Cantaloupe Inc (CTLP) 2015 Q1 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the USA Technologies first-quarter fiscal 2015 earnings conference call. (Operator Instructions). As a reminder, this conference call is being recorded.

I would now like to turn the call over to your host, Ms. Stephanie Prince from LHA. Ms. Prince, you may begin.

Thank you, Bridget, and good morning, everyone. This is Stephanie Prince and welcome to the USA Technologies first-quarter fiscal 2015 earnings conference call.

With me on the call this morning is Steve Herbert, Chairman and Chief Executive Officer of USA Technologies, and Dave DeMedio, Chief Financial Officer.

Before we begin today's call, I would like to remind you that all statements included in this call other than statements of historical fact are forward-looking statements. Actual results could differ materially from those contemplated by the forward-looking statements as a result of certain factors, including, but not limited to, business, financial, market, and economic conditions. A detailed discussion of the risks and uncertainties that could cause actual results and events to differ materially from such forward-looking statements is included with our filings with the SEC.

Listeners are cautioned not to place undue reliance on any such forward-looking statements, which reflect management's view only as of the date they are made. USA Technologies undertakes no obligation to update any forward-looking statements, whether as a result of new information, future events, or otherwise.

This call will also include a discussion of certain non-GAAP financial measures that we believe are useful for understanding USA Technologies' operations. These non-GAAP financial measures are supplemental to and not a substitute for GAAP financial measures, such as net income or loss. Details of these items and the reconciliation of these non-GAAP financial measures to GAAP financial measures can be found in our press release issued this morning and on the investor relations page of our website, www.usatech.com.

I'd now like to turn the call over to Steve Herbert. Steve?

Thank you, Stephanie, and good morning, everyone.

I will begin today's call with a review of the first-quarter highlights, before discussing our operational highlights for fiscal 2015. I will then turn the call over to Dave to review our financial results for the first quarter and our guidance for fiscal 2015.

In the first quarter, USA Technologies continued to make progress toward meeting its long-term goals of reaching 500,000 connections and $100 million in revenue in three years. In the quarter, we added 10,000 net new connections, ending with 276,000 connections, a 27% year-over-year increase.

We also added 600 new customers, a 41% year-over-year increase for 7,900 total customers on our ePort Connect service. In the first quarter, our service handled nearly 49 million transactions, 26% above a year ago. This equates to over $89 million in transaction volume, a 31% year-over-year increase. Transaction volume continues to increase faster than the number of transactions, clearly illustrating the sales gains that cashless payment can generate for our customers.

Growing proof of our value proposition is translating to customer satisfaction and greater stickiness of our customer relationships, supported by our 99% customer retention rate. 17% of new connections in the first quarter went to customers in adjacent self-serve retail markets, such as the commercial laundry, kiosk, and amusement verticals. This compares to 14% in the fourth quarter of fiscal 2014.

83% of new connections were sold to our traditional vending market. Part of our connection growth is from our growing presence on U.S. Navy bases through our relationship with NEXCOM, in which we now have nearly 1,100 connections on the ePort Connect service.

We are continuing to aggressively and proactively invest in our business to drive new connections, customers, revenue, and earnings growth.

In the first quarter, we began offering the QuickStart program on a trial basis to our preferred customers in order to determine whether it would move us closer to realizing our long-term growth objectives, while also reducing new and existing customer reliance on JumpStart.

QuickStart is a five-year noncancelable capital lease program for equipment, compared to JumpStart, which is a monthly rental program. We believe that shifting customers to the leasing or purchase of hardware will improve our ability to generate free cash flow.

We received an excellent reception to QuickStart from these customers in the first month of the program. Dave will get into some additional details in a few minutes.

From our perspective, this switch in customer behavior from short-term month-to-month engagements to longer-term commitments is further evidence of the market acceptance of our value proposition and our growing reputation for reliability and innovative services.

We also think that widening adoption, as demonstrated by the 41% increase in our customer base at the same time that we sold 84% of our gross connections into our existing customer base, points to an approaching tipping point in the markets we serve in the payment industry.

