Good day, ladies and gentlemen, and welcome to your HireQuest, Inc. second quarter 2020 earnings call. All lines have been placed on a listen-only mode, and the floor will be open for your questions and comments following the presentation. If you should require assistance throughout the conference, please press star zero to reach a live operator. At this time, it is my pleasure to turn the floor over to your host, Brett Maas of Hayden IR. Sir, the floor is yours.
Thank you, operator. I would like to welcome everybody to the call. Hosting the call today are HireQuest CEO, Rick Hermanns, and CFO, Cory Smith. Please be aware that some of the comments made during our call may include forward-looking statements within the meaning of federal securities laws. Statements about our beliefs and expectations containing words such as may, could, would, will, should, believe, expect, anticipate, and similar expressions constitute forward-looking statements. These statements involve risks and uncertainties regarding our operations and future results that could cause HireQuest results to differ materially from management's current expectations.
We encourage you to review the safe harbor statement and risk factors contained in the company's earnings release and in its filings with the SEC, including, without limitation, the most recent annual report on Form 10-K, the most recent quarterly report on Form 10-Q, and other periodic reports, which identify specific risk factors that also may cause actual results or events to differ materially from those described in forward-looking statements. Copies of the company's most recent reports on Forms 10-K and 10-Q may be obtained on the company's website at hirequest.com or the SEC's website at sec.gov. The company does not undertake to publicly update or revise any forward-looking statements after the call or date of this call. I would also like to remind everyone that this call will be available for replay through August 25th.
A link to the website replay of the call was also provided in the earnings release and is available on the company's website at hirequest.com. I will now turn the call over to CEO of HireQuest, Rick Hermanns. Rick?
Thank you for joining us. Since we completed our combination with Command Center and became a public company, we have been speaking about the benefits of our franchising model, which significantly mitigates the risks involved in the staffing industry and positions us for sustainable profitability. These benefits were clearly on display in the second quarter, as our industry experienced severe disruptions due to the COVID impact and the resulting economic shutdowns. Despite these significant challenges, HireQuest remained profitable, and we continue to maintain a strong balance sheet. To be sure, this quarter was particularly challenging for our franchises. One of the benefits of our model is that each unit is independently owned. This enables our franchise owners to move quickly based on local conditions.
We provided strong guidance to our franchises as this situation began to unfold. I am proud of the way that they moved quickly to mitigate the impact, cutting costs, communicating with key accounts, and taking other actions to help weather the storm. Many of our franchises were able to secure PPP loans to help them through the crisis. These loans were important and effective, achieving exactly what they were intended to do. Our results were also impacted as system-wide sales decreased by 15.2% compared to the second quarter last year. With it, royalty revenue declined 11.5%. Nevertheless, we generated $0.09 per share of earnings and $4 million of free cash flow from operations during the quarter, a testament to our business model. As the economy begins to reopen, we expect that we are well-positioned with a national footprint.
We can provide temporary staffing to customers rapidly and reliably, oftentimes faster than their HR teams can move to ramp up permanent staffing. Early in the year, as this pandemic began to unfold, some of our franchise owners made the decision to close or consolidate certain branches, and we made significant cuts at our headquarters to better position us for sustainability in what was an uncertain environment. Those cost reduction efforts were helpful. Unless the economy significantly worsens from here, we do not anticipate additional cuts. As I've said in the past, our business is quite susceptible to economic fluctuations. This is proving true yet again. However, we are better equipped than a lot of our competitors to weather economic cycles, and this too is being proven yet again.
With no debt to service and a lean cost structure, we remain focused on serving our franchisees and protecting our business as volatility is expected to continue in the short term. We continue to identify and evaluate M&A candidates. Specifically, we are looking for opportunities for growth through acquisitions that would add markets where we currently lack presence, strengthen the presence of our existing franchisees, or perhaps provide access to certain national accounts. The economic crisis and its impact on our industry in particular, increases the number of potential targets. Our strong balance sheet makes us a strong acquirer. That said, we continue to follow a disciplined and prudent approach to any acquisitions, and that is especially true in a challenging economic environment. Our ultimate goal is to acquire assets that can be transitioned to our franchise model as quickly as possible.
