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 the U.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 (a non-GAAP financial measure), and the growth thereof; the impact of any global pandemic including the novel coronavirus disease ("COVID-19"); operating results; dividends and shareholder returns; anticipated benefits of the merger with Command Center, Inc., or the conversion to the franchise model; 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 occur, 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; 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, and 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 including, without limitation, successful integration following the merger with Command Center, Inc.; disruptions to our technology network including computer systems and software; natural events such as severe weather, fires, floods, and earthquakes, or man-made or other disruptions of our operating systems; the factors discussed in the "Risk Factors" section herein and in our most recent Annual Report on Form 10-K which we filed with the SEC on March 30, 2020; 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.

Overview

We are a nationwide franchisor of on-demand labor solutions providers in the light industrial and blue-collar segments of the staffing industry. We were formed through the merger between Hire Quest Holdings, LLC ("Hire Quest Holdings") and Command Center, Inc. We refer to Hire Quest Holdings and its wholly owned subsidiary, Hire Quest, LLC, collectively as Legacy HQ. We refer to this merger, which closed on July 15, 2019 as the Merger. As of September 30, 2020, we had 138 franchisee-owned offices in 30 states and the District of Columbia. We provide employment for an estimated 80,000 individuals annually working for thousands of clients in many industries including construction, recycling, warehousing, logistics, auctioneering, manufacturing, disaster cleanup, janitorial, special events, hospitality, landscaping, and retail.




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COVID-19

The coronavirus pandemic has significantly impacted our operations. With widespread infection in the United States and abroad, national, state, and local authorities recommended social distancing and took dramatic action, including ordering the workforce to stay home, banning all non-essential businesses from operating, refusing to issue new building permits, and invalidating current building permits causing work to stop at many of our jobsites. These measures, while intended to protect human life, have had, and are expected to continue to have, adverse impacts on our business and the economy as a whole. While several states have advanced significantly into the reopening process, it is unclear when, or if, a full economic recovery will occur. As cases of COVID-19 again appear to be on the rise in many locations, it is also unclear whether businesses will remain open or another broad shutdown will occur. The long-term effectiveness of economic stabilization efforts, including government payments to affected citizens and industries, is also uncertain.

We entered 2020 with a strong balance sheet. Our assets exceeded liabilities by more than $28 million. In the first nine months of 2020, we significantly improved our liquidity position, primarily by converting accounts receivable into cash. Current assets improved from $37.0 million on December 31, 2019 to $39.6 million on September 30, 2020. We have remained profitable throughout the first nine months of 2020. Still, the sweeping and persistent nature of the COVID-19 pandemic has depressed our system-wide sales and resulting revenue. While we did not see major impacts on system-wide sales and resulting revenue until the final few weeks of the first quarter, these depressed sales have continued through our third quarter. On a month-to-month basis, our system-wide sales have consistently increased since April, however, they were lower than system-wide sales in the third quarter of 2019, and we expect negative impacts on system-wide sales and resulting revenue in the fourth quarter, and likely beyond. It remains unclear how long we will stay at this comparatively reduced level of sales, and the evolving nature of the pandemic makes reliable predictions extremely difficult.

To date, our franchisees have closed or consolidated 13 offices at least, in part, due to the financial impacts of COVID-19. Of these closures, 11 were in metropolitan areas where our franchisees still maintain at least one office that we expect can service customers of the closed or consolidated offices. The other two offices did not historically produce significant amounts of system-wide sales or resulting revenue. It is possible that other offices may still be forced to close. Some of our franchisees may experience economic hardship or even failure. In general, those franchisees whose businesses are oriented towards construction, manufacturing, logistics, or waste services have been less impacted to date than those whose businesses are more focused on hospitality, catering, special events, or auto auction services. Despite tough economic conditions, our franchisees have also opened 4 new offices in 2020.

In response to depressed economic conditions, we took measures to control and reduce selling, general, and administrative expense ("SG&A"). In addition, we placed a reserve of $1.6 million on the promissory notes we hold from our franchisees and the purchaser of our previously owned California offices.

As discussed more fully below, our liquidity position has improved since December 31, 2019 because of decreased funding requirements for temporary employees and the decrease in our accounts receivable balance as amounts are collected and converted to cash. As a result, we have been able to increase our cash balance by approximately $6.1 million through the third quarter of 2020 from $4.2 million at year end to $10.3 million. When combined with our borrowing capacity under our line of credit and absence of debt, we expect that we have sufficient liquidity to continue our operations for the foreseeable future, even under the current circumstances presented by COVID-19. That said, the impact of the COVID-19 crisis on availability of capital or credit is difficult to predict and may be significant.