Of course, mobile and cashless payments are now regularly in the news, following the introduction of Apple Pay. At USA Technologies, the Apple Pay startup went seamlessly, with our NFC terminals accepting payment without issue. As many of you know, virtually all of the terminals we're currently shipping are NFC enabled, allowing for the continued expansion of our NFC footprint.

Apple Pay has clearly created excitement in our customer base. Since the announcement, we have been receiving various inquiries from customers, including the desired upgrade from magstripe terminals to NFC-enabled terminals, as well as requests for Apple Pay point-of-sale materials for consumers. We've also been receiving more inbound calls from potential new customers.

New and existing customers are turning to us for high value-add solutions because we have, among other things, over a decade of experience in self-serve retail cashless payments, over three years experience with mobile payments, and the largest NFC-enabled payment network, with approximately 160,000 locations and growing. We are drawing from this deep experience and our market-leading position to drive growth from a position of strength, as we aggressively invest in our business to widen our market lead.

As we progress through fiscal 2015, we are beginning to realize the benefits from the investments we have made in our customers and marketing programs, including the grace period program we had in place during fiscal 2014 and the QuickStart program that we expect to expand as well.

We also continue to leverage our competitive advantage, which is led by our ability to offer one streamlined end-to-end solution that can integrate diverse services. For example, we recently worked with a customer to implement our Integrated Payment Services, which enables cashless payment and consolidated reporting across multiple types of point-of-sale locations, and the MORE program and prepaid loyalty program in a large industrial account.

The impact from this program on our customer's business has been substantive, including a 33% increase in total monthly sales revenue across the entire industrial account after just four months -- after four months from implementation. This mirrors the experience of our other customers who have implemented the MORE prepaid and loyalty program, where the average ticket has increased to $2.42 with a MORE prepaid or loyalty transaction versus $1.83 average ticket for credit or debit.

The conclusion is that these programs are not only a strategic competitive advantage that can drive growth for USAT, but they are also increasing incremental revenue or same-store sales for our customers.

With the increasing momentum in the cashless payment industry and our market-leading position, we are continuing to push assertively toward our three-year growth objectives that include reaching 500,000 connections to our service. Our growth strategy is focused on increasing the number of new connections to our ePort Connect service, deepening penetration of our existing customer base, and adding new customers, while continuing to add new and innovative services.

With our aggressive growth strategies, a robust pipeline, and widening adoption of cashless payments and self-serve retail, we believe that we are well positioned for future growth.

Before I turn the call over to Dave, I wanted to let you know that we recently learned USA Technologies has been named to the 2014 Deloitte Technology Fast 500, a ranking of the 500 fastest-growing technology, media, telecommunications, life sciences, and cleantech companies in North America. We are excited and proud to have achieved this recognition.

I am now going to turn the call over to Dave for comments on our financial results for the first quarter, as well as our guidance for fiscal 2015. Dave?

Thank you, Steve.

Before getting into the detailed quarterly results, I want to highlight a significant one-time item that negatively impacted this quarter's financial results, that being the $410,000 charge related to the anticipated settlement of a billing dispute we had with a customer, which was recorded to cost of services.

This charge had the effect of reducing gross profit and margins from license and transaction fees, adjusted EBITDA, and net income for the first quarter of fiscal 2015.

Another item that impacted the quarter's results was the QuickStart program we made available to customers during the quarter, which I will explain in more detail later.

Gross connections during the first quarter totaled 13,000, compared to 14,000 in Q1 of last year. Of the gross connections this quarter, 83% of these new connections were traditional vending, compared to 58% in the year-ago quarter. So although total gross connections were 1,000 less, connections from traditional vending demonstrated improvement quarter over quarter.

The remaining 17% of gross connections for the quarter came from other vertical markets, such as kiosk, amusement and gaming, and laundry.

Of the total gross connections, 84% came from existing customers. Net connections for the quarter totaled 10,000, compared to 3,000 in last year's first quarter.

