HireQuest, Inc (NASDAQ:HQI) Q3 2020 Earnings Conference Call November 12, 2020 4:30 PM ET
Brett Maas – Investor Relations
Rick Hermanns – Chief Executive Officer
Cory Smith – Chief Financial Officer
Conference Call Participants
Aaron Edelheit – Mindset Capital
David Lavigne – Trickle Research
Good day, ladies and gentlemen, and welcome to your HireQuest, Inc. Third Quarter 2020 Earnings Call. [Operator Instructions] At this time, it is my pleasure to turn the floor over to your host, Brett Maas of Hayden IR. Sir, the floor is yours.
Thank you, operator. I would like to welcome everybody to the call. Hosting the call today are HireQuest’s CEO, Rick Hermanns and CFO, Cory Smith.
Please be aware, some of the comments made during our call may include forward-looking statements within the meaning of federal securities laws. Statements about our beliefs and expectations containing words such as may, could, would, will, should, believe, expect, anticipate and similar expressions constitute forward-looking statements. These statements involve risks and uncertainties regarding our operations and our future results that could cause HireQuest’s results to differ materially from management’s current expectations. We encourage you to review the safe harbor statements and risk factors contained in the company’s earnings release and its filings with the SEC, including, without limitation, the most recent annual report on Form 10-K, the most recent quarterly report on Form 10-Q and other periodic reports, which identify specific risk factors that may also cause actual results or events to differ materially from those described in the forward-looking statements. Copies of the company’s most recent reports on forms 10-K and 10-Q may be obtained on the company’s website at hirequest.com or at the SEC’s website at sec.gov. Company does not undertake to publicly update or revise any forward-looking statements after the call or date of this call. I would also like to remind everyone that this call will be available for replay through November 26. A link to the website replay of the call was also provided in the earnings release and is available on the company’s website at hirequest.com.
I would now like to turn the call over to CEO of HireQuest, Rick Hermanns. Rick?
Thank you for joining us. For the third quarter, we experienced a modest stabilizing of the temporary employment market against the backdrop of continued uncertainty driven almost entirely by the global pandemic. By design, we created our franchising business model with the distinct purpose to be able to weather economic cycles. And over the last two quarters, it has proven to withstand the fallout from a once-in-a-generation pandemic. Make no mistake, this is a serious challenge to the operations of our franchises as construction, retail, concerts, sporting events and many other areas of the broader economy, which drove temporary staffing opportunities, have significantly decreased or stopped altogether. But our franchisees have moved quickly and judiciously to adjust staffing levels and associated expenses to help navigate these unprecedented times. The PPP loans were a key to this effort. And for HireQuest itself, while we have been challenged, we again delivered profitability and cash flow in the third quarter. Our balance sheet remains strong, we initiated a quarterly dividend, and we are increasingly confident that the worst is behind us.
Collectively, our third quarter franchisees system-wide sales were down 25% over the same period last year. However, the decline slowed during the third quarter, and we are encouraged by the franchisees resiliency and the swift actions that they are taking to adjust their cost structures with the realities of the current economic climate. To date, all of our franchises remain operational, and we have had no business failures.
Our third quarter is typically our strongest quarter, and this year is no different with revenue of $3.4 million, up marginally compared to $3.3 million in the year ago quarter and $2.9 million in the prior quarter despite challenging economic conditions. While we believe the industry sectors our franchisees serve are stabilizing, we don’t expect a more robust recovery into leisure, hospitality and construction return to more normalized levels. The recent encouraging news from Pfizer regarding their vaccine candidate gives us increased optimism that we could see full stadiums again in the next year. For the third quarter, we reported net income from continuing operations of $0.15 per diluted share and have generated nearly $6.7 million in operating cash flow from continuing operations through the first 9 months of 2020. Our balance sheet remains healthy and with no debt to service and positive cash flow generation.
We have insulated our business from earnings volatility that can arise when there is even a minimal level of financial leverage. I can’t emphasize enough how important this is to the predictability, term results as well as the possibly give us to be able to opportunistically make a strategic move at our discretion. As per strategic transactions, we continue to consider acquisition targets. Undoubtedly the current economic environment shines a brighter spotlight on distressed businesses and increases the number of potential targets.
However, we remain disciplined in our approach and mindful of the disruption, a less than highly qualified deal could have on profitability, our balance sheet and our overall value of our business. Having said that, we continue to screen for opportunities that could give us a presence in new geographies strengthen the presence of our existing franchisees or provide access to certain targeted national accounts. Our strong balance sheet provides us with the resources and access to additional capital as needed. Yet, let me assure you that any transaction we accept will need to be able to be absorbed quickly into our franchise model and provide a positive economic contribution in a short amount of time.
