Notes to Consolidated Condensed
Financial Statements
Note 1 – Overview and Summary of Significant Accounting
Policies
Nature of Business
HireQuest,
Inc. (“HQI,” the “Company,”
“we,” us,” or “our”) is a nationwide
franchisor of branch offices providing on-demand labor solutions in
the light industrial and blue-collar segments of the staffing
industry. We provide various types of temporary personnel through
two business models operating under the trade names
“HireQuest Direct,” previously known as “Trojan
Labor,” and “HireQuest,” previously known as
“Acrux Staffing.” HireQuest Direct specializes
primarily in unskilled and semi-skilled industrial and construction
personnel. HireQuest specializes primarily in skilled and
semi-skilled industrial personnel as well as clerical and
secretarial personnel.
Currently,
we have more than 150 franchisee-owned branches in 30 states and
the District of Columbia. Prior to September 29, 2019, when we
finalized our conversion of all company-owned branches to
franchise-owned branches, we also owned and operated branches. We
provide employment to more than 85,000 individuals annually working
for thousands of clients in various industries including
construction, recycling, warehousing, logistics, auctioneering,
manufacturing, hospitality, landscaping, and retail. We provide
staffing, marketing, funding, software, and administrative services
to our franchisees. Prior to September 29, 2019, we provided the
same services to our company-owned temporary staffing
locations.
HQI is the product of the merger between Command Center, Inc., or
Command Center, and Hire Quest Holdings, LLC, or Hire Quest
Holdings. We refer to Hire Quest Holdings collectively with its
wholly-owned subsidiary, Hire Quest, LLC, as Legacy HQ. Upon the
closing of the Merger, all of the ownership interests in Hire Quest
Holdings were converted into the right to receive an aggregate
number of shares representing 68% of the total shares of the
Company’s common stock outstanding immediately after the
closing. The Company accounted for the Merger as a reverse
acquisition. As such, Legacy HQ is considered the accounting
acquirer. Therefore, Legacy HQ's historical financial statements
replace Command Center’s historical financial statements
following the completion of the Merger, and the results of
operations of both companies will be included in our financial
statements for all periods subsequent to July 14,
2019.
For additional information related to the Merger,
see Note 2
– Acquisitions.
Basis of Presentation
We have prepared the accompanying unaudited consolidated
condensed
financial statements in accordance with accounting principles
generally accepted in the United States of America, or GAAP, for
interim financial reporting and the rules and regulations of the
United States Securities and Exchange Commission, or SEC.
Accordingly, certain information and footnote disclosures normally
included in financial statements prepared in accordance with GAAP
have been condensed or omitted. In the opinion of our management,
all adjustments, consisting of only normal recurring accruals,
necessary for a fair presentation of the financial position,
results of operations, and cash flows for the fiscal periods
presented have been included.
You should read these consolidated
condensed financial statements in conjunction with
the audited consolidated
condensed financial statements and accompanying notes
of Hire Quest, LLC included in our Form 8-K/A filed with the SEC on
August 23, 2019. The results of operations for the quarter and the
three quarters ended September 29, 2019 are not necessarily
indicative of the results expected for the full fiscal year, or for
any other fiscal period.
Fiscal period end
As of January 1, 2019, we changed our financial reporting period
from a calendar year to a fiscal year. Our fiscal year end is the
Sunday closest to the last day of December. Our fiscal quarters end
on the last Sunday closest to the last day in March, June and
September. This change in fiscal year end and fiscal quarter end
did not have a material effect on the comparability of the periods
presented.
Consolidation
The consolidated
condensed financial statements include the accounts
of HQI and all of its wholly-owned subsidiaries. All significant
intercompany balances and transactions have been eliminated in
consolidation.
Use of estimates
The preparation of consolidated
condensed financial statements in conformity with
GAAP requires us to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the consolidated
condensed financial statements and the reported
amounts of revenue and expenses during the reporting period. Actual
results could differ from those estimates. Significant estimates
and assumptions underlie our workers’ compensation claim
liabilities, the allowance for doubtful accounts, and our deferred
taxes.
Accounts receivables and allowance for doubtful
accounts
Accounts
receivables consist of amounts due for labor services from
customers of franchises and of previously company-owned locations.
At September 29, 2019, approximately 78% and 22% of our accounts
receivables were due from franchise and previously owned locations,
respectively. At December 31, 2018, approximately 99% and 1% of our
accounts receivable were due from franchise and previously
company-owned locations, respectively.
We own
accounts receivable from labor services provided by franchisees. We
charge accounts receivable that remain uncollected beyond 84 days
after the invoice date back to the franchisee. Accordingly, we do
not record an allowance for doubtful accounts on these accounts
receivable.
For
labor services provided by previously company-owned locations, we
record accounts receivable at face value less an allowance for
doubtful accounts. We determine the
allowance for doubtful accounts based on historical write-off
experience, the age of the receivable, other qualitative factors
and extenuating circumstances, and current economic data which
represents our best estimate of the amount of probable losses on
these accounts receivable, if any. We review the allowance for
doubtful accounts periodically and write off past due balances when
it is probable that the receivable will not be collected. Our
allowance for doubtful accounts on receivables generated by
company-owned locations was approximately $362,000 and $-0- at
September 29, 2019 and December 31, 2018,
respectively.
