HireQuest, Inc.: Form 10-K for the period ended Dec 31, 2021

Development of our Business

HireQuest, Inc. (collectively with its subsidiaries, the “Company,” “we,” “us,” or “our”) is a Delaware corporation originally organized in Washington as Command Staffing, LLC in 2002. In 2005, Temporary Financial Services, Inc., a public company, acquired the assets of Command Staffing, LLC, and the combined entity changed its name to Command Center, Inc. On September 11, 2019, Command Center, Inc. reincorporated in Delaware and changed its name to HireQuest, Inc. following its acquisition of Hire Quest Holdings, LLC (“Hire Quest Holdings,” and together with its subsidiary, Hire Quest, LLC, “Legacy HQ”). This acquisition is sometimes referred to as the “Merger.” Hire Quest, LLC was formed as a Florida limited liability company in 2002. Hire Quest Holdings, LLC was formed as a Florida limited liability company in 2017. Since the Merger, we have made a number of acquisitions which are discussed in more detail below.

The COVID-19 pandemic significantly impacted our business and operations in 2020, and to a lesser degree in 2021. Please see “Management's Discussion and Analysis of Financial Condition and Results of Operations” of this Annual Report on Form 10-K for a description of the effects COVID-19 has had on the Company.

Our common stock trades on the Nasdaq Market under the symbol “HQI.” All references to “common stock” means the common stock of HireQuest, Inc., par value $0.001 per share.

Our principal executive office is located at 111 Springhall Drive, Goose Creek, SC, 29445 and the telephone number is (843) 723-7400. More information about us may be found at www.hirequest.com (http://www.hirequest.com). The information on our website is not incorporated by reference in this Annual Report on Form 10-K.

The Snelling Acquisition

On March 1, 2021, we completed our acquisition of certain assets of Snelling Staffing in accordance with the terms of the Asset Purchase Agreement dated January 29, 2021 (the “Snelling Agreement”). At the time of acquisition, Snelling Staffing was a 67-year-old staffing company headquartered in Richardson, TX. Pursuant to the Snelling Agreement, HQ Snelling Corporation (“HQ Snelling”), our wholly-owned subsidiary, acquired approximately 47 offices, and acquired substantially all of the operating assets, and assumed certain liabilities of the sellers for a purchase price of $17.9 million, subject to customary adjustments for net working capital plus further adjustment of $7.2 million of collateral released to the sellers by their workers' compensation insurer (the "Snelling Acquisition"). Also on March 1, 2021, HQ Snelling entered into the First Amendment to the Purchase Agreement, pursuant to which HireQuest, Inc. agreed to advance $2.1 million to be paid to the sellers at closing to be used to pay accrued payroll liabilities that HQ Snelling assumed pursuant to the Snelling Agreement. We funded this acquisition with existing cash on hand and a draw on our existing line of credit with Truist Bank ("Truist").

The Link Acquisition

On March 22, 2021, we completed our acquisition of the franchise relationships and certain other assets of LINK Staffing (“Link”) in accordance with the terms of the Asset Purchase Agreement dated February 12, 2021 (the "Link Agreement"). At the time of acquisition Link was a family-owned staffing company headquartered in Houston, TX. Pursuant to the Link Agreement, HQ Link Corporation ("HQ Link"), our wholly-owned subsidiary, acquired approximately 35 franchised offices, customer lists and contracts, and other assets of Link for a purchase price of $11.1 million (the "Link Acquisition"). We funded this acquisition with existing cash on hand.

The Recruit Media Acquisition

On October 1, 2021 we completed our acquisition of Recruit Media, Inc. (“Recruit Media”) in accordance with the Stock Purchase Agreement dated October 1, 2021 (the “Recruit Agreement”). Pursuant to the Recruit Agreement, we purchased all of the outstanding shares of common stock of Recruit Media for approximately $4.4 million. Recruit Media is a tuck-in acquisition whose intellectual property compliments our technological structure, allowing us to accelerate improvements to our platform.

The Dental Power Acquisition

On December 6, 2021 we completed our acquisition of the Dental Power Staffing division (“DPS”) of Dental Power International, Inc. (“Dental Power”) in accordance with the terms of a definitive agreement, dated November 2, 2021, with Dental Power, for $1.9 million. Dental Power is a 46-year-old dental staffing company headquartered in Carrboro, North Carolina with long-standing client relationships in the dental industry. providing temporary, long-term contract, and direct-hire staffing services to dental practices across the U.S. As of December 31, 2021, all of the operations acquired from Dental Power remain company owned.

Together, the Snelling Acquisition, the Link Acquisition, the Recruit Acquisition and the Dental Acquisition are sometimes referred to as the "2021 Acquisitions."

Our Model

We are a nationwide franchisor of temporary staffing offices providing direct-dispatch and commercial staffing solutions in the light industrial and blue-collar industries. With the Snelling Acquisition and the Link Acquisition, we significantly expanded our traditional commercial staffing solutions. Following the December acquisition of DPS, we have a platform to build a customer base in the dental-oriented sector of the staffing industry, which will benefit our entire system by increasing revenue opportunities under the HireQuest Health brand.

Our franchises provide customers with seamless access to a contingent workforce whenever they need it. Flexible staffing solutions permit customers to focus on their underlying operations and to expand or contract their workforce quickly to meet fluctuating demands. We pay the majority of our temporary employees daily or weekly which attracts workers who cannot wait up to three weeks for their first paycheck under a traditional employment model.

In 2021, our franchisees operated under the trade names “HireQuest Direct,” “Snelling,” “HireQuest,” “LINK Staffing,” “DriverQuest,” and “HireQuest Health.” HireQuest Direct focuses on daily-work/daily-pay jobs primarily for construction and light industrial customers. Snelling, HireQuest, and LINK Staffing focuses on longer-term staffing positions in the light industrial and administrative arenas. DriverQuest specializes in commercial drivers serving a variety of industries and applications. HireQuest Health specializes in skilled personnel in the healthcare and dental industries.

Our revenue, which is primarily comprised of royalty fees generated by the operations of our franchised offices, license fees, and interest charged to our franchisees on overdue accounts receivable, was $22.8 million in 2021. Our system-wide sales, which we define as sales at all offices, whether owned and operated by us or by our franchisees, were $354.5 million in 2021. Nearly all system-wide-sales originated from franchisee-owned offices. We employed approximately 73,000 temporary employees during 2021. At December 31, 2021, we had 217 franchisee-owned offices operating in 36 states and the District of Columbia. On a net basis, we opened 78 offices in 2021 (acquiring 65, opening 14 and closing 1).

We provide incentives to our existing franchisees, including assistance with start-up funding and acquisition costs, to encourage them to expand into new markets. While staffing industry growth has outpaced overall economic and employment growth, the industry still employs only a small percentage of the United States’ non-farm workforce. We believe that the low percentage of the total workforce that is currently contingent, when combined with potential shifts towards a more contingent workforce in the overall economy, provides meaningful opportunities for future organic growth.

Our differentiated services are driven by two key elements:

• Local ownership and dedicated responsiveness. Our offices are franchisee-owned. We believe that ownership at the local level, where the vast majority of customer interactions occur, allows our organization to be agile and responsive to customer needs. Since our franchisees have a personal financial interest in the success of their offices, our customers interact with a representative who is incentivized to deliver excellent customer service and resolve issues efficiently. In addition, franchise owners are able to develop long-term relationships due to the lack of turnover. We believe the combination of local ownership coupled with properly-aligned incentives results in enhanced customer satisfaction and greater customer retention.
• Direct dispatch from our offices. The majority of our employees in our construction and light industrial segment are dispatched from our offices every day. This allows our franchisees and their staff to qualify the employees for work, provide them with any necessary personal protective equipment, assist them in arranging transportation amongst themselves, and ensure the right number of qualified individuals are dispatched at the right time. We believe that employee dispatch from franchise offices increases consistency as our employees are sent to a particular jobsite without having to rely on less reliable means of verification, such as telephone calls. Once we and our customers have developed a rapport with particular employees, we will sometimes dispatch these employees directly to a customer location.

Our Industry

Temporary Staffing

According to the American Staffing Association (ASA), the staffing and recruiting industry in the United States generated annual revenue of $161 billion in 2019 (prior to the pandemic). Approximately 85% of industry revenue is generated by temporary and contract employee placement services, with the remainder coming from executive search and permanent placement. According to ASA, industry revenue dipped by 13% in 2020 due to the economic impact of the pandemic. Staffing Industry Analysts (SIA) estimates that industry revenue rebounded by 16% in 2021. Following our 2021 Acquisitions, we expect to expand into several of the remaining segments of the staffing industry including health care, clerical and administrative, and professional.

The direct-dispatch staffing industry has developed based on business need for flexible staffing solutions. The industry provides contingent workforce solutions as an alternative to the costs and efforts that are required for recruiting, hiring, and managing permanent employees. Many of the customers we target operate in a cyclical production environment and find it difficult to staff according to their changing business requirements. Companies also desire a way to maintain consistent staffing levels when full-time employees are absent due to illness, vacation, or unplanned terminations. Direct-dispatch staffing offers customers the opportunity to respond immediately to changes in staffing needs, to reduce the costs associated with recruiting and interviewing, to eliminate unemployment and workers’ compensation exposure, and to draw from a larger pool of potential employees. We have found that staffing firms provide particular value in assisting customers with filling mundane or repetitive jobs, high turnover positions, staffing for project specific needs, and filling other short duration positions such as special events, disaster recovery, and seasonal jobs.