Our customer base increased approximately 600 customers during the first quarter and we ended the quarter with approximately 7,900 total customers. This is a 41% increase in the customer count from Q1 of fiscal 2014, which we believe is indicative of a broadening adoption and acceptance of cashless payments in the industries we serve.

For the first quarter, total revenue was $12.3 million, an increase of 21% compared to $10.1 million in the first quarter of fiscal 2014. License and transaction fees were $10.2 million compared to $8.5 million in the year-ago quarter, a 19.4% increase. These fees, which are comprised of recurring monthly service fees, plus recurring transaction processing fees, accounted for approximately 83% of total revenue. Growth was driven by the year-over-year increase in total connections to our ePort Connect service.

Equipment sales were $2.1 million compared to $1.6 million in last year's first quarter; driving the increase in equipment sales during the quarter was the QuickStart program. The QuickStart program is a noncancelable capital lease of the ePort equipment. Because the customer is entering into a noncancelable agreement to purchase the equipment, we account for these terminals as a sale versus a rental, as they are accounted for under JumpStart.

Why did we make QuickStart available? A key imperative of the Company is to increase free cash flow. One way to accomplish this is to promote the purchase of equipment and to reduce the cash we use under the JumpStart program. We believe QuickStart is a program that could facilitate that shift, so we offered it on a trial basis and we were encouraged by the results we saw after just one month of the program, which began in December.

For example, approximately 35% of gross new connections for the quarter were under the QuickStart program, and those were predominantly with existing customers who previously ordered equipment under the JumpStart program. Hence, JumpStart dropped to approximately 20% of gross connections for the quarter, compared to approximately 65% in Q4 of fiscal-year 2014.

We believe the willingness of our customers to opt into a noncancelable commitment to purchase the hardware is significant for several reasons. First, the commitment to purchase the hardware supports our belief that cashless is becoming an increasingly important technology for our customers in the industries we serve.

Second, it demonstrates our customers' faith in USAT as a long-term service provider.

Third, and perhaps most importantly, it represents an opportunity for USAT and our customers to utilize traditional third-party financing sources for the sale and acquisition of the ePort hardware. As such, we are currently in discussions with third-party leasing companies regarding providing financing options for the QuickStart program. If successful, this could allow USAT to reduce and perhaps even eliminate at some point in the future the use of USAT's cash for the customer's acquisition of the ePort hardware, thereby improving free cash flow.

Again, we are encouraged by the opportunity surrounding this program.

Gross profit was $3.1 million, compared to $3.5 million in the year-ago quarter. Total gross margin was 25.6%, compared to 35.4% in the first quarter last year. Gross margin on license and transaction fees was 28.6%, compared to 36.4% last year.

The most significant item impacting both total gross margins and license and transaction fee gross margins was the one-time charge of $410,000 related to the customer dispute previously discussed.

License and transaction fee margins were also impacted by two additional items, which we discussed in our last call. First, the larger impact of the two items is the extended grace period marketing program, which we had in place mainly in the second half of fiscal 2014 and are not currently offering. This program had the impact of delaying the monthly service fee, plus we were required to begin depreciating those terminals to cost of services when they shipped to the customer.

The second item was a sale-leaseback transaction, which shifts the depreciation for the JumpStart units sold under the agreement to a higher quarterly rental expense.

I would like to quickly review the sale-leaseback transaction in order to ensure that everyone understands why we did this and the financial impact. As you may recall, in June 2014 we entered into an $8 million sale-leaseback agreement for the ePort devices with Varilease Finance. We undertook this transaction in order to unlock capital for growth, as well as other possible strategic opportunities.

We received the remaining $5 million under this agreement during the first quarter of fiscal 2015, after receiving $3 million in the fourth quarter of fiscal 2014. Essentially, this transaction replaces an asset that we were depreciating with a higher monthly cash rental expense. As such, the impact or reduction to license and transaction fee gross profit was approximately $134,000 for the quarter, due to the higher rent expense, and the impact or reduction to adjusted EBITDA was $380,000.

Since the rental payments will remain consistent over the sale-leaseback agreement period, the financial impact to margins and adjusted EBITDA on a percentage basis will diminish each quarter as we continue to grow revenue and gross profit.