Revenue recognition
We account for revenue when both parties to the contract have
approved the contract, the rights and obligations of the parties
are identified, payment terms are identified, and collectability of
consideration is probable. Our revenue arises from royalties paid
by our franchisees and service revenue which includes interest we
charge our franchisees on overdue accounts along with other
miscellaneous fees for optional services we provide. We invoice
customers every week and generally do not require payment prior to
the delivery of service. Substantially all of our contracts include
payment terms of 30 days or less and are short-term in nature.
Because of our payment terms, there are no significant contract
assets or liabilities. We do not extend payment terms beyond one
year. Revenue
from franchise royalties is based on a percentage of sales
generated by the franchisee and recognized at the time the
underlying sales occur. We recognize revenue from interest on
overdue accounts receivable related to franchisee sales when they
age past forty-two days.
Leases
Operating leases are included in right-of-use asset and lease
current and long-term liabilities. We recognize lease expense for
operating leases on a straight-line basis over the lease term, and
include it in selling, general and administrative expenses. If any
of our leases require variable payments of property taxes,
insurance, and common area maintenance, in addition to base rent,
we do not include the variable portion of these lease payments in
our right-of-use asset or lease liabilities. We expense these
variable payments when we incur the obligation to pay them and
include them in lease expense as part of selling, general and
administrative expenses.
We measure lease right-of-use assets and lease liabilities using
the present value of future minimum lease payments over the lease
term at the lease commencement date. The right-of-use asset also
includes any lease payments made on or before the commencement date
of the lease, less any lease incentives we received. We use our
incremental borrowing rate based on the information available at
the lease commencement date in determining the present value of
lease payments. We estimate the incremental borrowing rates based
on what we would be required to pay for a collateralized loan over
a similar term.
Business combinations
We account for business acquisitions under the acquisition method
of accounting by recognizing identifiable tangible and intangible
assets acquired, liabilities assumed, and non-controlling interests
in the acquired business at their fair values. We record as
goodwill the excess of the cost of the acquired business over the
fair value of the identifiable tangible and intangible assets
acquired and liabilities assumed. We expense acquisition related
costs as we incur them.
Earnings
per share
Basic earnings per share is calculated by dividing net income or
loss available to common stockholders by the weighted average
number of common shares outstanding, and does not include the
impact of any potentially dilutive common stock equivalents.
Diluted earnings per share reflect the potential dilution of
securities that could share in our earnings through the conversion
of common shares issuable via outstanding stock options, except
where their inclusion would be anti-dilutive. Outstanding common
stock equivalents at September 29, 2019 and September 30, 2018
totaled approximately 61,000 and -0-, respectively.
Diluted common shares outstanding were calculated using the
treasury stock method and are as follows:
|
|
|
|
|
|
|
|
|
|
|
Weighted
average number of common shares used in basic net income per common
share
|
12,927,634
|
9,939,668
|
10,939,318
|
9,939,668
|
|
Dilutive
effects of stock options
|
-
|
-
|
-
|
-
|
|
Weighted
average number of common shares used in diluted net income per
common share
|
12,927,634
|
9,939,668
|
10,939,318
|
9,939,668
|
Fair Value
Measures
Fair value is the price that would be received to sell an asset, or
paid to transfer a liability, in the principal or most advantageous
market for the asset or liability in an ordinary transaction
between market participants on the measurement date. Our policy on
fair value measures requires us to maximize the use of observable
inputs and minimize the use of unobservable inputs when measuring
fair value. The policy establishes a fair value hierarchy based on
the level of independent, objective evidence surrounding the inputs
used to measure fair value. A financial instrument’s
categorization within the fair value hierarchy is based upon the
lowest level of input that is significant to the fair value
measurement. The policy prioritizes the inputs into three levels
that may be used to measure fair value:
Level 1: Applies to assets or liabilities for which there are
quoted prices in active markets for identical assets or
liabilities.
Level 2: Applies to assets or liabilities for which there are
inputs other than quoted prices that are observable for the asset
or liability such as quoted prices for similar assets or
liabilities in active markets; quoted prices for identical assets
or liabilities in markets with insufficient volume or infrequent
transactions (less active markets); or model-derived valuations in
which significant inputs are observable or can be derived
principally from, or corroborated by, observable market
data.
Level 3: Applies to assets or liabilities for which there are
unobservable inputs to the valuation methodology that are
significant to the measurement of the fair value of the assets or
liabilities.
Discontinued
Operations
During the quarter
ended September 29, 2019, we sold substantially all of the branches
acquired in the Merger. Accordingly, the assets and liabilities,
operating results, and cash flows for these businesses are
presented as operations, separate from our continuing operations,
for all periods presented in our consolidated
condensed financial statements and footnotes, unless
indicated otherwise.
Recently
adopted accounting pronouncements
In May 2014, the Financial Accounting Standards Board, or FASB,
issued new revenue recognition guidance under Accounting Standards
Update, or ASU, 2014-09, Revenue from Contracts with Customers,
that supersedes the existing revenue recognition guidance under
GAAP. The new standard focuses on creating a single source of
revenue guidance for revenue arising from contracts with customers
for all industries. The objective of the new standard is for
companies to recognize revenue when it transfers the promised goods
or services to its customers at an amount that represents what the
company expects to be entitled to in exchange for those goods or
services.