Historically, our business has been bolstered by declining unemployment rates as our customers find it more difficult and more expensive to recruit, interview, hire, and train qualified staff. As employers look for alternatives to combat these increasing costs and administrative burdens, opportunities arise for the temporary staffing industry. In addition, worker attitudes have changed from one which idealized extended tenure with a single employer to one which is more open to temporary or transient employment. This shift has increased the availability of temporary workers in the economy as a whole. Conversely, periods of declining unemployment are a challenge for our industry.

Government Regulation

While the offices under our brands are operated by franchisees, our wholly-owned subsidiary is the employer of record of the temporary employees. As a large employer, we are subject to a significant number of employment laws at the state, federal, and local levels. We are required to comply with all applicable federal and state laws and regulations relating to employment, including verification of eligibility for employment, occupational safety and health provisions, wage and hour requirements, employment insurance, and laws relating to equal opportunity employment. In addition to federal and state laws and regulations, many counties and cities have become active in regulating various aspects of employment, including minimum wages, living wages, paid sick leave, retirement savings programs, transportation benefits, application forms and background checks, mandatory training, and required notices to employees, among others.

In addition, fourteen states and the Federal Trade Commission impose pre-sale franchise registration or disclosure requirements on franchisors. A number of states also regulate substantive aspects of our relationship with our franchisees such as termination, nonrenewal, transfer, no-poach and non-competition provisions, discrimination among franchisees, and other aspects of the relationships between and with franchisees. Additional legislation, which we cannot predict, could expand these requirements imposed on us. Significant expansion could lead to a significant increase in compliance costs, which could have a material adverse effect on our business, financial position and results of operations.

Our Competitive Strengths

We attribute our success to the following strengths:

• Nationwide footprint with differentiated business model. 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. Our nationwide footprint allows us to compete for national account relationships not available to many of our local or regional competitors. Our size also allows us to obtain favorable terms on our workers’ compensation insurance program. Our franchise model has many advantages as well. Most of our competitors utilize a company-owned office model in which management of day-to-day interactions with customers is handled by individuals who do not have the same incentive to succeed as franchisees have as owners of their businesses. The company-owned model typically requires significant investment in middle management to overcome this lack of incentive. We largely avoid this expense because our franchisees are independent business owners responsible for their own financial well-being, and in doing so increase our store level economics.
• A franchise system with expansion capabilities. We incentivize our franchisees to expand their own businesses through our Franchise Expansion Incentive Program. Under this program, we offer assistance overcoming the startup costs of an office in a new metropolitan area by providing our existing franchisees with credits on the royalty fees they pay in their existing offices. In addition, under certain circumstances, we will provide assistance in acquisition funding or financing. We also maintain a Risk Management Incentive Program which allows us to reward franchisees who are successful in keeping their workers' compensation loss ratios below certain thresholds by providing them a credit. We believe that this incentivizes our franchisees to encourage workplace safety, while also providing franchisees with capital to reinvest in, or expand, their businesses.
• Responsible capital allocation with very little debt. Financing our day-to-day needs largely with cash produced from operations allows us to continue building cash reserves which we can use, in addition to our line of credit with Truist, to finance significant transactions such as major reinvestments in our business, strategic acquisitions, share buybacks, or stockholder dividends, depending on the opportunities that present themselves. Compared to company-owned offices, our franchise model allows us to employ relatively fewer full-time staff at our corporate headquarters decreasing the working capital needed for operations.

Our Growth Strategy

We believe there are considerable opportunities to grow our business and brands. The following are key components of our growth strategy:

• Make strategic acquisitions. We are continuously evaluating acquisition opportunities that will allow us to expand our franchisee base, expand the number of industries our franchisees service, and diversify our national footprint.
• Continue to grow the number of offices our franchisees operate. We believe attractive returns at the franchisee level position us to continue to attract new franchisees and encourage our existing franchisees to open new offices. In addition, we encourage our existing franchisees to explore new potential markets through our Franchise Expansion Incentive Program. When combined with the back-office support that we provide franchisees, we believe we are poised to expand into unserved or underserved markets.
• Capitalize on our national footprint to grow same store and system-wide sales. We anticipate that our enhanced scale combined with our royalty-driven business model will contribute to growth in our access to and profitability from national accounts. Traditionally, these larger national accounts have the leverage to impose lower margins on their temporary staffing providers. Our royalty-driven business model, in which we earn a percentage of gross billings or funded payroll regardless of margins, partially insulates stockholders from short-term margin volatility inherent in the ownership of the traditional company-owned model for temporary staffing.
• Increase our brand awareness. As we continue to develop new markets and to serve our existing markets, we expect our brands to become more recognizable and a greater asset to us in driving repeat customers, encouraging customers to expand their use of our services across multiple markets, and increasing new customer development.

Our Offices

We had 217 offices located in 36 states and the District of Columbia as of December 31, 2021. All offices were franchised, with the only exceptions being the recently acquired Dental Power office. The map below provides the number of offices we had in each state.

Number of Offices By State

December 31, 2021

In the first two months of 2022, we added franchises in Pennsylvania, New York, Texas and New Mexico. We have a strong concentration of offices in established and emerging regions such as the Southeast, Florida, Texas, Colorado, and Washington. These regional office concentrations contribute to greater brand recognition while we continue to add offices in unserved and underserved regions. These concentrations also allow us to better recognize local and regional market trends. Most of our franchisee offices are located near areas of concentrated construction or major manufacturing and industrial sites.

Our Franchise Program

Our franchised offices are a key component of our success. We urge our franchisees to customize their services according to the unique opportunities and assets available at each of their offices, while also leveraging the overall size of the organization whenever possible. This approach allows for each office to have a unique blend of customers and emphasis while also reducing overhead costs, improving economies of scale, establishing procedural uniformity and controls, and creating a predictable internal environment for temporary employees.

A typical franchised office is managed by an owner with the assistance of in-office personnel. Many offices hire business development staff to help drive business to the offices. We provide advice and guidance from our corporate headquarters.

Franchising Strategy

As of December 31, 2021, there were 217 franchised Snelling, HireQuest, and HireQuest Direct offices operated by 107 franchisees. Approximately one-third of our franchisees owned multiple offices. Our largest franchisee owned 14 offices, and about one-eighth of our franchisees owned 4 or more offices. One individual owned significant interest in 6 franchisees that operated 24 offices. We also had 23 franchisees that share common ownership with significant stockholders, directors, and officers of the Company. We refer to these as the "Worlds Franchisees." These 23 Worlds Franchisees operated 60 offices as of December 31, 2021.

Our approach to the franchise model creates what we believe to be superior office-level economics. We finance many of the initial working capital needs of our franchisees, including costs of new office openings, through our ownership of franchisee accounts receivable which we acquire through our franchise agreements. This is a relatively inexpensive source of capital for our franchisees and allows them to expand more freely. In addition, our Risk Management Incentive Program lowers the effective cost of workers’ compensation insurance at the franchisee level – a significant expense for many of our competitors. We thereby eliminate for our franchisees two of the largest barriers to entry, financing and workers’ compensation, and enable potentially higher operating margins at the office level.

Franchise Agreements

Our franchise agreements contain standard terms and conditions. In most cases, our franchisees are granted the exclusive right to operate their chosen brand, either Snelling, HireQuest or HireQuest Direct, in their protected territory. Typically, a protected territory corresponds with the metropolitan statistical area where the office is located. In a small number of densely populated cities, the protected territories are smaller.

As of December 31, 2021, our franchisees operated under 146 executed franchise agreements. For our HireQuest Direct brand we charge a royalty fee of between 6% and 8% of gross sales, depending on sales volume. For our Snelling and HireQuest brands, including HireQuest franchisees, Snelling franchisees, Link Franchisees, DriverQuest franchisees, and HireQuest Health franchisees, we charge a royalty fee of 4.5% of the payroll we fund plus 18% of the gross margin for the territory. For the Snelling franchise agreements assumed where the franchise owner did not execute new HireQuest or HireQuest Direct business line franchise agreements, the royalty fee ranges from 5% to 8%.

Our typical franchise agreement has a term of five years. Our franchise agreement is designed to remove some of the most significant barriers to entry in our industry – access to working capital, access to affordable workers’ compensation insurance, and dedicated software. By entering into a franchisee agreement with us, our franchisees gain access to our proprietary software, HQ WebConnect©, which we update regularly through a dedicated staff of developers, and gain access to working capital by factoring their accounts receivable through us. Additionally, in states that do not require participation in a state-run program, our franchisees gain access to our "A++" rated workers’ compensation insurance coverage.