In many cases, we provide buyer financing, which is possible due to our strong balance sheet. Historically, we've been able to recoup much of the cost of most acquisitions by immediately reselling the location to a franchisee, and that will be our intended model again, should the acquisition opportunities arise. Let me turn the call now over to Cory to discuss the second quarter results. Cory?
Thank you, Rick. Good afternoon, everyone. Total revenue in the second quarter of 2020 was $2.9 million, compared to $3.2 million in the second quarter of 2019, a decrease of 10.5%.
Our total revenue is made up of two components, franchise royalties, which make up roughly 90% of total revenue, and service revenue. The year-over-year decrease we saw in total revenue this quarter was overwhelmingly due to lower royalty revenue, which was down 11.5% to $2.6 million from $3.0 million in 2019. This decrease in royalty revenue was a reflection of lower system-wide sales directly related to the ongoing COVID pandemic and associated economic shutdowns. It is important to note franchise revenue attributable to the branches acquired in the merger was approximately $570,000. Service revenue, which is generated from interest charged to our franchisees on overdue accounts receivable and fees for various optional services we provide, was up slightly to $262,000 in the second quarter of 2020 compared to $257,000 last year.
Selling, general, and administrative expenses in the second quarter of 2020 were $1.9 million, compared to $871,000 in the second quarter of 2019, an increase of approximately $1.1 million. This increase included an additional $151,000 added to the reserve placed on promissory notes we issued to finance the sale of offices we acquired in the merger with Command Center. This reserve is directly related to the negative impact the COVID pandemic is having on the economy. The remainder of this increase in SG&A was related to additional costs associated with being a public company, inclusive of stock-based compensation and board fees of $293,000, which we did not incur in 2019. Higher computer-related service and consulting costs of $116,000, and a relative increase in our workers' compensation cost of $495,000 related to a reduction in accruals that was recorded last year prior to the merger.
Net income in the second quarter of 2020 was $1.2 million, or $0.09 per diluted share, compared to $2.3 million or $0.23 per diluted share in the second quarter of last year. Moving on to the balance sheet. We were able to continue to strengthen our balance sheet on the heels of another profitable quarter. Current assets on June 30th were $38.6 million, which included cash of $13.7 million and accounts receivable of $19.6 million. At the end of 2019, current assets were $37 million and included cash of $4.2 million and accounts receivable of $28.2 million. Property and equipment increased by approximately $890,000 to $2.8 million at June 30th, as we continue construction on a new building adjacent to our corporate headquarters.
Our current cash balance, which has increased by $9.6 million in 2020, is sufficient to continue to fund our ongoing operations for the foreseeable future while still funding other important initiatives. With that, I will turn the call back over to our operator for Q&A.
Thank you. Ladies and gentlemen, the floor is now open for questions. If you do have a question, please press star one on your telephone keypad at this time. If you're using a speakerphone, we ask that while posing your question, you pick up your handset to provide the best sound quality. Again, ladies and gentlemen, if you do have a question or comment, please press star one on your telephone keypad at this time. We'll take our first question from Peter Rabover with Artko Capital. Please go ahead.
Hey, guys. Nice way to power through the, literally, such a terrible economic scenario. Hey, wanted to ask you about your, I guess, opportunities with the cash. You announced a stock buyback and both said you're looking at distressed assets in general. Just curious how you're thinking about the allocation and, I guess, how you're thinking about executing the buyback. Thanks.
