Market Commentary

As we enter the second quarter, the economy continues to emerge from the deepest economic contraction ever recorded. While the recovery has been faster and stronger than anyone expected, questions still remain about the path forward.

Prior to COVID-19, there had only been one global pandemic in the last century that coincided with a recession: the 1957 outbreak of Asian flu. Though the economy did enter a brief recession at the beginning of that pandemic, the downturn is generally

attributed to weakness in the automotive industry, not to the disease. Of interest to note is the 1918 Spanish flu, which is often compared to the current COVID-19 pandemic. Though 675,000 Americans died (0.67% of the US population) and 20 million perished globally, the stock market and economy continued to grow despite the massive loss of life.

Given the high mortality rate and the extremely contagious nature of COVID-19, economic impacts were inevitable. Even after an initial period of societal behavior adjustments, the advent of sufficient testing capacity and a better understanding of COVID’s transmission modes, sectors of the economy remained greatly impacted. The resulting 31.4% decline in GDP prompted a strong legislative and monetary response that helped lead to a recovery in economic activity that may soon reach pre-pandemic levels, as well as a stunning rally in equity markets.

The stimulus package passed last spring (plus additional payments since then) is widely credited for the increase in consumer spending. However, less visible regulatory actions also played a dramatic role in the economic recovery. First, banking regulators permitted the deferral of principal and interest payments on loans without penalizing the banks or borrowers. This provided much needed debt relief to both parties and avoided a surge in distressed loans and bankruptcies. It also headed off further disruption in several key industries.

Second, foreclosure and eviction moratoriums provided indirect relief to countless families, helping them avoid the cost and stress of finding new housing in the middle of a deadly pandemic. This had the added benefit of allowing millions of people to focus their scarce dollars on critical needs, keeping money flowing into essential goods and services.

As we look forward to the remainder of this year, we see continued organic acceleration of the economy as Americans look to leave their homes and start traveling, dining out and safely socializing with others. As investors with a time horizon longer than most, we are looking ahead to the 2022 landscape. While society should return to relative normalcy, the cessation of the policies, stimulus payments and regulations that helped initiate the recovery will likely have future negative ramifications.

There are other competing trends that we see on the economic horizon: the potential of new tax legislation, a repeal of the SALT provision (a tailwind in high-tax states), an increase to the corporate tax rate (an immediate earnings headwind for most profitable publicly traded companies) and the passage of an infrastructure bill (likely a tailwind). All of these offsetting factors will provide a challenging backdrop for economic forecasters as we enter the back half of 2022.

*Preliminary results.  For additional performance information, see the related GIPS® Report on the last page.

Strategy Review

The Pacific Ridge Capital Partners’ Small Cap Value strategy rose 26.2%* during the first quarter of 2021, outperforming the 21.2% return of the Russell 2000® Value Index (“Index”). Over the trailing one-, three- and five-year periods, the strategy returned 109.6%*, 8.8%* and 12.5%* (annualized), respectively, compared to the Index returns of 97.1%, 11.6% and 13.6%. Since inception on August 1, 2010, the strategy returned 12.2%* annually versus 11.8% for the Index.

*Preliminary results.  For additional performance information, see the related GIPS® Report on the last page.

Top Contributors

Ultra Clean Holdings (“UCTT”) is a developer and manufacturer of critical subsystems in the semiconductor capital equipment industry. The stock’s strong performance in 2020 continues into this year, thanks in large part to shortages in the semiconductor industry and increased demand. The company has also benefited from the diversification and higher gross margin profile resulting from big acquisitions in 2018 and another that was just completed.

Customers Bancorp (“CUBI”), a Pennsylvania-based community bank, rebounded strongly during the first quarter following a sharp sell-off in 2020. In addition to better-than-expected earnings, the bank completed the spin-out of their BankMobile subsidiary in early January. The bank has been a major participant in the PPP program and stands to generate additional fees as those loans are forgiven and moved off its balance sheet.