Franchisees receive initial and ongoing training in our technology and methods of operation. We provide support personnel on an as-needed basis to our franchisees. We have a comprehensive brand standards manual which explains our policies on key operational, financial, and regulatory compliance issues. Under the franchise agreement, beneficial owners of our franchisees guaranty all debts and obligations of the franchise to us. Still, we have substantially less control over a franchisee’s operations than we would if we owned and operated an office ourselves. Franchisees are not required to provide full financial statements or other information that is outside of the royalty base.

The table below displays the number of franchise agreements scheduled to renew at the end of each year:

1. Excludes franchise agreements that renew at the end of 2022 which will renew again in 2027.

2. Excludes franchise agreements that renew at the end of 2023 which will renew again in 2028.

3. Excludes franchise agreements that renew at the end of 2024 which will renew again in 2029.

4. Excludes franchise agreements that renew at the end of 2025 which will renew again in 2030.

5. Excludes franchise agreements that renew at the end of 2026 which will renew again in 2031.

The large number of renewals in 2024 resulted from the significant number of new franchisees we added in 2019 after the Merger with Command Center. The large number of renewals in 2026 resulted from the significant number of new franchisees we added in 2021 after the 2021 Acquisitions.

Our Human Capital Resources

Temporary Employees

Our temporary employees are a key component of our success. We consider them one of our most valuable assets as they perform the services our franchises provide. Hire Quest, LLC, our wholly-owned subsidiary, is the employer of record of all temporary employees of the HireQuest Direct, Snelling, HireQuest, and Link brands. We have separate wholly-owned subsidiaries that employ the temporary employees of DriverQuest and HireQuest Health services. In 2021, we employed approximately 73,000 temporary employees and issued approximately 1.1 million paychecks. The vast majority of these payments were made via electronic transfer or paycard. Given the nature of temporary employment, it is difficult for us to determine the exact number of full-time employees on a given day, however, approximately 670 temporary employees worked at least 1,800 hours in 2021.

These temporary employees served thousands of customers, primarily in the construction, industrial/manufacturing, warehousing, hospitality, recycling/waste management, and disaster recovery industries. Our customers range in size from small, local businesses to large, multi-national corporations. Most of our work assignments are short-term, and many are filled with little advance notice from customers.

We continuously recruit temporary staff so we can respond to customer needs quickly. We attract our employees through various means, including in-person recruitment, online resources, cell phone texting services, our large and ever-growing internal database, job fairs, word-of-mouth, digital and print advertisements, and a number of other methods. Our success depends, in part, on our ability to attract and retain temporary employees. To that end, we have implemented a robust health insurance program giving qualifying temporary employees a list of plans to choose from, including Affordable Care Act (ACA) compliant coverage.

The safety of our temporary employees remains one of our highest priorities. We regularly provide safety and skills training. We also aggressively manage our workers' compensation program to identify trends in injuries and limit our losses and exposure. Through our Risk Management Incentive Program, our franchisees are incentivized to ensure safe working environments and to achieve quick resolutions of workers' compensation claims when they do arise.

Corporate Employees

We believe our success also depends on our ability to attract, develop, and retain talented employees at our corporate headquarters. The skills, experience, and industry knowledge of our employees significantly benefit our operations and performance. We believe a strong, positive corporate culture and employee engagement is key to attracting and retaining talented employees. Executives of the company set this tone at the top, and we routinely have Company functions designed to engage and integrate our employees into our culture. We employ approximately seventy corporate employees through HQ LTS Corporation, our wholly-owned subsidiary. Most of these individuals are employed at our corporate headquarters in Goose Creek, South Carolina. The vast majority of these employees are full-time. These employees provide back-office support, including financing, insurance, accounting, operations, national sales, information technology, legal, and human resources services to our franchisees and temporary employees. As of December 31, 2021 we had approximately 70 corporate employees in total, most of which were full time employees.

Executive Officers

Information about our executive officers follows:

Richard Hermanns is the President and Chief Executive Officer, as well as Chairman of the Board of Directors, of HireQuest, Inc. Mr. Hermanns has thirty-one years of experience in the temporary staffing industry. Previously, he served as chief executive officer and secretary of HireQuest, LLC, after the company’s founding in 2002, and similar capacities for predecessor entities since July 1991. Prior to founding HireQuest, Mr. Hermanns was the chief financial officer of Outsource International, formerly known as Labor World USA, Inc., and an assistant vice president at NCNB National Bank, now Bank of America. He graduated summa cum laude with a Bachelor of Science in economics and finance from Barry University and holds a Masters of Business Administration in finance from the University of Southern California. In addition to his business ventures, Mr. Hermanns is also involved in a number of charitable pursuits. One of them is the Higher Quest Foundation, a non-profit organization dedicated to fighting global hunger in a sustainable way.

David S. Burnett is the Chief Financial Officer of HireQuest, Inc. He has served as the Chief Financial Officer since December 2021. Prior to joining HQI, Mr. Burnett was Chief Financial Officer for Ivy Asset Group, an alternative credit provider and investment bank. Prior to Ivy, Mr. Burnett served as Chief Financial Officer for a series of publicly-traded companies under the umbrella of BKF Capital Group, including Interlink Electronics, Inc. (Nasdaq:LINK), BKF Capital Group, Inc. (OTC:BKFG) and Ridgefield Acquisition Corp (OTC:RDGA). Before that, Mr. Burnett served in various management positions with EnPro Industries, Inc. (NYSE:NPO), most recently as Vice President and Treasurer. EnPro is a diversified industrial technology company with $1.5 billion in global revenue. Prior to EnPro he was a Director at PricewaterhouseCoopers LLP and Senior Manager at Grant Thornton LLP. Mr. Burnett received his Bachelor of Science degree in Business Administration (Accounting) from Old Dominion University, and a Master of Science degree in Taxation from Golden Gate University. He is both a Certified Public Accountant and a Certified Treasury Professional.

John D. McAnnar is the Chief Legal Officer, Vice President, and Secretary of HireQuest, Inc. He has fulfilled the former two roles for both HQI, and its predecessor, HireQuest, LLC, since 2014. His work with HireQuest involves a range of legal, operational, and risk management affairs in different realms, including mergers and acquisitions, securities, employment, insurance and finance, workers’ compensation, and intellectual property. Previously, Mr. McAnnar served in the litigation departments of Carmody MacDonald, P.C., and Armstrong Teasdale, LLP, an Am Law 200 firm, where he focused on complex commercial litigation, corporate, and employment law. He is the co-founder of ArchCity Defenders, a non-profit organization in St. Louis, Mo., that led the push for change in Missouri’s municipal court system following the Ferguson unrest. For this work, Mr. McAnnar has received multiple awards, including the National Legal Aid & Defenders Association New Leaders in Advocacy Award and the Ina M. Boon Social Justice Award from the St. Louis City NAACP. Mr. McAnnar graduated cum laude with a Bachelor of Arts degree from the University of Pittsburgh. He achieved his juris doctorate, magna cum laude, from St. Louis University School of Law, where he was inducted into the Alpha Sigma Nu Jesuit Honor Society and the Order of the Woolsack. He is also an adjunct professor at the Charleston School of Law.

Our Competition

The staffing industry is highly fragmented and highly competitive, with relatively low barriers to entry aside from payroll funding, workers’ compensation premiums, and startup costs. No single staffing company dominates the industry. Our competitors range in size from small, local or regional operators with five or fewer offices to large, multi-national companies with hundreds or thousands of offices around the world. Some of our competitors are publicly traded corporations that have the same access to capital as we do. Our strongest competition in any market comes from companies that have established long-lasting relationships with their clients. Competition in the industry tends to track the overall strength of the economy and trends in workforce flexibility. As the economy grows, the number of competitors generally increases.

The primary competitive factors in our market includes price, the ability to provide the requested workers on a timely basis, and success in meeting customer expectations. Secondary factors include customer relationships, name recognition, and established reputation. Businesses operating in these areas of the staffing industry require access to significant working capital to pay temporary employees, particularly in the spring and summer when seasonal staffing requirements are highest, and to fund workers' compensation premiums and claims. Lack of working capital can be a significant impediment to growth for small, local, and regional staffing service providers. A second barrier to entry is an affordable workers’ compensation policy. Small entrants usually do not have the scale necessary to secure a policy on terms similar to ours. Regulatory compliance is becoming more burdensome, particularly for smaller firms that cannot profitably comply with the increasing number of federal, state, and local employment laws and regulations.

We also face increasing competition from gig-economy companies who are attempting to monetize the temporary staffing industry through smartphone applications. We believe these apps, however, will not be a major source of successful competition in the commoditized section of the labor markets where we have significant operations. The apps, which operate on a broad-blast, first-come-first-served basis, often result in too many or too few workers arriving at a jobsite, workers arriving without the necessary required personal protective equipment, or employees arriving at a jobsite unwilling or unable to perform the assigned tasks. In contrast, our direct dispatch model allows us to screen employees’ readiness for work every day, assist with arranging transportation to and from jobsites, and match employees with company-provided personal protective equipment before they leave the office. Our proprietary software does utilize bulk text messaging, but on a targeted basis specific to a particular job in a particular geography.

