ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS In this report, unless the context indicates otherwise, the terms "Labor Smart," "Company," "we," "us," and "our" refer to Labor Smart, Inc., a Delaware corporation.
Special note regarding forward-looking statements
This report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, or the "Securities Act," and Section 21E of the Securities Exchange Act of 1934 or the "Exchange Act." All statements other than statements of historical fact are "forward-looking statements" for purposes of federal and state securities laws, including, but not limited to, any projections of earnings, revenue or other financial items; any statements of the plans, strategies and objectives of management for future operations; any statements concerning proposed new services or developments; any statements regarding future economic conditions of performance; and statements of belief; and any statements of assumptions underlying any of the foregoing. Such forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements.
In some cases, you can identify forward looking statements by terms such as "may," "intend," "might," "will," "should," "could," "would," "expect," "believe," "anticipate," "estimate," "predict," "potential," or the negative of these terms. These terms and similar expressions are intended to identify forward-looking statements. The forward-looking statements in this report are based upon management's current expectations and belief, which management believes are reasonable. However, we cannot assess the impact of each factor on our business or the extent to which any factor or combination of factors, or factors we are aware of, may cause actual results to differ materially from those contained in any forward-looking statements. You are cautioned not to place undue reliance on any forward-looking statements. These statements represent our estimates and assumptions only as of the date of this report. Except to the extent required by federal securities laws, we undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.
You should be aware that our actual results could differ materially from those contained in the forward-looking statements due to a number of factors, including:
? uncertainties relating to general economic and business conditions; ? industry trends; changes in demand for our products and services; ? uncertainties relating to customer plans and commitments and the timing of orders received from customers; ? announcements or changes in our pricing policies or that of our competitors; ? unanticipated delays in the development, market acceptance or installation of our products and services; ? changes in government regulations; availability of management and other key personnel; ? availability, terms and deployment of capital; relationships with third-party equipment suppliers; and ? worldwide political stability and economic growth.
-31- (table of contents) Other risks and uncertainties include such factors, among others, as market acceptance and market demand for our products and services, pricing, the changing regulatory environment, the effect of our accounting policies, potential seasonality, industry trends, adequacy of our financial resources to execute our business plan, our ability to attract, retain and motivate key technical, marketing and management personnel, and other risks described from time to time in periodic and current reports we file with the United States Securities and Exchange Commission, or the "SEC." You should consider carefully the statements under "Item 1A. Risk Factors" and other sections of this report, which address additional factors that could cause our actual results to differ from those set forth in the forward-looking statements and could materially and adversely affect our business, operating results and financial condition. All subsequent written and oral forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by the applicable cautionary statements.
Overview
Labor Smart, Inc. was incorporated in the State of Nevada on May 31, 2011. We are an emerging provider of temporary employees to the construction, manufacturing, hospitality, restoration and retail industries. We provide unskilled and semi-skilled temporary workers to our customers. At the end of the 2nd Quarter 2015, the Company operated 26 branch office locations primarily throughout the Southeast and Midwest US.
Our mission is to be the provider of choice to our growing community of customers, with a service-focused approach, that positions us as a resource and partner for their business.
Seasonality
Generally, we expect our revenues to be higher and gross margin percent to be higher during the second and third fiscal quarters as compared to the first and fourth fiscal quarters each year. During the second and third quarters we receive the majority of our contracts to supply labor to construction firms. Contracts for construction work tends to be both larger in dollar amount and to be more profitable than our other contracts. However, the effects of seasonality is partially muted by our rapid revenue growth rate.
Growth Strategy
Historically, our growth strategy has been heavily focused on new branch office openings, growth in revenue from existing offices, and closing one small acquisition per year. On June 14, 2014, we secured a large deductible worker's compensation insurance policy which resulted in us becoming substantially self-insured. We have adjusted our growth strategy based on this significant change to the fundamentals of our business. This policy was renewed on June 14, 2015 with reduced insurance rates and lower collateral requirements from the prior policy period, further reinforcing our shift to grow through acquisitions.
During fiscal 2015 we do not expect to open new branch office locations, however, we are aggressively pursuing acquisitions that fit well with our culture and will continue to seek more acquisition opportunities than in prior years. This major shift in focus is directly related to our new large deductible worker's compensation policy. Our industry is very fragmented. We have invested heavily in our corporate infrastructure in the last three years. We believe we can execute acquisitions with an investment of one to four times EBITDA of the seller and immediately recognize economies of scale and a reduced cost of sales for the acquired customer lists as it is integrated into our operations. With our experienced management team, we believe we can successfully execute and close acquisitions totaling $20-$40 million in revenue in 2015, though financing our target acquisitions are expected to be a challenge.
For the balance of fiscal 2015, we will no longer seek opportunities to open new branches, as we shift our expansion strategy to be more acquisition centric. Additionally, during the 2nd Quarter 2015, the Company closed 4 under- performing branch locations and will continue to close branch locations that fail to become profitable within our expected timeline or seek opportunities to sell the operating assets when possible.
