Q1'23 Micro Cap Value Strategy

Performance Review

The Pacific Ridge Capital Partners Micro Cap Value strategy (the “Strategy”) returned -3.1%* (-3.5% net of fees) during the first quarter ended March 31, 2023, outperforming the Russell Microcap® Value Index (the “Index”) return of -5.2%.

The Strategy’s portfolio characteristics can be significantly different from the Index because we generally invest in smaller-sized and lower-valued stocks, as well as being sector indifferent. This difference is depicted in the charts below.

Size Analysis

The Strategy benefitted from a significant size bias tailwind during the quarter, as smaller companies in the Index outperformed larger companies. Those with a market capitalization below the $215 million Index median posted a 4.1% return, versus a -6.5% return for stocks with a market capitalization above the breakpoint level. The Index had 86.5% of its weight above the median market capitalization level, compared to 55.8% for the Strategy. This tailwind is notable because throughout the rest of the US equity universe above microcap stocks, the size factor worked in the other direction, with larger stocks generally outperforming smaller ones.

Style Analysis

The Strategy benefitted from an overall moderate value style bias tailwind during the quarter due to two factors. First, the Strategy was significantly underweight unprofitable companies (stocks with PEs less than 0x) compared to the Index. Those firms posted the worst return in the Index at -9.7%. The Strategy held 10.9% in unprofitable companies compared to 32.0% in the Index. Second, the Strategy was overweight in profitable companies with PEs greater than 15x, as those stocks in the Index posted the best return of 3.8%. The Strategy held 19.4% compared to 12.7% for the Index.

*P/E ratios are based on analyst estimates for the current fiscal year, including both completed and estimated quarterly results. Companies that have no earnings estimates have been excluded, and thus the bars may not add up to 100%.

Top Contributors

Top Detractors

Top Contributors

inTest (“INTT”) is a supplier of highly engineered process and test solutions used by a broad range of manufacturers, with a particular specialty in induction heating. The efforts of a relatively new management team began to pay off in 2022, with full-year organic revenue growth of 17%, and 28% in the fourth quarter. Key drivers include solutions for electric vehicles and silicon carbide semiconductor manufacturing. While nice long-term upside remains, we have been trimming weight after nearly a triple in the share price of this large holding over the past two quarters.

Asure Software (“ASUR”) is a provider of Human Capital Management (HCM) software and services, specifically in payroll processing and related functions. The stock has posted a significant move up in each of the past two quarters, after reporting organic quarterly revenue growth of 22% and 38% year-over-year. New marketplace options such as credit monitoring for employees of payroll customers, as well as a relatively new human resources compliance offering, are proving to be fruitful add-ons for a maturing sales force to sell into the existing customer base. We have been trimming this position, as the valuation moves more toward a fair level.

Red Robin Gourmet Burgers (“RRGB”) is a family-friendly hamburger restaurant chain with just over 500 locations, skewed towards the Western States. We initiated our position late in the third quarter of 2022, believing that the stock was in an oversold condition. A spike in food commodity prices and higher energy costs were impacting discretionary consumer spending and contributed to the oversell. Investors also had questions about an impending management change and degradation in debt coverage ratios. While still in the early days for the new CEO, the market is viewing these risks as overblown, despite potentially building economic headwinds.

Bowman Consulting Group (“BWMN”), a consulting firm offering engineering solutions, reported another strong quarter of financial results ahead of expectations and increased guidance for the rest of the year. Healthy demand from infrastructure-related end markets has led to significant organic revenue growth, while the acquisition strategy continues to be accretive to earnings. BWMN shares were also supported by the acquisition of a competitor during the quarter at a higher multiple of cash flow.

Cooper-Standard (“CPS”) manufactures sealing, fuel, brake delivery and fluid transfer systems for passenger vehicles. The company’s main customer base is large OEMs (Ford, GM, Stellantis), followed by a small business selling products to automotive suppliers. The stock rebounded during the quarter as the company completed its debt refinancing, removed its financial covenants and extended maturities to 2027. With a normalized level of auto production expected in the next several years, CPS should start to generate a healthy amount of cash flow and fetch a higher valuation multiple.

Top Detractors

Metropolitan Bank (“MCB”) is a New York City based community bank that has been extremely volatile year-to-date. The stock experienced a significant sell-off when Signature Bancorp was seized by regulators, as both firms had exposure to the crypto industry. While Signature had a far higher concentration of revenue from crypto and a very high percentage of total deposits that were uninsured, MCB’s exit from crypto was nearly complete and had a below-average concentration in uninsured deposits. The stock came under pressure again late in the quarter following the publication of a “short report,” though the stock bounced back somewhat the following day after a business update was provided by management.

BGSF (“BGSF” aka “BG Staffing”) is a provider of temporary staffing and managed services, split between highly differentiated multi-family and commercial real estate businesses. During 2022, the company divested its low-margin light industrial staffing business, investing those proceeds into an acquisition to expand professional staffing. The stock reacted favorably in fourth quarter of 2022 to the acquisition and improving financial results but sold off during the first quarter over macroeconomic concerns. We believe the shares are attractively valued at a PE ratio of less than 8x on current-year estimates.

