This letter is the first quarterly report for Owls Nest Partners Concentrated Long Only SMA (“Long Only”), which was launched on July 1st, 2018. Long Only is a new product designed for allocators who seek high concentration, high active share, and returns driven by selective idiosyncratic risk within a liquid, fully invested domestic investment strategy. It is available only through separately managed accounts, or SMA/UMA platforms. Results, therefore, are presented gross of management fees.

Performance & Investment Program:

For the quarter ended September 30, 2018, Long Only returned 4.07% compared to the total returns of the Russell 2000 and the S&P 500 of 3.26% and 7.20% respectively.^[1]

Long Only may be new, but the investment process has been refined by Long Only’s PM over a period close to 25 years during which he has worked on behalf of many of the nation’s top endowments. This time period also encompasses the full gamut of market environments, including the dot com bubble and the Global Financial Crisis. The investment discipline has been tested throughout these periods with successful results.

The hallmark of the Owls Nest Partners approach is the purchase of industry leading growth companies when a temporary headwind has recoiled the fundamental growth drivers and compressed its multiple. This typically happens as hot money “renters” exit and drive the price down. There is no such thing as a free lunch: we can only access high quality business models with liquid and strong balance sheets, proven management and a long runway of growth and margin expansion, if we accept that our companies will appear “catalyst-less” and therefore may be dead money for some time. Of course, the offset to this cost is that these moments are (ironically) when a company can invest in its own business with the highest returns, and there is wonderful optionality associated with a well-run, shareholder friendly, cash-laden company that is able to aggressively put money to work during a temporary headwind.

We began the quarter with 10 holdings and constructed the portfolio being careful to have both pro and counter cyclical names. It is our belief (and experience) that our future outperformance will not be driven by any economic or market forecasting prowess but instead by 10 unique investments, each playing out over time. We perceive these investments to have modest downside due to high quality and low expectations, and very significant upside as growth and margin expansion returns in spades. We seek reasonable ballast and diversification within the portfolio as a result of our natural conservatism (strengthened by our co-investment alongside clients), an unwillingness to think we can predict markets or economies, and a predisposition to avoid all crowded trades and instead invest in temporarily out of favor areas.

¹Past performance is not indicative of future results. All returns shown are preliminary, unaudited, figures that are subject to change. Actual client returns may be different from returns presented herein.

Current Holdings :

We are over 99% invested. The current holdings are as follows:

Quarterly Attribution:

During the quarter, we sold one name due to a pending merger and replaced it with a new name, such that we had 11 companies contributing to our performance. On the positive side, in order of impact, were Fastenal (FAST), FLIR Systems (FLIR), TJX Companies (TJX), Ross Stores (ROST) and Wabtec (WAB). Our decliners, also in order of impact, were Avalara (AVLR), Affiliated Managers Group (AMG), Allegiant Travel (ALGT), Welbilt (WBT), Healthcare Services Group (HCSG), and Grand Canyon Education (LOPE). We exited the quarter with a median market cap of ~$5B.

Portfolio Adjustments:

During the quarter WAB announced a proposed merger with GE’s Transportation Business. We believe this is a very positive and transformational deal for Wabtec. It is the sort of unique purchase of such a unique asset with such a logical partner, that the buyer generally massively overpays because the seller is selling at a top and the buyer feels the desperate need to avoid letting the target possibly slip into another’s hands. Since we aren’t GE shareholders, we can happily report that this is not the case. In fact, it is the seller that is desperate and is selling at something of a market trough. We are happy that WAB will close on this transaction in early 2019, and we understand Wall Street’s enthusiastic response to the deal. However, this transaction complicates our ownership of WAB. First, this transaction will leave the company with a significantly leveraged balance sheet on the very low end of investment grade, and we are big believers of liquid balance sheets and the dry powder that comes with that. Second, this will lead to a massive integration exercise, and it seems entirely reasonable if not likely that operational matters will miss some needed attention, increasing the risk of sloppy execution. Lastly, the increase in the share price gave us a fair piece of the upside of the deal. So, we sold. It is not impossible to imagine our owning it again after the dust settles and if a “triple win” situation presents itself.

In its place, we bought AVLR, which automates the generally manual process of calculating sales and other taxes for the nation’s 270,000 midsized businesses and then filing the monthly sales tax returns on behalf of those companies with all the relevant jurisdictions (there are 11,000 such jurisdictions in the U.S.). On average, AVLR does this all for ~$15,000 per year. With less than $300M in revenue and an extremely strong position in a growing market opportunity of $4B (when most narrowly defined), this company has a huge greenfield opportunity ahead of it. Of course, this is a software company with elegant technology, a recurring revenue business model, and extremely high retention of clients due to its being the go-to brand in the market. But the reason we can get so comfortable with this technology name for the long run is due to their business’s unique content requirements and their well-developed and impractical if not impossible to replicate ecosystem and network of partners. To build and maintain, and to guarantee the accuracy of a database that captures the relevant sales tax rate of almost every object across every jurisdiction is a herculean task.