Any of the above factors, or other cascading effects of the COVID-19 pandemic that are not currently foreseeable, could materially negatively impact our revenue, net income, and other results of operations, reduce system-wide sales, cause office closings or cause us to lose franchisees, and impact our liquidity position, possibly significantly. The duration of any such impacts cannot be predicted at this time.




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Results of Operations

Financial Summary The following table displays our consolidated statements of operations for the interim periods ended September 30, 2020 and September 29, 2019 (in thousands, except percentages). Sales and expenses at company-owned offices are reflected on the line item, "Income from discontinued operations, net of tax."




                 Three months ended                   Nine months ended


                 September 30,     September 29,      September 30,     September 29,
                 2020              2019               2020              2019

Franchise
royalties         $3,219   95.1%    $3,139    95.3%    $9,563   91.9%    $9,277    92.7%
Service revenue   164      4.9%     154       4.7%     841      8.1%     727       7.3%
Total revenue     3,383    100.0%   3,293     100.0%   10,404   100.0%   10,004    100.0%
Selling, general
and
administrative
expenses          1,358    40.1%    7,394     224.5%   6,542    62.9%    9,817     98.1%
Depreciation and
amortization      32       1.0%     40        1.2%     97       0.9%     76        0.8%
Income (loss)
from operations   1,993    58.9%    (4,141)   -125.7%  3,765    36.2%    111       1.1%
Other
miscellaneous
income            392      11.6%    505       15.3%    932      9.0%     752       7.5%
Interest and
other financing
expense           (10)     -0.3%    (106)     -3.2%    (39)     -0.4%    (522)     -5.2%
Net income
(loss) before
income taxes      2,375    70.2%    (3,742)   -113.6%  4,658    44.8%    341       3.4%
Provision for
income taxes      404      11.9%    4,717     143.3%   655      6.3%     4,817     48.1%
Income (loss)
from continuing
operations        1,971    58.3%    (8,459)   -256.9%  4,003    38.5%    (4,476)   -44.7%
Income from
discontinued
operations, net
of tax            -        0.0%     683       20.7%    -        0.0%     723       7.2%
Net income
(loss)            $1,971   58.3%    $(7,776)  -236.2%  $4,003   38.5%    $(3,753)  -37.5%

Three Months Ended September 30, 2020

Franchise Royalties We charge our franchisees a royalty fee on gross billings to customers based on one of two models: the HireQuest Direct model or the HireQuest model. Under the HireQuest Direct model, the royalty fee charged ranges from 6% to 8% of gross billings. Royalty fees are charged at 8% for the first $1,000,000 of annual billing, with the royalty fee dropping ½ of 1% for every additional $1,000,000 of annual billing thereafter until the royalty fee is 6%. The smaller royalty fee is charged only on the incremental billing, resulting in an actual royalty fee at a blended rate between 6% and 8%. Under this model, we grant our franchisees credits for low margin business. Under the HireQuest model, the royalty fee is 4.5% of the temporary payroll we fund plus 18% of the gross margin for the territory.

Franchise royalties for the three months ended September 30, 2020 were approximately $3.2 million, an increase of 2.5% from $3.1 million for the three months ended September 29, 2019. Approximately $681,000 of royalties in the third quarter 2020 are attributable to the offices acquired through the Merger. Although we experienced a year-over-year increase in royalty revenue in the third quarter 2020, average royalty revenue per office in that quarter was negatively impacted by decreased economic activity related to COVID-19. Although system-wide sales, and resulting franchise royalties, have been slowly increasing on a month-over-month basis since the beginning of April, we expect decreased royalty revenue for the remainder of 2020, and perhaps beyond, relative to historical levels.

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. 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. Accounts that age over 84 days are charged back to the franchisee and are no longer charged interest.




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Service revenue for the three months ended September 30, 2020 was approximately $164,000, a slight increase from approximately $154,000 for the three months ended September 29, 2019.

