HIREQUEST, INC. Management’s Discussion and Analysis of Financial Conditions and Operating Results (Form 10-K)
The following analysis is intended to help the reader understand our results of operations and financial condition, and should be read in conjunction with our consolidated financial statements and the accompanying notes located in Item 8 of this Form 10-K. This Annual Report on Form 10-K, including matters discussed in this Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations" contains forward-looking statements relating to our plans, estimates and beliefs that involve important risks and uncertainties. See "Special Note Regarding Forward-Looking Statements" and Item 1A. "Risk Factors" for a discussion of uncertainties and assumptions that may cause actual results to differ materially from those expressed or implied in the forward-looking statements. This section of this Annual Report on Form 10-K generally discusses 2021 and 2020 items and year-to-year comparisons between 2021 and 2020. Discussions of 2020 items and year-to-year comparisons between 2020 and 2019 that are not included in this Annual Report on Form 10-K can be found in "Management's Discussion and Analysis of Financial Condition and Results of Operations" in Part II, Item 7 of our Annual Report on Form 10-K for the fiscal year ended
December 31, 2020which we filed with the SECon March 25, 2021. Additionally, we use a non-GAAP financial measure and a key performance indicator to evaluate our results of operations. For important information regarding the use of the non-GAAP measure, including a reconciliation to the most comparable GAAP measure, see the section titled "Use of non-GAAP Financial Measure: Adjusted EBITDA" below. For important information regarding the use of the key performance indicator, see the section titled "Key Performance Indicator: System-Wide Sales" below. Overview We are a leading nationwide franchisor of offices providing direct-dispatch and commercial staffing solutions in the light industrial and blue-collar industries. Through our franchisees, we provided various types of temporary personnel in 2021 via two primary business models operating under the trade names "HireQuest Direct", " HireQuest," "LINK," and "Snelling". HireQuest Direct specializes primarily in unskilled and semi-skilled industrial and construction personnel. HireQuest, LINK, and Snelling specialize primarily in skilled and semi-skilled industrial personnel as well as clerical and administrative personnel. As of December 31, 2021we had 216 franchisee-owned offices and 1 company owned office in 36 states and the District of Columbia. We provide employment for an estimated 73,000 temporary employees annually working for thousands of clients in many industries including construction, recycling, warehousing, logistics, auctioneering, manufacturing, hospitality, landscaping, and retail. The COVID-19 pandemic materially adversely impacted our business in 2020 and, to a much lesser extent, in 2021. Comparisons between 2021 and 2020 should be viewed through a COVID-19 lens with the understanding that 2020 was a year in which our revenues and expenses were significantly lower than they otherwise would have been. A full economic recovery has been slow to occur, and it is uncertain if businesses will remain fully open, or another broad shutdown will occur due to a variant or new strain. The long-term effectiveness of economic stabilization efforts, including government payments to affected citizens and industries, and government vaccination efforts, is also uncertain. Also affecting comparisons between 2021 and 2020 were the 2021 Acquisitions. We finished 2021 with a strong balance sheet. Our assets exceeded liabilities by approximately $47 million. Throughout 2021, we improved our liquidity position, even with significant organizational changes brought on by the March 2021Acquisitions. Current assets increased from $39.0 millionon December 31, 2020to $42.0 millionon December 31, 2021. On a year-over-year basis, we saw a 68.1% increase in our system-wide-sales from $210.9 millionin 2020 to $354.5 millionin 2021. This improvement was across the board, as we saw increased sales from existing offices, increased sales from new offices, and sales added through the 2021 Acquisitions. We recorded record profits in 2021. Largely driven by the increase in system-wide-sales and resulting royalty revenue, we were also able to maintain our cost structure and not add selling, general, and administrative expense ("SG&A") in the same proportion as revenue. Even with these results, we believe the sweeping and persistent nature of the COVID-19 pandemic still depressed system-wide sales, resulting revenue, and net income during the year, and may continue to do so. 23
