HireQuest: Part 1

New equity research

These 10 pages compose the first of a series of write-ups on HireQuest. The business runs an asset-light model, is founder led, insider ownership exceeds 50%, with some recently buying more, operated at a 40-50% profit margin until 2023 when it declined to 16%, and it frequently engages in M&A, which appears to be done at very attractive terms. Its market cap is below $500M and it operates in a commonly regarded as boring sector.

Table of Contents:

• Brief history

• Overview of the business’ operations

• Characteristics of its franchising model, different from competitors

• How their working capital funding works

• How their workers’ compensation insurance works

History

HireQuest’s story begins in 1991. Richard Hermanns and Dan McAnnar had worked in the staffing industry, getting to executive roles, and decided to open their own staffing Labor World USA franchises. Richard operated in South Florida and Dan in South Carolina. After three years running their business, they decided to form a more solid partnership and expand into new markets. In 1997, they bought all franchises that Labor World USA had outside of Florida and changed their corporate name to Productivity Partners.

The next year, two trade names were introduced to replace Labor World USA, namely: (i) Trojan Labor, which would serve in the light industrial staffing sector; (ii) Acrux, aimed at skilled and semi-skilled labor. Some of the offices they opened were company-owned but, later that year, the team started pushing forward the franchising model, whereby entrepreneurs could run a franchise under any of both brands and pay a royalty fee. In 2002, HireQuest LLC was born, adopting the name that would carry onward.

In 2004, Richard and Dan acquired 14 Ready Staffing franchises. Three years later, they acquired seven more branches, getting to 42 Trojan Labor locations and four Acrux. By 2013, Hermanns realized that the franchising business model is far superior to the traditional approach. He therefore committed to having the completeness of the network running under a franchise agreement.

Half a decade later, Richard made a very peculiar decision. Having over 70 locations, HireQuest saw an opportunity to undertake the next growth phase. In 2019, they announced their merger with Command Center, a then public company. Command Center had almost the same size as HireQuest, pointing out the path that HireQuest would take thereafter. With this merger, the corporation adopted the name HireQuest, relocated headquarters to where HireQuest was based, Charleston, and the whole team got replaced by HireQuest’s executives. Richard Hermanns became CEO. His long-time partner, Dan McAnnar retired the following year.

Business Overview

HireQuest offers temporary staffing in various industries as well as executive recruitment services. Over time, and mostly due to the acquisitions made, the company has built a small conglomerate of trademarks, all of which serve their own markets. After briefly distilling these brands’ operations, I shall dive into the characteristics of HireQuest’s franchising model.

Broadly speaking, the business works as follows. People are employees of HireQuest’s franchisees, although I will more extensively address this point below, because it is not that simple. Customers ask for temporary staffing solutions to the offices and pay mostly a fixed rate per hour worked. Contracts may differ in time and pay rate. HireQuest earns a percentage of the gross billing that offices generate in the form of royalty fees or over funded payroll.

HireQuest Direct

HireQuest Direct, successor of Trojan Labor, is the most iconic brand that HireQuest owns. It currently has 128 branches across the US and 41 franchise owners. HireQuest Direct offers staffing services ranging from hourly labor to temporary and long-term contracts. They run their own screening, are in charge of the final placement, insurance, payroll, and taxes. The fact of the office being in charge of all paperwork and the hiring process immensely facilitates the fulfillment of clients’ needs, saves them time and resources.

HireQuest Direct serves in industries such as janitorial & cleaning; construction, including site construction, carpentry and others; hospitality for special events, including bartenders, cooks, food runners; operative talent needed for special events like setting it up or security services; traffic control; and warehousing & logistics. The comprehensiveness of HireQuest’s staffing offers allows for turnkey solutions depending on customers’ needs.

TradeCorp is a division of HireQuest Direct, specialized in providing on-demand labor for skilled positions in construction and light industrial. TradeCorp helps electricians, HVAC technicians, plumbers, metal workers and welders. They are continuously hiring people capable of performing these trades and have them readily available for when customers require their services. Conclusively, TradeCorp offers short-term skilled labor for specific construction trades.

