LTNC: Raising forecasts

Zacks Small Cap Research

By Marla Backer

We are revising our forecast to reflect Labor Smart’s (OTC BB:LTNC) recent revenue trends. Last week, the company noted that June 2013 revenue of $1.46 million exceeded June 2012 by 122%. With May and April 2013 revenue at $1.58 million and $1.00 million respectively, 2Q13 revenue came in at an estimated $4.04 million, nearly $275,000 ahead of our $3.76 million projection. We are raising our forecast to reflect the recent run rate. Our 2Q13, 3Q13 and 4Q13 estimates go to $4.04 million, $4.86 million and $4.69 million. This puts our full year 2013 projection at $16.09 million, the low end of management’s targeted $16-$18 million. If revenue trends remain as strong as they have been, we believe there could be further upside.

We are also raising our gross margin forecast. At this early stage, the company has not yet reached its targeted 28% branch level gross margin. Nevertheless, management recently indicated that gross margins are improving as Labor Smart’s customer base expands and diversifies. Revenue growth is highly correlated to customer base expansion, in our opinion. In 2011, Labor Smart had 47 customers. In November 2012, the company announced that its customer base exceeded 300. We estimate that it is well above 500 now.

Having a large and diversified customer base gives the company greater flexibility in managing gross margins, in our view. When a new location opens, the branch manager first looks to the construction and janitorial industries for potential customers. These industries have relatively short sales cycles and their staffing needs fluctuate considerably. As they mature, branches can fill more competitive assignments, often leveraging the customer base that the overall organization has established. Other industries that frequently turn to on demand staffing include: hospitality, warehousing, manufacturing, logistics and events, among others. For example, when hotel occupancy rates spike during peak seasons or holidays, hotels often add workers on a short term basis. The company also tries to generate sales in new verticals with existing customers.

We believe the company will manage for revenue and margin growth over footprint expansion for the remainder of 2013. Therefore, we would not be surprised if no additional branches opened in 2013, which implies that the company might not reach its targeted 18 to 20 offices by year-end. Nevertheless, Labor Smart has pursued an ambitious expansion strategy since launching operations two years ago. The company started with two branch offices in November 2011 and has grown to 14 branch offices currently, operating in nine different states.

We anticipate that branch expansion will resume in 2014. Labor Smart intends to open another 25 to 30 locations next year. Initially, expansion efforts were concentrated on the Southeast U.S. The first two branch offices were located in Marietta, Georgia and Nashville, Tennessee. Labor Smart has subsequently expanded into Kentucky, Florida, Indiana, Alabama, Missouri, South Carolina and North Carolina and ultimately plans to have a national footprint. This would provide a competitive advantage, we believe, over more regionally focused competitors and enable Labor Smart to leverage its marketing efforts across geographic markets.

Most of the early growth has been through new branch openings, although in 2Q13 the company acquired the operating assets of a small, three branch staffing company based in Florida. Qwik Staffing Solutions had offices in Jacksonville, Orlando and Tampa. Based on their historical performance, management anticipates they will contribute more than $3.2 million in revenue and roughly $350,000 in EBITDA over the next 12 months and be immediately accretive to EBITDA. Half of the purchase price is to be paid out over time as a percentage of the earnings the branches generate. In our view, this protects Labor Smart on the downside if the branches do not perform up to management’s expectations.

We believe it is also consistent with management’s goal of minimizing net cash use required to fuel its substantial growth. Labor Smart had $125,742 in cash as of March 2013. Although we expect the company to continue to engage in short term financings during this early period of rapid growth, we believe it has sufficient resources and access to funding to meet its 2013-15 expansion goals.

We also believe recent economic and industry data support continued growth. A key takeaway from the Bureau of Labor Statistics June 2013 Jobs Report is that the economy continues to shift towards temporary jobs in the current economic climate. The Bureau of Labor Statistics estimates that 28 million people are employed in part-time positions. Most of Labor Smart’s customers are engaged in businesses such as construction, freight handling, landscaping, warehousing, janitorial, disaster response, light manufacturing, hospitality, retail or wholesale operations. They frequently require manual laborers for services such as hauling, cleaning, digging, loading and assembly.

Florida Attractive Market Moreover, the Qwik Staffing Solutions acquisition gave Labor Smart entry into the Florida market, which we believe is one of the most attractive markets for on demand labor. According to the Associated Press (AP), Florida, along with Texas, Arizona, California, and Colorado is experiencing a dramatic shortage of labor for the rebounding construction industry because so many workers exited the industry during the recession. AP notes that “many former skilled construction workers have moved on to other fields.” For Labor Smart customers in the hospitality industry, hotel occupancy rates through May 2013 in Orlando, Tampa and Jacksonville were up 1.8%, 1.6% and 3.6% respectively, according to Smith Travel. In metropolitan Orlando where Labor Smart operates a new branch, hotel occupancy of 68.8% was the highest overall rate since 2005. According to consulting firm HVS, “The Amway Center… has served as a catalyst for a number of new downtown development projects” in Orlando, including new hotels and the Orlando Magic’s proposed sports and entertainment venue. We believe this bodes well for Labor Smart’s continued growth in the region.

In our view, True Blue and Command Center are direct competitors to Labor Smart in the on demand segment. There are also several other publically traded companies that provide the more traditional temporary staffing services. The shares of many of these companies have enjoyed strong price appreciation year-to-date on the back of economic drivers and the potential impact of the Affordable Care Act, despite its recent delay. We expect Labor Smart to benefit from these same exogenous drivers as it executes its expansion goals. Labor Smart is in the early stage of development and has yet to convert rapid revenue growth into net profits. However, we believe the company’s revenue expansion and potential uplisting down the road could be catalysts for the shares. Our $0.80 price target equates to EV / projected 2014 revenue of 0.5X, which is in-line with True Blue.

Risks include that the company is highly dependent on founder and CEO Ryan Schadel, is under capitalized, could expand too rapidly, competition could increase, customers could shift towards hiring permanent employees instead of using temporary workers and economic factors could constrain industry growth.

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