Ichor Holdings (“ICHR”) is a manufacturer of gas and fluid delivery subsystems for semiconductor capital equipment. The stock lagged most industry peers in 2020, due in large part to the concentration of new business in lower gross margin product areas, thereby affecting earnings. The maturation of this business, combined with a cleaned-up balance sheet from a recent share offering and strong industry conditions, makes the outlook for earnings growth very compelling for 2021 and beyond.

Signet Jewelers (“SIG”), an operator of jewelry stores, rallied strongly last quarter, thanks to a leaner pandemic cost structure that improved gross margins. The company’s loss to shareholders came in far lower than expected, enabling SIG to aggressively pay down debt and finish the year with an improved balance sheet. We continue to evaluate the company’s true earnings power going forward under normalized economic and societal conditions.

Rimini Street (“RMNI”) is a provider of support and services for enterprise software. The company broadened its shareholder base during the quarter through a secondary offering and set the stage to pay off high-cost legacy financings. The stock rallied early in the quarter and the company hosted its first ever Analyst Day. Management sounds increasingly confident in their ability to win new business and aggressively grow revenue through an expanded sales force and new service offerings.

Top Detractors

Lifetime Brands (“LCUT”) is a manufacturer of kitchenware and tableware products. The stock traded roughly flat during the quarter despite beating earnings expectations on strong sales in their core kitchenware and cutlery business. Margins were down slightly as the company dealt with an unfavorable product mix. Also, comparing the first quarter of 2021 with its pandemic woes with the first quarter of 2020, where company earnings were very strong, weighed on traders. Despite these factors, the stock remains inexpensive as investors eagerly await management to release full-year guidance in the coming quarter.

Perdoceo Education (“PRDO”) is the operator of Colorado Technical University and American Intercontinental University. The company reported another solid quarter of results but sold off along with the rest of the for-profit education space following the nomination of a new Under Secretary of Education who is likely to implement strict industry regulations. Having prepared itself years ago for changes in the political environment, PRDO has a strong balance sheet and healthy cash flow generation, positioning it well within the sector.

PRA Group (“PRAA”), a debt collection firm, traded sideways during the quarter as reported earnings roughly met expectations. The company stands to benefit in the coming years from an increased supply of delinquent borrowers and charged off receivables from lenders. Accordingly, the stock rallied sharply in the early days of the pandemic but has since moderated following a substantial stimulus package that buoyed consumers. The degree to which PRAA will benefit from the economic fallout of the coronavirus remains to be seen.

BM Technologies (“BMTX”), a mobile banking platform, was spun out of Customers Bancorp (“CUBI”) during the quarter, thus forming a new entity. BMTX is the operator of BankMobile, a deposit gathering institution that generates revenue from collecting interchange and deposit servicing fees. While the company has historically been a financial intermediary that focused on the disbursement of student financial aid, BMTX now provides white label banking services for partner organizations.

Intevac (“IVAC”) is a manufacturer of thin-film processing systems, digital sensors, cameras and systems. The stock traded down during the quarter following an earnings report that beat estimates. However, the company offered forward guidance that was far below analyst expectations. We believe that the slowdown in bookings is temporary because IVAC is the sole remaining supplier of key equipment used in hard drive manufacturing and a key provider of image sensors for U.S. military night-vision headset programs.

**Past performance does not guarantee future results. The holdings identified do not represent all the securities purchased, sold or recommended to clients. Top contributors and detractors to return represent those securities that had the largest positive and negative total contribution to the overall portfolio return for the quarter.  A complete list of contributors to portfolio return can be obtained by contacting Peter Trumbo, Chief Compliance Officer, at 503-886-8972 or by email at Peter.Trumbo@PacificRidgeCapital.com. For additional information, see the related GIPS® Report on the last page.

Market Capitalization Analysis

There was a significant size bias tailwind during the quarter as smaller companies in the Index outperformed larger companies. Those with a market cap under $1 billion in the Index gained 25.6%, versus a return of 20.0% for companies with a market cap above $1 billion. The strategy had 67.4% of its holdings in companies with a market cap below $1 billion, compared to 22.1% for the Index. 