Table of Contents Results of Operations The following table displays our consolidated statements of operations for the years ended
December 31, 2021and December 31, 2020(in thousands, except percentages): Year ended December 31, 2021 December 31, 2020 Franchise royalties $ 21,31794.4 % $ 12,79392.6 % Staffing revenue, owned locations 231 1.0 % - - % Service revenue 1,212 5.4 % 1,016 7.4 % Total revenue 22,760 100.8 % 13,809 100.0 % Cost of staffing revenue, owned locations (171 ) (0.8 )% - - % Gross profit 22,589 100.0 % 13,809 100.0 % Selling, general and administrative expenses 13,364 59.2 % 8,700 63.0 % Depreciation and amortization 1,563 6.9 % 129 0.9 % Income from operations 7,662 33.9 % 4,979 36.1 % Other miscellaneous income 4,571 20.2 % 1,171 8.5 % Interest income 412 1.8 % - - % Interest and other financing expense (157 ) (0.7 )% (50 ) (0.4 )% Net income before income taxes 12,488 55.3 % 6,100 44.2 % Provision for income taxes 638 2.8 % 741 5.4 % Net income $ 11,85052.5 % $ 5,35938.8 % Non-GAAP data Adjusted EBITDA $ 14,74465.3 % $ 9,55369.2 %
1. See the definition and reconciliation of Adjusted EBITDA in the
immediately following the section titled “Use of Non-GAAP Financial Measures:
Use of Non-GAAP Financial Measures: Adjusted EBITDA
Earnings before interest, taxes, depreciation and amortization, and non-cash compensation, or adjusted EBITDA, is a non-GAAP measure that represents our net income before interest expense, income tax expense, depreciation and amortization, non-cash compensation, costs related to the work opportunity tax credit ("WOTC") and other charges we consider non-recurring. We utilize adjusted EBITDA as a financial measure as management believes investors find it a useful tool to perform more meaningful comparisons and evaluations of past, present, and future operating results. We believe it is a complement to net income and other financial performance measures. Adjusted EBITDA is not intended to represent or replace net income as defined by
U.S.GAAP and should not be considered as an alternative to net income or any other measure of performance prescribed by U.S.GAAP. We use adjusted EBITDA to measure our financial performance because we believe interest, taxes, depreciation and amortization, non-cash compensation, WOTC-related costs and other non-recurring charges bear little or no relationship to our operating performance. By excluding interest expense, adjusted EBITDA measures our financial performance irrespective of our capital structure or how we finance our operations. By excluding taxes on income, we believe adjusted EBITDA provides a basis for measuring the financial performance of our operations excluding factors that are beyond our control. By excluding depreciation and amortization expense, adjusted EBITDA measures the financial performance of our operations without regard to their historical cost. By excluding non-cash compensation, adjusted EBITDA provides a basis for measuring the financial performance of our operations excluding the value of our restricted stock and stock option awards. By excluding WOTC related costs, adjusted EBITDA provides a basis for measuring the financial performance of our operations excluding the costs associated with qualifying for this tax credit. In addition, by excluding certain non-recurring charges, adjusted EBITDA provides a basis for measuring financial performance without non-recurring charges. For all of these reasons, we believe that adjusted EBITDA provides us, and investors, with information that is relevant and useful in evaluating our business. However, because adjusted EBITDA excludes depreciation and amortization, it does not measure the capital we require to maintain or preserve our fixed and intangible assets. In addition, because adjusted EBITDA does not reflect interest expense, it does not take into account the total amount of interest we pay on outstanding debt, nor does it show trends in interest costs due to changes in our financing or changes in interest rates. Adjusted EBITDA, as defined by us, may not be comparable to adjusted EBITDA as reported by other companies that do not define adjusted EBITDA exactly as we define the term. Because we use adjusted EBITDA to evaluate our financial performance, we reconcile it to net income, which is the most comparable financial measure calculated and presented in accordance with U.S.GAAP. Year ended December 31, December 31, 2021 2020 Net income $ 11,849,934 $ 5,359,414Interest expense 157,234 49,664 Provision for income taxes 638,064 741,038 Depreciation and amortization 1,563,088 129,182 