and interest payments on notes receivable that we issued in connection with the conversion of company-owned or acquired offices to franchised offices. In addition, we have the capacity to borrow under our line of credit with Truist (see "Revolving Credit and Term Loan Agreement with Truist" below). OnSeptember 30, 2022 , our current assets exceeded our current liabilities by approximately$25.3 million . Our current assets included approximately$1.5 million of cash and$45.7 million of net accounts receivable, which our franchisees have billed to customers and which we own in accordance with our franchise agreements. We used approximately$19.1 million of cash during the nine months endedSeptember 30, 2022 for acquisitions. Our largest current liabilities as ofSeptember 30, 2022 included approximately$11.4 million due to our franchisees on pending settlement statements,$3.9 million related to our workers' compensation claims liability, and$2.2 million of borrowings under our line of credit / term loan arrangements. 28
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Our working capital requirements are driven largely by temporary employee payroll, which is typically daily or weekly, and weekly cash settlements with our franchises. Since collections from accounts receivable lag employee pay our working capital requirements increase as system-wide sales increase, and vice-versa. When the economy contracts, our cash balance tends to increase in the short-term as payroll funding requirements decrease and aged accounts receivable are converted to cash upon collection. As the economy recovers, our cash balance generally decreases and accounts receivable increase. We believe that our current cash balance, together with the future cash generated from operations, and our borrowing capacity under our line of credit, will be sufficient to satisfy our working capital needs, capital asset purchases, and other liquidity requirements associated with our continuing operations for the next 12 months. We also believe that future cash generated from operations, principal and interest payments on notes receivable, and our borrowing capacity under our line of credit, will be sufficient to satisfy our working capital needs, capital asset purchases, future dividends, and other liquidity requirements associated with our continuing operations beyond the next 12 months. Our access to, and the availability of, financing on acceptable terms in the future will be affected by many factors including overall liquidity in the capital or credit markets, the state of the economy and our credit strength as viewed by potential lenders. We cannot provide assurances that we will have future access to the capital or credit markets on acceptable terms. We expect our borrowing costs to increase as theFederal Reserve raises its benchmark interest rates in an effort to bring down inflation.
Operating Activities
During the nine months endedSeptember 30, 2022 , cash generated by continuing operating activities was approximately$10.8 million and included net income from continuing operations of approximately$9.5 million , adjusted by non-cash items including a net loss on the sale of intangible assets acquired of approximately$2.2 million , depreciation and amortization in the amount of$1.8 million , and stock-based compensation of$1.9 million . These provisions were partially offset by changes in operating assets and liabilities requiring cash of approximately$3.7 million . During the nine months endedSeptember 30, 2021 , cash generated by operating activities was approximately$14.8 million and included net income of approximately$9.7 million , adjusted by non-cash items including a net loss on the sale of intangible assets acquired of approximately$1.2 million , depreciation and amortization in the amount of$1.0 million , and stock-based compensation of$1.2 million . Changes in operating assets and liabilities also generated cash of approximately$200 thousand , primarily related to the return of a workers compensation deposit. These provisions were partially offset by a bargain purchase gain recognized in relation to an acquisition of approximately$5.0 million . Cash for the nine months endedSeptember 30, 2021 was also boosted by the return of a workers' compensation claim deposit of approximately$7.0 million which was acquired in the Snelling transaction Investing Activities During the nine months endedSeptember 30, 2022 , cash used by investing activities was approximately$10.1 million and included cash paid for acquisitions of approximately$19.1 million . This use was partially offset by the proceeds from the sale of purchased locations of approximately$9.3 million . During the nine months endedSeptember 30, 2021 , cash used by investing activities was approximately$24.1 million and included cash paid for acquisitions of approximately$29.0 million . This use was offset by proceeds from the sale of notes receivable of approximately$5.3 million and the sale of purchased locations of approximately$1.0 million .
Financing Activities
During the nine months endedSeptember 30, 2022 , cash used by financing activities was approximately$882 thousand and included net proceeds from our revolving line of credit of approximately$2.0 million . This provision was offset by the payment of approximately$2.5 million in dividends and net payments on our term loan of$438 thousand . During 2021, cash provided by financing activities was approximately$352 thousand and included initiation of the term loan of approximately$3.2 million offset by the payment of dividends totaling approximately$2.3 million , and debt issuance costs of$477 thousand related to establishing our line of credit.