Thank you, Peter. As was announced, we've filed a 10b5-1 plan to begin purchasing shares, and we have begun purchasing shares under the terms of the buyback. So far, the amount of share purchases has been relatively small, but we are committed to continue to buy them back, so long as the price stays at a level that we consider to be well below the intrinsic value of the company. As laid out as well is we are on the hunt for acquisitions and opportunities. It's kind of funny, right before the call, in fact, my VP of operations texted me the fact that one of our competitors just went out of business. While obviously, I don't wish that upon any of our competitors, per se, it indicates that opportunities will start to present themselves.
I would pretty much argue that that would be probably the biggest area in which the funds will be deployed. It's really important that we take a disciplined approach to it as well. A bad acquisition is worse than no acquisition at all. The problem is you get a lot of people who are still wishing for a price that was based on 2019 performance.
Of course, we're in a completely different world here in August of 2020 than what we were in August of 2019. Part of that, it'll take some reality to set in as well. I hope that answers your question.
No, that does. That was great. Couple of other questions. One, maybe comment on where you're seeing pockets of strength, and weaknesses in the economies, the geographies that you serve, just so maybe something to keep track of performance a little better. I'll follow up with another one after this. Thanks.
Good question. Obviously, we are struggling most in areas that the lockdown is being sort of kept at a higher level. Like the State of Washington, and Oregon are two particularly difficult jurisdictions. Others are a bit better. I mean, our comparisons are a bit worse in places like that. At the end of the day, this kind of goes back to what I said after the first quarter call, is that realistically, until you start seeing people at baseball games, at basketball games, at football games, it's going to have a negative impact. It really goes down to, it's not always necessarily, gee, St. Louis is way off because St. Louis is off. It may well be because historically has been more geared towards hospitality, and so hospitality is still really way off.
Again, until people are cleared to go back into stadiums, we're just not going to recover that. As far as relative strengths, Florida, really the Southeast is still trending pretty strong, is probably the single strongest area. Again, because commercial construction remains relatively strong.
Great. Maybe a follow-up question. I think you guys generated something like $8.3 million in free cash flow so far this year, and obviously that's a result of some working capital release. I'm just curious, how much cash do you anticipate using, or a good way to think about it is probably a better way to ask that, as your same store sales start, your franchise sales start going up, what's a percentage of AR should we think about as, I guess, your franchise fees, et cetera?
Yeah. You're correct in pointing out, obviously, the bulk of the cash balance increase, or at least it's kind of funny, it's almost uncanny how the amount of, let's say, the decline in the AR almost equals the cash balance increase. However, it's not quite that simple either because a number of our accruals, and let's say the amount due to our franchisees, has also declined, meaning obviously we've paid more. It's not quite that simple. We also had a fairly large deferred tax liability that we paid down as well. Realistically, the way I kind of look at it is if we have a 20% increase in sales, it pretty much means our AR will go up by about 70% of that absolute dollar increase in sales, if that makes any sense.
If our sales go up $5 million a month, let's just say a cure is found tomorrow and things go back to normal and our sales go up $5 million a month. Our net cash will go down by about 70% of that $5 million per month increase for really about a month and a half. Typically, our AR runs around 49 days outstanding. You could expect somewhere in the neighborhood of like a $5 million increase in net working capital needs.
Okay, great. Thank you so much. I appreciate the call.
Sure.
As a reminder, ladies and gentlemen, if you do have a question, please press star one on your telephone keypad at this time. Again, that's star one if you'd like to ask a question. We'll take our next question from Paul Cronkey, Private Investor. Please go ahead.
Hi, Rick.
Hey, Paul.
I had noticed, as soon as I started looking at the balance sheet that what you had just mentioned, that the decline in accounts receivable correlated pretty closely with the increase in cash. At this time of year, is the accounts receivable generally rising? Aside from, I know we're in a COVID year, but generally, wouldn't our AR be increasing at this time of year?
Yes. The answer to that question is yes. Accounts receivable, even as we speak, they're increasing, which of course is a good thing, right?
Right
our sales are up, which is seasonal. They absolutely are up. I would expect that. I would not, it would not surprise me if our cash balance goes down during the third quarter.