Style Analysis

There was a modest value-bias during the quarter as stocks with lower PEs outperformed those with higher PEs. Those with a PE ratio greater than 15x returned 16.3% versus 21.7% for those companies with a PE below 15x. The strategy had 38.7% of its holdings in companies with a PE greater than 15x compared to 45.3% for the Index. However, strong performance of unprofitable companies in the Index created a modest headwind, as those stocks returned 29.6%, versus a gain of 20.5% for firms that were profitable. The strategy had 6.4% of its holdings in unprofitable companies, compared to 12.9% for the Index.

Economic Sector Analysis

The strategy’s performance in Information Technology, Financials, and Industrials contributed approximately 510 basis points of excess return compared to the Index. However, performance in Energy and Consumer Discretionary detracted approximately 150 basis points versus the Index. More specifically, strong performance in GameStop (“GME”), which we do not own, detracted approximately 70 basis points of performance. The strategy’s lack of exposure to the Communication Services and Utilities sectors provided approximately 70 basis points of excess returns during the quarter.

Market Outlook

We are optimistic for continued growth in the US economy in the near term, driven by another round of fiscal stimulus and greater availability of vaccines. On the heels of 4.3% growth in 4Q20 GDP, expectations for an economic rebound in the US have improved. Sentiment amongst purchasing managers remained positive for the tenth consecutive month, and the March 2021 reading of 64.7 was the highest level in nearly forty years. While strength in new orders and production suggest that growth trends will continue to persist, we are mindful of potential supply chain bottlenecks that could slow the system.

As always, we continue to search for companies that demonstrate an ability to earn a fair return on capital. We welcome any questions or comments you may have and thank you for your continued support.

Sincerely,

Pacific Ridge Capital Partners

Investment Team Additional Professionals
Mark Cooper, CFA® Co-Senior Portfolio Manager Peter Trumbo Chief Operating/Compliance Officer
Dominic Marshall, CFA® Co-Senior Portfolio Manager Mike McDougall Senior Trader
Ryan Curdy, CFA® Portfolio Manager Veronica Orazio Operations Assistant
Justin McKillip, CFA® Senior Analyst
Adam Boyce, CFA® Senior Analyst

Regulatory Disclosures

The contributors and detractors to return, market capitalization weightings and total effect, economic sector weightings and total effect, portfolio characteristics, and top ten holdings for the Small Cap Value Composite are based on a representative account within the strategy. The representative account statistics are shown as supplemental information and complement the composite's GIPS® Report as provided on the last page. 

The Russell 2000® Value Index measures the performance of the Russell 2000 companies with lower price-to-book ratios and lower forecasted growth values. For comparison purposes, the Index is fully invested, which includes the reinvestment of income. The return for the Index does not include any transaction costs, management fees or other costs. 

In order to maintain consistency when comparing the Small Cap Value strategy to the Russell benchmark, the Firm utilizes FactSet’s outlier methodology calculations which provide a comparable portfolio characteristic calculation methodology as Russell applies to its indices.

The information provided should not be considered a recommendation to purchase or sell any particular security. There is no assurance that any securities discussed herein will remain in our strategy at the time you receive this report or that securities sold have not been repurchased. It should not be assumed that any of the holdings discussed herein were or will be profitable or that the investment recommendations or decisions we make in the future will be profitable or will equal the investment performance of the securities discussed herein. Past performance is no guarantee of future results.

Although the statements of fact and data in this report have been obtained from, and are based upon, sources that the Firm believes to be reliable, we do not guarantee their accuracy, and any such information may be incomplete or condensed. All opinions included in this report constitute the Firm’s judgment as of the date of this report and are subject to change without notice. This report is for informational purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any security.

Disclosures                                                                                            

Pacific Ridge Capital Partners, LLC (“Pacific Ridge”, “PRCP”, or “the Firm”) is a 100% employee owned investment advisor registered with the Securities and Exchange Commission under the Investment Advisors Act of 1940. The Firm was established in June 2010, and has one office located in Lake Oswego, Oregon. Pacific Ridge claims compliance with the Global Investment Performance Standards (GIPS®) and has prepared and presented this report in compliance with the GIPS standards. Pacific Ridge has been independently verified for the periods June 10, 2010 through December 31, 2020. A firm that claims compliance with the GIPS standards must establish policies and procedures for complying with all the applicable requirements of the GIPS standards. Verification provides assurance on whether the firm’s policies and procedures related to composite and pooled fund maintenance, as well as the calculation, presentation, and distribution of performance, have been designed in compliance with the GIPS standards and have been implemented on a firm-wide basis. The Small Cap Value Composite has had a performance examination for the periods June 10, 2010 through December 31, 2020. The verification and performance examination reports are available upon request.