WOTC related costs 594,931 448,033 EBITDA 14,803,251 6,727,331 Non-cash compensation 2,326,772 1,226,890 Non-recurring acquisition related charges, net (2,693,094 ) - Non-recurring charge to notes receivable 307,440 1,598,673 Adjusted EBITDA $ 14,744,370 $ 9,552,894Total Revenue Our total revenue consists of franchise royalties, service revenue and staffing revenue with respect to our owned locations. For a description of our revenue recognition practices, please refer to "Note 1 - Overview and Summary of Significant Accounting Policies - Revenue Recognition," and "Critical Accounting Estimates - Revenue Recognition," which disclosure is incorporated herein by reference. Total revenue for the year ended December 31, 2021was approximately $22.8 millioncompared to $13.8 millionfor the year ended December 31, 2020, an increase of 64.8%. This increase is consistent with the 68.1% increase in underlying system-wide-sales. Revenue includes sales at company-owned offices. Once a company-owned office is sold, disposed off, or otherwise classified as available-for-sale, it would not be reflected in gross profit and instead reported as "Income from discontinued operations, net of tax." 24
Table of Contents Franchise Royalties We charge our franchisees a royalty fee on the basis of one of two models. Under the HireQuest Direct model, the royalty fee charged ranges from 6% of gross billings to 8% of gross billings. Royalty fees are charged at 8% for the first
$1,000,000of billing with the royalty fee dropping 0.5% for every $1,000,000of billing thereafter until the royalty fee is 6% once gross billings reach $4,000,000annually. The smaller royalty fee is charged only on the incremental dollars resulting in an effective royalty fee at a blended rate of between 6% and 8%. We grant our franchisees credits for low margin business. For the HireQuest, Snelling, LINK, and DriverQuest model, our royalty fee is 4.5% of the temporary payroll we fund plus 18% of the gross margin for the territory. Franchise royalties for the year ended December 31, 2021were approximately $21.3 millioncompared to $12.8 millionfor the year ended December 31, 2020, an increase of 66.6%, also in line with the increase in system-wide-sales. The blended effective royalty rate for both 2021 and 2020 was 6.0%. The $8.5 millionincrease in total revenue was primarily attributable to the following factors: (a) a $3.8 millionincrease in revenue from existing offices, and (b) a $4.7 millionincrease in revenue from offices added through the 2021 Acquisitions. The $3.8 millionincrease in revenue from existing offices is primarily due to an increase in number of hours worked over the prior year, which was diminished due to the COVID-19 pandemic.
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 no longer incur interest. Some of our franchisees elect to charge back accounts that age over 42 days in order to avoid the interest charge. Service revenue for the year ended
December 31, 2021was approximately $1.2 millioncompared to $1.0 millionfor the year ended December 31, 2020, an increase of 19.3%. This increase follows the overall increase in accounts receivable, although relatively few age over 42 days and result in service revenue for us. In addition, for the year ended December 31, 2021, more franchisees elected to charge back accounts early in order to avoid the interest charge. Therefore, there will not be a proportionally large increase in service revenue even when there is a large increase in accounts receivable. We pride ourselves on maintaining quality, creditworthy customers who pay timely. The Company does not strive to increase interest on aged accounts receivable.
Selling, general and administrative (“SG&A”) expenses
SG&A for the year ended
December 31, 2021was approximately $13.4 millioncompared to $8.7 millionfor the year ended December 31, 2020, an increase of 53.6%. This increase in 2021 is primarily due to expenses related to the March 2021Acquisitions. These transaction related costs were approximately $1.8 million, and consist of professional fees, severance payments, reorganizational and rebranding expenses, and other non-recurring expenses. Also contributing to the increase was additional stock-based compensation to employees and directors of approximately $400,000. Performance bonuses tied to the Company's growth and other key factors was approximately $1.7 millionhigher in 2021 than it was in 2020. During 2020, some of our note holders experienced significant economic hardships due to the impacts of COVID-19. As a result, we recognized approximately $1.6 millionin allowance for losses on notes receivable in 2020, and another $0.3 millionin 2021.