Revolving Credit and Term Loan Agreement with Truist
OnJune 29, 2021 the Company and all of its subsidiaries as borrowers (collectively, the "Borrowers") entered into a Revolving Credit and Term Loan Agreement withTruist Bank , as Administrative Agent, and the lenders from time to time made a party thereto (the "Credit Agreement"), pursuant to which the lenders extended the Borrowers (i) a$60 million revolving line of credit with a$20 million sublimit for letters of credit (the "Line of Credit") and (ii) a$3,153,500 term loan (the "Term Loan").Truist Bank may also make Swingline Loans available in its discretion. The Credit Agreement replaced the Company's prior$30 million credit facility with BB&T, now Truist. The Credit Agreement provides for a borrowing base on the Line of Credit that is derived from the Borrowers' accounts receivable subject to certain reserves and other limitations. Interest will accrue on the outstanding balance of the Line of Credit at a variable rate equal to (a) the LIBOR Index Rate plus a margin between 1.25% and 1.75% per annum or (b) the then applicable Base Rate, as that term is defined in the Credit Agreement plus a margin between 0.25% and 0.75% per annum. In each case, the applicable margin is determined by the Company's Average Excess Availability on the Line of Credit, as defined in the Credit Agreement. Interest will accrue on the Term Loan at a variable rate equal to (a) the LIBOR Index Rate plus 2.0% per annum or (b) the then applicable Base Rate plus 1.0% per annum. In addition to interest on outstanding principal under the Credit Agreement, the Borrowers will pay a commitment fee on the unused portion of the Line of Credit in an amount equal to 0.25% per annum. All loans made pursuant to the Line of Credit mature onJune 29, 2026 . The Term Loan will be paid in equal monthly installments based upon a 15-year amortization of the original principal amount of the Term Loan and will be payable in monthly installments with the remaining principal balance due and payable in full on the earlier of the date of termination of the commitments on the Line of Credit andJune 29, 2036 . The Credit Agreement and other loan documents contain customary representations and warranties, affirmative, and negative covenants, including without limitation, those covenants governing indebtedness, liens, fundamental changes, restricting certain payments including dividends unless certain conditions are met, transactions with affiliates, investments, engaging in business other than the current business of the Borrowers and business reasonably related thereto, sale/leaseback transactions, speculative hedging, and sale of assets. The Credit Agreement and other loan documents also contain customary events of default including, without limitation, payment default, material breaches of representations and warranties, breach of covenants, cross-default on material indebtedness, certain bankruptcies, certain ERISA violations, material judgments, change in control, termination or invalidity of any guaranty or security documents, and defaults under other loan documents. The Credit Agreement also requires the Borrowers, on a consolidated basis, to comply with a fixed charge coverage ratio of at least 1.25:1.00 and a leverage ratio of not more than 3.0:1.0. The obligations under the Credit Agreement and other loan documents are secured by substantially all of the assets of the Borrowers as collateral including, without limitation, their accounts and notes receivable, stock of the Company's subsidiaries, and intellectual property and the real estate owned byHQ Real Property Corporation . The Company utilized the proceeds of the Term Loan (i) first to pay off its prior credit facility, and (ii) second, to pay transaction fees and expenses incurred in connection with closing the transactions described above. The Company intends to utilize the proceeds of any loans made under the Line of Credit and the remainder of the Term Loan for working capital, acquisitions, required letters of credit, and general corporate purposes in accordance with the terms of the Credit Agreement. OnMarch 1, 2022 , our workers' compensation provider agreed to reduce the required collateral deposit from$14.3 million to$10.7 million . The collateral is currently accomplished by delivering letters of credit under the Credit Agreement. AtSeptember 30, 2022 , availability under the line of credit was approximately$26.1 million based on eligible collateral, less letter of credit reserves, bank product reserves, and current advances. 29