Selling, General, and Administrative Expenses SG&A expenses for the three months ended September 30, 2020 were approximately $1.4 million, a decrease of 81.6% from $7.4 million for the three months ended September 29, 2019. This significant decrease is primarily related to Merger related costs of approximately $4.7 million incurred in 2019. In addition, we saw a decrease in charges related to workers' compensation of approximately $537,000, and a decrease in bad debt expense of approximately $272,000.

Miscellaneous Income Miscellaneous income for the three months ended September 30, 2020 was approximately $392,000, a decrease of 22.2% from $505,000 for the three months ended September 29, 2019. In 2020, miscellaneous income was comprised primarily of interest income on notes receivable and a recovery related to a legal settlement, while in 2019 it was primarily comprised of a gain on the sale of intangible assets acquired in the Merger that were sold when the acquired locations were franchised.

Nine Months Ended September 30, 2020

Franchise Royalties Franchise royalties for the nine months ended September 30, 2020 were approximately $9.6 million, an increase of 3.1% from $9.3 million for the nine months ended September 29, 2019. Included in this increase are approximately $2.0 million of royalties attributable to the offices acquired through the Merger. Royalty revenue in the last few weeks of March 2020 began to be negatively impacted by decreased activity related to COVID-19. This negative impact continued through the third quarter. We expect decreased royalty revenue for the remainder of 2020, and perhaps beyond, relative to historical levels.

Service Revenue Service revenue for the nine months ended September 30, 2020 was approximately $841,000, an increase of 15.6% from approximately $727,000 for the nine months ended September 29, 2019. This increase is related to the increase in franchised offices due to the Merger.

Selling, General, and Administrative Expenses SG&A expenses for the nine months ended September 30, 2020 were approximately $6.5 million, a decrease of 33.4% from $9.8 million for the nine months ended September 29, 2019. The majority of this decrease is due to Merger related costs of approximately $4.7 million incurred in 2019. We also saw a decrease in charges related to workers' compensation of approximately $743,000, and a decrease in bad debt of approximately $284,000. These decreases were partially offset by an increase in stock-based compensation of approximately $603,000 and a $1.6 million reserve placed on notes receivable we issued to finance the sale of offices acquired in the Merger. This reserve is directly related to the negative impact COVID-19 has had on the economy, the financial condition of our borrowers, and the value of the underlying collateral.

Miscellaneous Income Miscellaneous income for the nine months ended September 30, 2020 was approximately $932,000, an increase of 24.0% from $752,000 for the nine months ended September 29, 2019. In 2020, miscellaneous income was comprised primarily of interest income on notes receivable, while in 2019 miscellaneous income was made up primarily of gains related to the sale of property and intangible assets.

Liquidity and Capital Resources

Our major source of liquidity and capital is cash generated from our ongoing operations. We also receive principal and interest payments on notes receivable, most of which were issued in connection with the sale of offices acquired in the Merger. In addition, we have the capacity to borrow under our line of credit with Truist.




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On September 30, 2020, our current assets exceeded our current liabilities by approximately $29.4 million. Our current assets included approximately $10.3 million of cash and $24.0 million of accounts receivable, which our franchisees have billed to customers and which we own in accordance with our franchise agreements. Our largest current liabilities include approximately $3.2 million related to our workers' compensation claims liability, $2.3 million due to our franchisees on upcoming settlement statements, and $2.1 million in accrued benefits and payroll taxes.

Our working capital requirements are driven largely by temporary employee payroll and accounts receivable from customers. Since receipts lag employee pay - which is typically daily or weekly - 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 accounts receivable are converted to cash upon collection. We witnessed this in the first half of 2020. When the economy recovers, our cash balance tends to decrease and accounts receivable tend to increase. This trend explains the decrease in cash we experienced in the third quarter of 2020. It is difficult to predict whether this trend will continue in the fourth quarter as, traditionally, the final quarter of the year results in a smaller amount of new accounts receivable relative to the third quarter.

We believe that our current cash balance, together with the 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, and other liquidity requirements associated with our continuing operations for at least 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. The impact of the COVID-19 crisis on availability of capital or credit is difficult to predict and may be significant.

Operating Activities During 2020, cash generated by operating activities was approximately $6.9 million and included net income of approximately $4.0 million and a decrease in accounts receivable which generated approximately $4.2 million. These provisions were partially offset by an increase in prepaid workers' compensation of approximately $1.2 million, payments of income taxes of approximately $1.9 million, and a decrease the amount due to our franchisees of approximately $1.3 million. During 2019, cash used by operating activities was approximately $1.2 million and included a net loss from continuing operations of $4.5 million and an increase in accounts receivable of approximately $12.7 million. These uses were partially offset by an increase in the amount due to our franchisees of approximately $4.7 million and an increase in other current liabilities of approximately $4.2 million.

Investing Activities During 2020, cash used by investing activities was approximately $6,000 and included the purchase of property and equipment of approximately $1.2 million, most of which was related to the construction of a new building at our corporate headquarters. This use was offset by proceeds from notes receivable of approximately $1.6 million. During 2019, cash provided by investing activities was approximately $1.1 million and included proceeds from the sale of property and equipment of approximately $574,000 and an increase in franchisee deposits of approximately $666,000. These provisions were partially offset by the purchase of property and equipment of approximately $285,000.

Financing Activities During 2020, cash used by financing activities was approximately $824,000 and included the payment of a dividend of approximately $678,000 and the purchase of treasury stock of approximately $146,000. During 2019, cash provided by financing activities was approximately $316,000 and included cash received for the effective issuance of common stock in connection with the Merger of approximately $5.4 million and an increase in our line of credit of $7.6 million. These provisions were partially offset by the purchase of treasury stock of approximately $8.4 million, and a decrease in the amount due affiliates of approximately $5.5 million.

Non-GAAP Financial Measure: System-Wide Sales

We refer to total sales generated by our franchisees as "franchise sales." We refer to sales at company-owned and operated offices as "company-owned sales." Company-owned sales are reflected net of costs, expenses, and taxes associated with those sales on our financial statements as "Income from discontinued operations, net of tax." 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. System-wide sales is a non-GAAP financial measure. While 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 franchise royalty revenue, are directly related to interest charged on overdue accounts which we record under service revenue, and are indicative of the financial health of our franchisee base. System-wide sales are not intended to represent revenue as defined by U.S. GAAP, and such information should not be considered as an alternative to revenue or any other measure of performance prescribed by U.S. GAAP.




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During 2020, all of our offices were franchised. As such, system-wide sales for the three and nine months ended September 30, 2020 were all derived from franchised offices. The following table reflects our system-wide sales broken into its components for the periods indicated:




                    Three months ended          Nine months ended


                    September 30, September 29, September 30,  September 29,
                    2020          2019          2020           2019

Franchise sales $55,626,751 $60,626,049 $156,163,051 $159,768,691 Company-owned sales -

             13,551,950    -              13,934,276

System-wide sales $55,626,751 $74,177,999 $156,163,051 $173,702,967

System-wide sales were $55.6 million for the three months ended September 30, 2020, down $18.6 million, or 25.0% compared to the three months ended September 29, 2019. The decrease in system-wide sales is primarily a result of the effects of COVID-19. Additionally, because the Merger occurred on July 15, 2019, prior year third quarter results did not include system-wide sales attributable to the merged locations from July 1 through July 14.

System-wide sales were $156.2 million for the nine months ended September 30, 2020, down $17.5 million, or 10.1% compared the nine months ended September 29, 2019. This decrease in system-wide sales is primarily a result of the effects of COVID-19. The decrease was partially offset by the effect of offices added in the Merger.

In the closing weeks of the first quarter of 2020, we experienced a substantial decline in week-over-week system-wide sales as a direct result of COVID-19. This depressed level of system-wide sales compared to historical averages continued throughout the third quarter and into the fourth quarter. We have started to see week-over-week system-wide sales improve, which has slowly begun to shrink the gap between 2020 and 2019 comparative week-over-week sales. We believe this trend is a result of many states reopening their economies. However, we still expect system-wide sales to be materially lower than historical averages in the fourth quarter of 2020, and likely into 2021. It is unclear when, or if, a full economic recovery will occur.

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. Our franchisees opened two offices in the third quarter 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 2020.



Franchised offices, December 31, 2019   147
Closed in 2020                          (13)
Opened in 2020                          4

Franchised offices, September 30, 2020 138

Office closures and consolidations in 2020 were largely related to the economic impacts of COVID-19. These closures were mostly in metropolitan areas still serviced by other offices. Accordingly, we do not expect such closures and consolidations in-and-of themselves to have a material impact on our system-wide sales, revenue, or other results of operations. It is difficult to predict whether the impacts of COVID-19 will cause more closures.

Off-Balance Sheet Arrangements

We do not engage in any off-balance sheet financing arrangements.

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