The equipment margin was 11%, compared to 30% in the year-ago quarter. This decline reflects the impact of purchase incentives that were coupled with the QuickStart program during the first quarter.

Selling, general, and administrative expenses were $3.6 million in the first quarter, compared to $3.3 million in the year-ago quarter, a 9.1% increase. Approximately half of the $0.3 million increase was due to non-cash expenses related predominantly to an increase in the reserve for doubtful accounts and equity-related compensation.

For the first quarter, adjusted EBITDA was $0.9 million, compared to $1.5 million in the comparable period last year. Results this quarter, again, were significantly impacted by the one-time charge of $410,000, as well as the $380,000 from the sale-leaseback transaction.

GAAP operating loss for the quarter was approximately $0.7 million. Adding other income of approximately $245,000 and a tax benefit of $360,000, GAAP net loss was approximately $61,000, or $0.01 per share.

On a non-GAAP basis, we recorded a net loss of approximately $0.4 million, or $0.01 per share, for the first quarter, compared to a non-GAAP net income of $0.1 million, or $0.00 per share, in the same period last year.

Cash and cash equivalents at September 30 were $10.9 million. Proceeds from the sale-leaseback agreement contributed $5 million of cash this quarter. After the quarter-end, we repaid $2.5 million on our line of credit, giving us $4.5 million of current availability.

Looking out over fiscal 2015, we continue to expect total revenue to be in the range of $51 million to $53 million for a growth rate of 20% to 26%. License and transaction fee revenue is estimated to grow to $44 million to $47 million for an increase of 24% to 31%, and we also expect net new connections in the range of 66,000 to 76,000, for an increase of 27% to 46%.

We expect that margins will increase as the year progresses for several reasons. In order of magnitude, contributions to margin expansion will come as units under the extended grace period start to bill, which we expect to ramp as the year progresses.

New connections added to our network at the present time will also contribute to margin improvement, as we are currently not offering the extended grace period.

Lastly, the sale-leaseback transaction impact will diminish on a percentage basis each quarter as we continue to grow revenue and gross profit.

These improvements will be offset by any investments made in our growth strategies, designed to drive connections, penetration, and share.

On balance, we do expect adjusted EBITDA to increase sequentially throughout fiscal 2015 and to deliver growth over fiscal 2014 results in both adjusted EBITDA and non-GAAP net income.

Now I would like to turn the call back over to Steve.

Thank you very much, Dave. Thank you, everyone, for joining us this morning.

In closing, we remain excited about the future of USA Technologies and our growing market opportunity with new and existing customers. We believe that we are well along the path to realization of our long-term goals.

We would now like to open the call up for questions. Operator?

(Operator Instructions). Gary Prestopino, Barrington Research.

A couple of questions here. First of all, Dave, how much did you pay down on the credit facility this quarter? I didn't quite get that.

For September's quarter, we did not pay it down. It was the same at the end of the June quarter.

Subsequent to September 30, we paid down $2.5 million. So the balance subsequent to September 30 is $2.5 million, which leaves availability under the line of $4.5 million.

Okay, and just in terms of when you are presenting your adjusted EBITDA, why didn't you back out that $400,000 charge? And for your debt covenants, does that $400,000 charge get backed out for the adjusted EBITDA calculation?

The $400,000 charge related to the sale-leaseback or the customer?

The customer.

Okay. From not backing out from a customer perspective, we anticipate it is going to be a cash item, so it really shouldn't be backed out of adjusted EBITDA, we felt. In terms of our covenant with the bank, we entered into an agreement -- an amendment with the bank to adjust that item out.

Okay.

So from a bank perspective, it was adjusted out.

Okay. Then just on the inbound calling since Apple Pay has been introduced, could you say that you are starting -- I know you mentioned that it was getting good traction, but are you really getting a tremendous amount of interest from your client base in these NFC apparatuses for Apple Pay?

Gary, it's Steve Herbert. Good morning, by the way. Thanks for your questions.