Snelling

Snelling was founded in 1951 by Lou and Gwen Snelling. The first office was opened then, and, by the late 60s, the company got to 50 locations. Snelling serves numerous industries and provides on-demand skilled and semi-skilled labor for administrative, engineering, finance, hospitality, manufacturing, light industrial, and commercial needs. In contrast to HireQuest Direct which focuses on daily-work jobs, Snelling focuses on longer-term staffing positions.

Snelling offers three different forms of staffing solutions: (i) direct hire, whereby Snelling does all the screening and filters a few candidates for the firm; (ii) temp-to-hire, where Snelling provides candidates who are then subject to a 90-days trial period, after which the hiring firm decides if they permanently hire them; (iii) temporary staffing.

HireQuest acquired Snelling in 2021, when it had 47 locations and system-wide sales of 87 million dollars. The price paid amounted to $17.9 million and Snelling offices continued to operate under their brand.

DriverQuest

DriverQuest provides companies with commercial and non-CDL (commercial driver’s license) drivers. It serves numerous industries and customers, focusing on the long-haul and last mile segments. DriverQuest was launched in 2021 as a part of management’s plan to add verticals that can be leveraged throughout the network. Franchisees who’d like to offer one of these can opt in. By August of that year, Richard mentioned that over 35 franchisees had already started offering driving services.

HireQuest Health

HireQuest Health provides skilled temporary and direct-hiring staffing solutions within the healthcare space. The company serves hospitals, dental offices, physician groups, clinics, and medical centers. HireQuest Health operates in verticals such as inpatient & outpatient care, home health, hospice, senior care, private practice, pharmaceutical and medical devices, schools, and manufacturing & supply chain.

In 2021, HireQuest acquired Dental Power (DPS) for 1.9 million dollars. Dental Power was a 46+ years old family-owned business that provides staffing solutions for dental practice, including temporary and long-term contracts. The company counted with multiple long-term client relationships and a nationwide network with more than 100 thousand dental professionals. Dental Power had presumably generated $3.5 million in sales over the prior 12 months.

Thereafter, DPS operated as a subsidiary of HireQuest and kept its brand. Jamie Understein had been DPS’ president for 22 years at the time of the acquisition and remains a consultant for HireQuest. In March of 2023, HireQuest sold DPS’ assets to one of MRI’s franchisees, who would continue to run the business as part of their franchise.

“I am also so delighted to be passing along the Dental Power flagship services, started by my mother in 1975, to another successful family founded company.” Jaime Understein

Management Recruiters International

Management Recruiters International (MRI) was founded in 1965 by Alan Schonberg. MRINetwork has over 200 offices around the world, mostly in the US, and connects firms with candidates, ranging from graduates to high-level executives. MRI has been an industry leader for several decades, working with all types of companies, from startups to Fortune 500s, and has done more than 800 thousand placements worldwide.

In 2019, Bert Miller acquired MRI through a vehicle he controlled, named MRI Network Holdings, after which the company was renamed. Bert founded Protis Global, an executive recruitment firm focused on the beverages, consumer products, healthcare, and pet industries in 1995. He led it until the acquisition of MRI, whereupon he focused on strengthening MRI’s network-centric model. Since Protis Global inception, the firm has been part of MRI’s network.

HireQuest acquired MRINetwork in December of 2022 for approximately 13.3 million dollars from Miller. At the moment of the acquisition, MRI had around 210 active franchises and presumably generated $283 million in system-wide sales. MRI kept operating as a subsidiary, keeping its brand.

This acquisition complemented HireQuest’s business, helping HireQuest expand into the executive recruitment market.  It must be observed, however, that MRI also counts with a contract labor division, which, at the time of the acquisition, had over 50 million dollars in system sales.

Sales Consultants and Northbound are the two other trademarks that offer executive recruitment services. Nonetheless, it is to be observed that, similar to MRI, many franchisees offer short-term staffing services and advisory as well.

Northbound Executive Search was founded in 2010 in New York, wherein most of its operations reside. It provides short-term advisory services and mostly serves blue-chip corporations in the financial industry. Northbound was acquired by HireQuest in February of 2022 for approximately 11.4 million dollars.