The remainder of the increase is primarily related to variable general and administrative expenses which increased due to increased daily transactions and the cost of providing administrative support to our franchisees. Overall, general and administrative expenses represented 3.8% of system-wide sales in 2021 compared to 4.1% of system-wide sales in 2020 (3.6% without the provision for losses on loans). Typically, we were able to leverage a lot of the increased revenue by using existing resources.
Depreciation and amortization
Depreciation and amortization for the year ended
December 31, 2021was approximately $1.6 millioncompared to $130,000for the year ended December 31, 2020. The increase of almost $1.5 millionwas due to additional amortization stemming from acquisitions. We acquired $21.9 millionof franchise agreements and $9.0 millionof other intangibles in the 2021 Acquisitions. Of the $9.0 millionin other intangibles, $2.2 millionis indefinite lived and is not amortized. Future years will continue to have a full year of amortization until the underlying intangibles are disposed of, impaired or fully amortized. Future acquisitions are expected to further increase tangible and intangible assets on our balance sheet, and correspondingly increase depreciation and amortization. Other income and expense Other miscellaneous income includes all nonoperating income and expense other than interest and taxes. For the year ended December 31, 2021other miscellaneous income was approximately $4.6 million, compared to $460,000for the year ended December 31, 2020. The 2021 period includes a bargain purchase gain of approximately $5.6 million, which is recorded net of deferred taxes. This gain was offset by losses on the transfer of unwanted assets acquired in the Link transaction to the California Purchaser of approximately $1.9 million. The remaining items of other miscellaneous income consist of small gains and losses resulting from the conversion of Snelling owned stores to franchises, and gross rents from leasing excess space at our corporate headquarters to third parties. Interest income for the year ended December 31, 2021was approximately $400,000compared to $700,000for the year ended December 31, 2020. Interest income represents interest related to the financing of franchised locations , and one note to the California Purchaser. The decrease is consistent with a decrease in principal related to the financing of franchised locations from approximately $8.0 millionat December 31, 2020to $4.4 millionat December 31, 2021. During 2021, we sold approximately $5.3 millionof notes receivable for no gain or loss in order to mitigate credit risk and potential future losses. In addition, in 2020 we impaired the note to the California Purchaser and stopped accruing interest. Interest and other financing expense relates primarily to the Revolving Credit and Term Loan Agreement with Truist. Interest and other financing expense increased approximately $107,000to $157,000at December 31, 2021from December 31, 2020, when it was $50,000. Interest and other financing expense will fluctuate as we utilize the line of credit for acquisitions or other short-term liquidity needs. Provision for income tax Income tax expense was approximately $638,000in 2021 and $741,000in 2020. The effective tax rates for 2021 and 2020 were 5.1% and 12.1% respectively. The effective tax rate is primarily driven by the federal Work Opportunity Tax Credit, which is included as part of income tax expense because it can be claimed only on the income tax return and can be realized only through the existence of taxable income. Other factors reducing our effective rate in 2021 include the non-taxable bargain purchase gain recognized in 2021, and windfall tax deductions related to stock-based compensation. Bargain purchase gains are recorded net of deferred taxes, and are treated as permanent differences, resulting in a lower effective tax rate in the period recorded. We do not expect that benefit to reoccur, but generally expect that our effective tax rate will be significantly lower than statutory rates due to ongoing Work Opportunity Tax Credits and stock-based compensation, 25
Income from discontinued operations, net of tax
There were no discontinued operations in 2021 or 2020, however, company-owned offices could be disposed of by sale, disposed of other than by sale or classified as held for sale and would in such case be reported separately as discontinued operations. In addition, a newly acquired business that on acquisition meets the held-for-sale criteria will be reported as discontinued operations.