The interest has been -- the interest level has been very high. It has manifested itself in several ways. Customers that have invested, if you will, with us in building out that NFC infrastructure, they are interested in leveraging it, so their questions are about point-of-sale material that can alert consumers that they can use Apple Pay at those locations.

We also have other customers that in the past have gone with magstripe -- that have gone with magstripe-only solutions. Their interest level is in a potential trade-up or swap-out to NFC-type technology. And then, we have other customers simply reaching out with the question of, can I accept Apple Pay, and if so, what can I do to maximize that?

The questions are -- they're really all over the lot, but I would say the response has been very good. Our transition was really seamless. The iOS 8.2 came out for iPhone 6. Consumers downloaded it. I think at one point they had 1 million downloads in something like three days, and they immediately started using it at our customers' locations. So from a technological standpoint, it has gone very well.

Then is it -- for new clients that want to get the ePort with the NFC chip in it, is it a higher-cost product versus a non-NFC?

Not at this point, no.

Okay, and then, the last --

Gary, it made a difference in the past, but it no longer makes a difference. We sell very, very little magstripe-only product. Dave, it's got to be 1% or less.

It is. Yes.

Yes.

Okay, and then as we get through the year with the reduced impact of the delays in the monthly fees, do you think that your license and transaction gross margins, even with the sale-leaseback now component of what you're doing, can they get back into the high 35%, 36% or could you give us some directionally where you think that gets to?

Gary, we do expect the license and transaction fee margins to improve to right around what you had indicated, 35%, possibly 36%, as we go out through the fiscal year, but it will be a ramp as those fees begin to come into the P&L.

Actually, if you add back the $400,000 customer dispute item that was incurred this quarter and recorded to cost of services, the margins were right around where you and several other analysts had thought they would be for the quarter. So we are kind of on target with what we said last quarter.

Right, yes, I know. I realize that. I'm just trying to get an understanding of how -- with what you're doing with QuickStart, how that impacts the margin and how things would change. All right, thank you.

Mike Latimore, Northland Capital.

This is Jim Fitzgerald sitting in for Mike Latimore. My first question here is regarding Apple Pay. What are you guys hearing from your vending operator customers regarding Apple Pay, and is that still in the analysis phase?

Then I guess a second question building off of that, are you seeing more interest and increased plans for cashless because of it?

It's Steve Herbert here and thanks for the question.

First of all, what we are hearing from our operators are some of the things that I mentioned when Gary asked the question. We are getting questions from our existing operators about -- if they have an NFC footprint already, they are asking questions about what they can do to more fully leverage Apple Pay with their customer base or with consumers in their markets.

They are looking for any guidance they can get out of us on point-of-sale material, maybe increasing their number of locations, et cetera. To answer -- and that's just one of the types of questions we get.

Another I think I mentioned, those that are magstripe only from some old work that might have been done in the past -- I would call that part of the legacy devices out there, they are looking for a way to trade up and, of course, we're making that available for them.

I think your other question was, do you see this stimulating the overall business? Is that essentially what your second question was?

Yes, it's just the increased plans for cashless.

Right, well, I can say this. It's definitely not hurting.

I have not been in direct contact with the customer that has said, I'm going to do -- instead of X, X plus 10 because of Apple Pay, but what we do know is that when you put together all the pieces regarding the reaction to that rollout in the marketplace, we're expecting -- we're certainly expecting an impact on connections for the fiscal year.

It will have some impact. What that is, we don't know. But it is definitely not going to hurt.

Okay, and when do you think that impact would start to show up in your numbers?

I would think in the quarter that we are sitting in and then the back half of the fiscal year. It's definitely going to impact the numbers in some way. I wouldn't say that it would be very substantial, but it will have some positive impact, and already has.

Okay, great. Then, I guess, if there are hundreds of millions of EMV chip and PIN cards next year in the US, how do you think your customers will react to that? Do you think they will have a desire to change systems or will they need to change systems? What are your thoughts around that?

Jim, thanks for the question. First, every EMV chip or EMV card that is going to be issued is still going to have a magstripe on the back as well. So customers who are cardholders will still be able to use that card in a traditional manner with a magstripe.

