Q4'22 Micro Cap Value Strategy

Performance Review

The Pacific Ridge Capital Partners Micro Cap Value strategy returned 10.9%* during the fourth quarter ended December 31, 2022, outperforming the Russell Microcap® Value Index (“Index”) return of 6.1%. For the twelve-month period ended December 31, 2022, the strategy returned -14.0%* versus the Index return of
–16.7%.

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 faced a moderate size bias headwind during the fourth quarter, as smaller companies in the Index underperformed larger companies. Stocks in the Index with a market capitalization below the $217 million Index median posted a 3.7% return, versus a 6.5% return for stocks with a market capitalization above the median. The Index had 85.5% of its weight above the median market capitalization level, compared to 53.1% for the strategy.

Style Analysis

The strategy benefitted from a significant style bias tailwind for profitable companies during the quarter, as stocks with lower PEs outperformed those with higher PEs. Those with a PE ratio greater than 15x had a 3.7% return, versus a 9.3% return for those companies with a PE below 15x. The performance of unprofitable companies in the Index also created a tailwind, as those stocks posted a 1.5% return. We held 7.5% in unprofitable companies compared to the Index weight of 34.9%.

*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

BuildABear Workshop, Inc. (“BBW”) is a specialty retailer offering an interactive “make your own stuffed animals” experience, with a strong brand and consumer affinity. After very strong fundamental results and stock performance the past couple of years, the shares sold off during the third quarter due to concerns that a softening economy would lead to lower growth and margins. However, strong third quarter results and management’s bullishness led to a sharp recovery in the shares. Gross margins are now significantly higher due to a higher mix of teen and adult sales, as well as cashing in on royalty payments for partners using the BBW brand.

Sterling Infrastructure, Inc. (“STRL”), a provider of highway construction and site development services, reported solid results in its most recent quarter, and the highest operating margins in over a decade. Strong demand for new distribution centers, data centers, and warehouses has led to revenue and profit growth in the excavating segment. STRL’s legacy highway business has benefited from more disciplined bidding practices and the diversification to alternative markets such as airports and ports.

Asure Software (“ASUR”) is a provider of Human Capital Management (HCM) software and services, specifically in payroll processing and related functions. Management spent the year working through several corporate changes, including the divestiture of some assets, buying-in resellers, and developing their immature sales force. The top-line was also pressured as their small-company client base was hit particularly hard during the pandemic. ASUR is making the turn towards growth and are benefiting from multiple tailwinds. In addition to an upturn in bookings activity a few quarters ago, we are seeing the early stages of revenue growth and higher margins.

CRA International (“CRAI”), aka Charles River Associates, is a specialty consulting company that offers litigation, regulatory, financial, and management consulting services. This well-run company has posted consistent, mostly organic, revenue growth of nearly 10% over our seven-year holding period with a nice margin expansion. The results seem to finally be catching the attention of Wall Street, and the gap in valuation between CRAI and some of its larger peers has started to close. As such, we are paring back our position on strength.

Bowman Consulting Group, Ltd. (“BWMN”), a consulting firm offering engineering solutions, reported strong September quarter results and raised full year guidance for the fourth time. The company has seen healthy demand from several markets, including data center, quick serve restaurant, and e-commerce distribution center. This has led to significant organic revenue growth. BWMN remains active in rolling up smaller engineering firms, gradually adding scale and revenue synergies.

Top Detractors

AXT, Inc. (“AXTI”) is a maker of alternative semiconductor substrates. After seeing tremendous growth and margin expansion the past couple of years, AXTI saw declining results and expectations in the second half of fiscal 2022. This trend was driven by sluggish high-end cell phone unit growth, manufacturing and supply chain issues in AXTI’s China facilities, and the possible delay in growth of MicroLED applications because of economic and China-related concerns. AXTI’s growth prospects, notably from wearable technology sensors and anticipated MicroLED adoption over the next five years, remain very strong, given that the company is one of only a few global suppliers of InP and GaAs substrate materials.

Manitex International (“MNTX”), a provider of highly specialized lifting and hauling solutions, reported strong September quarter results that beat expectations. While the outlook appears favorable, thanks to near record backlog levels, the market remains concerned about the company’s high debt load because of the macro uncertainty and higher interest rates. We believe MNTX is set up well to generate strong free cash flow over the next couple of years and reduce its leverage.

Lifecore Biomedical, Inc. (“LFCR”) recently changed its name from Landec (and ticker from “LNDC”) and is in the late stages of selling off its legacy food businesses. LFCR will soon be a pure play CDMO (pharmaceutical contract development and manufacturing organization), with an expertise in developing and packaging pharmaceuticals into vials and syringes. The stock sold off due to uncertainty with its balance sheet, which should be remedied once the remaining food business is sold and its corporate debt is paid down. LFCR raised $5 million in an equity sale to fund growth-related manufacturing expenditures from its largest shareholder.

Twin Disc, Inc. (“TWIN”), a manufacturer of power transmission equipment, reported mixed September quarter results with strong revenue growth despite currency headwinds. That said, supply chain and inflationary pressures reemerged leading to disappointing margins. Backlog continues to grow, driven by North American oil and gas and industrial end markets. Strong demand, easing supply chain constraints, and internal cost reduction efforts should lead to improved profitability and cash flow this year.

BM Technologies, Inc. Class A (“BMTX”) provides white-label banking services to nonfinancial companies, as well as digital-only checking accounts for students. The company has fallen short of its account growth and partner bank targets over the past year, which has caused shares to underperform. With the current interest rate environment and the lack of Covid-related government assistance, deposits fell more than anticipated. Despite these hiccups, we view the current share price as a “worst case” scenario and see substantial upside from account growth and stabilization of its legacy business.

Market Outlook

The performance of U.S. equities in the last three months of 2022 was primarily driven by investors’ expectations of the Federal Reserve’s (the Fed) interest rate policies. October returns were solid as investors expected the Fed to “pivot” from previous aggressive rate hikes. November results were positive but subdued as investors digested another 75-basis points rate hike. December returns were negative as investors feared further large interest rate hikes due to sticky inflation.

For the full calendar year 2022, domestic equities turned negative after three consecutive years of positive returns. The primary concerns were high inflation, interest rates, and worries about a potential recession. This resulted in a rotation out of growth stocks and into value stocks that had strong earnings, dividends, and cash flows. The gap between value and growth returns has been widest amongst large cap stocks with the Energy sector producing the best results in excess of 60% for the year.

The pace of the Fed’s 2022 interest rate hikes—350 points in total--was the fastest in 40 years. The target interest rate is expected to go over 5.0% by the end of 2023 with the intent of slowing down consumer spending and employment. Housing and oil prices have already come down significantly. Given the amount of public discussion in the press about a possible recession, companies and consumers are already acting with caution. As such, we believe that the probability of a soft landing is more likely.

We continue to have a modest growth outlook for the US economy, though supply chain disruptions, inflationary pressures, and rising interest rates have created uncertainty in the near-term. GDP rebounded and increased 3.2% in 3Q22, driven by growth in consumer spending (particularly in service-related industries), and higher government spending. While 4Q22 GDP growth is expected to tick even higher sequentially, consensus is for growth to slow in 2023.

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 September 30, 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 September 30, 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. 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. 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.

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 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 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 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 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 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.