Cash and capital resources
Overview Our major source of liquidity and capital is cash generated from our ongoing operations consisting of royalty revenue, service revenue and staffing revenue from owned locations. We also receive principal and interest payments on notes receivable that we issued in connection with the conversion of company-owned offices to franchised offices. At
December 31, 2021, our current assets exceeded our current liabilities by approximately $20.5 million. Our current assets included approximately $1.3 millionof cash and $38.2 millionof 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 $4.6 milliondue to our franchisees, $4.6 millionof accrued wages, benefits and payroll taxes, and $4.5 millionrelated to our workers' compensation claims liability. As of December 31, 2021, the outstanding balance under our line of credit with Truist was $171,286, with approximately $19 millionavailable for borrowing under the line as of such date, assuming compliance with necessary conditions. Our working capital requirements are driven largely by temporary employee payroll, which is typically daily or weekly, and weekly cash settlements with our franchises. Since collections from accounts receivable lag employee pay 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. As the economy recovers, our cash balance generally decreases and accounts receivable increase. We believe that our current cash balance, together with the future cash generated from operations, principal and interest payments on notes receivable, and our borrowing capacity under our line of credit, will be sufficient to satisfy our working capital needs, capital asset purchases, future dividends, and other liquidity requirements associated with our continuing operations for the next 12 months. We also believe that future cash generated from operations, principal and interest payments on notes receivable, and our borrowing capacity under our line of credit, will be sufficient to satisfy our working capital needs, capital asset purchases, future dividends, and other liquidity requirements associated with our continuing operations beyond 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. Cash Flows Operating Activities During 2021, net cash generated by operating activities was approximately $17.4 million. Operating activity for the year included net income of approximately $11.9 millionand a decrease in balance sheet assets combined with an increase in balance sheet liabilities totaling approximately $8.8 million. We also had significant non-cash expenses in 2021, including approximately $1.6 millionin stock-based compensation and $1.6 millionin depreciation and amortization. These provisions of cash were partially offset by a decrease in deferred taxes of approximately $2.4 million, and the bargain purchase gain of $5.6 million. During 2020, net cash generated by operating activities was approximately $10.9 million. Operating activity for the year included net income of approximately $5.4 millionand a decrease in accounts receivable of approximately $6.9 million. We also had non-cash expenses in 2020, including approximately $1.2in stock-based compensation and an increase in our allowance for losses on notes receivable of approximately $1.6 million. These provisions of cash were partially offset by a decrease in deferred taxes of approximately $1.8 million, and a decrease in our risk management incentive program liability of approximately $953,000. 26
Table of Contents Investing Activities During 2021, net cash used by investing activities was approximately
$29.4 millionand included cash paid for acquisitions of $33.8 million. These were partially offset by a net change on the principal balance of notes receivable of approximately $5.1 million, and proceeds from the conversion of Snelling company-owned offices into franchises of $1.0 million. This provision was offset by the purchase of property and equipment of approximately $1.4 million, most of which was related to the construction of a new building at our corporate headquarters. During 2020, net cash provided by investing activities was approximately $36,000and included proceeds from payments on notes receivable of approximately $2.0 million. This provision was offset by the purchase of property and equipment of approximately $1.4 million, most of which was related to the construction of a new building at our corporate headquarters. Financing Activities During 2021, net cash used by financing activities was approximately $347,000which was primarily due to the payment of dividends of approximately $3.1 millionoffset by transactions on our line of credit and term loan amounting to $2.8 million, net. During 2020, net cash used by financing activities was approximately $1.4 millionwhich was primarily due to the payment of dividends of approximately $1.4 millionand the purchase of treasury stock of approximately $146,000. Capital Resources
Revolving Credit and Term Loan Agreement with Truist