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Table of Contents Economy and Inflation Many leading economists predict high rates of inflation will continue through 2022. We do not believe inflation has had a material effect on our Company's results of operations as inflation generally results in higher rates per hour that can offset any slowdown in organic growth opportunities. This might not be the case if inflation continues to grow. A prolonged period of high inflation may also impact our ability to carry out our acquisition strategy. On the other hand, if business conditions deteriorate, it may be easier for us to identify an acquisition candidate. In late 2019, there was an outbreak of a new strain of coronavirus (COVID) first identified inWuhan ,Hubei Province ,China , which has since spread globally. OnMarch 11, 2020 , theWorld Health Organization declared COVID a pandemic. Further, the COVID outbreak has resulted in government authorities around the world implementing numerous measures to try to reduce the spread of COVID, such as travel bans and restrictions, quarantines, "shelter-in-place," "stay-at-home," total lock-down orders, business limitations or shutdowns and similar orders. As a result, the COVID pandemic has negatively impacted the global economy, disrupted global supply chains and workforce participation, and created significant volatility and disruption of financial markets. More recently, more contagious variants of COVID, such as the Delta and Omicron variants, have emerged and spread globally, which has caused some governments to reimplement various measures, or impose new restrictions, in an effort to lessen the spread of COVID and its variants. While we do not expect COVID to impact our operations, it could impact our acquisition strategy, positively or negatively. The extent to which new opportunities are presented to us will depend on future developments, which remain highly uncertain and cannot be predicted with confidence.
Key Performance Indicator: System-Wide Sales
We refer to total sales generated by our franchisees as "franchise sales." For any period prior to their conversion to franchises, we refer to sales at company-owned and operated offices as "company-owned sales." In turn, we refer to the sum of franchise sales and company-owned sales as "system-wide sales." In other words, system-wide sales include sales at all offices, whether owned and operated by us or by our franchisees. In addition, system-wide sales includes sales at company-owned offices that are classified as discontinued operations. System-wide sales is a key performance indicator, although we do not record system-wide sales as revenue. Management believes that information on system-wide sales is important to understanding our financial performance because those sales are the basis on which we calculate and record much of our franchise royalty revenue, are directly related to all other royalty revenue and service revenue and are indicative of the financial health of our franchisee base. Management uses system-wide sales to benchmark current operating levels to historic operating levels. System-wide sales should not be considered as an alternative to revenue. During the nine months endedSeptember 30, 2022 , nearly all of our offices were franchised with the only exceptions being theDental Power location acquired in the fourth quarter of 2021 and a portion of the Dubin operations acquired in the first quarter of 2022. The Dubin operations are presented in the consolidated financial statements as discontinued operations because they are considered held-for-sale. During the nine months endedSeptember 30, 2021 , all of our offices were franchised. The following table reflects our system-wide sales broken into its components for the periods indicated. Percentages indicate the change in system-wide sales relative to the comparable prior period (in thousands, except percentages). Three months ended Nine months ended September September September September 30, 2022 30, 2021 Change 30, 2022 30, 2021 Change System-wide sales$ 123,245 $ 101,888 21.0 %$ 344,311 $ 247,737 39.0 % Approximately$35.5 million of system-wide sales during the three months endedSeptember 30, 2022 was due to the 2021 acquisitions, and approximately$8.0 million was due to the 2022 acquisitions. For the nine months endedSeptember 30, 2022 , approximately$104.0 million was due to the 2021 acquisitions and approximately$18.5 million was due to the 2022 acquisitions. For the three and nine months endedSeptember 30, 2021 approximately$32.4 million and$71.0 million was due to the 2021 acquisitions, respectively. Number of Offices We examine the number of offices we open and close every period. The number of offices is directly tied to the amount of royalty and service revenue we earn. We count an office if it has a physical location and is generating revenue. Company-owned locations are not counted. Our franchisees opened four offices in the third quarter of 2022 and did not close any. The following table accounts for the number of offices opened and closed or consolidated in the first nine months of 2022. Offices, December 31, 2020 139 Purchased in 2021 (net of sold locations) 65 Opened in 2021 14 Closed in 2021 (1 ) Offices, December 31, 2021 217 Opened in 2022 9 Purchased in 2022 5 Closed in 2022 (4 ) Offices, September 30, 2022 227
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