Our Cyclicality and Seasonality

The temporary staffing industry has historically been cyclical. Success tends to track the economy. When our franchisees’ customers expect to have long-term permanent needs, they tend to increase their use of temporary employees. Our revenue tends to increase as the economy expands, and conversely, our revenue tends to decrease when the economy contracts.

Some of the industries in which we operate are subject to seasonal fluctuation. Many of the jobs filled by temporary employees are outdoors and generally performed during the warmer months of the year. As a result, activity increases in the spring and continues at higher levels through the summer, then begins to taper off during fall and through winter. In addition, demand by industrial customers tends to slow after the holiday season and pick up again in the third and fourth quarters – peaking in the third quarter. Our exposure to seasonality is mitigated, in part, by our strong presence in the Southern United States where seasonal fluctuations are typically less pronounced.

Our Intellectual Property

We own the rights to all of our key trademarks including “HireQuest,” “HireQuest Direct,” “Snelling,” “DriverQuest,” “HireQuest Health,” “Recruit,” “VETSQuest,” “The Right People at the Right Time”, and all of our stylized logos. We also own the rights to trademarks we have utilized in the past. We license the use of our marks to our franchisees via the franchise agreements. Following our March 2021 Acquisitions, we have a license to use the Link-associated trademarks with franchisees acquired in the Link Acquisition. In California, we license the use of the Snelling and Link names to an independent third-party.

We have developed and own our proprietary software to handle most aspects of operations, including temporary employee dispatch and payroll, invoicing, and accounts receivable. Our software system also allows us to produce internal reports necessary to track and manage financial performance of franchisees, customer trends, detect potential fraud, and to examine other key performance indicators. We believe that our software facilitates efficient customer interaction, allowing for online bill payment, invoice review, and other important functions. Because WebConnect is a proprietary system, we maintain a dedicated IT development staff, who continually refine our software in response to feedback from franchisees, customers, and employees. We license the use of our software to franchisees via our franchise agreements. The system is not patented. We have invested in off-site back-up and storage systems that we believe provide reasonable protections for our electronic information systems against breakdowns as well as other disruptions and unauthorized intrusions.

We rely on common law protection of our copyrighted works. These works include advertising and marketing materials and other items that are not material to our business. We license some intellectual property from third parties for use in our corporate headquarters, but such licenses are not material to our business.

Our Organizational Structure

HireQuest, Inc. is a holding company. As of December 31, 2021, HireQuest, Inc. was the corporate parent of a series of wholly-owned subsidiaries including: (1) HQ LTS Corporation, which employs the staff of our corporate headquarters; (2) HQ Financial Corporation, which provides financing and related services to our franchisees; (3) Hire Quest, LLC, which is the employer of record of the temporary employees of our HireQuest Direct, HireQuest, and Snelling operations; (4) DriverQuest 2, LLC, which employs the temporary employees of our DriverQuest operations; (5) HQ Medical, LLC, which employs the temporary employees of our HireQuest Health operations; (6) HQ Franchising Corporation, which is the franchisor of our franchised relationships; and (7) HQ Real Property Corporation, which owns our corporate headquarters buildings. HireQuest Inc. was also the corporate parent to a series of additional wholly-owned subsidiaries which had no operations in 2021 (all of which are listed on Exhibit 21.1 filed herewith and incorporated herein by reference).

Our Securities Exchange Act Reports

We maintain a website at the following address: www.hirequest.com (http://www.hirequest.com). The information on our website is not incorporated by reference in this Annual Report on Form 10-K.

We make available on our website certain reports and amendments to those reports that we file with or furnish to the Securities and Exchange Commission (the “SEC”) in accordance with the Securities Exchange Act of 1934, as amended (the “Exchange Act”). These include our annual reports on Form 10-K, our quarterly reports on Form 10-Q, our current reports on Form 8-K, Section 13 filings by our 5% shareholders and Section 16 filings by our officers, directors and 10% stockholders. We make this information available on our website free of charge as soon as reasonably practicable after we or they electronically file the information with, or furnish it to, the SEC.

Our common stock value and our business, results of operations, cash flows, and financial condition are subject to various risks, including, but not limited to, those set forth below. If any of these risks actually occur, the value of our common stock, business, results of operations, cash flows, and financial condition could be materially adversely affected. In such case, the value of your investment could decline, and you may lose all or part of the money you paid to buy our common stock. These risk factors should be carefully considered together with the other information in this Form 10-K, including the risks and uncertainties described under the heading “Special Note Regarding Forward-Looking Statements.”

Risks Related to Our Business and Industry

Acquisitions may have an adverse effect on our business.

We intend to continue making acquisitions a part of our growth initiative. This strategy may be impeded, and we may not achieve our long-term growth goals if acquisition candidates are not available under acceptable terms. Additionally, we may have difficulty integrating acquired companies into our business, including our operational software and financial reporting systems, and may not effectively manage or (if deemed necessary) divest acquired companies to achieve expected growth.

Future acquisitions may cause us to incur additional debt and contingent liabilities, and result in an increase in interest expense, amortization expense, and non-recurring charges related to integration efforts. Acquisitions financed through equity offerings may cause dilution to our existing shareholders. Acquisitions we announce could be viewed negatively by investors, which may adversely affect the price of our common stock. Acquisitions can also result in the addition of goodwill and intangible assets to our financial statements, and we may be required to record a significant charge in our financial statements during the period in which we determine an impairment of our acquired goodwill and intangible assets has occurred, which would negatively impact our financial results. The potential loss of key executives, franchisees, clients, and other business partners of businesses we acquire may adversely impact the value of the assets, operations, or business we acquire. Any combination of these events or consequences could cause material harm to our business, and adversely affect our operations and financial condition.

New business initiatives will cause us to incur additional expenditures and may have an adverse effect on our core business.

We expect to expand our business by entering new business initiatives as part of our growth strategy. New business initiatives, strategic business partners, or changes in the composition of our business can be distracting to our management and disruptive to our operations, causing our core business and results of operations to suffer materially. New business initiatives and entering new markets could involve significant unanticipated challenges and risks and divert management’s attention away from our core business.

The COVID-19 pandemic has been unpredictable and could continue to negatively impact our financial condition and results of operations.

The COVID-19 pandemic adversely affected our business and financial results in 2020 and, to a lesser extent in 2021, and we expect that it may continue to negatively impact our business and financial results going forward. The extent to which it does so depends on the length of the pandemic and its economic repercussions. Since March 13, 2020, 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, had serious adverse impacts on our business and domestic and foreign economies. They caused our system-wide sales and resulting revenue to decline in 2020 and into early 2021.

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 by the COVID-19 outbreak, variants of COVID-19, and any virus that spreads in a similar fashion. Our operations were disrupted by customers decreasing the amount of orders they placed for temporary employees, safety measures we and our franchisees put in place to prevent spread of the virus, inability to locate temporary employees willing to work, and in other ways. In 2020, 13 of our franchised offices closed or consolidated into other existing offices at least, in part, due to the impact of COVID-19. 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 $1.9 million as of December 31, 2021.

A repeat of the cascading effects of the COVID-19 pandemic could materially increase our costs, severely negatively impact our revenue, net income, and other results of operations, reduce system-wide sales, cause additional office closings or cause us to lose franchisees, and impact our liquidity position, possibly significantly. The extent and duration of any such impacts on our business, financial condition, and results of operations cannot be predicted.

Price increases and supply shortages may negatively affect our results of operations.

Supply chain challenges related to the COVID-19 pandemic and the impact of Russia’s invasion of Ukraine on oil and gas delivery have contributed and continue to contribute to price increases and supply shortages in a variety of industries, including construction, industrial/manufacturing and consumer goods. If these impacts continue to affect our industrial/manufacturing, construction or other clients, demand for our labor may decrease, which would decrease gross billings and therefore our royalty revenue. Furthermore, sustained increases in the consumer price index will likely put upward pressure on wages. If we are unable to match or exceed wages offered by other potential employers to our temporary employees, we may suffer from employee attrition.

We have been and may continue to be unable to attract sufficient qualified candidates to meet all of the needs of our clients.

We compete to meet our clients’ needs for workforce solutions and, therefore, we must continually attract qualified candidates to fill positions. Attracting qualified candidates depends on factors such as the number of candidates available in the relevant location, desirability of the assignment, the health of our workforce, and the associated wages and other benefits. We have experienced shortages of qualified candidates and we may experience such shortages in the future due to a number of factors beyond our control, such as the COVID-19 pandemic, demographic shifts in the workforce, benefits received by our candidates from other sources including government benefits, and the overall desire of workforce aged employees to fulfill the types of jobs our customers need. If there is a shortage of candidates, the cost to employ or recruit qualified individuals could increase. If we are unable to pass those increases through to our clients, it could materially and adversely affect our business.

We are vulnerable to seasonal fluctuations with lower demand in the winter months.

Royalty fees generated from office sales in markets subject to seasonal fluctuations are less stable and may be lower than in other markets. Locating offices in highly seasonal markets involves higher risks. Individual franchisee revenue can fluctuate significantly on both a quarter over quarter and year over year basis thereby impacting our royalty and service revenue, depending on the local economic conditions and need for temporary staffing services in the local economy. Weather can also have a significant impact on our operations as there is typically lower demand for staffing services during adverse weather conditions in the winter months. To the extent that seasonal fluctuations become more pronounced, our royalty fees could fluctuate materially from period to period.

