The preparation of financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses. Actual results could differ from those estimates.
Significant estimates and assumptions underlie our workers’ compensation claim liabilities, our workers’ compensation Risk Management Incentive Programrisk management incentive program accrual, our deferred taxes, the reserve for losses on notes receivable, and the estimated fair value of assets acquired, and liabilities assumed.
Property and Equipment
We record property and equipment at cost. We compute depreciation using the straight-line method over the estimated useful lives of the assets. Computers, furniture, and equipment are typically three to five years, and buildings are typically 30 years. Repairs and maintenance are expensed as incurred. When assets are sold or retired, we eliminate cost and accumulated depreciation from the consolidated balance sheet and reflect a gain or loss in the consolidated statement of income.
Accounts Receivable and Allowance for Doubtful Accounts
Accounts receivable consist of amounts due for labor services from customers of franchisees and of previously company-owned offices. At March 31,September 30, 2020 and December 31, 2019, substantially all of our accounts receivable were due from customers of franchisees.
We own the accounts receivable from labor services provided by our franchisees. Accounts receivable thatfranchisees until they age beyond 84 days. When accounts receivable age beyond 84 days, they are charged back to our franchisees. Accordingly, we do not record an allowance for doubtful accounts on these accounts receivable.
For labor services originally provided by previously company-owned offices, 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 accounts receivable generated by company-owned offices was approximately $99,000$92,000 and $168,000 at March 31,September 30, 2020 and December 31, 2019, respectively.
Revenue Recognition
Our primary source of revenue comes from royalty fees based on the operation of our franchised offices. Royalty fees from our HireQuest Direct business linemodel are based on a percentage of sales for services our franchisees provide to customers, which ranges from 6% to 8%. Royalty fees from our HireQuest business line are 4.5% of the payroll we fund plus 18% of the gross margin for the territory. We present revenue on a net basis as agent as opposed to a gross basis as principal. We recognize revenue when we satisfy our performance obligations. Our performance obligations take the form of a franchise license and promised services. Promised services consist primarily of paying temporary employees, completing all statutory payroll related statutory obligations, and providing workers' compensation insurance on behalf of temporary employees. Because these performance obligations are interrelated, we do not consider them to be individually distinct and therefore account for them as a single performance obligation. Because our franchisees receive and consume the benefits of our services simultaneously, our performance obligations are satisfied when our services are provided. Franchise royalties are billed on a weekly basis. We also offer various incentive programs for franchisees including royalty incentives, royalty credits, and other support initiatives. Royalty fees are reduced to reflect any royalty incentives earned or credits granted under these programs. These incentives and credits are provided to driveencourage new locationoffice development, to encourage organic growth, and to limit workers' compensation exposure. We present franchise royalty fees net of these incentives and credits.
Below are summaries of our franchise royalties disaggregated by brand:
| | | |
| | | | | | |
HireQuest Direct | $3,561,403 | $2,890,714 | $3,023,166 | $2,906,856 | $9,053,150 | $8,553,618 |
HireQuest | 143,839 | 265,421 | 195,440 | 232,302 | 509,985 | 723,096 |
Total | $3,705,242 | $3,156,135 | $3,218,606 | $3,139,158 | $9,563,135 | $9,276,714 |
Service revenue, which forms the other component of our total revenue, consists of interest we charge our franchisees on overdue customer accounts receivable and other fees for optional services we provide. InterestWe recognize interest income is recognized based on the effective interest rate applied to the outstanding principal balance. Revenue forbalance of overdue accounts. We recognize revenue from optional services is recognized as services are provided.we provide them.
Workers’ Compensation Claims Liability
We maintain reserves for workers’ compensation claims based on their estimated future cost. These reserves include claims that have been reported but not settled, as well as claims that have been incurred but not reported. Annually, we engage an independent actuary to estimate the future costs of these claims. Quarterly, we use development factors provided by an independent actuary to estimate the future costs of these claims. Adjustments are madeWe make adjustments as necessary. If the actual costcosts of the claims exceedsexceed the amount estimated, we may incur additional charges may be incurred.charges.
Workers’ Compensation Risk Management Incentive Program (“RMIP”)
Our RMIP is designed to incentivize our franchises to keep our temporary employees safe and control their exposure to large workers’ compensation claims. We accomplish this by paying our franchisees an amount equivalent to a percentage of the premium our franchisesamount they pay for workers’ compensation insurance if they keep their workers’ compensation loss ratios below specified thresholds.
Notes Receivable
Notes receivable consist primarily of amounts due to us related to the financing of franchised locations.offices. We report notes receivable at the principal balance outstanding less an allowance for losses. We charge interest at a fixed rate and interest income is calculated by applying the effective rate to the outstanding principal balance. Notes receivable are generally secured by the assets of each locationoffice and the ownership interests in the franchise. We monitor the financial condition of our franchisees and record provisions for estimated losses when we believe it is probable that our franchisees will be unable to make their required payments. Our allowance for losses on notes receivable was approximately $1.4$1.6 million and $-0- at March 31,September 30, 2020 and December 31, 2019, respectively.
Stock-Based Compensation
Periodically, we issue restricted common shares or options to purchase our common shares to our officers, directors, or employees. We measure compensation costs for equity awards at their fair value on their grant date and expense these costs over the service period on a straight-line basis. The fair value of stock awards is based on the quoted price of our common stock on the grant date. The fairWe use the Black-Scholes valuation model to determine the value of option awards is determined using the Black-Scholes valuation model.awards.
Intangible Assets – Internal Use Software
We capitalize costs to develop or purchase computer software for internal use which are incurred during the application development stage. These costs include fees paid to third parties for development services and payroll costs for employees' time spent developing the software. We expense costs when incurred during the preliminary project stage and the post-implementation stage.
Capitalized development costs will be amortized on a straight-line basis over the estimated useful life of the software. The capitalization and ongoing assessment of recoverability of development costs requires considerable judgment by management with respect to certain external factors, including, but not limited to, technological and economic feasibility, and estimated economic life.
Savings Plan
We have a savings plan that qualifies under Section 401(k) of the Internal Revenue Code. Under our 401(k) plan, eligible employees may contribute a portion of their pre-tax earnings, subject to certain limitations. As a benefit, we match 100% of each employee’s first 3% of contributions, then 50% of each employee’s contribution beyond 3%, up to a maximum match of 4% of the employee’s eligible earnings.
Earnings per Share
We calculate basic earnings (loss) per share by dividing net income or loss available to common stockholders by the weighted average number of common shares outstanding. We do not include the impact of any potentially dilutive common stock equivalents in our basic earnings (loss) per share calculations. 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 December 31, 2019September 30, 2020 totaled approximately 29,000.17,000.
Diluted common shares outstanding were calculated using
We use the treasury stock method and areto calculate the diluted common shares outstanding which were as follows:
| | | |
| | | | | | |
Weighted average number of common shares used in basic net income per common share | 13,533,247 | 9,939,668 | 13,573,086 | 12,927,634 | 13,551,507 | 10,939,318 |
Dilutive effects of stock options | 1,753 | - | 1,777 | - | 2,112 | - |
Weighted average number of common shares used in diluted net income per common share | 13,535,000 | 9,939,668 | 13,574,863 | 12,927,634 | 13,553,619 | 10,939,318 |
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.