On January 1, 2019, we adopted the new revenue recognition guidance
using the modified retrospective method for all open contracts and
related amendments. Results for reporting periods beginning after
January 1, 2019 are presented under the new revenue recognition
guidance, while prior period amounts were not adjusted and continue
to be reported in accordance with historic accounting guidance. The
adoption of this new guidance did not have a material impact on our
consolidated
condensed financial statements.
In February 2016, the FASB issued guidance on lease accounting. The
new guidance continues to classify leases as either finance or
operating, but results in the lessee recognizing most operating
leases on the balance sheet as right-of-use assets and lease
liabilities. This guidance was effective for annual and interim
periods beginning after December 15, 2018, with early adoption
permitted. In July 2018, the FASB amended the standard to provide
transition relief for comparative reporting, allowing companies to
adopt the provisions of the new standard using a modified
retrospective transition method on the adoption date, with a
cumulative-effect adjustment to retained earnings recorded on the
date of adoption. We have elected to adopt the standard using the
transition relief provided in the July amendment.
We have elected the three practical expedients allowed for
implementation of the new standard, but have not utilized the
hindsight practical expedient. Accordingly, we did not reassess: 1)
whether any expired or existing contracts are or contain leases; 2)
the lease classification for any expired or existing leases; or 3)
initial direct costs for any existing leases.
As a result of adopting this guidance, we recognized a right-of-use
asset, and corresponding lease liability, of approximately
$200,000 as of July 15, 2019, the date the guidance became
effective for us because of the Merger between Legacy HQ and
Command Center. Had we adopted this guidance at the beginning of
the year, the effect to our balance sheet would have been
substantially the same as with the mid-year adoption. The adoption
of this guidance did not have a material impact on expense
recognition. The difference between the right-of-use assets
and lease liabilities relates to the deferred rent liability
balance as of the end of fiscal 2018 associated with the leases
capitalized. The deferred rent liability, which was the difference
between the straight-line lease expense and cash paid, reduced the
right-of-use asset upon adoption.
Recently issued accounting pronouncements
In June 2016, the FASB issued ASU 2016-13, Financial Instruments
– Credit Losses (Topic 326): Measurement of Credit Losses on
Financial Instruments. The standard significantly changes how
entities will measure credit losses for most financial assets and
certain other instruments that are not measured at fair value
through net income. The standard will replace today's
“incurred loss” approach with an “expected
loss” model for instruments measured at amortized cost. For
available-for-sale securities, entities will be required to record
allowances rather than reduce the carrying amount, as they do today
under the other-than-temporary impairment model. It also simplifies
the accounting model for purchased credit-impaired debt securities
and loans. This guidance is effective for annual periods beginning
after December 15, 2019, and interim periods therein. Early
adoption is permitted for annual periods beginning after December
15, 2018, and interim periods therein. We are currently evaluating
the impact of the new guidance on our consolidated
condensed financial statements and related
disclosures.
We do not expect other accounting standards that the FASB or other
standards-setting bodies have issued to have a material impact on
our financial position, results of operations, and cash
flows.
Note 2 – Acquisitions
On July 15, 2019, the Company completed its acquisition of Legacy
HQ, in accordance with the terms of the Agreement and Plan of
Merger dated April 8, 2019, or the Merger Agreement. Upon the
closing of the Merger, all of the membership interests in Hire
Quest Holdings were converted into the right to receive 68% of the
Company’s common stock outstanding immediately after the
closing, or 9,939,668 shares.
In
accordance with ASC 805, Business Combinations, we accounted for
the Merger as a reverse acquisition. As such, Legacy HQ is
considered the accounting acquirer. Therefore, Legacy HQ's
historical financial statements replace Command Center’s
historical financial statements following the completion of the
Merger, and the results of operations of both companies will be
included in our financial statements for all periods after July 14,
2019.
Because
the Merger is considered a reverse acquisition, the fair value of
the purchase consideration is calculated based on the Company's
stock price as it is considered to be more reliable than the fair
value of the membership interests of Legacy HQ, a private company.
Consideration is calculated based on the Company's closing share
price of $5.76 on Nasdaq on July 15, 2019.
The following table summarizes the estimated fair values of the
identifiable assets acquired and liabilities assumed as of the
acquisition date. These estimates are preliminary, pending final
evaluation of certain assets and liabilities, and therefore are
subject to revisions that may result in adjustments to the values
presented below:
|
Stock
issued
|
4,677,487
|
|
Closing
share price on July 15, 2019
|
$5.76
|
|
Total
allocable purchase price
|
$26,942,325
|
|
|
|
|
Accounts
receivable
|
$10,480,907
|
|
Cash
and cash equivalents
|
5,376,543
|
|
Identifiable
intangible assets
|
16,881,428
|
|
Other
current assets
|
725,453
|
|
Property,
plant and equipment, net
|
281,186
|
|
Other
non-current assets
|
1,642,695
|
|
Current
liabilities
|
(4,002,805)
|
|
Deferred
tax liability
|
(2,796,518)
|
|
Other
liabilities
|
(1,646,564)
|
|
Preliminary
purchase price allocation
|
$26,942,325
|
The
following table presents the unaudited pro forma information
assuming the Merger occurred on January 1, 2018. The unaudited pro
forma information is not necessarily indicative of the results of
operations that would have been achieved if the acquisition had
taken place on that date:
|
|
|
|
|
|
|
|
|
|
|
Royalty
revenue
|
$20,615,713
|
$21,216,830
|
$27,063,188
|
$27,513,503
|
|
Net
income
|
416,040
|
817,715
|
3,515,142
|
3,717,119
|
|
Basic
earnings per share
|
$0.03
|
$0.06
|
$0.24
|
$0.28
|
|
Basic
weighted average shares outstanding
|
14,633,639
|
13,222,334
|
14,622,670
|
13,281,839
|
|
Diluted
earnings per share
|
$0.03
|
$0.06
|
$0.24
|
$0.28
|
|
Diluted
weighted average shares outstanding
|
14,643,436
|
13,229,795
|
14,623,959
|
13,289,045
|
These
calculations reflect the decreased amortization expense and the
consequential tax effects that would have resulted had the Merger
closed on January 1, 2018.
Effective
September 11, 2019, as contemplated by the Merger Agreement and as
approved by our shareholders, Command Center changed its name to
HireQuest, Inc., changed its state of
incorporation from Washington to Delaware, adopted new bylaws, and
moved its principal executive offices to Goose Creek, South
Carolina. In connection with our name change to HireQuest, Inc., we
also changed the trading symbol of our common stock from
“CCNI” to “HQI.”
Discontinued operations
We sold the branches we acquired from Command Center to franchisees
in the third quarter of 2019 through sales of operating branch
assets to existing and new franchisees in two tranches. We also
made the strategic decision to sell the assets of Command
Center’s four California branches outside of our franchise
system to an unaffiliated third party and we no longer conduct
business in the state of California. We have summarized these
transactions below.
July sale: On July 15, 2019, we closed on the sale of
certain assets related to the operations of Company-owned branches
in Conway and North Little Rock, AR; Flagstaff, Mesa, North
Phoenix, Phoenix, Tempe, Tucson, and Yuma, AZ; Aurora and Thornton,
CO; Atlanta, GA; College Park and Speedway, IN; Shreveport, LA;
Baltimore and Landover, MD; Oklahoma City and Tulsa, OK;
Chattanooga, Madison, Memphis, and Nashville, TN; Amarillo, Austin,
Houston, Irving, Lubbock, Odessa, and San Antonio, TX; and Roanoke,
VA, or collectively, the July Franchise Assets. In connection with
their purchases, the buyers executed franchise agreements with us
and became franchisees.
The aggregate sale price for the July Franchise Assets consisted of
approximately (i) $4.7 million paid in the form of promissory notes
accruing interest at an annual rate of 6% issued by the buyers to
the Company plus (ii) the right to receive 2% of annual sales in
excess of $3.2 million in the aggregate for the franchise territory
containing Phoenix, AZ for 10 years, up to a total aggregate amount
of $2.0 million.
We sold a subset of these July Franchise Assets to buyers in which
some of our directors and significant shareholders have direct or
indirect interests, or the Worlds Buyers (see Note 3 – Related Party
Transactions).
Contemporaneously with the sale of these assets, we entered into an
agreement with Hire Quest Financial, LLC, or HQF, an affiliate of
two of our directors, Richard Hermanns and Edward Jackson, who are
also our two largest shareholders, whereby the promissory notes
issued by the Worlds Buyers to the Company in the aggregate
principal amount of approximately $2.2 million were transferred to
HQF in exchange for accounts receivable of an equal
value.
September
sale:
On September 29, 2019, we closed on the sale of certain assets
related to Company-owned branches in Coeur D’Alene, ID;
Griffith, IN; Bloomington, Brooklyn Park, Cambridge, Hopkins, St.
Paul, and Wilmar, MN; Bismarck, Dickinson, Fargo, Grand Forks,
Minot, and Watford City, ND; Bellevue and Omaha, NE; Hillsboro, OR;
Sioux Falls, SD; and Bellingham, Everett, Kent, Mt. Vernon,
Seattle, Spokane, Tacoma, and Vancouver, WA , or collectively, the
September Franchise Assets. We simultaneously entered into
franchise agreements with affiliates of the buyer, pursuant to
which the affiliates will operate these branches as franchisees
under franchise agreements with us.
The aggregate purchase price for the September Franchise Assets
consisted of approximately $9.7 million paid in the form of
five-year promissory notes accruing interest at an annual rate of
6% issued by the buyer to the Company. Subsequent to the end of our
third quarter, we received a $3.0 million cash payment on these
notes. In accordance with an agreement with the buyer, this cash
payment also triggered a discount in the purchase price equal to
10% of the cash payment, or $300,000.
Both the July 15, 2019 and September 29, 2019 purchase agreements
contain negotiated representations, warranties, covenants, and
indemnification provisions by the parties which are believed to be
customary for transactions of this type. The related-party
transactions contain covenants and warranties similar to those
contained in all other transactions.
The
California Purchase Agreement: On
September 27, 2019, we closed on the sale of substantially all of
the operating and intangible assets of our four California branch
locations in Corona, Hayward, Sacramento, and Fresno, or
collectively the California Assets, to Resolute Enterprises, LLC,
or Resolute, a Florida limited liability company and unaffiliated
third party. We retained the net working capital of these branches.
The aggregate purchase price for the California Assets consisted of
$1.8 million paid in the form of a four-year promissory note
accruing interest at an annual rate of 10% issued by Resolute to
the Company. The promissory note is secured by the California
Assets. The California Purchase Agreement contained negotiated
representations, warranties, covenants, and indemnification
provisions by the parties, which are believed to be customary for
transactions of this type.