Motorcar Parts of America (“MPAA”) is a manufacturer of automotive parts; specifically starters, alternators and brake components. Shares sold off during the quarter after an announcement that its stock will be removed from the S&P 600 due to newly established market cap thresholds. Because the current price-to-value mismatch appears favorable, we viewed the sell-off as an opportunity to add to our position.

Northeast Bank (“NBN”) is a specialized finance company based out of Boston. While it operates a community bank through a small branch footprint in Maine, NBN has also developed expertise in purchasing discounted commercial real estate (CRE) loans. The company completed a large purchase of loans in the fourth quarter that significantly improved its earnings power for the coming years. The stock sold off late in the quarter following the turmoil in the banking industry related to uninsured deposits and concerns over CRE exposure. Management has a strong track record of managing acquired nonperforming loans and generating impressive returns. Given the low loan-to-value ratios in its CRE book, the stock should perform well in the coming years as investor concerns over potential losses wane.

Whole Earth Brands (“FREE”) operates primarily in the alternative sweeteners industry, with a smaller segment focused on flavors and ingredients. The company has struggled over the past year as it works through labor shortages, rising interest rates, streamlining supply chains and shifting production to third parties. A reconstituted management team, led by a new CEO tied to a large outside investor, plans to spend the next year turning the business around.

Market Outlook

Despite a turbulent first quarter characterized by the Federal Reserve’s (the “Fed”) commitment to aggressive rate hikes and a banking sector crisis, US equities remained surprisingly stable. Investors responded by swiftly shifting from value stocks to growth stocks, speculating that the Fed might slow or pause its rate hikes to promote financial stability and in response to reports of slowing inflation.

As expected, the Fed increased its key short-term interest rate by 25 basis points on March 22, bringing it to a range of 4.75% to 5.00%. The current yield curve is extremely inverted, a traditional sign of potential economic recession. Specifically, the spread between the 10-year and 3-month Treasury is inverted by 120 basis points, which is a cause for concern.

In February, the Core Personal Consumption Expenditure Index (the Fed’s preferred measure of inflation) rose by 4.6% on an annualized basis. Although this is slightly lower than January’s reading of 4.7%, it is still well above the central bank’s target of two percent. It is important to note that the inflation reading for March will factor into recent stresses in the banking system, and that could have implications for future Fed policy decisions.

GDP increased 2.6% in the fourth quarter of 2022, driven by increased private inventory investment in the manufacturing, mining and construction sectors, as well as growth in consumer spending (particularly in service-related industries). While first quarter 2023 GDP growth is expected to remain positive, various leading indicators point to slower/negative growth later in the year. Additionally, sentiment amongst purchasing managers continues to weaken. The March 2023 US Purchasing Managers’ Index (“PMI”) reading was 46.3, the fifth consecutive monthly reading below 50 and the lowest since the initial Covid lockdowns. Most PMI sub-components, including New Orders and Production, remain depressed, while Inventories appear to show early signs of contracting and Employment expectations are beginning to roll over.

We continue to have a modest growth outlook for the US economy over our investment horizon. That said, recent stress in the banking system, the extremely inverted yield curve and stubborn inflationary pressures have created near-term uncertainty.

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, 2022. 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 Micro Cap Value composite has had a performance examination for the periods June 10, 2010 through December 31, 2022. The verification and performance examination reports are available upon request.

The Micro Cap Value composite was created on June 10, 2010 and incepted on April 1, 2007. Performance from 2007 to 2010 is from portfolios managed at another entity. The Micro Cap Value composite comprises fully discretionary portfolios managed by the Firm invested primarily in a concentrated equity portfolio of smaller companies with market capitalizations similar to those found in the Russell Microcap® Index. Smaller capitalization equities have historically had greater volatility than large capitalization equities. 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 Microcap Value Index which is used as our benchmark. Eligible portfolios must be managed for a full calendar month prior to inclusion in the Micro 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 Microcap Value Index measures the performance of the microcap segment of the U.S. equity market. 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. It is not possible to invest directly in the Index.

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 Micro Cap Value composite are time-weighted and 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 1.50% from the quarterly gross composite return. Performance-based fees are available upon request. All returns are calculated after the deduction of the actual transaction costs incurred during the period.

The fee schedule for separately managed accounts is a flat rate of 1.50%.

The portfolio characteristics, sector weightings and attribution analysis for the Micro 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 of contributors and detractors to portfolio return as well as a complete list and description of composites and pooled funds, policies for valuing portfolios, calculating performance, and preparing GIPS Reports, all of which are available upon request by contacting Peter Trumbo, Chief Operating Officer/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 and Bottom Performing Securities represent those security holdings that had the largest positive and negative total contribution to the portfolio return for the quarter. Top and Bottom Economic Sectors represent those sectors that had the largest positive and negative total contribution to the portfolio return. The holdings identified do not represent all the securities purchased, sold or recommended to clients.

In order to maintain consistency when comparing the Micro 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.

Special Announcement

We are pleased to announce that as of June 30, 2023, Dominic Marshall will be the sole Senior Portfolio Manager on both the Micro Cap Value and Small Cap Value strategies.

Mark Cooper will continue in his role as President and remain a Portfolio Manager and contributing analyst on both strategies. He will also be assisting with marketing and business/product development.

If you would like to discuss these changes, or if you have questions on any other topics, please don’t hesitate in contacting us. We look forward to hearing from you.