The carrying amounts of cash and cash equivalents, accounts receivable, accounts payable and all other current liabilities approximate fair values due to their short-term nature. The fair value of notes receivable approximates the outstanding principal balance, net of estimates for losses, and areis reviewed for impairment at least annually.
| | | | |
| | | | | | |
Cash | 1 | $10,040,828 | $4,187,450 | 1 | $10,297,147 | $4,187,450 |
Notes receivable | 2 | 9,605,114 | 11,409,709 | 2 | 8,521,897 | 11,409,709 |
Accounts receivable | 2 | 24,426,333 | 28,201,279 | 2 | 24,024,564 | 28,201,279 |
Discontinued Operations
During the third quarter ended September 29,of 2019, we sold substantially all of the offices we acquired in the Merger with Command Center.Merger. Accordingly, we present the assets and liabilities, operating results, and cash flows for these businesses and previously company-owned offices as discontinued operations separate from our continuing operations for all periods presented in our consolidated financial statements and footnotes, unless indicated otherwise.
Recently Adopted Accounting Pronouncements
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 adopted as of January 1, 2019. The adoption of this guidance did not have a material impact on expense recognition. 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. 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, 2022, 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 financial statements and related disclosures.
In December 2019, the FASB issued ASU No. 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes (“ASU 2019-12”). ASU 2019-12Taxes. The standard was issued as a means to reduce the complexity of accounting for income taxes for those entities that fall within the scope of the accounting standard. The guidance is to be applied using a prospective method, excluding amendments related to franchise taxes, which should be applied on either a retrospective basis for all periods presented or a modified retrospective basis through a cumulative-effect adjustment to retained earnings as of the beginning of the fiscal year of adoption. We are currently evaluating the impacts of adoption of the new guidance to our consolidated financial statements.
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, andor cash flows.
Note 2 – Acquisitions
On July 15, 2019, Command Center completed its acquisition of Legacy HQ in accordance with the terms of the Agreement and Plan of Merger dated April 8, 2019.HQ. Upon the closing of the Merger, all of the membership interests in Hire Quest Holdings, LLC were converted into the right to receive 68% of the Company’s common stock outstanding immediately after the closing, or 9,939,668 shares.
We accounted for the Merger as a reverse acquisition. As such, Legacy HQ is considered the accounting acquirer and Legacy HQ's historical financial statements replace Command Center’s historical financial statements following the completion of the Merger. The results of operations of both companiesthe combined company are included in our financial statements for all periods beginning July 15, 2019.
The fair value of the purchase consideration is calculated based on the Company's stock price on the NASDAQ Capital Market as it is considered to be more reliable than the fair value of the membership interests of Legacy HQ, a private company.company, Legacy HQ. 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 adjustment to the values presented below:date:
Common stock | 4,677,487
|
Closing share price on July 15, 2019 | $5.76 |
Common stock | 4,677,487 |
Stock consideration | $26,942,325 |
| |
Accounts receivable | $10,480,907 |
Cash and cash equivalents | 5,376,543 |
Identifiable intangible assets | 17,015,857 |
Other current assets | 725,453 |
Property, plant and equipment, net | 281,186 |
Right-of-use asset | 1,642,695 |
Current liabilities | (3,124,081) |
Lease liabilities | (1,624,461) |
Deferred tax liability | (2,930,947) |
Other liabilities | (900,827) |
Preliminary purchasePurchase 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 | $3,218,606 | $3,139,158 | $9,563,135 | $9,276,714 |
Net income | 1,971,133 | 504,651 | 4,003,313 | 3,515,142 |
Basic earnings per share | $0.15 | $0.04 | $0.30 | $0.27 |
Basic weighted average shares outstanding | 13,573,086 | 13,238,818 | 13,551,507 | 13,281,839 |
Diluted earnings per share | $0.15 | $0.04 | $0.30 | $0.27 |
Diluted weighted average shares outstanding | 13,574,863 | 13,248,615 | 13,553,619 | 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.
Note 3 – Discontinued Operations
Prior to SeptemberOctober 2019, we operated a number of company-owned offices. Subsequently, all ownedAll of these company-owned offices were sold. Thesold, the vast majority of these offices became franchisees. As a result,becoming franchisees, and we now no longer operate any company owned offices and operatingcompany-owned offices. Operating results from company-owned locationsoffices are included in our consolidated financial statements as discontinued operations. The income from discontinued operations as reported on our consolidated statements of operations was comprised of the following amounts:
| |
| | |
Revenue | $-
| $179,747
|
Cost of staffing services | -
| 149,288
|
Gross profit | -
| 30,459
|
SG&A | -
| 4,190
|
Net income before tax | -
| 26,269
|
Provision for income taxes | -
| 6,567
|
Net income | $-
| $19,701
|
| | |
| | | | |
Revenue | $- | $13,551,950 | $- | $13,934,276 |
Cost of staffing services | - | 9,390,509 | - | 9,710,757 |
Gross profit | - | 4,161,441 | - | 4,223,519 |
Gain on sale | - | 393,697 | - | 393,697 |
Selling, general and administrative expense | - | (3,644,907) | - | (3,653,541) |
Net income before tax | - | 910,231 | - | 963,675 |
Provision for income taxes | - | 227,557 | - | 240,919 |
Net income | $- | $682,674 | $- | $722,756 |
We continue to be involved with the offices we sold through franchise agreements. The term of our franchise agreementsagreement is five years, subject to renewal at the end of the current term. For the quarter ended March 31, 2020 and March 31, 2019, approximately $783,000 and $-0- is included in royalty revenue in our consolidated statement of operations that originatedFranchise royalties from sold locations that subsequently became franchisees.
franchisees were approximately $681,000 and $708,000, for the three months ended September 30, 2020 and September 29, 2019 respectively. Franchise royalties from these locations were approximately $2.0 million and $708,000 for the nine months ended September 30, 2020 and September 29, 2019, respectively.
Note 4 – Related Party Transactions
Some significant shareholders of HQI also own portions of Hire Quest Financial, LLC; Hirequest Insurance Company; Brave New World Services, LLC, formerly known as Hire Quest LTS, LLC; Jackson Insurance Agency, Bass Underwriters, Inc. and its related entities;Inc; Insurance Technologies, Inc.; and a number of our franchisees.
Hire Quest Financial LLC (“HQF”)
Richard Hermanns, our President, CEO, Chairman of our Board, and most significant stockholder, and Edward Jackson, a member of our Board and a significant stockholder, own a majority of HQF, a financial services entity.
On July 14, 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.Merger. At March 31,September 30, 2020 and December 31, 2019, HQI was not indebted to HQF for any amount. We currentlydo not have noany current or planned business dealings with HQF.
Hirequest Insurance Company (“HQ Ins.”)