Franchising Model

HireQuest runs a franchising business model. Offices that operate under one of HireQuest’s trademarks are franchisee-owned and pay a royalty fee to HireQuest. It must be observed, however, that some are company-owned and held for sale. The latter is the natural consequence of their M&A model, in which I’ll dive in the next write-up.

Offices are managed and run by the owner, who typically hires in-office personnel, recruiters to bring employees in, and business development staff. These costs are incurred by the respective franchises. HireQuest provides guidance and assistance when needed. They have “substantially less control over a franchisee’s operations than we would if we owned and operated an office ourselves.”

Management believes that franchisees owning the offices helps align incentives and impactfully enhances performance. Operators’ income will depend on how well their unit performs, hence making them have a personal interest in ensuring success. HireQuest has several programs to reward franchisees who execute well.

Several advantages further arise from the franchising model, probably the most important of which is the nimbleness and agility that result from the decentralization of control. When customers approach an office, it is in the owner’s best interest to serve them rapidly and efficiently. Their response will determine if clients hire them, and their service will dictate whether they come back or not.

The staffing industry has tended towards webs of long-lasting relationships, which is partly what causes it to be highly fragmented, with local players not being displaceable. Opportunities to forge new long-term relationships occasionally emerge and it seems better to have franchisors with strong personal interest in ceasing these.

Additionally, local ownership entails having a franchisee, or manager, that is most likely thinking about remaining in their position for a long time and that’s in charge of a single office. Their horizon and personal commitment lead to closer and better managed relationships with clients and employees. As a side note, it is to be observed that some franchisees have multiple franchises.

Owner-operators are also inclined to better handle the high turnover that’s present in the staffing industry. Most employees seek these firms temporarily, some may be permanently hired by another firm, and contracts are short term. A franchisee who’s personally interested in the branch performing well will be incentivized to appropriately deal with this large obstacle.

Direct dispatch

The remaining feature that characterizes some of HireQuest’s operations is their direct-dispatch approach, especially in the construction and light industrial segments. Employees go to the offices and are then sent toward their daily activity’s location. Management believes this dramatically increases the consistency with which HireQuest is able to fulfill their obligations. This drives customers’ satisfaction, makes the service more valuable, for it is more reliable, and eliminates a huge problem inherent to the staffing industry.

Additionally, a direct-dispatch approach addresses the main reason why the staffing industry came about in the first place. The latter arose in response to customers’ shift in labor needs. Some businesses are highly cyclical and cannot know when cycles turn. Peaks come somewhat suddenly, and managing cycles oneself ends up being a costly endeavor. Hiring, recruiting, interviewing, and workers’ compensation insurance are resource intensive, affecting companies’ bottom line. They may therefore conclude it’s safer to hire temporary employees during upticks in demand

Having a workforce immediately ready for when these companies require it is capital intensive but lays the ground for a competitive advantage. Delivering a better service is one of the only ways in which staffing companies can compete. Moreover, due to the aforementioned profitability dilemma, customers are happy to utilize staffing companies’ services.

“We believe we are one of the largest providers of direct-dispatch temporary staffing solutions in the light industrial and blue-collar segments of the staffing industry measured by number of offices” 2023 annual report

Centralized Operations and Benefits

Although HireQuest has essentially built a decentralized chain of chains of operations, there are a couple of things that the company does for its franchises, on a centralized basis. Some of these are practices and modus-operandi, whereas others imply the centralization of certain processes. On occasions, scale brings benefits, and this is the reason why management has opted to pursue this route since inception.

One of the requirements for building or owning one of HireQuest’s franchises is the utilization of the company’s proprietary software, HQ WebConnect. The software helps handle operating processes underlying running a staffing service, including payroll and accounts receivable, which is, incidentally, fundamental for HireQuest’s added value. Furthermore, it allows HireQuest to keep track of certain KPIs and detect potential fraud. With the objective of having a valuable product, HireQuest hires a dedicated team of developers who update it periodically.

Working Capital Funding

The staffing industry does not possess significant barriers to entry, but it does not favor small players. To build an office and get the business going, a significant amount of capital is required; if not for the building itself, in the form of working capital.

Temporary employees need to be hired before the client asks for your services, therefore requiring franchisees to incur salary expenses, with all of its implications. More importantly, clients’ receivables have a certain lag. These tend to be 30-60-90 payment-days terms, for which financing salaries for this period requires upfront capital.

