In the third quarter, USA Technologies became one of the Fund’s top five portfolio holdings. USA Technologies, Inc. is a machine-to-machine (M2M) transaction and payment processing company. The company focuses primarily on the unattended retail market of vending, laundry, and remote kiosks machines. The vending machine industry is a mature industry, dating back over 120 years, with approximately 6 million machines in the United States and generating
roughly $45 billion in annual revenues. Characterized by slow changing technology and sales growth, vending machine revenues are, for the most part, uncorrelated to economic cycles. The biggest structural change the industry has witnessed over the past 20 years was the widespread adoption of the dollar bill reader to transact sales. Currently, the vending machine industry is being dragged into the 21st century as it transitions from analog to digital, joining the rest of the economy by offering cashless transactions.

USAT was one of the first companies to recognize the transition to cashless transactions and began providing point-of-sale (POS) units that would allow the use of credit cards and NFC enabled devices like mobile phones. Initially, the company rented these POS units to the vending machine owners in order to capture the recurring licensing and transaction fees on items sold, the lion share of its revenues. Achieving scale was critical to the company’s longterm profitability, as the more transactions processed translated into lower negotiated fees with processing companies and the cellular companies responsible for the machine-to-machine communications. However, renting the POS machines meant that USA Technologies was leveraging its own balance sheet, and the faster its growth, the more levered it became. In 2015, USAT changed course and pivoted to using a third party leasing agent to distribute its POS units. This transition allowed the USAT to recognize revenue from its POS sales, de-lever its balance sheet, and with the help of its leasing agent, lock-in the vending machine operator into a 5 year contract.

Vending machine operators soon discovered that being digitally connected to their vending machines meant that they could manage their machine’s inventories in real-time, design a more comprehensive restocking schedule, identify and adjust which products to carry based on sell through, and change product prices for their machines remotely. Additionally, cashless transactions meant that there was less cash to collect which reduced vandalism and/or theft when the cash is collected. But the greatest benefit vending machine owners were noticing was the increase in revenue each machine was generating. By having the ability to transact cashless sales, vending machine operators witnessed between a 30 to 40% increase in revenues. Part of the increase came from servicing customers who do not carry cash or “loose change.” But more telling is the fact that cashless transactions have a higher dollar sale amount than items purchased with cash. This behavior reflects recent studies that found consumers are willing to pay over 20% more for an item if purchased with a credit card. Spending cash is tangible, representing a decline in net worth; a credit card transaction delays the impact until one’s monthly statement is received, and even then, there is another delay until tangible cash is needed to pay it off. Using a credit card has the added benefit, unlike cash, of a rewards program. In its most recent quarter, USAT reported that the average cashless transaction from its POS units was $1.90 versus ~$1.30 average cash transaction for the vending machine industry. Vending machine operators are keying in on consumer behavior when it comes to cashless transactions and are now stocking their machines with higher priced items such as energy drinks, items that were once the impulse purchase domain of convenient and drug stores.

Hazelton Capital Partners initially looked at USA Technologies in 2012 when they were operating under the old business model of renting out its POS units. We were attracted by the recurring and growing revenue the company was generating from cashless sales and recognized that USAT was building a respectable market share in a very niche segment of the retail industry. Our concern remained centered around the leverage being placed on the company’s balance sheet which ultimately meant that USAT would have to either add more debt or dilute equity shareholders by issuing more shares, and so we decided to pass on the investment. After learning about the change in its business model in early 2015, Hazelton Capital Partners reviewed the company and its financials and decided to add USAT to our portfolio in November of 2015. Even though we were purchasing shares of the company at more than double its 2012 share price, we felt much more comfortable with the long-term growth and financial strength of the company. During USA Technologies recent run higher, Hazelton Capital Partners trimmed its holding. Our investing thesis for the company has not changed and we believe there is more upside potential for USAT, as only an estimated 10% of all vending machines in the US are currently cashless. But, we also feel that the market’s short-term valuation of USAT might have gotten a bit ahead of itself and we stand ready to repurchase those shares if USAT were to sell-off.

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This write-up has been excerpted from a letter to partners of Hazelton Capital Partners.

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