-32- (table of contents) At December 26, 2014, we had 30 branches and at June 26, 2015, we had 26 branches. We will consider closing under-performing branches on a case by case basis.
Use of Non-GAAP Financial Information
In addition to GAAP results, this quarterly report on Form 10-Q also includes certain non-GAAP financial measures as defined by the Securities and Exchange Commission. The Company defines EBITDA as net income, plus interest and finance expense net of interest income, provision for income taxes, depreciation and amortization. The Company defines Adjusted EBITDA as these items plus non-recurring acquisition and expansion costs, pretax. EBITDA and Adjusted EBITDA are measures used by management to evaluate ongoing operations and as a general indicator of its operating cash flow (in conjunction with a cash flow statement that also includes, among other items, changes in working capital and the effect of non-cash charges). Management believes these measurements are useful to investors because they are frequently used by securities analysts, investors and other interested parties in the comparative evaluation of companies. Because not all companies use identical calculations, Labor Smart's presentation of EBITDA and Adjusted EBITDA may not be comparable to similarly titled measures of other companies. EBITDA and Adjusted EBITDA are not recognized terms under GAAP, do not purport to be alternatives to, and should be considered in addition to, and not as a substitute for or superior to, net income (loss) as a measure of operating performance or to cash flows from operating activities or any other performance measures derived in accordance with GAAP as a measure of liquidity. Additionally, EBITDA and Adjusted EBITDA are not intended to be measures of free cash flow for management's discretionary use as they do not reflect certain cash requirements, such as interest payments, tax payments and debt service requirements.
Pursuant to the requirements of Regulation G, a reconciliation of EBITDA and Adjusted EBITDA to GAAP net loss has been provided in the table below.
RECONCILIATION OF GAAP NET INCOME (LOSS) TO EBITDA
(UNAUDITED)
Six months Ended June 26, 2015 GAAP, net loss $ (2,026,385) Add: Provision for income taxes - Interest and finance expense, net 1,353,155 Depreciation and amortization 122,693 EBITDA (550,537) Non-recurring acquisition and expansion costs - Adjusted EBITDA $ (550,537)
-33- (table of contents) Results of Operations - Three Months Ended June 26, 2015
Summary of Operations:
Revenue for the three months ended June 26, 2015 was $6,370,424 as compared to $6,437,976 for the three months ended June 27, 2014. The decrease in revenue for the three months ended June 26, 2015 was $67,552 or 1%. This decrease was due to a strategic decision to remove high risk, low margin accounts from our revenue stream during the 2nd and 3rd quarters of 2014.
Selling, General and Administrative Expenses (SG&A):
General and administrative fees were 13% of revenue for the three months ended June 26, 2015 and 13% for the three months ended June 27, 2014.
For the three months ended June 26, 2015, of our total $1,864,271 in operating expenses, $73,567 is attributable to professional fees including legal, accounting, and consulting services, $(32,461) in stock based compensation related to current period stock compensation expense netted by reversal of expense related to forfeited shares, $872,798 to staff payroll expenses, $159,752 to bad debts, and $790,615 to other general and administrative fees.
For the three months ended June 27, 2014, of our total $1,501,749 in operating expenses, $59,545 is attributable to professional fees including legal, accounting, and consulting services, $12,841 in stock based compensation related to vesting (reversing) of stock options, $590,933 to staff payroll expenses, $84,064 to bad debts, and $754,366 to general and administrative fees.
Results of Operations - Six Months Ended June 26, 2015
Summary of Operations:
Revenue for the six months ended June 26, 2015 was $11,081,591 as compared to $11,230,917 for the six months ended June 27, 2014. The decrease in revenue for the six months ended June 26, 2015 was $149,326 or 1%. This decrease was due to a strategic decision to remove high risk, low margin accounts from our revenue stream during the 2nd and 3rd quarters of 2014.
Selling, General and Administrative Expenses (SG&A):
General and administrative fees were 16% of revenue for the six months ended June 26, 2015 and 16% for the six months ended June 27, 2014.
For the six months ended June 26, 2015, of our total $3,652,724 in operating expenses, $155,912 is attributable to professional fees including legal, accounting, and consulting services, $(17,357) in stock based compensation related to current period stock compensation expense netted by reversal of expense related to forfeited shares, $1,699,484 to staff payroll expenses, $181,516 to bad debts, and $1,633,169 to other general and administrative fees.
For the six months ended June 27, 2014, of our total of $2,885,736 in operating expenses, $152,142 is attributable to professional fees including legal, accounting, and consulting services, $69,997 in stock based compensation related to vesting of stock options, $1,034,587 to staff payroll expenses, $96,046 to bad debts, and $1,532,964 to general and administrative fees.