The Small Cap Value composite was created and incepted on August 1, 2010. The Small Cap Value composite comprises fully discretionary portfolios managed by the Firm invested primarily in an equity portfolio of small companies with market capitalizations similar to those found in the bottom three-quarters of the Russell 2000® Index. The strategy ascribes to a disciplined bottom-up fundamental  selection process with an emphasis given to the cash flow generating capabilities of a company. The strategy’s objective is to outperform the Russell 2000® Value Index which is used as our benchmark. Eligible portfolios must be managed for a full calendar month prior to inclusion in the Small Cap Value composite. Composite dispersion is measured using an asset weighted standard deviation of gross returns of the portfolios included for the entire year. Returns and asset values are stated in US dollars.

The Russell 2000® Value Index measures the performance of the Russell 2000 companies with lower price-to-book ratios and lower forecasted growth values. For comparison purposes, the index is fully invested, which includes the reinvestment of income. The return for the index does not include any transaction costs, management fees or other costs.

Sources: Pacific Ridge; FactSet Research Systems (“FactSet”); and Russell Investment Group (“Russell”) who is the source and owner of the Russell Index data.

Returns for the Small Cap Value composite are presented gross and net of management fees and other expenses and includes realized and unrealized gains and losses, cash and cash equivalents and related interest income, and accrued based dividends. Net returns are calculated by deducting the highest annual management fee of 1.00% from the quarterly gross composite return. Performance-based fees are available upon request. All returns are calculated after the deduction of the actual trading expenses incurred during the period. The management fee schedule and total expense ratio for the Small Cap Value Fund, which is included in the composite, are 1.00% on all assets and 1.23%, respectively, as of the most recent audit. Total fees for the fund may not exceed 1.25% annually.

The fee schedule for separately managed accounts is a flat rate of 1.00%.

The portfolio characteristics, sector weightings and attribution analysis for the Small Cap Value composite are based on a representative account within the strategy. The representative account statistics are shown as supplemen­tal information. The Firm maintains a complete list and description of composites and pooled funds, policies for valuing portfolios, calculating performance, and preparing GIPS Reports which are available upon request by contacting Peter Trumbo, Chief Compliance Officer at (503) 886-8972 or Peter.Trumbo@PacificRidgeCapital.com.

GIPS® is a registered trademark of CFA Institute. CFA Institute does not endorse or promote this organization, nor does it warrant the accuracy or quality of the content contained herein.

Top 5 and Bottom 5 Performing Securities represent those security holdings that had the largest positive and negative total contribution to the portfolio return. Top 3 and Bottom 3 Economic Sectors represent those sectors that had the largest positive and negative total contribution to the portfolio return.

In order to maintain consistency when comparing the Small Cap Value strategy to the Russell benchmark, the Firm utilizes FactSet’s outlier methodology calculations which provide a comparable portfolio characteristic calcula­tion methodology as Russell applies to its indices.

The information provided should not be considered a recommendation to purchase or sell any particular security. There is no assurance that any securities discussed herein will remain in our strategy at the time you receive this report or that securities sold have not been repurchased. It should not be assumed that any of the holdings discussed herein were or will be profitable or that the investment recommendations or decisions we make in the future will be profitable or will equal the investment performance of the securities discussed herein. Past performance is no guarantee of future results.

Although the statements of fact and data in this report have been obtained from, and are based upon, sources that the Firm believes to be reliable, we do not guarantee their accuracy, and any such information may be incom­plete or condensed. All opinions included in this report constitute the Firm’s judgment as of the date of this report and are subject to change without notice. This report is for informational purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any security.