We are critically dependent on workers’ compensation insurance coverage at commercially reasonable rates, and unexpected changes in claim trends on our workers’ compensation may negatively impact our financial condition.

We employ workers for whom we provide workers’ compensation insurance. Our workers’ compensation insurance policies are renewed annually. The majority of our insurance policies are with Chubb/Ace American. Our insurance carriers require us to collateralize a significant portion of our workers’ compensation obligation. We currently collateralize our policies largely with a letter of credit from Truist. If we no longer had access to that collateral, we could not be certain we would be able to obtain appropriate types or levels of insurance in the future or that adequate replacement policies would be available on acceptable terms. As our business grows or if our financial results deteriorate, the amount of collateral required could increase and the timing of providing collateral could be accelerated. Resources to meet these requirements may not be available to us in a timely manner or at all. The loss of our workers’ compensation insurance coverage would prevent us from operating as a staffing services business in the majority of our markets. Further, we cannot be certain that our current and former insurance carriers will be able to pay claims we make under such policies.

We are responsible for a significant portion of expected losses under our workers’ compensation program. Unexpected changes in claim trends, including the severity and frequency of claims, changes in state laws regarding benefit levels and allowable claims, actuarial estimates, or medical cost inflation, could result in costs that are significantly higher. There can be no assurance that we will be able to increase the fees charged to our clients in a timely manner and in a sufficient amount to cover increased costs as a result of any changes in claims-related liabilities.

Our efforts to actively manage the safety of our temporary workers and actively control costs with internal staff and our network of workers’ compensation related service providers may not be sufficient to prevent material increases to our workers’ compensation costs.

We are dependent on a small number of individuals who constitute our current management.

We are highly dependent on the services of our senior management team and other key employees at our corporate headquarters and on our franchisees’ ability to recruit, retain, and motivate key operations related employees. Competition for such employees can be intense, and the inability to attract and retain the additional qualified employees required to expand our activities, or the loss of current key employees could adversely affect our operating efficiency and financial condition. In addition, our growth strategy may place strains on our management who may become distracted from day-to-day duties.

We may incur employment related claims or other types of claims and costs that could materially harm our business.

We are in the business of employing people in the workplaces of our clients. We incur a risk of liability for claims for personal injury, wage and hour violations, immigration, discrimination, harassment, and other liabilities arising from the actions of our clients and/or temporary workers. Some or all of these claims may give rise to negative publicity, litigation, settlements, or investigations. As a result, we may incur costs, charges or other material adverse impacts on our financial statements.

We maintain insurance with respect to some potential claims and costs with deductibles. We cannot be certain that our insurance will be available, or if available, will be of a sufficient amount or scope to cover claims that may be asserted against us. Should the ultimate judgments or settlements exceed our insurance coverage, they could have a material effect on our business. We cannot be certain we will be able to obtain appropriate types or levels of insurance in the future, that adequate replacement policies will be available on acceptable terms, or at all, or that our insurance providers will be able to pay claims we make under such policies.

We offer our qualifying temporary workers government-mandated health insurance in compliance with the Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act of 2010 (collectively, the “ACA”). We cannot be certain that compliant insurance coverage will remain available to us on reasonable terms, and we could face additional risks arising from future changes to or repeal of the ACA or changed interpretations of our obligations under the ACA.

If we fail successfully to implement our growth strategy, which includes new office development by existing and new franchisees, our ability to increase our revenue and operating profits could be adversely affected.

Portions of our growth strategy rely on new office development by existing and new franchisees. Our franchisees may face many challenges in opening new offices including:

• Availability and cost of financing;
• Negotiation of acceptable lease and financing terms;
• Trends in the overall and local economy of the target market;
• Recruitment, training, and retention of qualified core staff and temporary personnel; and
• General economic and business conditions

These factors are outside of our control and could hinder our franchisees from opening new offices or expanding existing ones. This could prevent us from successfully implementing our growth strategy.

Changes in our industry could place strains on our management, employees, information systems, and internal controls, which may adversely impact our business.

Changes in the temporary staffing industry and how our customers utilize, order, and pay for temporary staffing services, particularly through new and innovative uses of technology, may place significant demands on our administrative, operational, financial, and other resources or require us to obtain different or additional resources. Any failure to respond to or manage such changes effectively could adversely affect our business. To be successful, we will need to continue to implement management information systems and improve our operating, administrative, financial, and accounting systems and controls in order to adapt quickly to such changes. These changes may be time-consuming and expensive, increase management responsibilities, and divert management attention, and we may not realize a return on our investment in these changes due to the high obsolescence rate of current technology.

Proposed vaccination mandate, if implemented, is likely to adversely impact our business, results of operations, cash flows and financial position.

On November 5, 2021, the Occupational Safety and Health Administration announced an emergency temporary standard mandating the COVID-19 vaccine or weekly testing for most U.S. employees, which includes our employees. That standard was struck down by the U.S. Supreme Court on January 13, 2022. However, the Biden Administration has indicated that it may seek to impose alternative vaccine mandates and other governmental authorities have imposed more targeted vaccine and testing orders and regulations, and may continue to do so in the future. If a mandate is ultimately issued and implemented in some form, we expect there would be further disruptions to our operations and increased compliance burdens, including financial costs, diversion of administrative resources, and increased downtimes to accommodate for any required ongoing COVID-19 testing.

Shifts in attitudes towards contingent workforces could negatively impact our results of operations and financial condition.

Attitudes and beliefs about contingent workforces could change such that our customers no longer desire to utilize our services. If this occurs, it could negatively impact our financial condition and results of operations. Such a shift could also make it challenging or impossible for us to successfully implement our growth strategies.

Difficult political or market conditions, wars, 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, pandemics, and the ripple effects on the economy from wars and other geopolitical events. For example, the outbreak of COVID-19 materially affected our business in 2020 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 the impact on our business in 2021 was lessened, we believe COVID-19 still depressed our results. 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.

Risks Related to our Credit Facility and Liquidity

Our level of debt and restrictions in our credit agreement could negatively affect our operations and limit our liquidity and our ability to react to changes in the economy.

Our revolving line of credit with Truist Bank (“Truist”) contains restrictive covenants that require us to maintain certain financial conditions, which we may fail to meet if there is a material decrease in our profitability or liquidity. Our failure to comply with these covenants could result in an event of default, which, if not cured or waived, would require us to repay these borrowings before their due date. We may not have sufficient funds on hand to repay these loans, and if we are forced to refinance these borrowings on less favorable terms, or are unable to refinance at all, our results of operations and financial condition could be materially adversely affected by increased costs and rates.

If our debt level significantly increases in the future, it could have significant consequences on our ongoing operations including requiring us to dedicate a significant portion of our cash flow from operations to servicing debt rather than using it to execute our strategic initiatives, such as acquisitions; limiting our ability to obtain additional debt financing for future working capital, capital expenditures, or other worthwhile endeavors; and limiting our ability to react to changes in the market.

In addition, the line of credit agreement limits, among other things, our ability to:

• Sell, lease, license, or otherwise dispose of assets;
• Undergo a change in control;
• Consolidate and merge with other entities; or
• Create, incur, or assume liens, debt, and other encumbrances.

A breach of any of the restrictions and covenants could result in a default under our agreements which could cause any outstanding indebtedness under the agreements or under any future financing arrangements to become immediately due and payable, and result in the termination of commitments to extend further credit.

Without sufficient liquidity, we may not be able to pursue accretive business opportunities.

Our major source of liquidity and capital is cash generated from our ongoing operations. We also receive principal and interest payments on notes receivable. We must have sufficient sources of liquidity to meet our working capital requirements, fund our workers’ compensation collateral requirements, service our outstanding term loan, and finance growth opportunities. Without sufficient liquidity, we may not be able to pursue accretive business opportunities.

We may be unable to obtain financing of our working capital, acquisition, capital, dividend, and other needs on favorable terms.

Our success and growth is largely dependent upon meeting and covering our working capital and other financial needs on favorable terms. If we need to expand our current line of credit in the future, or lose our existing line of credit, it is possible we would be unable to secure a replacement line of credit on favorable terms or at all which would have a negative impact on our financial condition and results of operations.

Risks Related to Our Franchisees and Business Model

Converting company-owned offices to franchises has multiple risks.

We believe that the franchise model is superior to the company-owned store model. To that end, we have historically converted all company-owned offices of any entities we acquire to franchises. However, we have less control over the day-to-day operations of the offices and the franchisees may operate in a manner that is counter to our interests or introduce risks to our business by departing from our operating norms. Further, franchises are generally regulated at both the federal and the state level, so operating as franchises will introduce additional regulatory risk. We have added a significant number of new franchisees through the 2021 Acquisitions, and other transactions. Acquired franchisees need to adapt to a new operating model, a new IT system, and new business processes. Their failure to do so could negatively impact our financial condition and results of operations.

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 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 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 at December 31, 2021. 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 franchisees could take action that could harm our business.