This is more pronounced during the Spring and Summer seasons, when staffing demand is at its highest. Seasonality indirectly mandates that a large percentage of the yearly working capital will be needed in relatively concentrated periods, namely these two seasons.

Through the franchise agreement, HireQuest acquires the ownership of franchisees accounts receivable and funds their initial working capital needs. The company owns these receivables up to 42-84 days, after which they are charged back to franchisees.

“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 between 42 and 84 days are charged back to the franchisee and no longer incur interest”

Management believes this proves an inexpensive capital source for franchisees and helps them finance their growth. It’s interesting to note that management has historically found that franchisees tend to collect outstanding accounts faster than company-owned offices would. The arrangement seems to align interests in this regard.

Additionally, HireQuest encourages franchisees to expand operations. If they want to open a new office, even if destined for markets or industries they currently do not serve, HireQuest can provide them with credits on the royalty fees they’d pay. Furthermore, HireQuest can occasionally assist with acquisition funding. Naturally, this is only a good thing if management knows who to partner with. Otherwise, it’s value-destroying. Large players in the staffing industry have no problem with this, since these types of investments are centralized.

All of these may help explain why the industry remains fragmented with locally dominant players, but who didn’t expand. It also allows me to infer why the most classical approach that dominant firms employ is that of company-owned offices. Concentrating capital investments and the building of a single brand seem to be natural outcomes. Similarly, some companies may fear getting capped by bad operators.

Given the aforementioned local dominance, present since the industry’s inception, and a byproduct of long-term relationships, I suspect HireQuest’s business is not at risk on the name’s front. I wouldn’t bet on the company having to unify their operations under a single trademark. Although a very immature hypothesis, in which I’ll dive over the coming months, it doesn’t seem necessary.

Working capital investments are required for expanding operations by hiring temporary employees before getting paid by customers. This phenomenon is what drives HireQuest’s liquidity. For system-wide sales to increase, or even a single office’s sales, larger sums of capital have to be invested. Therefore, as the economy expands and franchisees expect increased demand, HireQuest’s cash balance falls and the company’s accounts receivable rise as customers are signed. The obverse also occurs. When the economy contracts, franchisees hire fewer temporary employees, for which less investment is required. As they start collecting their receivables and don’t immediately re-deploy that capital, HireQuest’s cash balance grows.

“As discussed more fully below, our already strong liquidity position has improved since December 31, 2019 because of decreased funding requirements for temporary employees and the decrease in our accounts receivable balance as amounts are collected and converted to cash” Q2 2020

This specific mechanic has helped management pay for acquisitions in cash when valuations started getting more attractive. It is to be observed, nonetheless, that receivables can end up not being collected. If the economy deteriorates enough, some customers may not be able to come up with the funds for paying, which I believe is part of what happened during the GFC.

Workers Compensation Policy

The second barrier new entrants and small competitors face is the limited accessibility to affordable workers’ compensation insurance policies. Companies have the legal responsibility of buying insurance to protect their employees. Whether it is a legal obligation or not varies depending on the state. This covers the pay for work-related accidents, illnesses, time lost from work, and other issues.

Given the fact that insurance companies spread risk among policyholders, a company with more employees tends to pay lower premiums per employee. Larger companies also present better conditions for insurance companies, some safety-related, which provides them with negotiation power. This leads to cheaper and better policies.

By being responsible for the whole network of offices, HireQuest is more efficient on a per unit basis than small players. Additionally, regulatory compliance is getting increasingly expensive, with litigation costs trending higher. Local players may not produce enough operating income to sustain these.

Worker compensation expenses are recorded as G&A expenses. The company has an established reserve for the future costs they estimate will have to incur due to claims. This includes reported claims that have not yet settled and claims incurred but not reported.

The length of compensation benefits varies per state. However, there are some where employees are entitled to receive benefits up to three-seven years if the injury persists. Given some claims end up being long tail (claimed after several years), estimating their cost is an excruciating task. In consequence, HireQuest’s reserve for this cost fluctuates significantly, affecting the reported income in both directions, depending on whether the reserve is raised or lowered.