-34- (table of contents) Liquidity and Capital Resources
We have funded our operations to date primarily through the sale of equity, invoice factoring, convertible notes payable and shareholder loans. Based on our current operating plan, we anticipate that we have sufficient cash and cash equivalents to fund our operations into the coming months. We will require additional cash to fund our operating plan past that time. If the level of sales anticipated by our financial plan are not achieved or our working capital requirements are higher than planned, we will need to raise additional cash sooner or take actions to reduce operating expenses. We are implementing plans to reduce our costs of capital and improve our revenue. If we cannot generate adequate cash by implementing these steps, we plan to obtain additional cash through the issuance of equity or debt securities. There can be no assurance that additional cash will be available or that, if available, it will be available on terms acceptable to us on a timely basis. If adequate funds are not available on a timely basis, we intend to limit our operations to extend our funds as we pursue other financing opportunities and business relationships. This limitation of operations could include reducing our planned investment in working capital to fund revenue growth and result in reductions in staff, operating costs, and capital expenditures.
Net cash provided by operations was $391,980 during the six months ended June 26, 2015. Net cash flows provided by operating activities for the six months ended June 26, 2015 mainly consisted of a net loss of $2,026,385 adjusted for stock based compensation of $(17,357), financing fees of $1,353,155, by an increase of $437,457 in accounts receivable and an increase of $1,206,600 in payroll taxes payable.
Net cash used in operations was $1,744,172 during the six months ended June 27, 2014. Net cash flows used in operating activities for the six months ended June 27, 2014 mainly consisted of a net loss of $1,997,354 adjusted for stock based compensation of $69,997, financing fees of $1,565,546, by an increase of $1,048,383 in accounts receivable and an increase of $10,538 in payroll taxes payable.
Cash used in investing activities totaled $57,064 for the six months ended June 26, 2015. Net cash flows used in investing activities consists of the purchase of fixed assets of $24,634 and $49,805 in the purchase of marketable securities offset by $17,375 in proceeds from the sale of marketable securities.
Cash used in investing activities totaled $160,364 for the six months ended June 27, 2014. Net cash flows used in investing activities consists of assets acquired in asset purchase agreement of $70,797, the purchase of fixed assets of $68,467 and $56,403 in the purchase of marketable securities offset by $35,303 in proceeds from the sale of marketable securities.
Net cash used in financing activities totaled $265,929 for the six months ended June 26, 2015. Net cash flows from financing activities consisted of payments on a convertible note payable of $416,082, net amount received from factor of $192,519 and payments towards a contingent liability of $42,366.
Net cash provided by financing activities totaled $2,001,119 for the six months ended June 27, 2014. Net cash flows from financing activities consisted of proceeds from convertible notes payable of $2,046,365 offset by payments on a convertible note payable of $430,170, payments on related party notes of $18,581, net amount received from factor of $485,854 and payments towards a contingent liability of $82,349.
Our continued capital needs will depend on branch operating performance, our ability to control costs, and the continued impact from our expansion plans in 2014.
-35- (table of contents) Assets and Liabilities:
At June 26, 2015, we had total current assets of approximately $3,841,144 and current liabilities of approximately $8,737,156. Included in current assets are trade accounts receivable of approximately $3,323,534 and prepaid expenses of $65,452. Accounts receivable are recorded at the invoiced amounts. We regularly review our accounts receivable for collectability. We will typically refer overdue balances to a collection agency at 120 days and the collection agent pursues collection for another 60 days. Most balances over 120 days past due are written off, as it is probable the receivable will not be collected. We wrote down $181,516 in bad debt included in operating expenses during the six months ended June 26, 2015. As our business matures, we will continue to monitor and seek to improve our historical collection ratio and aging experience with respect to trade accounts receivable. As we grow, our historical collection ratio and aging experience with respect to trade accounts receivable will continue to be important factors affecting our liquidity.
Financing:
On July 31, 2013 the Company entered into a Purchase and Sale Agreement with Transfac Capital, Inc. ("Transfac"). Under the terms of the Purchase and Sale Agreement, Transfac shall have the right, but not the obligation, to purchase up to Two Million Dollars ($2,000,000) worth of accounts receivable (the "Maximum Advances") of the Company. For each account receivable purchased, Transfac shall advance seventy percent (70%) of the face value of the account and the balance after receipt of full payment on the account. As consideration, the Company shall pay Transfac two percent (2%) of the average monthly balance of the outstanding accounts purchased, with a minimum of one half of one percent (0.5%) of the Maximum Advances per month, as long as the Purchase and Sale Agreement remains in effect.
Our total financing costs through our facility with Transfac for the three months ended June 26, 2015 and June 27, 2014 was $68,300 and $54,784, respectively and for the six months ended June 26, 2015 and June 27, 2014 was $173,300 and $124,583, respectively, which is reflected on our Statements of Operations as interest and finance expense. As collateral for repayment of any and all obligations, we granted Transfac a security interest in all our property, including, but not limited to, accounts receivable, intangible assets, contract rights, investment property, deposit accounts, and other such assets.
Off-Balance Sheet Arrangements
As of June 26, 2015, we do not have any off-balance sheet arrangements except for our factored receivables under our agreements with Transfac Capital, Inc. The cash received from our factored receivables finance the Company's operating expenses and is a significant source of liquidity for the Company. For more information about the factoring terms, see "Financing" discussion above.
Inflation
Inflation has not had a material impact on our business and we do not expect inflation to have an impact on our business in the near future Form 10-Q for LABOR SMART, INC.