Our franchisees are contractually obligated to operate their offices in accordance with the operations standards set forth in our agreements with them and applicable laws. However, although we attempt to properly train and support all our franchisees, they are independent third parties whom we do not control. The franchisees own, operate, and oversee the daily operations of their offices, and their core office employees are not our employees. While we have the ability to enforce our franchise agreements, many of our franchisees’ actions are outside of our control. Although we have developed criteria to evaluate and screen prospective franchisees, we cannot be certain that our franchisees will have the business acumen or financial resources necessary to operate successful franchises at their approved offices, and state franchise laws may limit our ability to terminate or not renew these franchise agreements. Moreover, despite our training, support, and monitoring, franchisees may not successfully operate offices in a manner consistent with our standards and requirements or may not hire and adequately train qualified office personnel. The failure of our franchisees to operate their franchises in accordance with our standards or applicable law, actions taken by their employees or a negative publicity event at one of our franchisees’ offices or involving one of our franchisees could have a material adverse effect on our reputation, our brands, our ability to attract prospective franchisees, and our business, financial condition, or results of operations.

If we fail to identify, recruit, and contract with a sufficient number of qualified franchisees, our ability to open new offices and increase our revenue could be materially adversely affected.

The opening of additional offices and expansion into new markets depends, in part, upon the availability of prospective franchisees who meet our selection criteria. Many of our franchisees open and operate multiple offices, and part of our growth strategy requires us to identify, recruit and contract with new franchisees or rely on our existing franchisees to expand. We may not be able to identify, recruit or contract with suitable franchisees in our target markets on a timely basis or at all. If we are unable to recruit suitable franchisees or if franchisees are unable or unwilling to open new offices, our growth may be slower than anticipated, which could materially adversely affect our ability to increase our revenue and materially adversely affect our business, financial condition and results of operations.

Opening new offices in existing markets and aggressive development could cannibalize existing sales and may negatively affect sales at existing offices and relationships with existing franchisees.

We intend to continue opening new franchised offices in our existing markets as a part of our growth strategy. Expansion in existing markets may be affected by local economic and market conditions. Further, the customer target area of our offices varies by location, depending on a number of factors, including population density, area demographics and geography. As a result, the opening of a new office in or near markets in which our franchisees’ offices already exist could adversely affect the sales of these existing franchised offices. Sales cannibalization between offices may become significant in the future as we continue to expand our operations and could affect sales growth, which could, in turn, materially adversely affect our business, financial condition or results of operations. There can be no assurance that sales cannibalization will not occur or become more significant in the future as we increase our presence in existing markets.

A large number of our franchises are controlled by a small number of individuals.

A significant number of our franchises are controlled or beneficially owned by a small number of individuals. Mr. Jackson and immediate family members of Mr. Hermanns have ownership interests in certain of our franchisees, which we label the “Worlds Franchisees.” There were 23 Worlds Franchisees at December 31, 2021 that operated 60 of our 217 franchised offices. Mr. Hermanns’ three children and son-in-law own in the aggregate between 26.8% and 62.8% of each of the Worlds Franchisees. Mr. Jackson owns between 10.7% and 25.4% of each of the Worlds Franchisees.

Approximately one-third of our franchisees owned multiple offices. If any of our relatively large ownership groups were to experience financial difficulty, reduced sales volume, or close, we may experience a negative impact on our results of operations, liquidity, or 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.

We occasionally lend money to our franchisees to facilitate a franchise conversion or expansion into a new market. 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 purchase financing loans in 2019 in connection with the Command Center Merger and subsequent sales and conversions of company-owned offices to franchises. In addition, the purchaser of our California office assets (the "California Purchaser") 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 had difficulty in repaying their debts to us. To that end, we placed a reserve of approximately $1.9 million on our notes receivable at December 31, 2021. 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.

The ability of such parties 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 December 31, 2021, our loans receivable from franchisees and from the California purchaser, net of an approximately $1.9 million reserve, constituted 5.4% of our total 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.

We may have improperly balanced the costs and benefits related to our Franchise Expansion Incentive Program.

Through our Franchise Expansion Incentive Program, we have agreed, under certain circumstances, to provide certain franchisees with credits to their royalty fees, financing assistance, or acquisition funding. If the new offices which are funded in whole or in part by this program fail or underperform, we may suffer financially, and it may have an adverse impact on our results of operations, liquidity, or financial condition.

Risks Related to Technology and Cybersecurity

The improper disclosure of, or access to, our confidential and proprietary information, or a failure to adequately protect this information, could materially harm our business.

Our business requires the collection, use, processing, and storage of confidential information about applicants, candidates, temporary workers, other employees, and clients. We will likely encounter cyberattacks, computer viruses, social engineering schemes, and other means of unauthorized access to our systems. The security controls over sensitive or confidential information and other practices we and our third-party vendors follow may not prevent the improper access to, disclosure of, or loss of such information. We may fail to implement practices and procedures that comply with the ever-expanding regimes of privacy regulation. Failure to protect the integrity and security of the confidential information we possess could expose us to regulatory fines, litigation, contractual liability, damage to our reputation, and increased compliance costs.

Our information technology systems may need to be updated or replaced.

We regularly implement, modify, retire, and upgrade our systems and proprietary software. These changes to our information technology systems may be disruptive, take longer than desired, be more expensive than anticipated, be distracting to management, or fail, causing our business and results of operations to suffer materially.

Advances in technology may disrupt the labor and recruiting markets.

We expect the increased use of internet-based and mobile technology will attract additional technology-oriented companies and resources to the staffing industry. We face increasing competition from “gig-economy” companies entering the temporary staffing industry by providing apps to connect workers with employers. Such competition could adversely affect our business and results of operations. Our candidates and clients increasingly demand technological innovation to improve the access to and delivery of our services.

Our clients increasingly rely on automation, artificial intelligence and other new technologies to reduce their dependence on labor needs, which may reduce demand for our services and impact our operations. Our franchisees face extensive pressure for lower prices and new service offerings and we must continue to invest in and implement new technology and industry developments to remain relevant to our ultimate clients and candidates. If we are unable to do so, our business and results of operations may decline materially. Furthermore, if our clients are able to increase the effectiveness of their internal staffing and recruitment functions through analytics, automation or otherwise, their need for the services our franchisees offer may decline. New technology and more sophisticated staffing management and recruitment processes may cause clients to outsource less of their staffing management, reducing the demand for our franchisees services.

Our facilities, operations, and information technology systems may be vulnerable to damage and interruption.

Our primary computer systems, headquarters, support facilities, and operations are vulnerable to damage or interruption from power outages, computer and telecommunications failures, computer viruses, employee errors, security breaches, natural disasters, and catastrophic events. Failure of our systems or damage to our facilities may cause significant interruption to our business, and require significant additional capital and management resources to resolve, causing material harm to our business.

Risks Related to Ownership of Our Stock

If we are a “personal holding company,” we may be required to pay personal holding company taxes, which would have an adverse effect on our cash flows, results of operations, and financial condition.

Under the Code, a corporation that is a “personal holding company” may be required to pay a personal holding company tax in addition to regular income taxes. A corporation generally is considered a personal holding company if (1) at any time during the last half of the taxable year more than 50% of the value of the corporation’s outstanding stock is owned, directly, indirectly, or constructively, by or for five or fewer individuals, the Ownership Test, and (2) at least 60% of the corporation’s “adjusted ordinary gross income” constitutes “personal holding company income", the Income Test. A corporation that is considered a personal holding company is required to pay a personal holding company tax at a rate equal to 20% of such corporation’s undistributed personal holding company income, which is generally taxable income with certain adjustments, including a deduction for U.S. federal income taxes and dividends paid.

We will likely fail the Ownership Test for the 2021 tax year. However, we do not expect to fail the Income Test in 2020 and 2021. Accordingly, we do not believe that we will be considered a personal holding company for these years. However, because personal holding company status is determined annually and is based on the nature of the corporation’s income, dividends paid, and percentage of the corporation’s outstanding stock that is owned, directly, indirectly, or constructively, by major stockholders, there can be no assurance that we will not become a personal holding company in any future taxable year. If we were considered a personal holding company with undistributed personal holding company income in a taxable year, the payment of personal holding company taxes would have an adverse effect on our cash flows, results of operations, and financial condition.

Our directors, officers, and current principal stockholders own a large percentage of our common stock and could limit other stockholders’ influence over corporate decisions.

As of March 15, 2022, our directors, officers, and current stockholders holding more than 5% of our common stock collectively beneficially own, directly or indirectly, in the aggregate, approximately 62% of our outstanding common stock. Mr. Hermanns beneficially owns approximately 28% of our outstanding common stock, a trust for the benefit of his family owns approximately 16% of our outstanding common stock, and Mr. Jackson beneficially owns approximately 19% of our outstanding common stock. As a result, these stockholders acting alone or together may be capable of controlling most matters requiring stockholder approval, including the election of directors, approval of acquisitions requiring the issuance of a significant amount of the Company’s equity, approval of equity incentive plans, and other significant corporate transactions. This concentration of ownership may have the effect of delaying or preventing a change in control. The interests of these stockholders may not always coincide with our corporate interests or the interests of our other stockholders, and they may act in a manner with which some stockholders may not agree or that may not be in the best interests of all stockholders.