Mr. Hermanns, his wife, his adult daughter, a trust established for the benefit of his children, and Mr. Jackson, collectively own a majority of HQ Ins., a North Carolina protected cell captive insurance company. Effective March 1, 2010, Hire Quest, LLC purchased a deductible reimbursement insurance policy from HQ Ins. to cover losses up to the $500,000 per claim deductible on the Hire Quest, LLC high-deductible workers’ compensation policy originally obtained through AIG and, later, through ACE American Insurance Company.policy. Hire Quest, LLC terminated its policy with HQ Ins. on July 15, 2019 upon the closing of the Merger.For additional information related to our workers’ compensation insurance, see Note 6 – Workers’ Compensation Insurance and Reserves.
Premiums invoiced by HQ Ins. to HQI and Legacy HQ for workers compensation deductible reimbursement insurance during the quartersthree months ended March 31,September 30, 2020 and March 31,September 29, 2019 were approximately $-0- and $1.8approximately $262,000, respectively. Premiums invoiced by HQ Ins. to HQI and Legacy HQ for workers compensation deductible reimbursement insurance during the nine months ended September 30, 2020 and September 29, 2019 were $-0- and approximately $3.6 million, respectively. We currentlydo not have noany current or planned business dealings with HQ Ins. other than cooperating to close Legacy HQ's workers' compensation claims.
Brave New World Services, LLC, (“BNW”) formerly known as Hire Quest LTS, (“HQ LTS”)LLC
Mr. Jackson and Mr. Hermanns' son-in-lawfamily members collectively own a majority of HQ LTS.BNW.
Historically, HQ LTSBNW employed the personnel at Legacy HQ headquarters. HQI terminated this relationship on July 15, 2019 upon the closing of the Merger. Amounts invoiced by BNW to HQI and Legacy HQ LTS invoiced usfor payroll services during the three months ended September 30, 2020 and September 29, 2019 were $-0- and approximately $7,000, respectively. Amounts invoiced by BNW to HQI and Legacy HQ for payroll services during the quarternine months ended March 31, 2019.September 30, 2020 and September 29, 2019 were $-0- and approximately $19,000, respectively. We currentlydo not have noany current or planned direct business dealings with HQ LTS.BNW. Since BNW now serves as a management company for the Worlds Franchisees (defined below), we will have a franchisor-franchisee relationship with BNW's customers.
Jackson Insurance Agency ("Jackson Insurance") and Bass Underwriters, Inc. ("Bass")
Mr. Jackson owns a majority of Jackson Insurance. An immediate family member owns the remainder. Mr. Jackson, Mr. Hermanns, and irrevocable trusts set up by each of them, collectively own a majority of Bass, a large managing general agent. Jackson Insurance and Bass brokered Legacy HQ's property, casualty, general liability, and cybersecurity insurance prior to the Merger. Since July 15, 2019, they have brokeredcontinued to broker these same policies for the Company.HQI. Jackson Insurance also brokers certain insurance policies on behalf of some of our franchisees, including the Worlds Franchisees.Franchisees (defined below).
Premiums, taxes, and fees invoiced by Jackson Insurance and Bass to HQI and Legacy HQ for these insurance policies during the Company'sthree months ended September 30, 2020 policesand September 29, 2019 were approximately $561,000 in$178,000 and $369,000, respectively. Premiums, taxes, and fees invoiced by Jackson Insurance and Bass to HQI and Legacy HQ for these insurance policies during the first quarter of 2020. These entities invoiced Hire Quest, LLCnine months ended September 30, 2020 and September 29, 2019 were approximately $240,000 in the first quarter of 2019.$726,000 and $608,000, respectively. Jackson Insurance and Bass do not retain the majority of the premiums invoiced to HQI and Legacy HQ, but they do retain a commission of approximately 9% - 15% of premiums depending on the market.premiums.
Insurance Technologies, Inc. ("Insurance Technologies")
Mr. Jackson, Mr. Hermanns, and irrevocable trusts set up by each of them, collectively are theown a majority owners of Insurance Technologies, an IT development and security firm. On October 24, 2019, the CompanyHQI entered into an agreement with Insurance Technologies to add certain cybersecurity protections to our existing information technology systems and to assist in developing future information technology systems within our HQ Webconnect software. This arrangement was reviewed and approved by the Audit Committee of our Board of Directors and is monitored by the Audit committee on an ongoing basis.
During the three months ended September 30, 2020, Insurance Technologies invoiced the CompanyHQI approximately $50,000 in the first quarter of 2020for services provided pursuant to this agreement.
Insurance Technologies invoiced HQI approximately $135,000 during the nine months ended September 30, 2020.
The Worlds Franchisees
Mr. Jackson and immediate family members of Mr. Hermanns have significant ownership interests in certain of our franchisees (the “Worlds Franchisees”). There were 2021 Worlds Franchisees at March 31,September 30, 2020 that operated 48 of our 135138 offices.
Transactions regarding the Worlds Franchisees are summarized below:
| | |
| | | | |
Franchisee royalties | $1,196,956 | $1,723,981 | $3,659,851 | $5,017,479 |
Balances regarding the Worlds Franchisees are summarized below:
| | | | |
Due to franchisee | $1,034,194 | $993,495 | $497,397 | $993,495 |
Risk management incentive program | 1,186,135 | 1,027,960 | 914,464 | 1,027,960 |
Transactions regarding the Worlds Franchisees are summarized below:
| |
| | |
Franchisee royalties | $1,373,876 | $1,633,782 |
Note 5 – Line of Credit
In July 2019, we entered into an agreement with Branch Banking and Trust Company, now Truist Bank (“Truist”), for a $30 million line of credit with a $15 million sublimit for letters of credit. At March 31,September 30, 2020, approximately $9.1 million was utilized by outstanding letters of credit that secure our obligations to our workers’ compensation insurance carrier $1and $1.0 million was utilized by a letter of credit that secures our paycard funding account, leaving $19.9 million potentially available under the agreement for additional borrowings. For additional information related to the letter of credit securing our workers’ compensation obligations see borrowingsNote 6 – Workers’ Compensation Insurance and Reserves..
This line of credit is scheduled to mature on May 31, 2024. Outstanding borrowings under the loan agreement currently bear interest at a variable rate equal to the Daily One Month London Interbank Offering Rate (“LIBOR”) 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 March 31,September 30, 2020 the effective interest rate was 2.5%1.40%. A non-use fee of between 0.125% and 0.250% accrues on the unused portion of the line of credit. As collateral for repayment of any and all obligations under this agreement, we granted Truist 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. This agreement requires us to comply with a fixed charge coverage ratio of at least 1.10:1.00, which will be tested quarterly, on a rolling four quarter basis, commencing with the four quarters endingbasis. At September 30, 2020.2020, we were in compliance with this covenant. Our obligations under this agreement are subject to acceleration upon the occurrence of an event of default as defined in the loan agreement.