The
income from discontinued operations amounts as reported on our
consolidated statements of operations was comprised of the
following amounts:
|
|
|
|
|
|
|
|
|
|
|
Revenue
|
$13,551,950
|
$178,874
|
$13,934,276
|
$555,154
|
|
Cost of staffing services
|
9,390,509
|
145,487
|
9,710,757
|
482,470
|
|
Gross
profit
|
4,161,441
|
33,387
|
4,223,519
|
72,684
|
|
Gain
on sale
|
393,697
|
-
|
393,697
|
-
|
|
SG&A
|
(3,644,907
)
|
(6,393)
|
(3,653,541)
|
(18,603)
|
|
Net
income before tax
|
910,231
|
26,994
|
963,675
|
54,081
|
|
Tax
|
227,557
|
6,748
|
240,919
|
13,520
|
|
Net
income
|
$682,674
|
$20,246
|
$722,756
|
$40,561
|
Restructuring charges reserve
During the quarter ended September 29, 2019, we accrued
approximately $595,000 as a restructuring charges reserve
liability. This liability relates to one-time Merger-related
expenses including, among other things, the expense for certain
Command Center employees to relocate to Goose Creek, South
Carolina, termination benefits for employees of Command Center,
rebranding our branches pursuant to our name change, elimination of
staff redundancies, and other costs that we will continue to incur
under various contracts that provide no future economic benefit to
us.
Note 3 – Related Party Transactions
HQI
shares some common ownership with Hire Quest Financial, LLC; Hire
Quest Insurance, LLC; Brave New World Services, LLC, formerly known
as Hire Quest LTS, LLC; Bass Underwriters, Inc. and its related
entities; a number of our franchisees; and the not-for-profit
Higher Quest Foundation, Inc.
Hire Quest Financial LLC, or HQF
Richard
Hermanns, our President, CEO, Chairman of the Board, and most
significant shareholder, and Edward Jackson, a member of our Board
and a significant shareholder, collectively own a majority of
HQF.
Prior
to March 20, 2018, Legacy HQ had an agreement with HQF to provide
finance and insurance related services and a line of credit. The
management fee charged by HQF, which included the interest charge
on the line of credit, amounted to 2% of the sales of our
franchisee-owned and Company-owned locations, also known as
system-wide sales. Legacy HQ terminated this arrangement in March
2018 and there is no amount included in our statement of operations
for quarters ended September 29, 2019 and September 30, 2018.
Amounts included in our statements of operations for the three
quarters ended September 30, 2018 are approximately
$249,000.
During
the year ended December 31, 2018, Legacy HQ transferred
approximately $1.8 million of accounts and notes receivable due
from franchisees to HQF, as well as approximately $600,000 of
investments and property and equipment. On July 15, 2019, Legacy HQ
conveyed approximately $2.2 million of accounts receivable to HQF.
These transfers were used to pay down intercompany debt
obligations.
The
intercompany debt was entirely extinguished prior to the Merger
between Legacy HQ and Command Center. At September 29, 2019 and
December 31, 2018, HQI owed HQF approximately $-0- and $6.7
million, respectively.
Hire Quest Insurance, or HQ Ins.
Mr.
Hermanns, certain of his immediate family members, a dynasty trust
under his control, Mr. Jackson, and certain of his immediate family
members collectively own a majority of HQ Ins.
HQ Ins.
is a North Carolina protected cell captive insurance company.
Effective March 1, 2010, Legacy HQ purchased a deductible
reimbursement insurance policy from HQ Ins. to cover losses up to
the $500,000 per claim deductible on the Legacy HQ high-deductible
workers’ compensation policy originally obtained through AIG
and, later through ACE American Insurance Company (see Note 5, Workers’ Compensation).
Legacy HQ terminated its policy and with HQ Ins. on July 15, 2019
upon the closing of the Merger.
Premiums
paid by Legacy HQ to HQ Ins. for workers compensation insurance
during the quarter ended September 29, 2019 and September 30, 2018
are approximately $262,000 and $2.0 million, respectively. Premiums
paid by Legacy HQ to HQ Ins. for workers compensation insurance
during the three quarters ended September 29, 2019 and September
30, 2018 are approximately $3.6 million and $5.5 million,
respectively.
Brave New World Services, LLC, formerly known as Hire Quest LTS, or
HQ LTS
Mr.
Jackson and a relative of Mr. Hermanns collectively own a majority
of HQ LTS.
Historically,
it employed the personnel at Legacy HQ headquarters. HQI terminated
this relationship on July 15, 2019 upon the closing of the Merger.
Payroll service fees paid to HQ LTS during the quarter ended
September 29, 2019 and September 30, 2018 are approximately $7,000
and $13,000, respectively. Payroll service fees paid to HQ LTS
during the three quarters ended September 29, 2019 and September
30, 2018 are approximately $19,000 and $28,000, respectively. HQ
LTS now occupies independent office space and employs an
independent staff to manage its operations.
Jackson Insurance Agency and Bass Underwriters, Inc., or
collectively, Bass
Mr.
Hermanns and Mr. Jackson collectively are the majority owners of
Bass Underwriters. Mr. Jackson and Mr. Hermanns are also
significant or majority shareholders of the following entities
related to Bass: Bulldog Premium Finance LLC, Gridiron Insurance
Underwriters, Inc., Insurance Technologies, Inc., and Genesis
Educational Services of Florida, Inc. Mr. Jackson owns a majority
stake in Jackson Insurance Agency.