Our stock typically trades in low volumes daily which could lead to illiquidity, volatility, or depressed stock price.

Our stock is listed on Nasdaq, but typically trades in low daily volumes. Because of a history of low trading volume, our stock may be relatively illiquid and its price may be volatile. This may make it more difficult for our stockholders to resell shares when desired or at attractive prices. Some investors view low-volume stocks as unduly speculative and therefore not appropriate candidates for investment. Also, due to the low volume of shares traded on any trading day, persons buying or selling in relatively small quantities may easily influence prices of our stock.

Analysts covering our stock could negatively impact both the stock price and trading volume of our stock.

The trading market for our common stock will likely be influenced by the research and reports that industry or securities analysts may publish about us, our business, our market or our competitors. We currently have research coverage by two financial analysts. If one or both of the analysts covering our business downgrade their evaluation of our stock, the price of our stock could decline. If one or both of these analysts cease to cover our stock, we could lose visibility in the market for our stock, which in turn could cause our stock price to decline. Furthermore, if our operating results fail to meet analysts’ expectations our stock price would likely decline.

Our stock price has been and will likely continue to be extremely volatile, and, as a result, stockholders may not be able to resell shares at or above their purchase price, and we may be more vulnerable to securities class action litigation.

In 2021, our stock price, as reported by Nasdaq, has ranged from a low of $9.62 to a high of $24.39. As a result, the market price and trading volume of our common stock is likely to be similarly volatile in the future, and investors in our common stock may experience a decrease, which could be substantial, in the value of their stock, including decreases unrelated to our results of operations or prospects, and could lose part or all of their investment.

In the past, following periods of volatility in the market price of a company’s securities, securities class action litigation has often been brought against that company. Because of the potential volatility of our stock price, we may become the target of securities litigation in the future. If we were to become involved in securities litigation, it could result in substantial costs, divert management’s attention and resources from our business and adversely affect our business.

If we cease paying cash dividends on our common stock, you may not receive any return on investment unless you sell your common stock for a price greater than that which you paid for it.

We began paying quarterly dividends in the third quarter of 2020. At any time, our board of directors may instead revert to our prior practice of retaining any future earnings exclusively for future operations, expansion and debt repayment and cease paying cash dividends on our common stock. The declaration, amount, and payment of any future dividends on shares of our common stock will be at the sole discretion of our board of directors, which may take into account general economic conditions, our financial condition and results of operations, our available cash and current and anticipated cash needs, capital requirements, contractual, legal, tax, and regulatory restrictions (including restrictions imposed by our credit facility), the implications of the payment of dividends by us on our stockholders, and any other factors that our board of directors may deem relevant. As a result, if we cease paying dividends, you may not receive any return on an investment in our common stock unless you sell our common stock for a price greater than that which you paid for it.

We are a “smaller reporting company” as defined in SEC regulations, and the reduced disclosure requirements applicable to smaller reporting companies may make our common stock less attractive to investors.

We are a “smaller reporting company” as defined under SEC regulations and we may take advantage of certain exemptions from various reporting requirements that are applicable to other public companies that are not smaller reporting companies including, among other things, reduced financial disclosure requirements including being permitted to provide only two years of audited financial statements and reduced disclosure obligations regarding executive compensation. As a result, our stockholders may not have access to certain information that they may deem important. We could remain a smaller reporting company indefinitely. As a smaller reporting company, investors may deem our stock less attractive and, as a result, there may be less active trading of our common stock, and our stock price may be more volatile.

General Risk Factors

Our industry is subject to extensive government regulation and the imposition of additional regulations, which could materially harm our future earnings.

Our workforce solutions are subject to extensive government regulation. In particular, we are subject to a significant number of employment laws due to our being a large employer. Additionally, there are state and federal rules regarding disclosure requirements to potential franchisees and regulations regarding our relationship with existing franchisees. The cost to comply, and any inability to comply with government regulation, could have a material adverse effect on our business and financial results. Increases or changes in government regulation of the workplace or of the employer-employee relationship, or judicial or administrative proceedings related to such regulation, could materially harm our business.

We may engage in litigation with our franchisees.

Although we believe we generally enjoy a positive working relationship with our franchisees, the nature of the franchisor-franchisee relationship may give rise to litigation with our franchisees. While we do not engage in litigation with our franchisees in the ordinary course of business, it is possible that we may experience litigation with some of our franchisees in the future. We may engage in future litigation with franchisees to enforce our contractual indemnification rights if we are brought into a matter involving a third party due to the franchisee’s alleged acts or omissions. In addition, we may be subject to claims by our franchisees relating to our franchise disclosure document, including claims based on financial information contained in our franchise disclosure document. Engaging in such litigation may be costly and time-consuming and may distract management and materially adversely affect our relationships with franchisees and our ability to attract new franchisees. Any negative outcome of these or any other claims could materially adversely affect our results of operations as well as our ability to expand our franchise system and may damage our reputation and brands. Furthermore, existing and future franchise-related legislation could subject us to additional litigation risk in the event we terminate or fail to renew a franchise relationship.

We operate in a highly competitive industry and may be unable to retain clients or market share.

Our industry is highly competitive and rapidly innovating. We compete in national, regional and local markets with full-service and specialized temporary staffing companies. Our competitors offer a variety of flexible workforce solutions. Therefore, there is no assurance that we will be able to retain clients or market share in the future, nor can there be any assurance that we will, in light of competitive pressures, be able to remain profitable or maintain our current profit margins.

Our information technology systems may need to be updated or replaced.

We occasionally implement, modify, retire and change our systems. These changes to our information technology systems may be disruptive, take longer than desired, be more expensive than anticipated, be distracting to management, or fail, causing our business and results of operations to suffer materially.

The improper disclosure of, or access to, our confidential and/or proprietary information, or a failure to adequately protect this information, could materially harm our business.

Our business requires the use, processing, and storage of confidential information about applicants, candidates, temporary workers, other employees and clients. We occasionally experience cyberattacks, computer viruses, social engineering schemes and other means of unauthorized access to our systems. The security controls over sensitive or confidential information and other practices we and our third-party vendors follow may not prevent the improper access to, disclosure of, or loss of such information. We may fail to implement practices and procedures that comply with increasing privacy regulations. Failure to protect the integrity and security of such confidential and/or proprietary information could expose us to regulatory fines, litigation, contractual liability, damage to our reputation and increased compliance costs.

Our facilities, operations, and information technology systems are vulnerable to damage and interruption.

Our primary computer systems, headquarters, support facilities and operations are vulnerable to damage or interruption from power outages, computer and telecommunications failures, computer viruses, employee errors, security breaches, natural disasters and catastrophic events. Failure of our systems or damage to our facilities may cause significant interruption to our business and require significant additional capital and management resources to resolve, causing material harm to our business.

If we fail to establish and maintain adequate internal control over financial reporting, we may not be able to report our financial results in a timely and reliable manner, which could harm our business and impact the value of our securities.

We are required by the SEC to establish and maintain adequate internal control over financial reporting that provides reasonable assurance regarding the reliability of our financial reporting and the preparation of financial statements. Accordingly, we are required to assess the effectiveness of our internal control over financial reporting annually and the effectiveness of our disclosure controls and procedures quarterly. We are also required to disclose any change that has materially affected or is reasonably likely to materially affect our internal controls over financial reporting on a quarterly basis.

If we fail to achieve and maintain the adequacy of our internal controls, we may not be able to ensure that we can conclude on an ongoing basis that we have effective internal control over financial reporting. If we cannot provide reliable financial reports, our business could be harmed, investors could lose confidence in our reported financial information, and the trading price of our common stock could drop significantly. Likewise, if our financial statements are not filed on a timely basis as required by the SEC, we could face severe consequences, and our reputation could be harmed which in turn could affect the value of our securities.

Uncertainty about the continuing availability of LIBOR may adversely affect our business.

The interest rates under our line of credit with Truist are calculated by reference to LIBOR. The United Kingdom's Financial Conduct Authority, the authority that regulates LIBOR, announced in 2017 that it intends to stop compelling banks to submit rates required for the calculation of LIBOR after 2021. Subsequently, the cessation date for most LIBOR tenors was extended to June 30, 2023. In addition, other regulators have suggested reforming or replacing other benchmark rates. These may be replaced by the Secured Overnight Financing Rate or other benchmark rates over the next several years. The discontinuation, reform or replacement of LIBOR or any other benchmark rates may have an unpredictable impact on contractual mechanics in the credit markets or cause disruption to the broader financial markets. These changes, and related uncertainty as to the nature of such potential discontinuation, reform or replacement may create incremental uncertainty in obtaining financing or increase the cost of borrowing. If LIBOR ceases to exist, then the interest rate benchmark will be replaced as set forth in the loan agreement. It is not possible to predict the effect of these changes, other reforms, tax legislation impacts, or the establishment of alternative reference rates in the United Kingdom, the United States or elsewhere, and such changes may result in, among other things, increased volatility and illiquidity in markets for instruments that currently rely on LIBOR, increased borrowing costs, reductions in the value of certain instruments or the effectiveness of related transactions such as hedges, difficulty and costly processes to amend applicable contracts and instruments and difficulties, complications or delays in connection with future financing and hedging efforts.