Note 6 – Workers’ Compensation Insurance and Reserves
Beginning in March 2014, Legacy HQ obtained its workers’ compensation insurance through Chubb Limited and ACE American Insurance Company (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, weLegacy HQ terminated ourits deductible reimbursement policy with HQ Ins. and haveWe assumed the primary responsibility for all claims up to the deductible occurring on or after July 15, 2019. The primary responsibility of all claims occurring before July 15, 2019 remains with HQ Ins. We assumed the Legacy HQ policy with ACE.
Command Center also obtained its workers’ compensation insurance through ACE. Pursuant to Command Center’s most recent policy, which expired on March 1, 2020, ACE provided insurance for covered losses and expenses in excess of $500,000 per incident. Command Center’s ACE policy included 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 were 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, we are effectively self-insured. Per our contractual agreements with ACE, we must provide collateral deposits of approximately $9.1 million, which we accomplished by providing lettersa letter of credit under our agreement with Truist.
For workers’ compensation claims originating in the monopolistic jurisdictions of Washington, North Dakota, Ohio, Washington, 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 financial statements reflect only the mandated workers’ compensation insurance premium liability for workers’ compensation claims in these jurisdictions.
Note 7 – Stockholders’ Equity
Treasury Stock
Effective July 2020, our Board of Directors authorized a one-year repurchase plan for up to 1 million shares of our common stock. During the three months ended September 30, 2020, we purchased 23,638 shares of our common stock at an aggregate cost of approximately $146,000 resulting in an average price of $6.20 per share. Additionally, there were 9,454 restricted shares that did not meet the vesting criteria. These shares are held in treasury.
Dividend
On September 15, 2020, we declared and paid a $0.05 per common share dividend to shareholders of record as of the close of business on September 1, 2020. This amounted to an aggregate cash payment of approximately $678,000. We intend to continue to pay this dividend on a quarterly basis, based on our business results and financial position.
Note 78 – Stock Based Compensation
Employee Stock Incentive Plan
In November 2016, our stockholders approved a stock incentive plan (the “2016 Plan”) under which we arewere authorized to grant awards for up to 500,000 shares of our common stock over the 10-year life of the plan. In June 2020, our stockholders approved a new stock incentive plan (the “2019 Plan”) that replaced the 2016 Plan. Under the terms of the 2019 Plan, we are authorized to grant awards for up to 1.5 million shares of our common stock over the 10-year life of the plan. Outstanding awards under the 2016 Plan remain in effect according to the terms of the plan and the award documents.
In September 2019, our Board approved a share purchase match program to encourage ownership and further align the interests of key employees and directors with those of our shareholders. Under this program, we will match 20% of any shares of our common stock purchased on the open market or granted in lieu of cash compensation by key employees and directors up to $25,000 in aggregate value per individual within any one-year period.calendar year. These shares vest on the second anniversary of the date on which the matched shares were purchased.purchased if the individual is still with the Company. During 2020, we issued 20,014 shares valued at approximately $118,000 under this program. During 2019, we issued 1,639 shares valued at approximately $10,000 under this program.
In September 2020, we issued 25,000 shares of restricted common stock to an employee pursuant to the 2019 Plan valued at approximately $179,000 for services, and to encourage retention. These shares vest over four years, with 50% vesting on September 11, 2021, and 6.25% vesting each quarter thereafter for the next eight quarters. Also in September 2020, we issued 140 shares of restricted common stock pursuant to our share purchase match program valued at approximately $2,000.
In July 2020, we issued 8,874 shares of restricted common stock pursuant to the 2019 Plan valued at approximately $55,000 to non-employee members of our Board of Directors for services. Of these, 7,396 shares have vested and the remaining 1,478 shares vest on the second anniversary of the date of grant. Also in July 2020, we issued 6,468 shares of restricted common stock pursuant to our share purchase match program valued at approximately $40,000.
In June 2020, we issued 30,000 shares of restricted common stock pursuant to the 2019 Plan valued at approximately $188,000 to non-employee members of our Board of Directors for services. These shares vested equally over the following three months.
In April 2020, we issued 8,381 shares of restricted common stock pursuant to the 2016 Plan valued at approximately $53,000 to certain members of our Board of Directors for their services in lieu of cash compensation. Of these, 6,985 shares vested equally over the following three months, and the remaining 1,396 shares vest on the second anniversary of the date of grant.
In January 2020, we issued 10,124 shares of restricted common stock pursuant to the 2016 Plan valued at approximately $70,000 to certain members of our Board of Directors for their services in lieu of cash compensation. Of these, 10,124 shares, 8,436 shares vestvested equally over the following three months, and the remaining 1,688 shares vest on the second anniversary of the date of grant.grant date. Also in January 2020, we issued 8,582 shares of restricted common stock pursuant to our share purchase match program valued at approximately $59,000.
In November 2019, we issued 9,833 shares of restricted common stock pursuant to the 2016 Plan valued at approximately $59,000 to certain members of our Board of Directors for their services in lieu of cash compensation. Of these, 9,833 shares, 8,194 shares vestvested equally over the following three months, and the remaining 1,639 shares vest on the second anniversary of the date of grant. Also in November of 2019, we issued 4,202 shares of restricted common stock pursuant to the 2016 Plan valued at $25,000 to an employee in lieu of cash for a bonus, which vestvested equally over the following three months.
In September 2019, we issued 160,000 shares of restricted common stock to certain key employees pursuant to the 2016 Plan valued at approximately $1.1 million for services and to encourage retention. 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. TheseOne third of these shares vest equally over approximately three years with the first vesting occurring the day before our annual stockholder meeting to be held invested on June 14, 2020, and the remainder vestingwill vest in equal portionsproportions on each of the first two anniversaries of that date.
The following table summarizes our restricted stock outstanding at December 31, 2019, and changes during the quarternine months ended March 31,September 30, 2020.
| | Weighted average grant date price | | Weighted average grant date price |
Non-vested, December 31, 2019 | 255,634 | $7.18 | 255,634 | $7.18 |
| 18,706 | 7.15 | 97,570 | 6.60 |
Forfeited | | (1,954) | 6.92 |
| (14,057) | 6.69 | (62,777) | 6.34 |
Non-vested, March 31, 2020 | 260,283 | 7.32 | |
Non-vested, September 30, 2020 | | 288,473 | 7.97 |
Stock options that were outstanding at Command Center were deemed to be issued on the date of the Merger. Outstanding awards continue to remain in effect according to the terms of the Command Center 2008 Plan, the 2016 Plan, and the corresponding award documents. There were approximately 17,000 and 24,000 stock options vested at March 31,September 30, 2020 and December 31, 2019.2019, respectively ..
The following table summarizes our stock options outstanding at December 31, 2019, and changes during the quarternine months ended March 31,September 30, 2020:
| Number of shares underlying options | Weighted average exercise price per share | Weighted average grant date fair value |
Outstanding, December 31, 2019 | 29,165 | $7.20 | $3.46 |
Granted | - | - | - |
Forfeited | - | - | - |
| - | - | - |
Outstanding, March 31, 2020 | 29,165 | 7.20 | 3.76 |
| Number of shares underlying options | Weighted average exercise price per share | Weighted average grant date fair value |
Outstanding, December 31, 2019 | 29,165 | $7.20 | $3.76 |
Forfeited | (12,083) | 8.76 | 4.34 |
Outstanding, September 30, 2020 | 17,082 | 6.10 | 3.36 |
The following table summarizes our non-vested stock options outstanding at December 31, 2019, and changes during the quarternine months ended March 31,September 30, 2020:
| Number of shares underlying options | Weighted average exercise price per share | Weighted average grant date fair value |
Non-vested, December 31, 2019 | 5,416 | $5.48 | $3.01 |
| - | - | - |
| - | - | - |
| - | - | - |
Non-vested, March 31, 2020 | 5,416 | 5.48 | 3.01 |
| Number of shares underlying options | Weighted average exercise price per share | Weighted average grant date fair value |
Non-vested, December 31, 2019 | 5,416 | $5.48 | $3.01 |
Vested | (3,228) | 5.47 | 2.98 |
Non-vested, September 30, 2020 | 2,188 | 5.50 | 3.05 |
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 $5.97$7.61 at March 31,September 30, 2020:
| Number of shares underlying options | Weighted average exercise price per share | Weighted average remaining contractual life (years) | Aggregate intrinsic value | Number of shares underlying options | Weighted average exercise price per share | Weighted average remaining contractual life (years) | Aggregate intrinsic value |
Outstanding | 29,165 | $7.20 | 4.47 | $36,171 | 17,082 | $6.10 | 5.92 | $39,703 |
Exercisable | 23,749 | 7.59 | 3.64 | 32,334 | 14,894 | 6.18 | 5.66 | 23,053 |
At March 31,September 30, 2020, there was unrecognized stock-based compensation expense totaling approximately $1.3$1.0 million relating to non-vested options and restricted stock grants that will be recognized over the next 3.32.9 years.
Note 89 – Commitments and Contingencies
Franchise Acquisition Indebtedness
WeNew franchisees financed the purchase of several offices by new franchisees with notes receivable.promissory notes. In some instances, this financing resulted in certain franchises being considered VIEs. We have determined that we are not required to consolidate these entities because we do not have the power to direct these entities’ daily operations. If these franchises default on these notes, we bear the risk of loss of the outstanding balance on these notes, less what we could recoup from the potential resale of the repossessed office. The balance due from the franchises determined to be VIEs on March 31,September 30, 2020 and December 31, 2019 was approximately $2.2 million and $2.5 million.million, respectively.
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 March 31,September 30, 2020.
Note 910 – Income Tax
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 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. For additional information related to our notes receivable, see changesNote 10 – Notes Receivable..
Our effective tax rate for the quarterthree and nine months ended March 31,September 30, 2020 was 18.5%.17.0% and 14.1%, respectively. The bulk of the difference between the statutory federal income tax rate of 21.0% and our effective income tax rate results primarily from the federal Work Opportunity Tax Credit. This tax credit is designed to encourage employers to hire workers from certain targeted groups with higher than average unemployment rates. Other differences between the statutory federal income tax rate of 21.0% and our effective tax rate result from state income taxes, certain non-deductible expenses, and tax effects of stock-based compensation. Our effective tax rate for the three and nine months ended September 29, 2019 was negative 126.0% and 1,413.4%, respectively. The bulk of the difference between the statutory federal income tax rate of 21.0% and our effective income tax rate is related to Legacy HQ having been a pass-through entity before the Merger, and subsequently changing to the accrual basis of accounting from the cash basis of accounting for tax reporting purposes.
Note 1011 – Notes Receivable
Some franchisees, as well as the purchaser of our previously owned California locations, have borrowed funds from us primarily to finance the initial purchase price of sold locations.office assets. Notes outstanding net of allowance for losses were approximately $9.6$8.5 million and $11.4 million as of March 31,September 30, 2020 and December 31, 2019, respectively, net of allowance for losses.respectively.
Notes receivable bear interest at a fixed rate between 6.0% and 10.0%. Notes are generally secured by the assets of each locationoffice and the ownership interests in the franchisee. Interestfranchise. We report interest income on franchisee notes is reported inas other miscellaneous income in our consolidated statements of operations andoperations. This interest income was approximately $198,000$177,000 and $-0- in$88,000 during the quartersthree months ended March 31,September 30, 2020 and March 31,September 29, 2019, respectively, and approximately $551,000 and $91,000 during the nine months ended September 30, 2020 and September 29, 2019, respectively.
We estimate the allowance for losslosses for franchisees discretelyseparately from the allowance for losslosses from non-franchisees because of the level of detailed sales information available to us.us with respect to the former. There have been no historic losses for either segment.
Based on our review of the financial condition of the borrowers, the underlying collateral value, and the potential future impact of COVID-19 on certain borrowers’ economic performance and estimated future cash flows, we have established an allowance of approximately $1.4$1.6 million as of March 31,September 30, 2020 for potentially uncollectible notes receivable. There were no loansnotes receivable in default as of March 31,September 30, 2020.
The following table summarizes changes in our notes receivable balance to franchisees:
Balance as of December 31, 2019 | $9,702,471 |
Notes issued | 38,00084,629 |
Accrued interest | 60,986 |
Payments received | (438,4101,434,755) |
Change in valuation allowance | (366,472405,313) |
Balance as of March 31,September 30, 2020 | $8,935,5898,008,018 |
The following table summarizes changes in our notes receivable balance to non-franchisees:
Balance as of December 31, 2019 | $1,707,238 |
Accrued interest | 43,155130,414 |
Total unpaid balancePayments received | 1,750,393(130,414) |
Change in valuation allowance | (1,080,8681,193,359) |
Balance as of March 31,September 30, 2020 | $669,525513,879 |
Note 11 - Subsequent Events19
Issuance of Common Stock
In April 2020, we issued 8,381 shares of restricted common stock pursuant to the 2016 Plan valued at approximately $52,000 to certain members of our Board of Directors for their services in lieu of cash compensation. Of these 8,381 shares, 6,985 shares vest equally over the following three months, and the remaining 1,396 shares vest on the second anniversary of the date of grant.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Special Note Regarding Forward-Looking Statements
This Quarterly Report on Form 10-Q for the quarter ended March 31, 2020 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; and the factors discussed in the “Risk Factors” section herein and elsewhere in our most recent Annual Report on Form 10-K which we filed with the SEC on March 30, 2020.2020; 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 March 31,September 30, 2020, we had 135138 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.
COVID-19
The recent coronavirus pandemic has already had, and we expect it to continue to have, a significant impact onsignificantly impacted our operations. In March 2020, infections of the novel coronavirus disease ("COVID-19") had become pandemic with persons testing positive in all fifty states and the District of Columbia. With widespread infection in the United States and abroad, national, state, and local authorities recommended social distancing and have takentook dramatic action, including without limitation, 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, serious adverse impacts on domesticour business and foreign economiesthe 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 uncertain duration.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. Most economists are predicting the United States will soon enter, or may already have entered, a recession.
We entered 2020 prepared for a potential economic downturn with a strong balance sheet. Our assets exceeded liabilities by more than $30$28 million. In the first quarternine months of 2020, we significantly improved our already-strong cashliquidity position, primarily by converting accounts receivable into cash. Current assets improved from $37.0 million on December 31, 2019 to $10 million. The$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 makes it extremely difficult to predict howhas depressed our business operations will be affected in the long term. But the likely overall impact of the pandemic is viewed as highly negative to the general economy. The COVID-19 outbreak has negatively impacted our operationssystem-wide sales and revenue as well as those of our franchisees.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 into April and May. Ourthrough our third quarter. On a month-to-month basis, our system-wide sales appeared to be consistent for the last few weeks ofhave consistently increased since April, however, they were lower than system-wide sales in March,the third quarter of 2019, and we expect negative impacts on system-wide sales and resulting revenue in the secondfourth quarter, and perhaps,likely beyond. WhatIt remains unclear and difficult to predict is the length of timehow long we will stay at this comparatively reduced level of sales.
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 potential 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. We have witnessed a significant drop in the amount of hospitality, event service, catering, and auto auction business thatDespite tough economic conditions, our franchisees do. Our other lines of business may sufferhave also opened 4 new offices in the future as well. For example, in a small number of jurisdictions our customers have been declared non-essential businesses causing business to slow extensively. Some of our other customers may choose voluntarily to close their worksites. To date, however, our business remails open, and we continue to provide key services to essential businesses.
2020.
In response to currentdepressed economic conditions, we are taking appropriatetook measures to control and reduce selling, general, and administrative expense ("SG&A"). In addition, we placed a reserve of $1.4$1.6 million on the promissory notes we hold from our franchisees and the purchaserspurchaser of our previously owned California offices. We calculated the reserve based on our review of the financial condition of the borrowers and of the underlying collateral. This reserve arose directly out of the impacts of COVID-19. We believed such a reserve would assist us in dealing with non-payment or delayed payment of portions of these notes.
As discussed more fully below, our already strong liquidity position has improved since December 31, 2019 because of decreased funding requirements for temporary employees which has causedand the decrease in our accounts receivable to bebalance as amounts are collected and converted to cash upon collection. We increasedcash. As a result, we have been able to increase our cash balance by approximately $5.8$6.1 million inthrough the firstthird quarter of 2020 from $4.2 million at year end to $10.0$10.3 million. When combined with our borrowing capacity under our line of credit and lackabsence 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.
Results of Operations
Financial Summary
The following table displays our consolidated statements of operations for the quartersinterim periods ended March 31,September 30, 2020 and March 31,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.”
| | | |
| | | | | | |
Franchise royalties | $3,705 | 89.9% | $3,156 | 90.9% | $3,219 | 95.1% | $3,139 | 95.3% | $9,563 | 91.9% | $9,277 | 92.7% |
Service revenue | 415 | 10.1% | 316 | 9.1% | 164 | 4.9% | 154 | 4.7% | 841 | 8.1% | 727 | 7.3% |
Total revenue | 4,120 | 100.0% | 3,472 | 100.0% | 3,383 | 100.0% | 3,293 | 100.0% | 10,404 | 100.0% | 10,004 | 100.0% |
Selling, general and administrative expenses | 3,253(1) | 79.0% | 1,552 | 44.7% | 1,358 | 40.1% | 7,394 | 224.5% | 6,542 | 62.9% | 9,817 | 98.1% |
Depreciation and amortization | 32 | 0.7% | 14 | 0.4% | 32 | 1.0% | 40 | 1.2% | 97 | 0.9% | 76 | 0.8% |
Income (loss) from operations | 835 | 20.3% | 1,906 | 54.9% | 1,993 | 58.9% | (4,141) | -125.7% | 3,765 | 36.2% | 111 | 1.1% |
Other miscellaneous income | 251 | 6.1% | 28 | 0.8% | 392 | 11.6% | 505 | 15.3% | 932 | 9.0% | 752 | 7.5% |
Interest and other financing expense | (11) | (0.3%) | (185) | (5.3%) | (10) | -0.3% | (106) | -3.2% | (39) | -0.4% | (522) | -5.2% |
Net income before income taxes | 1,074 | 26.1% | 1,749 | 50.4% | |
Provision (benefit) for income taxes | 199 | 4.9% | 51 | 1.5% | |
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 | 875 | 21.2% | 1,698 | 48.9% | 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% | 20 | 0.6% | |
Income from discontinued operations, net of tax | | - | 0.0% | 683 | 20.7% | - | 0.0% | 723 | 7.2% |
Net income (loss) | $875 | 21.2% | $1,717 | 49.5% | $1,971 | 58.3% | $(7,776) | -236.2% | $4,003 | 38.5% | $(3,753) | -37.5% |
1.
Includes a reserve of approximately $1.4 million on notes receivable.
QuarterThree Months Ended March 31,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 quarterthree months ended March 31,September 30, 2020 were approximately $3.7$3.2 million, an increase of 17.4%2.5% from $3.2$3.1 million for the three months ended September 29, 2019. Approximately $681,000 of royalties in the third quarter ended March 31, 2019. Of this increase, approximately $783,000 arose from2020 are attributable to the offices acquired through the Merger. RoyaltyAlthough we experienced a year-over-year increase in royalty revenue duringin the last few weeks of the firstthird quarter 2020, average royalty revenue per office in that quarter was negatively impacted by decreased economic activity related to COVID-19. This negative impact continued intoAlthough system-wide sales, and resulting franchise royalties, have been slowly increasing on a month-over-month basis since the second quarter. Webeginning of April, we expect decreased royalty revenue infor the second quarter,remainder of 2020, and perhaps beyond, when comparedrelative 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.
Service revenue for the quarterthree months ended March 31,September 30, 2020 was approximately $415,000, an$164,000, a slight increase of $99,000 from approximately $316,000 in$154,000 for the first quarter ofthree months ended September 29, 2019. This increase is largely related to an increase in interest charged on overdue customer accounts receivable.
Selling, General, and Administrative Expenses (“SG&A”)
SG&A expenses for the quarterthree 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 $3.3$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 109.6%3.1% from $1.6$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 first quarterlast 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 increasedecrease is due to Merger related costs of approximately $4.7 million incurred in 2019. We also saw a $1.4decrease 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. We also had
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 stock-based compensation2019 miscellaneous income was made up primarily of approximately $323,000, an increase in legal and professional fees of $282,000 primarily as a result of increased auditor and legal feesgains related to SEC filings,the sale of property and increased compensation costs of approximately $147,000. These increased costs were offset by a decrease in workers’ compensation costs of approximately $702,000.
In the last few weeks of the first quarter, we significantly cut our payroll costs at our corporate headquarters to partially offset our expectation of decreased revenue resulting from COVID-19.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 in the Merger. In addition, we have the capacity to borrow under our line of credit with Truist.