During the third quarter, the Board declared and the company paid a quarterly cash dividend of $0.05 a share, which at recent stock prices represent a yield of nearly 2.4%. Given the cash-flow-generating profile of our business and barring any unforeseen challenges, we expect to pay quarterly dividends at similar levels going forward. This decision should underscore the Board’s confidence in the resilience of our business even during a once-in-a-lifetime pandemic.
I will turn the call over now to Cory to discuss the third quarter results further. Cory?
Thank you, Rick and good afternoon everyone. Thank you for joining us. Total revenue in the third quarter of 2020 was $3.4 million compared to $3.3 million in the third quarter of 2019, an increase of 2.7%, which was primarily due to higher franchisee royalties. Our total revenue is made up of 2 components: franchise royalties, which make up roughly 90% of total revenue; and service revenue.
Franchise royalties in the third quarter of 2020 were $3.2 million compared to $3.1 million in the third quarter of 2019, an increase of 2.5%. This increase may seem counterintuitive, given the negative impact COVID-19 has had on our system-wide sales, the reason we saw this increase in franchise royalties is due to the handful of locations that were still company-owned after the merger in the third quarter of last year, which are currently reported as discontinued operations. All of these company-owned locations, with the exception of the California-based locations, which were sold, were subsequently converted to franchisees at the very beginning of the fourth quarter of 2019. Approximately $681,000 of our royalty revenue was attributable to branches acquired in the merger that had already, became franchisees.
Service revenue, which is generated from interest charge to our franchisees on overdue accounts receivable and fees for various optional services, was up 6.7% to $164,000 compared to $154,000 in the third quarter of last year. This increase was primarily related to an increase in the fees charged for optional services. Selling, general and administrative expenses in the third quarter of 2020 were down to $1.4 million compared to $7.4 million in the third quarter of last year, a decrease of $6 million. This $6 million decrease was primarily due to $4.7 million in merger-related expenses that were included in the third quarter of 2019, not present in the current period.
In addition, we saw a relative decrease related to our workers’ compensation costs and a decrease in bad debt as we have moved away from operating company-owned locations. Net income from continuing operations was $2.0 million or $0.15 per diluted share in the third quarter of 2020 compared to a net loss from continuing operations of $8.5 million or negative $0.65 per diluted share in the third quarter of 2019.
During the third quarter, our Board approved, and the company paid its first quarterly dividend of $0.05 per common share to shareholders of record as of September 1, 2020. As Rick previously mentioned, barring any currently unforeseen circumstances, we expect to continue this practice and pay a dividend each quarter, and we recently announced that we will pay a dividend in our fourth quarter.
Moving on to the balance sheet, we have been able to grow our current assets to $39.6 million at September 30, 2020, from $37.0 million at December 31, 2019. Current assets at September 30, 2020, included $10.3 million of cash and $24 million of accounts receivable while current assets at December 31, 2019, included $4.2 million of cash and $28.2 million of accounts receivable. Property and equipment increased by $1.1 million to $3.0 million as we continue the construction on a new building adjacent to our corporate headquarters. We have also begun an IT project that resulted in an intangible asset with a balance of $187,000 at September 30, 2020. Our notes receivable balance, net of reserve at September 30, was $10.1 million, and we have collected approximately $1.3 million in cash from these notes during 2020.
And with that, I will turn the call back over to the operator for Q&A.
Thank you. [Operator Instructions] We will take our first question from Aaron Edelheit with Mindset Capital. Please go ahead.
Hi, thanks and great quarter. I had two questions. The first question was can – if we get a vaccine, like the Pfizer vaccine and it’s effective and things kind of go back to normal. Could you talk about like how much of your business do you think would come back? Because I’m guessing most of your stadium, like cleanup and hospitality business is running pretty close to zero. I would imagine that you would have a pretty sharp snapback. That’s my first question. My second question is, was there anything – your operating margins, which are normally quite high, seem really high in this quarter. And I am just wondering were there any special factors that your operating margin was so high this quarter? Thanks.