The one thing that changes in October, the liability shift -- for certain fraud transactions, not everyone, but certain fraud transactions would shift to a merchant who is not processing from an EMV-compliant terminal.

Now the nature -- given the nature of the vending industry, I'm not necessarily sure what the uptake will be from our customers wanting to go to EMV. We're certainly going to have an EMV-compliant device available for them to take come time of October 1, 2015, when that liability shift occurs. But again, given the nature of the vending industry and the small ticket size, I am not necessarily certain what the uptake will be.

Okay, great. Then one last question from me. Can you guys just touch on any interesting partnership activity you see right now?

There are several things going on. One we mentioned -- I think we mentioned at least one during the call, and that was our work with NEXCOM on Navy bases.

They have steadily been rolling out our service on Navy bases across the United States. I think we're actually in Hawaii, as well, at Pearl Harbor, and as I understand it, we're getting ready to go to Guam with them.

That's a relationship that we announced some time ago and it's recently picked up momentum. From a -- just from a pure connection and revenue perspective, kind of a meat and potatoes thing, I think that's a good example of a partnership or customer relationship that we feel good about.

Dave, would you have anything to add in that regard?

I do, and this relates to our card processing partner, so that relationship and the agreement with them is expiring in the next six months, and any new agreement or any new partnership agreement that we would enter into with a card processor, we believe, is going to help improve and should help to improve transaction processing margins.

Given the scale we achieved over the three-year agreement with them, the improvement and number of transaction volume has grown. I would expect that any new agreement we would enter into would be favorable to the Company and that would help improve the margins from transaction fees. That's also, from a service partner perspective, something that I think you can look forward to.

Okay. Thank you, guys. I appreciate it.

Josh Nichols, B. Riley.

Looking at the transition from JumpStart over to QuickStart, relatively new, but one is what kind of take rates are you guys seeing and what do you expect longer term for the transition?

The take rate for the quarter was fairly substantive. It was somewhere in the range of 35%, and you can see that. I think Dave outlined in his prepared remarks the movement of JumpStart, down from the 60% range to the 20% odd range.

So essentially what you're doing is you are moving -- conceptually, you are moving customers off of USA Technologies' capital, and our goal is to move them through the negotiations that Dave mentioned with third-party lenders, move them onto a long-term lease.

The take rate was very good. What we -- I don't know that we have a projection for the long term. I don't know that it would be as high as a 35% take rate. We don't know that, but what we do know is that if everything plays out the way that we have planned, moving customers in that regard and moving that QuickStart transaction to third-party financing, we are looking forward to a very positive impact on free cash flow. That was really the goal at the end of the day, strategically.

Regarding the new connections at amusement, laundry and what have you, is there a particular really bright spot where the Company is seeing a lot of growth or any comments on what they are seeing as far as different avenues for growth, but in the subset?

The commercial laundry business is one that, A, I think performed fairly well in the quarter, but we also have a partner in Setomatic Systems that is very, very active in terms of driving our solution into the marketplace.

In a nutshell, they sell payment solutions and technology in commercial laundry all day, every day, so they are essentially our distribution and service arm and they use our service exclusively.

One of the things that we've recently done is we've extended our mobile payment and loyalty program over to that channel of business, which has really created some excitement for them in terms of driving new locations. I think recently they made a statement that over some period of time -- Dave, I can't remember how long it was, but I remember hearing out in public and Setomatic Systems 25,000 incremental connections.

So that's -- A, it's performing well and, B, our partner is very active and optimistic. So that's one that I would point to to look at in the future in terms of some potential movement.

Last question for me is looking here, it looks like the average transaction size increased pretty substantially sequentially, about $1.83 versus $1.76. Any granularity or additional info you could provide on what management thinks is driving that? It's such a big jump.

Sure, two reasons. One is some of our new integrated payment services that we are offering. So some of our vending customers, for example, signed up for online type processing. It's a card not-present service.