On March 31,September 30, 2020, our current assets exceeded our current liabilities by approximately $28.5$29.4 million. Our current assets included approximately $10.0$10.3 million of cash and $24.4$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 $3.3 million due to our franchisees, $2.5$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 due in relation to our risk management incentive program.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 20202020. It is difficult to predict whether this trend will continue in the fourth quarter as, COVID-19 decreased our temporary payroll requirements. Our cash balance rose from $4.2 million attraditionally, the end of 2019 to $10.0 million at the endfinal quarter of the firstyear 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, with Truist, will provide adequate resourcesbe sufficient to meetsatisfy our working capital needs, capital asset purchases, and cashother 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
NetDuring 2020, cash providedgenerated by operating activities from continuing operations for the quarter ended March 31, 2020 was approximately $5.5 million. Operating activity for the quarter$6.9 million and included net income of approximately $875,000,$4.0 million and a decrease in accounts receivable ofwhich generated approximately $3.8 million, and an increase in our allowance for losses on notes receivable of approximately $1.4$4.2 million. These provisions were partially offset by an increase in prepaid expenses, deposits, and other assetsworkers’ compensation of approximately $954,000. Net$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 providedused by operating activities from continuing operations for the quarter ended March 31, 2019 was approximately $2.1 million. Operating activity for the first quarter of 2019$1.2 million and included a net incomeloss from continuing operations of approximately $1.7$4.5 million and an increase in accounts receivable of approximately $1.4 million$12.7 million. These uses were partially offset by an increase in the amount due to our franchisees. These provisions were offsets by a decrease in accounts payablefranchisees of approximately $1.1$4.7 million and an increase in other current liabilities of approximately $4.2 million.
Investing Activities
NetDuring 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 for the quarter ended March 31, 2020 was approximately $323,000. Investing activity for$1.1 million and included proceeds from the first quartersale of 2020 includedproperty and equipment of approximately $574,000 and an increase in franchisee deposits of approximately $643,000 and payments on notes receivable of approximately $438,000, which$666,000. These provisions were partially offset by the purchase of property and equipment of approximately $677,000. Net cash provided by investing activities for the quarter ended March 31, 2019 was approximately $875,000 and was primarily due an increase in franchisee deposits.$285,000.
Financing Activities
NetDuring 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 the quarter ended March 31, 2020 was approximately $28,000$316,000 and was due toincluded cash received for the effective issuance of common stock in connection with the Merger of approximately $5.4 million and an increase in amounts due from affiliates. Net cash usedour line of credit of $7.6 million. These provisions were partially offset by financing activities for the quarter ended March 31, 2019 waspurchase of treasury stock of approximately $3.3$8.4 million, and was primarilya decrease in the amount due to payments to affiliates of approximately $3.1$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 offices that we ownedsales at company-owned and operated offices as “company-owned offices.sales.” Sales at company-owned officesCompany-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 sales at company-owned officessales 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 franchisesystem-wide sales as revenue, management believes that information on system-wide sales is important to understanding the Company’sour 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 theour 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.
During the first quarter of 2020, all of our offices were franchised. Accordingly,As such, system-wide sales for the first quarter ofthree and nine months ended September 30, 2020 were all produced atderived from franchised offices. The following table reflects our system-wide sales broken into its components for the periods indicated:
| | | |
| | | | | | |
Franchise sales | $56,462,605 | $47,384,474 | $55,626,751 | $60,626,049 | $156,163,051 | $159,768,691 |
Company-owned sales | - | 179,747 | - | 13,551,950 | - | 13,934,276 |
System-wide sales | $56,462,605 | $47,564,221 | $55,626,751 | $74,177,999 | $156,163,051 | $173,702,967 |
System-wide sales were $56.4$55.6 million infor the first quarter ofthree months ended September 30, 2020, up $8.9down $18.6 million, or 18.7% over25.0% compared to the first quarter ofthree months ended September 29, 2019. The increasedecrease in system-wide sales arose largelyis 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 July 2019 via the Merger.
In the closing weeks of the first quarter of 2020, we experienced a substantial decline in week-over-week system-wide sales.sales as a direct result of COVID-19. This decline hasdepressed level of system-wide sales compared to historical averages continued throughout the third quarter and into the secondfourth quarter. TheWe have started to see week-over-week system-wide sales appearedimprove, which has slowly begun to stabilize atshrink the gap between 2020 and 2019 comparative week-over-week sales. We believe this trend is a decreased level in the last few weeksresult of April. Wemany states reopening their economies. However, we still expect system-wide sales to be materially lower than historical averages in the secondfourth quarter of 2020, and perhaps, beyond.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 quarternine months of 2020.
Franchised Offices,offices, December 31, 2019 | 147 |
Closed or consolidated in 2020 | (13) |
Opened in 2020 | 14 |
Franchised Offices, March 31,offices, September 30, 2020 | 135138 |
Office closures and consolidations in the first quarter of 2020 were largely related to the economic impacts of COVID-19. Of the 13These closures or consolidations, 11 were mostly in metropolitan areas where our franchisees still maintain one or multipleserviced by other offices. The remaining 2 offices, Findlay, OH and Flagstaff, AZ, did not historically produce significant amounts of system-wide sales and resulting revenue. 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. A franchisee opened one office
Off-Balance Sheet Arrangements
We do not engage in Rock Hill, South Carolina.
any off-balance sheet financing arrangements.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
We are a “smaller reporting company” as defined by Regulation S-KRule 12b-2 of the Exchange Act, and, as such, we are not required to provide the information contained inrequired by this item pursuant to Regulation S-K.Item.
Item 4. Controls and Procedures
(a) EvaluationUnder the supervision and with the participation of disclosure controls and procedures. Our Chief Executive Officer and our Chief Financial Officer evaluated our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) undermanagement, including the Securities and Exchange Act of 1934, as amended, the Exchange Act), prior to the filing of this Form 10-Q. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer, concluded that, aswe have evaluated the effectiveness of March 31, 2020, our disclosure controls and procedures as required by Exchange Act Rule 13a-15(b) as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that these disclosure controls and procedures are effective as of the end of such period. There were effective.
(b) Changes in internal controls over financial reporting. There have not been anyno changes in our internal control over financial reporting during our last quarter ended March 31, 2020, whichthat have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
PART II. OTHER INFORMATION
Item 1. 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 outcomes of these proceedings, even if determined adversely, will not have a material adverse effect on our business, financial condition, results of operations, or liquidity and capital resources.
ThereOur business, financial condition, and operating results can be affected by a number of factors, whether currently known or unknown, including but not limited to those described below and in Part I, Item 1A of our most recent annual report on Form 10-K which we filed with the SEC on March 30, 2020 under the heading “Risk Factors,” any one or more of which could, directly or indirectly, cause our actual financial condition and operating results to vary materially from past, or from anticipated future, financial condition and operating results. Any of these factors, in whole or in part, could materially and adversely affect our business, financial condition, operating results, and stock price. Except as set forth below, there have been no material changes fromto the risk factors we previously disclosedincluded in our Annual Report on Form 10-K for the year ended December 31, 2019, filed with the Securities and Exchange CommissionSEC on March 30, 2020.
The coronavirus pandemic is a serious threat to health and economic well-being affecting our franchisees, employees, customers and the overall economy.