June 29, 2021the Company and all of its subsidiaries as borrowers (collectively, the "Borrowers") entered into a Revolving Credit and Term Loan Agreement with Truist Bank, as Administrative Agent, and the lenders from time to time made a party thereto (the "Credit Agreement"), pursuant to which the lenders extended the Borrowers (i) a $60 millionrevolving line of credit with a $20 millionsublimit for letters of credit (the "Line of Credit") and (ii) a $3,153,500term loan (the "Term Loan"). Truist Bankmay also make Swingline Loans available in its discretion. The Credit Agreement replaced the Company's prior $30 millioncredit facility with BB&T, now Truist. The Credit Agreement provides for a borrowing base on the Line of Credit that is derived from the Borrowers' accounts receivable subject to certain reserves and other limitations. Interest will accrue on the outstanding balance of the Line of Credit at a variable rate equal to (a) the LIBOR Index Rate plus a margin between 1.25% and 1.75% per annum or (b) the then applicable Base Rate, as that term is defined in the Credit Agreement plus a margin between 0.25% and 0.75% per annum. In each case, the applicable margin is determined by the Company's Average Excess Availability on the Line of Credit, as defined in the Credit Agreement. Interest will accrue on the Term Loan at a variable rate equal to (a) the LIBOR Index Rate plus 2.0% per annum or (b) the then applicable Base Rate plus 1.0% per annum. In addition to interest on outstanding principal under the Credit Agreement, the Borrowers will pay a commitment fee on the unused portion of the Line of Credit in an amount equal to 0.25% per annum. All loans made pursuant to the Line of Credit mature on June 29, 2026. The Term Loan will be paid in equal monthly installments based upon a 15-year amortization of the original principal amount of the Term Loan and will be payable in monthly installments with the remaining principal balance due and payable in full on the earlier of the date of termination of the commitments on the Line of Credit and June 29, 2036. The Credit Agreement and other loan documents contain customary representations and warranties, affirmative, and negative covenants, including without limitation, those covenants governing indebtedness, liens, fundamental changes, restricting certain payments including dividends unless certain conditions are met, transactions with affiliates, investments, engaging in business other than the current business of the Borrowers and business reasonably related thereto, sale/leaseback transactions, speculative hedging, and sale of assets. The Credit Agreement and other loan documents also contain customary events of default including, without limitation, payment default, material breaches of representations and warranties, breach of covenants, cross-default on material indebtedness, certain bankruptcies, certain ERISA violations, material judgments, change in control, termination or invalidity of any guaranty or security documents, and defaults under other loan documents. The Credit Agreement also requires the Borrowers, on a consolidated basis, to comply with a fixed charge coverage ratio of at least 1.25:1.00 and a leverage ratio of not more than 3.0:1.0. The obligations under the Credit Agreement and other loan documents are secured by substantially all of the assets of the Borrowers as collateral including, without limitation, their accounts and notes receivable, stock of the Company's subsidiaries, and intellectual property and the real estate owned by HQ Real Property Corporation. 27
The Company utilized the proceeds of the Term Loan (i) first to pay off its existing credit facility with BB&T, now Truist, and (ii) second, to pay transaction fees and expenses incurred in connection with closing the transactions described above. The Company intends to utilize the proceeds of any loans made under the Line of Credit and the remainder of the Term Loan for working capital, acquisitions, required letters of credit, and general corporate purposes in accordance with the terms of the Credit Agreement. At
December 31, 2021, availability under the line of credit was approximately $19.2 millionbased on eligible collateral, less letter of credit reserves, bank product reserves, and current advances. On March 1, 2022, our workers' compensation provider agreed to reduce the required collateral deposit from $14.3 millionto $10.7 million. The collateral is currently accomplished by delivering letters of credit under the Credit Agreement. The reduction directly increases our availability under the letter of credit.
KPI: System wide sales
We refer to total sales generated by our franchisees as "franchise sales." For any period prior to their conversion to franchises, we refer to sales at company-owned and operated offices as "company-owned sales." In turn, we refer to the sum of franchise sales and company-owned sales as "system-wide sales." In other words, system-wide sales include sales at all offices, whether owned and operated by us or by our franchisees. System-wide sales is a key performance indicator, although we do not record system-wide sales as revenue. Management believes that information on system-wide sales is important to understanding our financial performance because those sales are the basis on which we calculate and record much of our franchise royalty revenue, are directly related to all other royalty revenue and service revenue and are indicative of the financial health of our franchisee base. Management uses system-wide sales to benchmark current operating levels to historic operating levels. System-wide sales should not be considered as an alternative to revenue.