Right. That was the other point was that since we'll be funding additional payroll, the $13.7 million, it's possible that that would be declining or may have already declined.
Yeah, I would expect that. Obviously, as AR goes up, and that's the whole thing. As AR goes up, certainly our cash will go down. Look, if you strip away even just the changes in working capital, I think the most important part is we're still profitable. We're still earning. Not only did we earn more than $2 million in the first half of the year, we're also collecting on the notes related to the Command sale as well. We are generating strong underlying cash flow as well, never mind the changes in cash. It is true, we are very seasonal. We're in a bit of a challenging business from the perspective, not only are we seasonal, but we are cyclical. Something COVID obviously impacts our operations, and then on top of it, you have the seasonality. That's just an ongoing, that's always occurring.
The key is not to lose sight of the most important part, which is we continue to earn real money. Generally speaking, the notes are performing well.
Are we just reserving for that one group of the California? Is that?
The-
Yes.
The answer to that question is no. That's not just one. That's just not one. We're required to take a comprehensive look at all of the notes.
I get it.
Yeah. It's just one part of it.
Okay. I just had one other question. Looking at the consolidated statements of income, looking at the three months ended and the six months ended comparing this year with last year, were those our HQ numbers alone? Were those HQ because there weren't franchise royalties from Command Center prior to July of 2019.
That's right.
So those-
Those were HQ alone. What you'll see in the third quarter, because the merger took place on July 15th, the third quarter will be truly sort of the combined results of Command and HireQuest compared to the company now.
That's what I was thinking. It's really hard to get a picture of what was added from Command Center since they weren't on the franchise. They had no franchise revenue at that time. In the next quarter, we will see what's been added and where we were a year ago, correct?
That's correct.
Okay.
Of course, the third quarter will also conclude the comparisons of all of the merger-related costs and all of the sort of the one-time tax issues that took place in the third quarter.
Why did the deferred tax liability decrease so much in one year? Weren't we doing a four-year spread on that or?
I'm going to leave that question for Cory.
The deferred tax liability, it's made up primarily of workers' compensation reserves as well as that spread.
Oh, the 481(a) adjustment. Okay.
Yeah. Mm-hmm.
Okay, good.
Again, ladies and gentlemen, if you do have a question or comment, please press star one on your telephone keypad at this time. That's star one on your telephone keypad. We'll take our next question from Aaron Edelheit with Mindset Capital. Please go ahead.
Hey, thanks for taking my question. I had a question for how things are trending. I'm assuming that April was a real low and things have been trending back since, but I was wondering if you could just give some color commentary on how you see the business trending now that we're a month and a half into the next quarter.
That's a good question.
how things are going.
At the beginning, around the end of March, our year-to-year comparisons were off nearly, well, in some cases more than 40%. We'll just say roughly 40%. We are seeing a lot of improvements, part of those are based on seasonal factors. July, August, September, October are always our four best months. Part of the improvements we've seen in absolute dollars since March are just related to normal seasonal factors. However, the year-over-year comparisons have improved to the point where we're off typical week, we're off somewhere between 26% and 28%, 29% from the prior year.
Thanks.
Once more, ladies and gentlemen, if you do have a question or comment, please press star one on your telephone keypad at this time. There appear to be no further questions at this time. We'll turn the floor back to Mr. Herman for closing remarks. Please go ahead.
Thank you everybody for participating in the call. Hopefully what you can discern from both the earnings release and from the comments is the company is well-positioned to grow in the future due to the strong balance sheet. An important part as viewing your holdings in the company is to recognize that we have really good protection against a decline in the economy. That uniquely positions us to take advantage of the situation going forward and still make meaningful investments in our business going forward. We're not just in a preservation mode. I thank you for joining us and look forward to a good third quarter. Thanks a lot.
Ladies and gentlemen, this does conclude today's teleconference. We thank you for your participation. You may disconnect your lines at this time, and have a great day.