Bagels are not taxed in New York unless they are sliced, in which case it is considered a sandwich and is hence taxed. Unless the purchaser is exempt from sales tax and gives the seller a properly completed exemption certificate (and yes AVLR has a module to check, hold and apply those certificates). Of course, you still have to pay sales tax on that bagel if you intend to resell it, but you may take a credit for that sales tax when you file you your own sales tax return. This is per New York’s Tax Bulletin ST-835 which references Tax Law sections 1105(d)(i)(3) and 1115(a)(1) and section 527.8 of the state tax regulations. And that 8.875% tax is of course owed to multiple jurisdictions – state and city and metro commuter transportation district surcharge – each of which grabs a bite of your bagel as it were. The good news is that if you spill your cream cheese and ruin your shirt, a new shirt is tax exempt… so long as it’s below $110. The point is, more than just software, they’ve built a database that is the best available and in a world of compliance with heavy penalties assessed by bureaucrats, you want the best especially if it doesn’t cost any more than not the best. Even if you know you need an automated solution, you will seldom replace the legacy manual system unless the new automated system is already integrated with your ERP or POS system. This interdependence is where AVLR brilliantly built a huge competitive advantage to which will accrue long-lasting benefits of their network effect. By being first to a cloud product and then building integrations with over 700 ERP, financial and operating systems vendors (and by paying a referral fee for successfully closed introductions), AVLR has become the default choice when a company asks its ERP vendor: “who should I use for sales tax calculation and filing?” It won’t happen overnight; rather gradually as people replace their systems. As with payroll, sales and other tax calculation and filing will be automated over time, and AVLR will be the clear and very entrenched leader.

We launched Long Only once we had a built-out portfolio and a pipeline of new ideas waiting for their entry point. As you can tell whenever you hear us discuss individual names, we are glad we don’t own the market but instead own a handful of very special businesses that have secular growth drivers because of their ability to innovate and thrill their customers. To prevent this letter from being too long, we have only highlighted in detail our newest name and one we exited since a sale is as important as a purchase and deserves as much illustration. Please reach out to us to learn more about our other investments.

Thank you for the interest and the support.

Owls Nest Partners.

Disclaimer

In General: This disclaimer applies to this document and the verbal or written comments of any person presenting it. This document has been prepared by Owls Nest Partners IA, LLC as Investment Adviser (the “Adviser”) of Owls Nest Partners Concentrated Long Only SMA (the “Strategy”). By receiving this document you acknowledge that you are an investor in the Strategy, or a prospective investor who is known to the Adviser, and that you meet all regulatory definitions of “Accredited Investor” and “Qualified Client,” in order to be considered a prospective client of the Adviser. The information included herein reflects current views of the Adviser only, is subject to change, and is not intended to be promissory or relied upon. There can be no certainty that events will turn out as the Adviser may have opined herein.

No reliance, no update and use of information: You may not rely on this document as the basis upon which to make an investment decision. To the extent that you rely on this document in connection with any investment decision, you do so at your own risk. This document is being provided in summary fashion and does not purport to be complete. The information in this document is provided you as of the dates indicated and the Adviser does not intend to update information after its distribution, even in the event the information becomes materially inaccurate.

No tax, legal or accounting advice: This document is not intended to provide and should not be relied upon for (and you shall not construe it as) accounting, legal, regulatory, financial or tax advice, or investment recommendations. Any statements of U.S. federal tax consequences contained in this document were not intended and cannot be used to avoid penalties under the U.S. Internal Revenue Code or to promote, market or recommend any tax-related matters addressed herein.

Confidential information and distribution: By accepting receipt or reading any portion of this document, you agree that you will treat all information contained herein confidentially. Any reproduction or distribution of this document or any related marketing materials, as a whole or 

in part, or the disclosure of the contents hereof, without the prior written consent of the Adviser, is prohibited.

Suitability: Any investment program involves a high degree of risk and is suitable only for sophisticated investors who meet certain other suitability standards.

Investment strategies, market conditions and risk disclosures: Notwithstanding the general objectives and goals described in this document, readers should understand that the Adviser is not limited with respect to the types of investment strategies it may employ or the markets or instruments in which it may invest. Over time, markets change and the Adviser will seek to capitalize on attractive opportunities wherever they might be. Depending on conditions and trends in securities markets and the economy generally, the Adviser may pursue other objectives or employ other techniques it considers appropriate and in the best interest of the Fund. No representation or warranty is made as to the efficacy of any particular strategy or actual returns that may be achieved.

Projections: This document may contain certain “forwardlooking statements,” which may be identified by the use of such words as “believe,” “expect,” “anticipate,” “should,” “planned,” “estimated,” “potential” and other similar terms. Examples of forward-looking statements include, but are not limited to, estimates with respect to financial condition, results of operations, and success or lack of success of the Strategy’s investment strategy. All are subject to various factors, including, but not limited to general and local economic conditions, changing levels of competition within certain industries and markets, changes in interest rates, changes in legislation or regulation, and other economic, competitive, governmental, regulatory and technological factors affecting a portfolio’s operations that could cause actual results to differ materially from projected results.

PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE RESULTS

Disclosures

All “portfolio” information presented is for the Owls Nest Partners Concentrated Long Only SMA (the “Strategy”). Such data represents preliminary, unaudited, figures that are subject to change. The Adviser prepares final monthend and quarterly performance figures for the Strategy, which therefore represent its own internal, unaudited estimates of performance. Because the Strategy is only offered via separate account or SMA/UMA 

1. platforms, fees will be different for each client of the Strategy. Therefore, all performance returns are presented gross of all fees and expenses. For further information regarding Strategy performance, please contact the Adviser at info@owlsnestpartners.com, or by calling 484-352-1110.
2. The Russell 2000 Total Return Index (the “Benchmark”) is a broad market index that is presented for comparative purposes as the performance benchmark to the Fund. The Benchmark is an unmanaged index consisting of the smallest 2000 stocks in the Russell 3000 Index. The stocks are issued in the United States, and the Benchmark includes the reinvestment of all dividends and income. Because the Benchmark is unmanaged, it assumes no transaction costs, management and performance fees, or other expenses. Unlike the Fund, it contains only domestic companies and is rebalanced monthly. Therefore, while the Benchmark contains publicly traded companies, it does not purport to represent an exact performance comparison to the Strategy. It is not possible to invest directly in an index, such as the Benchmark