In 2021, almost all of our offices were franchised, with the sole exception of the DPS locations acquired in the fourth quarter. In 2020, all of our offices were franchised. The following table reflects our system-wide sales broken down into its components for the periods indicated:
December 31, December 31, 2021 2020 Franchise sales
$ 354,265,352 $ 212,750,963Company-owned sales 230,668 - System-wide sales $ 354,496,020 $ 212,750,963System-wide sales were $354.5 millionin 2021, an increase of 68.1%, from $210.9 millionin 2020. The increase in system-wide sales is related to acquisitions completed in 2021 along with organic growth related to the rebound from the economic downturn experienced in 2020 due to COVID-19. System-wide sales attributable to acquisitions in 2021 were approximately $89 million. Organic growth from offices that were not acquired was approximately $55 million. Organic growth stems from additional revenues to existing customers, expansion to new customers, including national accounts, and expansion into new staffing verticals such as medical or commercial trucking. Number of Offices We examine the number of offices we open and close every year. The number of offices is directly tied to the amount of royalty and service revenue we earn. In 2021, we added 78 offices on a net basis by opening or acquiring 79 and closing 1. In 2020, we closed 8 offices on a net basis by opening 5 and closing 13 offices. The majority of the closures in 2020 were related to the economic shutdown due to COVID-19.
The following table shows the number of offices opened and closed in 2021 and 2020.
December 31, 2019147 Opened in 2020 5 Closed in 2020 (13 ) Franchised offices, December 31, 2020139 Purchased in 2021 (net of sold locations) 65 Opened in 2021 14 Closed in 2021 (1 )
Table of Contents Seasonality Our revenue fluctuates quarterly and is generally higher in the second and third quarters of our year. Some of the industries in which we operate are subject to seasonal fluctuation. Many of the jobs filled by employees are outdoor jobs that are generally performed during the warmer months of the year. As a result, in an average year, activity increases in the spring and continues at higher levels through summer, then begins to taper off during fall and through winter.
Critical accounting estimates
Management's Discussion and Analysis of Financial Condition and Results of Operations are based upon our financial statements, which have been prepared in accordance with
U.S.GAAP. The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue, and expenses and the related disclosure of contingent assets and liabilities. Note 1, "Overview and Summary of Significant Accounting Policies", to the Consolidated Financial Statements describes the significant accounting policies used to prepare the Consolidated Financial Statements and recently issued accounting guidance. A critical accounting estimate is an estimate that: (i) is made in accordance with generally accepted accounting principles, (ii) involves a significant level of estimation uncertainty and (iii) has had or is reasonably likely to have a material impact on the Company's financial condition or results of operations. On an ongoing basis we evaluate our estimates, including, but not limited to, those related to our workers' compensation claim liabilities, our Risk Management Incentive Program, our deferred taxes, our notes receivable allowance for losses, and estimated fair value of assets and liabilities acquired. Management bases its estimates and judgments on historical experience and on various other factors that it believes to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. Management believes that the following accounting estimates are the most critical to aid in fully understanding and evaluating our reported financial results, and they require management's most difficult, subjective, or complex judgments, resulting from the need to make estimates about the effect of matters that are inherently uncertain.