Jackson
Insurance Agency has historically brokered Legacy HQ’s, and
since July 15, 2019 has brokered HQI’s property, casualty,
general liability, and cybersecurity insurance. It also brokers
certain insurance policies on behalf of some of our franchisees,
including the Worlds Franchisees. Premiums paid through Bass for
various insurance policies during the quarter ended September 29,
2019 and September 30, 2018 are approximately $369,000 and $18,000,
respectively. Premiums paid to Bass during the three quarters ended
September 29, 2019 and September 30, 2018 are approximately
$608,000 and $209,000, respectively. Bass does not retain the
majority of the premiums but does profit by making a
commission.
The Worlds Franchisees
Mr.
Hermanns and Mr. Jackson have direct or indirect ownership
interests in certain of our franchisees, or the Worlds Franchisees.
There were 20 Worlds Franchisees at September 29, 2019 that
operated 62 of our 152 branch office locations. There were 23
Worlds Franchisees that operated 50 of our 97 branches at December
31, 2018.
Balances
regarding the Worlds Franchisees at September 29, 2019 and December
31, 2018 are summarized below:
|
|
|
|
|
Due
to (from) franchisees
|
$71,509
|
$(254,943
)
|
|
Risk
management incentive program liability
|
817,857
|
988,562
|
Transactions
regarding the Worlds Franchisees for the quarter and three quarters
ended September 29, 2019 and September 30, 2018 are summarized
below:
|
|
|
|
|
|
|
|
|
|
|
Franchise
royalties
|
1,786,975
|
1,375,439
|
5,529,777
|
4,500,617
|
Risk management incentive program liability relates to a program we
sponsor for our franchisees whereby we pay our franchisees an
amount equal to a percentage of the premium they pay for
workers’ compensation insurance if they keep their workers'
compensation loss ratios below specific thresholds. This program,
which we call the Risk Management Incentive Program, incentivizes
our franchisees to keep our temporary employees safe and to control
their exposure to large workers' compensation claims.
Note 4 – Debt
In July 2019, we entered into a loan agreement with Branch Banking
and Trust Company, or BB&T, for a $30 million line of credit
with a $15 million sublimit for letters of credit. This line of
credit matures on May 31, 2024. The current agreement bears
interest at a variable rate equal to the Daily One Month London
Interbank Offering Rate plus a margin between 1.25% and 1.75%. The
margin is determined based on the value of our net collateral,
which is equal to our total collateral plus unrestricted cash less
the outstanding balance, if any, under the loan agreement. At
September 29, 2019 the effective interest rate was 3.5%. A non-use
fee of between 0.125% and 0.250% will accrue on the unused portion
of the line of credit. As collateral for repayment of any and all
obligations under the loan agreement, we granted BB&T a
security interest in substantially all of our operating assets and
the operating assets of our subsidiaries. This agreement, and other
loan documents, contain customary events of default and negative
covenants, including but not limited to those governing
indebtedness, liens, fundamental changes, transactions with
affiliates, and sales of assets. The loan agreement requires us to
comply with a fixed charge coverage ratio of at least 1.10:1.00.
This covenant will be tested quarterly on a rolling four quarter
basis commencing with the four quarter period ending September 30,
2020. Our obligations under the line of credit are subject to
acceleration upon the occurrence of an event of default as defined
in the loan agreement.
At September 29, 2019, we have two letters of credit with BB&T
totaling approximately $9.8 million in the aggregate that secure
our obligations to our workers’ compensation insurance
carrier and reduce the amount available to us under the loan
agreement. For additional information related to these letters of
credit, see Note 5 – Workers’
Compensation.
In
March 2018, Legacy HQ entered into a $5 million line of credit
agreement with BB&T with an
interest rate of LIBOR plus 1.75%. The line was
collateralized by substantially all Legacy HQ assets and contained
certain restrictive covenants. There were no borrowings on the line
of credit at December 31, 2018. It was terminated in July 2019 upon
the execution of the current loan agreement.
Prior
to March 20, 2018, Legacy HQ had a $16 million line of credit with
HQF. The line was collateralized by substantially all Legacy HQ
assets and a personal guarantee of the CEO of Legacy HQ. In lieu of
interest, use of the line of credit was included in the management
fee of 2% of system-wide sales as described above in Note 3 – Related Party
Transactions.
Note 5 – Workers’ Compensation
Beginning
in March 2014, Legacy HQ obtained its
workers’ compensation insurance through Chubb Limited and ACE
American Insurance Company, or, collectively, ACE, in all states in
which it operated, other than monopolistic jurisdictions. The ACE
policy was a high deductible policy pursuant to which Legacy HQ had
primary responsibility for all claims with ACE providing insurance
for covered losses and expenses in excess of $500,000 per incident.
In addition to the ACE policy, Legacy HQ purchased a
deductible reimbursement insurance policy from HQ Ins. to cover
losses up to the $500,000 deductible with ACE. This resulted in
Legacy HQ effectively being fully insured during this time period.