These companies have other businesses beside vending in which they need to accept payment on and this service allows them to accept credit cards that they might typically have accepted checks in the past for Accounts Receivable. They tend to have higher average ticket sizes, much higher, actually. You could see transaction sizes of several hundred dollars.

That helped -- the uptake and the transactions from those services helped increase the ticket size.

Then, of course, I think as Steve mentioned, generally vending transactions are going to start to continue to grow. The industry is raising price points when they adopt cashless, so they are increasing prices inside the machines.

Those two things is what is driving that price increase -- or the average ticket increase.

Thanks a lot. I appreciate it.

Kevin Dede, H.C. Wainwright.

It's Kevin Dede. Dave, could you just review your assumptions for SG&A expenses for the balance of the year? Just remind me how your selling activities specifically impact that line in supporting loyalty programs?

SG&A expenses, if you remember on last call, they were upwards of a little over $4 million and I had indicated they would come down this fiscal quarter. They came down to around $3.6 million.

I expect SG&A to slowly grow through the fiscal year. We are going to continue to invest in sales and marketing activity, predominantly. I don't expect SG&A to significantly ramp, but it would ramp a little bit or grow a little bit from the $3.6 million through the fiscal -- the remaining fiscal year. Again, predominantly in the sales and marketing activity.

Right, okay. Then the loyalty program is really an impact on gross margin then, correct?

It would be a positive impact.

Positive, right, okay.

Positive. The loyalty and prepaid program would be a positive impact on margins.

Dave, just from a transaction perspective, a prepaid transaction costs us a fraction, a tiny fraction, of what a credit debit transaction costs, so that's -- if you see our pre-paid activity going up, when you hear us talk about that going up and a good market reception to that, every pre-pay transaction carries a much higher margin for the Company.

Kevin, just -- you may know this, just to be clear. The loyalty aspect is not a USAT loyalty. It is our vending operators who are providing the loyalty incentives, so they are a consumer.

Or a partner.

Or a partner.

Such as a mobile payment partner, who perhaps -- we have right now, as an example, Kevin, we have the Fifth Purchase Free program out there with Softcard, formerly Isis. I think we're in 85,000 or 90,000 locations with that, and all day, every day, consumers are doing mobile transactions using a Softcard mobile wallet as well, and their fifth purchase is free. That is funded by our partner.

Those -- we don't anticipate -- if that was your question, we don't anticipate the loyalty component or the loyalty reward coming from USA. It would come from some sort of partner.

Right, right, right, right. Okay. Then Dave, I know you touched on the equipment gross margin again and regarding the switch from Jump to Quick. Could you just go over where you think those margins would have been otherwise?

When we -- the shift to QuickStart increased -- because we accounted for it as a sale, it increased both equipment revenue and equipment cost of sales.

But we coupled the program, the QuickStart program, with some other incentives during the quarter. It was really those other incentives that impacted the margin.

QuickStart in and of itself doesn't necessarily impact margins. The only thing QuickStart really is is a capital lease, so the only thing we are doing under a capital lease is traditional vending. It's a matter of what do you sell the product for and what is the interest rate -- the rate you're discounting those payments at.

So it was these other incentives that we offered during the quarter that impacted margin.

Now if you go back -- if we did not offer QuickStart and those connections -- the 35% of the connections came in as JumpStart, margins probably in equipment would have been closer to historical. They would have been closer to the 30% margin that we saw in the previous quarter.

I think it's important to note that, Kevin, I think the thing to look -- there are a couple things to think about here.

First of all, we brought this program to market, QuickStart, which is something we had done in the past, which we don't have time to talk about, but we brought it back to market on a limited basis, really, if you think, as a litmus test to see where the market was in terms of the willingness to use their own cash or make a long-term commitment to moving in that direction.

Remember, our ultimate goal is free cash flow, so this is a program -- we are very encouraged by what we saw, and I think the thing -- for anyone out there who is thinking about modeling this, what you want to think about is the reduction, some reduction in JumpStart and thereby working capital moving over to potentially free cash flow.

Really, the things that happened during the quarter, during that limited rollout, to essentially what we call our preferred customers and a few others, that's a bit of an anomaly.