Our primary source of revenue comes from royalty fees based on the operation of our franchised offices. Royalty fees from our HireQuest Direct business model are based on a percentage of sales for services our franchisees provide to customers, which ranges from 6% to 8%. Royalty fees from our
HireQuestbusiness line, including HireQuestfranchisees, DriverQuest franchisees, and Snelling and Link franchisees who executed new franchise agreements upon closing, are 4.5% of the payroll we fund plus 18% of the gross margin for the territory. Royalty fees from the Snelling and Link franchise agreements assumed and not renegotiated at closing range from 5.0% to 8.0% of sales for services our franchisees provide to customers. The fees could be lower in certain situations, depending on the franchisee-specific operations. Our franchisees are responsible for taking customer orders, providing customers with services, establishing the prices charged for services, and controlling other aspects related to providing service to customers prior to the service being transferred to the customer, such as determining which temporary employees to dispatch to the customer and establishing pay rates for the temporary employees. Accordingly, we present revenue from franchised locations on a net basis as agent as opposed to a gross basis as principal. With company owned locations, we control the conditions under which we provide services to customers. Accordingly, we present revenue from owned locations on a gross basis as principal. In addition to royalty fees, we also charge a license fee to some locations that utilize our intellectual property that are not franchisees. License fees are 9% of the gross margin for the location. We have no employees and provide no services at the licensed locations. For franchised locations, we recognize revenue when we satisfy our performance obligations. Our performance obligations primarily take the form of a franchise license and promised services. Promised services consist primarily of paying temporary employees, completing all statutory payroll related 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. These incentives and credits are provided to encourage new office development and organic growth, and to limit workers' compensation exposure. We present franchise royalty fees net of these incentives and credits. For owned locations, we account for revenue when both parties to the contract have approved the contract, the rights and obligations of the parties are identified, payment terms are identified, and collectability of consideration is probable. Revenue derived from owned locations is recognized at the time we satisfy our performance obligation. Our contracts have a single performance obligation, which is the transfer of services. Because our customers receive and consume the benefits of our services simultaneously, our performance obligations are satisfied when our services are provided. Revenue from owned locations is reported net of customer credits, discounts, and taxes collected from customers that are remitted to taxing authorities. Our customers are invoiced every week and we do not require payment prior to the delivery of service. Substantially all of our contracts include payment terms of 30 days or less and are short-term in nature. Because of our payment terms with our customers, there are no significant contract assets or liabilities. We do not extend payment terms beyond one year.
Liability for Workers’ Compensation Claims
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. Our estimated workers' compensation claims liability was
$8.2 millionat December 31, 2021, versus $4.6 millionat December 31, 2020. The increase was primarily due to growth in the number of temporary employees, particularly after the 2021 Acquisitions. 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. We make adjustments as necessary. If the actual costs of the claims exceed the amount estimated, we may incur additional charges. 29
Workers Compensation Risk Management Incentive Program (“RMIP”)
Our RMIP is designed to incentivize our franchises to keep our temporary employees safe and control exposure to large workers' compensation claims. We accomplish this by paying our franchisees an amount equivalent to a percentage of the amount they pay for workers' compensation insurance if they keep their workers' compensation loss ratios below specified thresholds.
Notes receivable consist primarily of amounts due to us related to the financing of franchised locations. 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 location and the ownership interests in the franchise. We monitor the financial condition of our debtors and record provisions for estimated losses when we believe it is probable that our debtors will be unable to make their required payments. We evaluate the potential impairment of notes receivable based on various analyses, including estimated discounted future cash flows, at least annually and whenever events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. When a specific note receivable is deemed impaired, we discontinue accruing interest and only recognize interest income when payment is received. Our allowance for losses on notes receivable was approximately
$1.9 millionand $1.6 millionat December 31, 2021and December 31, 2020, respectively.
We account for business acquisitions under the acquisition method of accounting by recognizing identifiable tangible and intangible assets acquired, liabilities assumed, and non-controlling interests in the acquired business at their fair values. We record the portion of the purchase price that exceeds the fair value of the identifiable tangible and intangible assets acquired and liabilities assumed, if any, as goodwill. Any gain on a bargain purchase is recognized immediately. We recognize identifiable assets acquired and liabilities assumed in a business combination regardless of whether they have been previously recognized by the acquiree prior to the acquisition. We expense acquisition related costs as we incur them. Any contingent consideration is measured at fair value at the date of acquisition. Contingent consideration is remeasured at fair value each reporting period with subsequent changes in the fair value of the contingent consideration recognized during the period.
When we purchase a group of assets in a transaction that is not accounted for as a business combination, usually because the group of assets does not meet the definition of a business, we account for the transaction using a cost accumulation model, with the cost of the acquisition allocated to the acquired assets based on their relative fair values.
Goodwillis not recognized. In an asset acquisition, direct transaction costs are treated as consideration transferred to acquire the group of assets and are capitalized as a component of the cost of the assets acquired.
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