On March 11, 2020, the World Health Organization announced that infections of COVID-19 had become pandemic, and on March 13, 2020, the President of the United States announced a National Emergency relating to the disease. Since March 13, state and local authorities have taken dramatic action including, without limitation, ordering the workforce to stay home, banning all non-essential businesses from operating, implementing shelter in place orders, refusing to issue new building permits, and invalidating current building permits causing work to stop. There has been widespread infection in the United States and abroad, with a resulting catastrophic impact on human lives, including those of our franchisees and employees, and the economy as a whole, including our customers. In addition to the actions described above, national, state, and local authorities have recommended social distancing and imposed quarantine and isolation measures on large portions of the population and additional mandatory business closures. These measures, while intended to protect human life, have had serious adverse impacts on our business and domestic and foreign economies. They have caused our system-wide sales and resulting revenue to decline. The extent and duration of this decline is uncertain. The ultimate and long-term effectiveness of economic stabilization efforts, including government payments to affected citizens and industries, such as the CARES Act and Paycheck Protection Program, is uncertain.
The sweeping and evolving nature of the COVID-19 pandemic makes it extremely difficult to predict how our business operations will be affected in the long term. But the overall economic impact of the pandemic has been highly negative to the general economy. Our operations have been disrupted by customers decreasing the amount of orders they place for temporary employees, safety measures we and our franchisees have put in place to prevent spread of the virus, and in other ways. The COVID-19 outbreak has had a negative impact on our operations, system-wide sales, and revenue as well as those of our franchisees. 13 of our franchised offices have closed or consolidated into other existing offices at least, in part, due to the impact of COVID-19. It is possible that additional offices may be forced to close. Some of our franchisees have experienced economic hardship including loss of customers or business. A small number of franchisees, as well as the purchaser of our California offices, have experienced difficulty in repaying their financing obligations to us, causing us to set aside a reserve of $1.6 million for that purpose as of September 30, 2020. Others may experience economic hardship or even failure. If the recent resurgence of the virus and infections continues to expand in the fourth quarter of the year, we may be forced to temporarily or permanently close other offices. Our customers may choose to voluntarily close their worksites.
Any of the above factors, or other cascading effects of the coronavirus pandemic that are not currently foreseeable, could materially increase our costs, severely 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. We expect COVID-19 will continue to negatively impact customer demand throughout 2020, and likely beyond. While we expect some recovery in some markets in the final quarter of the year, the impact of COVID-19 on our sales and revenue will likely still be significant. We do not yet know the full extent of the impact of COVID-19 on our business, financial condition and results of operations.
Difficult political or market conditions, natural disasters, global pandemics, or other unpredictable matters could affect our business in many ways including by reducing the amount of available temporary employees, reducing the amount of customer projects, or harming the overall economy which could materially reduce our revenue, earnings and cash flow and adversely affect our financial condition.
Our business is linked to conditions in the overall economy, such as those impacting the ability of our customers to obtain financing, the availability of temporary employees, changes in laws, and catastrophic events such as fires, floods, earthquakes, tornadoes, hurricanes, and pandemics. In particular, the outbreak of COVID-19 has materially affected our business by decreasing activity in the economy overall and negatively impacting the industries our customers are in, especially hospitality, event staffing, auto auctioneering, and similar industries. While we have encouraged our franchisees to implement specific policies which the CDC has suggested could help decrease the spread of COVID-19, and we have not experienced a significant number of infections among our employees, it is possible that COVID-19 could infect a large number of temporary employees removing them from the available worker pool. To date, we have experienced a decline in system-wide sales and resulting revenue due to decreased economic activity. Our franchisees have closed or consolidated 13 offices at least in part due to the negative impacts of the coronavirus. These factors are unpredictable and outside of our control. They may affect the level and volatility of securities prices and the liquidity and value of investments, including investments in our common stock.
Our operating and financial results and growth strategies are closely tied to the success of our franchisees.
With all of our offices being operated by franchisees, we are dependent on the financial success and cooperation of our franchisees. We have limited control over how our franchisees’ businesses are run, and the inability of franchisees to operate successfully could adversely affect our operating and financial results through decreased royalty payments or otherwise. If our franchisees incur too much debt, if their operating expenses increase, or if economic or sales trends deteriorate (including as a result of the global pandemic caused by COVID-19) such that they are unable to operate profitably or repay existing debt, it could result in their financial distress, including insolvency or bankruptcy. To date, a small number of franchisees have had difficulty in servicing the debts they owe to us as a result of the financial impacts of COVID-19. We have placed a reserve on the notes receivable from those franchisees in the amount of approximately $405,000. In addition, franchisees have closed or consolidated 13 offices at least in part due to the impact of COVID-19. If a significant franchisee or a significant number of franchisees become financially distressed, our operating and financial results could be impacted through reduced or delayed royalty payments. A franchisee bankruptcy could have a substantial negative impact on our ability to collect payments due under such franchisee’s franchise agreement. Our success also depends on the willingness and ability of our franchisees to be incentivized to deliver excellent customer service, resolve any issues efficiently, and ensure customer retention. In addition, our success depends on the willingness and ability of our franchisees to implement major initiatives, which may include financial investment. Our franchisees may be unable to successfully implement strategies that we believe are necessary for their further growth, which in turn may harm our growth prospects and financial condition.
Our results of operations may be significantly affected by the ability of certain franchisees and the purchaser of our California offices to repay their loans to us.
Lending money to our franchisees for startup costs and short-term funding is an essential part of our business. While most of our franchisees have historically repaid their loans to us, for various reasons, a small number have not, and there is no guarantee that our franchisees will continue to repay their loans in the future. We extended, for us, unprecedented levels of purchase financing loans in 2019 in connection with the Merger and subsequent sales and conversions of company-owned offices to franchises. In addition, the purchaser of our California office assets financed the transaction by providing us a note for $1.8 million. As a result of the negative impacts of COVID-19, a small number of our franchisees and the California purchaser have already had difficulty in repaying their debts to us. To that end, we placed a reserve of approximately $1.6 million on our notes receivable. The risk of non-payment is affected, among other things, by:
● The overall condition and results of operations of the particular franchise or operating entity;
● Changes in economic conditions that impact specific franchisees, the California purchaser, our industry, or the overall economy;
● The amount and duration of the loan;
● Credit risks of a particular borrower; and
● In terms of collateral, the value of the franchised business or California operations and any individual guarantee we have or have not obtained.
Our borrowers’ ability to repay their loans usually depends upon their successful operation of their business and income stream. Loans we extend to finance the purchase of office assets typically are our largest and riskiest loans; however, given their historical role in driving growth in our overall size and revenue streams, we intend to continue those lending efforts. At September 30, 2020, our loans receivable from franchisees and from the California purchaser, net of an approximately $1.6 million reserve, constituted 17.3% of our assets. If our franchisees or the California purchaser do not repay these loans, it may negatively impact our overall financial condition and results of operations.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Recent Sales of Unregistered Securities
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, hereunto duly authorized.