Effective July 15, 2019, we terminated our deductible reimbursement
policy with HQ Ins. and have assumed the primary responsibility for
all claims up to the deductible occurring on or after July 15,
2019. We assumed the Legacy HQ policy with ACE.
Command
Center also obtained its workers’ compensation insurance
through ACE. Pursuant to Command
Center’s policy, ACE provides insurance for covered losses
and expenses in excess of $500,000 per incident. Command
Center’s current ACE policy includes a one-time obligation
for the Company to pay any single claim filed under the Command
Center policy within a policy year that exceeds $500,000 (if any),
but only up to $750,000 for that claim. All other claims within the
policy year are subject to the $500,000 deductible.
Effective July 15, 2019, in connection with the Merger, we assumed
all of the workers’ compensation claims of Command
Center. We also assumed Command
Center’s workers’ compensation policy with
ACE.
Under these high deductible programs, HQI is effectively
self-insured. Per our contractual agreements with ACE, we must
provide collateral deposits of approximately $9.8 million, which we
accomplished by providing letters of credit under our line of
credit with BB&T.
For workers’ compensation claims originating in Washington,
North Dakota, Ohio, and Wyoming, we pay workers’ compensation
insurance premiums and obtain full coverage under mandatory state
administered programs. Our liability associated with claims in
these jurisdictions is limited to premium payments based upon the
amount of payroll paid within each jurisdiction. Accordingly, our
consolidated
condensed financial statements reflect only the
mandated workers’ compensation insurance premium liability
for workers’ compensation claims in these
jurisdictions.
Note 6 – Analysis of Franchise Locations
Below
is a summary of changes in the number of branch
locations:
|
Branches,
December 31, 2017
|
79
|
|
Closed
in 2018
|
(3)
|
|
Opened
in 2018
|
21
|
|
Branches,
December 31, 2018
|
97
|
|
Closed
in 2019
|
(5)
|
|
Opened
in 2019
|
60
|
|
Branches,
September 29, 2019
|
152
|
Note 7 – Stockholders’ Equity
Tender Offer
In June 2019, we commenced an issuer tender offer to purchase up to
1,500,000 shares of our common stock at a fixed price of $6.00 per
share. This tender offer expired on July 25, 2019, and we accepted
for purchase approximately 1.4 million shares for an aggregate cost
of approximately $8.4 million, excluding fees and
expenses.
Note 8 – Stock Based Compensation
Employee Stock Incentive Plan
Pursuant to the Merger, we adopted Command Center’s existing
Stock Incentive Plans and will honor all outstanding option awards
in accordance with the pre-existing terms of these
plans.
Our 2008 Stock Incentive Plan, or the 2008 Plan, which permitted
the grant of up to 533,333 equity awards, expired in January 2016.
In November 2016, our stockholders approved a new stock incentive
plan, the 2016 Plan, under which we are authorized to grant
awards for up to 500,000 shares of our common stock over the 10
year life of the plan.
Stock options that were outstanding at Command Center were deemed
to be issued on the date of the acquisition. Outstanding awards
continue to remain in effect according to the terms of the 2008
Plan and the corresponding award documents. There were
approximately 55,000 and -0- stock options vested at September 29,
2019 and December 31, 2018, respectively. The following table
summarizes our stock options outstanding at December 31, 2018, and
changes during the period ended September 29, 2019.
|
|
Number
of shares underlying options
|
Weighted
average exercise price per share
|
Weighted
average grant date fair value
|
|
Outstanding,
December 31, 2018
|
-
|
$-
|
$-
|
|
Granted
|
160,831
|
5.86
|
3.18
|
|
Forfeited
|
(100,000)
|
5.70
|
3.16
|
|
Outstanding,
September 29, 2019
|
60,831
|
6.11
|
3.20
|
The following table summarizes our non-vested stock options
outstanding at December 31, 2018, and changes during the period
ended September 29, 2019:
|
|
Number
of shares underlying options
|
Weighted
average exercise price per share
|
Weighted
average grant date fair value
|
|
Non-vested,
December 31, 2018
|
-
|
$-
|
$-
|
|
Granted
|
84,523
|
5.56
|
3.05
|
|
Forfeited
|
(57,857)
|
5.70
|
6.16
|
|
Vested
|
(21,250)
|
5.09
|
2.93
|
|
Non-vested,
September 29, 2019
|
5,416
|
5.48
|
3.01
|
The following table summarizes information about our outstanding
stock options, and reflects the intrinsic value recalculated based
on the closing price of our common stock of $7.00 at September 27,
2019:
|
|
Number of shares underlying options
|
Weighted
average exercise price per share
|
Weighted
average remaining contractual life (years)
|
Aggregate
intrinsic value
|
|
Outstanding
|
60,831
|
$6.11
|
6.65
|
$109,267
|
|
Exercisable
|
55,415
|
6.17
|
6.46
|
37,916
|
The following table summarizes information about our stock options
outstanding, and reflects the weighted average contractual life at
September 29, 2019:
|
|
|
|
|
|
Number of shares underlying options
|
Weighted
average remaining contractual life (years)
|
Number of shares exercisable
|
Weighted
average remaining contractual life (years)
|
|
$4.80 - 7.00
|
44,582
|
8.28
|
39,166
|
8.24
|
|
$7.01 - 8.76
|
16,249
|
2.17
|
16,249
|
2.17
|
In September 2019, we issued 160,000 shares of restricted common
stock pursuant to the 2016 Plan valued at approximately $1.1
million for services, and to encourage retention, to certain
employees. These shares vest over four years, with 50% vesting on
September 1, 2021, and 6.25% vesting each quarter thereafter for
the next eight quarters. Also in September 2019, we issued 90,000
shares of restricted common stock pursuant to the 2016 Plan valued
at $648,000 for services to non-employee members of our board of
directors. These shares vest equally over approximately three years
with the first vesting occurring the day before our annual
shareholder meeting to be held in 2020, and the remainder vesting
in equal portions on each of the first two anniversaries of that
date.