Yes. Thank you, Aaron. So to answer the first question is realistically, throughout the quarter, our revenues, as discussed in the last earnings call, we were running around the – basically about 27% to 30% behind the comp period of the prior year. By the end of this quarter, we were down to about low 20s, so 21%, 22% less than the prior year, probably almost 100% of that is due to leisure, hospitality and similar businesses. So to your point, is – provided the Pfizer or the similar vaccines become widely available and as effective as purported, I would expect that we would go back to similar revenues or system-wide sales of 2019. There’s – we are, as you said, and your assumption is correct, we’re running at extraordinarily low levels as far as auto auctions and arenas and stadiums, and those are fairly significant contributors for us. And again, those are virtually nonexistent right now. So that’s a good question. And again, once you see – and I said this in the last quarter, once you see stadiums full again, that will have a significant increase, you should – and significantly increase our revenues.
As far as the second question, the – and I am going to leave this to Cory to correct me if I’m wrong, but my guess is the main reason for the increase in the operating margin is due to the workers’ comp, which is sort of our – basically the performance of our workers’ comp book. As time goes on, we expect that to improve as our workers’ comp experience becomes more seasoned. And to give a little more color to that is basically when we did the merger, there was – we did not pick up any of the old experience from HireQuest. And as a result, our results for the last 15 months have basically only included sort of new workers’ comp claims. And new workers’ comp claims tend to be more heavily reserved. But as time moves on, we would expect some relaxation of that. And I think that, that’s part of what you saw probably in the – that’s what we saw in the third quarter. And the improvement also was partially – the second quarter still contained a lot of – also contained – first of all, lower sales. And also, we still had – some of the major cuts that we made were in – were as late as in the end of April. And so they really didn’t fully flush out until the third quarter.
Okay. Well, great. I mean, I am just looking at close to a 60% operating margin, and that’s pretty phenomenal. Thank you for the explanation.
[Operator Instructions] We will take our next question from David Lavigne with Trickle Research. Please go ahead.
Hi, all. You have done a fantastic job. This is a really good quarter, I mean all things considered. So can you give us some sense sort of along the lines of the last question, but can you give us some sense of what maybe normalized SG&A will look like going forward then? Because I think the operating margin was really a function of that. I mean just sort of trying to get my arms around, I don’t know, some kind of range or something to expect. It’s been sort of all over the place, though.
David, thank you for the question. So what I would say is more – and this is on our sort of investor deck, on our website. But in the longer term, our target is more from, I would say, from a net margin standpoint, as it relates to system-wide sales, is to fall somewhere between 3.75% and 4.25% of system-wide sales. And again, workers’ comp can swing and things like that. And the difficulty is the margins seem like they swing more when they’re shown as a percentage of revenues, which, of course, the revenues mostly just represent royalties. When you compare them to system-wide sales, those SG&A expenses and other operating expenses are a lot more stable. Because the problem is that we only have $3.4 million worth of revenues in a quarter, if you have a $200,000 swing in workers’ comp, it seems like a really big deal. But when you take that $200,000 compared to $60 million, $55 million worth of system-wide sales, the $200,000 is nothing. And that – so I would encourage you, even as you look at it, to really look at it more as a percentage of system-wide sales. It gives you a better sense of really – it – because actually, the beauty of our model is we really are very stable, not unstable. And so, but again, to get that sense, you really have to look at the system-wide sales. I don’t know if that answers your question, but I would really advise that.
Yes. That answers my question. It doesn’t make the modeling any easier, but that answers my question though. That’s good. Appreciate it. Thanks.
[Operator Instructions] And there appear to be no further questions at this time.
Great. Well, I thank everybody for joining us today. I thank you for your continued support of the company. I think there are a lot of really good things happening. Again, as the markets have reacted over the last week with the Pfizer vaccine, I am very hopeful that – and more confident that there’s at least now a bright light at the end of the tunnel. And I would also just reiterate that it’s really good news as well that all of our franchisees have made it through this period, and – which really sets us up for the future as leisure and hospitality, as that business snaps back that we’re in a great position to capture back the business that was lost due to the COVID-19. We are in a great spot for it. And then I would also say that as we put a little bit more distance behind us from the – basically from March is we’re starting to see more acquisition opportunities because I think it’s become more clear, sort of where the economy is likely to end and/or at least settle in at, the election uncertainty is over. Mostly over, I guess the – and that’s all helpful as well as far as getting sellers to come to realistic prices. And so we are hopeful that again that viable acquisitions will be available to us in the near future. And so again, thank you for joining us and have a good day.
Ladies and gentlemen, this does conclude today’s teleconference. We thank you for your participation. You may disconnect your lines at this time and have a great day.