The thing to pay attention to is, and I think somebody asked the question earlier, what percentage -- and I'm going to leave it to Dave to try to answer this question at some future date, but what percentage of our customers do we think over the long haul will move to QuickStart in a scenario where it is funded by third-party financing and therefore we are not using USA's capital to get there and it is going to free cash flow.

I hope you follow that. I think you do.

Kevin, just one more point with respect to that. It is on a trial basis, so when the program is officially launched, we intend that it is going to be officially launched with financing sources in place.

Okay, so that begs another question, Dave. With a third-party financier involved, is it your evaluation or their evaluation of the leasee?

That will depend upon the program that we are able to put in place with the third party.

We are talking on a number of different programs. Direct relationships with the lessor to the vending operator and/or USAT possibly being the lockbox for the lessee -- lessor, excuse me. There is a number of programs we are discussing right now, so it could vary (multiple speakers)

Okay, fair enough. Just going forward on the equipment margin line, granted you offer a consolidated view. I am just curious about how you see these programs affecting the equipment line going forward. It's just difficult to tell from where I'm sitting on what your plans are in terms of your preferred customer and a few others, and how extensively you have been able to penetrate that base?

Kevin, thanks. I think from a -- I am not 100% certain how to answer that. I think generally once the program is officially launched, and our intention is to have financing in place, I don't -- we are anticipating that there won't be any historical change to traditional both license and transaction fee margins and/or equipment margins.

They would help -- again, it would help increase equipment revenue, but cost of sales would increase as well, but margins we don't anticipate being impacted.

Even so, at the end of the day, at the end of the day, it's the old 80/20 rule. 80% of the impact here is going to be on the movement of customers away from our capital and onto someone else's capital. That's the thing for all of us to keep our eye on.

If we are able to come anywhere close to the results that we got in the recent quarter, then we are all going to be very happy about the impact -- the reduction in capital that it takes on a quarterly basis for us to drive our connection number and what that might translate to down the road in terms of free cash flow. That's what I would emphasize from a modeling perspective.

Right, okay. I guess what I am still curious about is where you -- I get the direction, Steve, don't get me wrong. I understand the objective. It's just not clear to me how much -- from a sales and marketing perspective, what your team is putting an emphasis on. Is it still -- is it JumpStart to an extent with certain customers, QuickStart with your preferreds, or -- what's the best way to look at that, do you think, for an outsider?

You raised a good point. Another thing that -- I just want to take the opportunity to make this point, Dave, and you may have covered it. You may have covered it, but I'm going to go ahead and say it anyway.

An interesting dynamic that also occurred during the quarter is that the customers who purchased equipment, the number of connections that came through purchases went up, so let's be very clear about it. We are emphasizing purchases with customers. That number moved 20% to 28% of connections during the quarter.

That was primarily driven by a segment of our business that we've talked about before that is growing fairly rapidly, is what we call SMB, small to medium business, a high margin, low cost of acquisition sale. Those customers typically buy and we push very hard to -- we're pushing very hard to continue to get them to buy.

We are also -- because of the fact that we rolled out QuickStart on a limited basis in the quarter, we are also continuing to offer JumpStart. So right now, right this minute as we sit here today, there is a heavy focus on purchase. There is still a focus on JumpStart, and based upon the results that we have gotten from QuickStart and the negotiations that Dave mentioned that really put a bow on the whole thing in terms of moving where the capital comes from, to a lesser extent there is an emphasis on QuickStart.

Now where that shakes out in the future, it's our belief and our hope and our intent to have it -- have most purchases shake out in the category of purchase and QuickStart. There is a long-winded answer to your question, but I hope that helps.

No, it absolutely helps. Yes, thanks for (technical difficulty) Steve.

Good, you got it.

Thank you, and I am not showing any further questions. Mr. Herbert, please proceed with any closing remarks.

All right, very good. Just want to thank everyone for joining us this morning. We look forward to reporting back to you on our second-quarter call in mid-February. I hope everyone has a great day and a very nice weekend.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program and you may all disconnect. Everyone, have a great day.