At September 29, 2019, there was unrecognized stock-based
compensation expense totaling approximately $1.6 million relating
to non-vested options and restricted stock grants that will be
recognized over the next 3.8 years.
Note 9 – Commitments and Contingencies
Leases
At September 29, 2019, we had an operating lease for our previous
corporate headquarters in Lakewood, CO. We determined the discount
rate used to calculate the present value of future minimum lease
payments based on our incremental borrowing rate and consistent
with financing terms currently in place with financial
institutions. The weighted average discount rate on our operating
leases is 5.0%. The weighted average remaining lease term on our
operating lease is 1.3 years.
Below is a table of our future minimum operating lease commitments
for the remainder of the current year and for the next five years,
and a reconciliation to the lease liability recognized on our
consolidated balance sheet. The amount necessary to reduce our
minimum lease payments to present value was calculated using our
incremental borrowing rate.
|
|
|
|
|
|
|
Future
minimum lease payments
|
$40,921
|
$153,317
|
$12,154
|
$206,392
|
|
Lease
liability interest
|
(2,174)
|
(4,003)
|
-
|
(6,177)
|
|
Lease
liability as of September 29, 2019
|
$38,747
|
$149,314
|
$12,154
|
$200,215
|
Lease expense for both the quarter and the three quarters ended
September 29, 2019 was approximately $296,000. There was no lease
expense in 2018.
Consulting
Agreement
As contemplated by the Merger Agreement, on July 15, 2019, the
Company entered into a consulting arrangement with Dock Square.
Pursuant to this consulting arrangement, Dock Square introduces
prospective customers and expands relationships with existing
customers of the Company in return for which it is
eligible to receive unregistered shares of the Company’s
common stock, subject to certain performance metrics and vesting
terms. The grant of any such shares by the Company would be based
on the Company’s gross revenue generated from the services of
Dock Square as measured over a 12 month period. Upon the grant of
any such shares, 50% of such granted shares would vest immediately,
and the remaining 50% of such granted shares would be subject to a
vesting requirement linked to the Company’s gross revenue
generated from the services of Dock Square measured over a 3 year
period. We refer to any such shares as the “Performance
Shares.” We anticipate the maximum aggregate number of
Performance Shares issuable under the consulting arrangement would
not exceed approximately 1.6 million shares. Any Performance Shares
would be in addition to the pro rata portion of the shares of
Company common stock that Dock Square’s members received as
merger consideration at the closing of the Merger along with the
other investors in Hire Quest Holdings. Dock Square would
receive any declared and paid dividends on issued Performance
Shares, including the unvested portion of such shares during the
3-year vesting measurement period, and the issued but unvested
Performance Shares would vest on a change of control of the
Company. In addition, Dock Square received piggy-back registration
rights with respect to its Performance Shares issued and vested at
the time of such registration.
Legal Proceedings
From time to time, we are involved in various legal and
administrative proceedings. Based on information currently
available to us, we do not expect material uninsured losses to
arise from any of these matters. We
believe the outcome of these matters, even if determined adversely,
will not have a material adverse effect on our business, financial
condition or results of operations. There have been no material
changes in our legal proceedings as of September 29,
2019.
Note 10 - Employee Retirement Plan
HQ LTS
sponsored a 401(k) Plan for Legacy HQ’s headquarters
employees who met certain eligibility requirements. This plan
allowed eligible employees to make annual pre-tax contributions up
to the lesser of 20% of their eligible compensation or the limit
established by the Internal Revenue Service. Matching contributions
to the employees’ account were approximately $36,000 for the
three quarters ended September 29, 2019 and $50,000 for the year
ended December 31, 2018.
Under
this plan, Legacy HQ could also make discretionary non-elective
contributions. No discretionary non-elective contributions were
made by Legacy HQ during 2019 or 2018.
Note 11 – Income Tax
In conjunction with the Merger, Legacy HQ changed its status as an
S-corporation to a C-corporation, and changed the method of
accounting for income taxes from the cash to the accrual basis of
accounting. This change in accounting basis resulted in the
recognition an additional income tax of approximately $5.6 million
that will paid over the next four years. In relation to this change
in accounting method, we have a deferred tax liability of
approximately $4.1 million. The Merger also resulted in the
recognition of intangible assets that had no basis for income tax,
and the subsequent sale of these intangible assets resulted in a
taxable gain. Income tax expense during interim periods is based on
applying an estimated annual effective income tax rate to
year-to-date income, plus any significant unusual or infrequently
occurring items which are recorded in the interim
period. The provision for income taxes for the interim
periods differs from the amount that would be provided by applying
the statutory U.S. federal income tax rate to pre-tax income
primarily because of state income taxes. The computation of
the annual estimated effective tax rate at each interim period
requires certain estimates and significant judgment including, but
not limited to, the expected operating income for the year and
changes in tax law and tax rates. The accounting
estimates used to compute the provision for income taxes may change
as new events occur, more experience is obtained, additional
information becomes known, or as the tax environment
changes.