This has in fact occurred over the past few years, whereupon workers’ compensation has very high volatility, in this case causing HireQuest to report much higher expenses. At the same time, the MRI acquisition, which brought in several other costs, and the ongoing amortization of intangibles acquired, caused operating margins to contract severely.

HireQuest developed a risk management program (RMIP) to incentivize franchisees to maintain workers’ claims at relatively low levels. By controlling exposure to large claims, ensuring a safe workplace, and resolving claims quickly, franchisees can achieve this. HireQuest rewards those who succeed in maintaining their loss ratio below a defined threshold by giving them a credit on generated royalties. Furthermore, the company pays franchisees a percentage of what they pay for workers’ compensation insurance if the loss ratio is maintained at desirable levels.

The following table illustrates the fluctuation that workers’ compensation claims (current liability), those net of current portion (liability), and the liability related to the RMIP. These have all severely impacted HireQuest’s financial statements.

I’m not very knowledgeable on workers’ compensation insurance, but I read as many sources as I could. Further, a friend spoke with IR and was kind enough to send me what they said. I’ll try to reproduce HireQuest’s insurance dynamics as faithfully as I can.

The company buys high deductible policies. When claims effectuate, HireQuest covers up to the first $500,000 in cost. Up from that threshold, the carrier (Chubb and ACE) pays for the expenses. Taking this into consideration, HireQuest incurs two costs: the premium paid to the carrier and the claims expense up to the initial $500 thousand.

There is an element, however, that helps offset this. HireQuest acts as an insurer themselves to franchises, for which the latter pay a premium to HireQuest. Management emphasized they do not intend to make a profit on this in the long run; rather, they only want to pass the cost through.

The net benefit or expense that the company will record on their p&l depends on all three elements.

“For example, if our blended manual premium rate for the year is 8% of payroll, the base rate premium paid to the carrier is 2% of payroll, and the total cost of claims (up to the deductible) is 4% of payroll (or 50% of manual premium), we would record a Work Comp Net Benefit equal to 2% of payroll.”

Typically, manual premiums collected had been enough to cover for the base rate paid to the carrier and claims that arose. But, over the past couple of years, manual premiums declined substantially, whereas the base rate and claims’ cost declined, but on smaller proportions. Therefore, manual premiums have not been enough to cover both expenses and HireQuest recorded a net expense from workers’ comp.

“This increase is primarily due to (i) medical claims that were higher than historical claims, (ii) continued increases in medical costs and (iii) 2022 was a one-time benefit from the Snelling acquisition”

Terms and Royalties

When franchisees sign the temporary staffing franchise agreements, HireQuest grants them exclusive territory. No other HireQuest franchisee can operate an office in a protected area. The extension of the accorded territory varies depending on numerous factors. Large cities that tend to be more densely populated give room for more franchises operating, diminishing each particular’s territory.

Typical franchise agreements are signed for five years. But the acquisitions HireQuest made over the past few years entailed management negotiating the sale of hundreds of branches. Some of them ended up having longer-term agreements. Therefore, there’s a current mix on agreements’ duration.

Franchise agreements for permanent placement, mostly inherited and assumed from MRI’s acquisition, tend to have a 10-year duration. But there are ongoing agreements for longer periods. Management plans to standardize the length of the agreements as renewals come into effect.

Acquiring staffing companies with different economic characteristics and end markets caused royalty fees to differ depending on the trademark. It is not to my knowledge that management would also want to standardize these, for it may be a mistake. The following table illustrates the royalty fee each franchise incurs.

There are some elements I’ll hereby point out. The actual royalty fee that ends up being paid by franchises exposed to ranges (6-8%, 5-8%, 1-9%) depends on the office’s sales volume. Branches that generate higher levels of revenue are charged incrementally lower fees. For instance, HireQuest Direct franchises pay an 8% fee on the first million in billings, which diminishes by 0.5% for every extra million dollars in billings, up to 6%. Importantly, the lower fee is charged to each incremental million in sales.

Royalties are billed on a weekly basis, except for MRI, which are monthly. HireQuest counts on, as mentioned, several incentive programs, many of which provide franchisees with a credit on their royalties. Reported royalties are net of these credits and incentives, and management mentioned they’ll grant credit for low margin business.