We own our corporate headquarters, a building of approximately 15,000 square feet, in Goose Creek, South Carolina. This building serves as our base of operations for nearly all of the employees who provide franchisee support functions. We lease approximately 3,220 square feet of office space in our headquarters to an unaffiliated company. This lease is at the market rate.

We recently completed the construction of a 10,000 square foot building adjacent to our corporate headquarters and a supporting parking lot. This building serves as additional space for our corporate employees. We lease approximately 6,000 square feet of office space in the adjacent building to an unaffiliated company. This lease is at the market rate.

We have a term loan secured by a mortgage on our real property. The term loan is scheduled to mature in June 2036 and bears interest at a variable rate equal to LIBOR plus a margin of 2.0%. Our monthly payment consists of a fixed principle payment of approximately $17,500 plus interest.

We are unaware of any material liens or other encumbrances on our real property, other than as general collateral for our Revolving Credit and Term Loan Agreement with Truist.

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.

The Company and its consolidated subsidiaries file tax returns in multiple jurisdictions and are subject to occasional audits and routine examinations. The federal government requires us to list any "Reportable Transactions", which include abusive transactions and transactions having a significant tax avoidance purpose. We do not have any Reportable Transactions, and have not been assessed or paid any tax penalties with respect to Reportable Transactions.

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, 2020 which we filed with the SEC on 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, 2021 we 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 2021 Acquisitions. Current assets increased from $39.0 million on December 31, 2020 to $42.0 million on December 31, 2021.

On a year-over-year basis, we saw a 68.1% increase in our system-wide-sales from $210.9 million in 2020 to $354.5 million in 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.

Results of Operations

The following table displays our consolidated statements of operations for the years ended December 31, 2021 and December 31, 2020 (in thousands, except percentages):

1. See the definition and reconciliation of Adjusted EBITDA within the immediately following section titled “Use of Non-GAAP Financial Measures: Adjusted EBITDA.”

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.

Total 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, 2021 was approximately $22.8 million compared to $13.8 million for 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.”

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 $1,000,000 of billing with the royalty fee dropping 0.5% for every $1,000,000 of billing thereafter until the royalty fee is 6% once gross billings reach $4,000,000 annually. 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, 2021 were approximately $21.3 million compared to $12.8 million for 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 million increase in total revenue was primarily attributable to the following factors: (a) a $3.8 million increase in revenue from existing offices, and (b) a $4.7 million increase in revenue from offices added through the 2021 Acquisitions. The $3.8 million increase 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

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, 2021 was approximately $1.2 million compared to $1.0 million for 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 Expenses (“SG&A”)

SG&A for the year ended December 31, 2021 was approximately $13.4 million compared to $8.7 million for the year ended December 31, 2020, an increase of 53.6%. This increase in 2021 is primarily due to expenses related to the March 2021 Acquisitions. 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 million higher 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 million in allowance for losses on notes receivable in 2020, and another $0.3 million in 2021.

The remainder of the increase primarily relates to variable SG&A costs that increased as a result of the increase in daily transactions and the cost of providing back-office support to our franchisees. Overall, SG&A represented 3.8% of system-wide-sales in 2021 versus 4.1% of system-wide sales in 2020 (3.6% without the allowance for loan losses). Generally, we have been able to leverage much of the increase in revenue using existing resources.

Depreciation and amortization

Depreciation and amortization for the year ended December 31, 2021 was approximately $1.6 million compared to $130,000 for the year ended December 31, 2020. The increase of almost $1.5 million was due to additional amortization stemming from acquisitions. We acquired $21.9 million of franchise agreements and $9.0 million of other intangibles in the 2021 Acquisitions. Of the $9.0 million in other intangibles, $2.2 million is 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, 2021 other miscellaneous income was approximately $4.6 million, compared to $460,000 for 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, 2021 was approximately $400,000 compared to $700,000 for 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 million at December 31, 2020 to $4.4 million at December 31, 2021. During 2021, we sold approximately $5.3 million of 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 $107,000 to $157,000 at December 31, 2021 from 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 $638,000 in 2021 and $741,000 in 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,

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.

Liquidity 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 million of cash and $38.2 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 $4.6 million due to our franchisees, $4.6 million of accrued wages, benefits and payroll taxes, and $4.5 million related 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 million available 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 million and 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 million in stock-based compensation and $1.6 million in 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 million and a decrease in accounts receivable of approximately $6.9 million. We also had non-cash expenses in 2020, including approximately $1.2 in 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.

Investing Activities

During 2021, net cash used by investing activities was approximately $29.4 million and 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 $36,000 and 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 $347,000 which was primarily due to the payment of dividends of approximately $3.1 million offset 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 million which was primarily due to the payment of dividends of approximately $1.4 million and the purchase of treasury stock of approximately $146,000.

Capital Resources

Revolving Credit and Term Loan Agreement with Truist

On June 29, 2021 the 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 million revolving line of credit with a $20 million sublimit for letters of credit (the "Line of Credit") and (ii) a $3,153,500 term loan (the "Term Loan"). Truist Bank may also make Swingline Loans available in its discretion. The Credit Agreement replaced the Company's prior $30 million credit 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.

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 million based 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 million to $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.

Key Performance Indicator: 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.

During 2021, nearly all of our offices were franchised with the only exception being DPS locations acquired in the fourth quarter. During 2020, all of our offices were franchised. The following table reflects our system-wide sales broken into its components for the periods indicated:

System-wide sales were $354.5 million in 2021, an increase of 68.1%, from $210.9 million in 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 accounts for the number of offices opened and closed in 2021 and 2020.

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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.

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 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 HireQuest business line, including HireQuest franchisees, 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.

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. Our estimated workers’ compensation claims liability was $8.2 million at December 31, 2021, versus $4.6 million at 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.

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

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 million and $1.6 million at December 31, 2021 and December 31, 2020, respectively.

Business Combinations

We account for business acquisitions under the acquisition method of accounting by recognizing identifiable tangible and intangible assets acquired, liabilities assumed, and non-controlling interests in the acquired business at their fair values. We record 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.

Asset Acquisitions

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. Goodwill is 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.

Evaluation of Disclosure Controls and Procedures

As of December 31, 2020, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and our Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities and Exchange Act of 1934, as amended (the “Exchange Act”)). Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of December 31, 2021, our disclosure controls and procedures were effective.

Management's Annual Report on Internal Control Over Financial Reporting

Our management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act). Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control—Integrated Framework (2013). Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles and includes those policies and procedures that:

a) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company;

b) provide reasonable assurance that transactions are recorded as necessary to permit the preparation of financial statements in accordance with generally accepted accounting principles and that receipts and expenditures of the Company are being made only in accordance with authorizations of our management and directors; and

c) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the financial statements.

A system of controls, no matter how well designed and operated, cannot provide absolute assurance that the objectives of the system of controls are met, and no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within a company have been detected.

Material Weakness

As previously reported beginning with our quarterly report on Form 10-Q for the quarter ended March 31, 2021, we identified a material weakness in our internal control over financial reporting as we did not have sufficient accounting resources available to handle the volume of technical accounting issues and provide adequate review functions.

A material weakness is a deficiency or combination of deficiencies in internal control over financial reporting such that there is a reasonable possibility that a material misstatement of our annual or interim financial statements will not be prevented or detected on a timely basis.

Notwithstanding the material weakness, which still existed as of December 31, 2021, the Company’s management, including its Chief Executive Officer and Chief Financial Officer, have concluded that the consolidated financial statements included in this Form 10-K present fairly, in all material respects, our financial position, results of operations and cash flows as of the dates, and for the periods presented, in conformity with accounting principles generally accepted in the United States.

Based on our evaluation under the framework described above, our management concluded that our internal control over financial reporting was not effective as of December 31, 2021 in accordance with Item 308(a)(3) of Regulation S-K. The certifications required by Rule 13a-14 of the Exchange Act are filed as exhibits 31.1 and 31.2, respectively, to this Annual Report on Form 10-K.

Management Plans to Remediate Material Weakness

On December 1, 2021 we hired David Burnett as CFO. We believe that the addition of Mr. Burnett materially strengthened our internal control over financial reporting. Management continues to take action to remediate the material weakness in internal control over financial reporting, including hiring additional staff in the accounting department and engaging third party professionals with the appropriate technical expertise.

We are committed to maintaining a strong internal control environment and implementing measures designed to help ensure that control deficiencies contributing to the material weakness are remediated as soon as possible. We have made significant progress towards remediation and continue to implement our remediation plan for the material weakness in internal control over financial reporting described above. We will consider the material weakness remediated after the applicable controls operate for a sufficient period of time, and management has concluded, through testing, that the controls are operating effectively.

Changes in Internal Control Over Financial Reporting

Other than efforts to remediate the material weakness described above, there was no change to the Company's internal control over financial reporting that occurred during the Company's year ended December 31, 2021 and that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting.