Q4'24 Micro Cap Value Strategy (revised)

Performance Review

The Pacific Ridge Capital Partners Micro Cap Value strategy (the “Strategy”) returned 4.0%* (3.6%* net of fees) during the fourth quarter ended December 31, 2024, outperforming the Russell Microcap® Value Index (the “Index”) return of 2.7%. For the twelve-month period, the Strategy returned 11.3%* (9.6%* net of fees) outperforming the Index return of 9.2%.

The Strategy’s portfolio characteristics can be significantly different from the Index because we primarily invest in smaller, undervalued stocks and adopt a sector-agnostic approach. You can see these distinctions in the charts below.

Size Analysis

During the quarter, the Strategy benefited from a significant tailwind driven by its size bias, as smaller companies within the Index outperformed larger ones. Companies with market capitalizations below the Index median of $268 million delivered a 10.9% return, considerably outpacing the 0.9% return for companies above the median. The Index allocated 17.5% of its weight to companies below the median, compared to the Strategy's substantially higher allocation of 41.7%.

Style Analysis

The Strategy faced a modest value-style bias headwind from unprofitable companies (PE ratio below 0x) during the quarter, as these stocks posted the highest return in the Index of 6.3%. The Index had a 28.7% weighting, compared to the Strategy’s lower weighting of 11.5%. Profitable companies with lower valuations (PE ratio below 15x) were the second best-performing segment with a return of 1.7%. The Strategy was overweight at 46.5% compared to the Index’s 38.5%. Lastly, profitable companies with PE ratios above 15x returned 0.5% in the Index, where the Strategy was slightly overweight.

*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%.

Sector Analysis (revised to correct previously miscategorized securities that impacted sector weightings and returns)

The top two contributors to the Strategy’s performance were the Financials and Health Care sectors. A moderate overweight in Financials, combined with positive stock selection scores, benefited the Strategy. The Strategy’s lack of Health Care investments provided a moderate tailwind as the Index returned -3.3%. Conversely, the two sectors that most negatively impacted the Strategy’s performance were Information Technology and Industrials. The Strategy’s weighting to the Technology sector was close to the Index. However, poor stock selection scores moderately detracted from overall performance. In the Industrials sector, while overweighting relative to the Index provided some benefit, negative stock selection scores resulted in a modest headwind.

Top Contributors

Top Detractors

Top Contributors

Natural Gas Services Group (“NGS”), a provider of compression equipment to the oilfield industry, continued to execute its strategy of expanding in the high-horsepower compression market. Strong demand lifted rental utilization, and the higher mix of premium equipment led to significant revenue growth and associated margin benefit from greater scale. The near-term outlook remains positive with the recent announcement of new rental contracts and project bookings into 2026. NGS maintains adequate liquidity to fund planned growth investments that are expected to deliver increased earnings and cash flow. 

BuildABear Workshop (“BBW”) is a specialty retailer that offers an interactive “make your own stuffed animals” experience. The market continues to take notice that BBW is a different company than it was five years ago, with consistently high operating margins and strong cash flow, and much-reduced seasonality. Management is growing its store base, much of it at non-traditional locations and via international franchises. BBW shares are up over 10-fold over the past four years, and we have trimmed this large position on strength, but continue to believe there is solid upside potential.

Northeast Bank (“NBN”) is a community bank and specialty finance lender. Management has significant expertise investing in distressed commercial real estate assets. The bank has done an excellent job of managing its portfolio of loans and avoiding any credit challenges that have impacted others in the space. By using additional capital to grow its loan book and drive earnings higher, NBN continues to execute impressively.

Unity Bancorp (“UNTY”) is a community bank based in Clinton, New Jersey. The stock has been on a very strong run for the past few years as management resolved an outstanding issue with its regulators and has successfully grown the balance sheet and earnings per share. Disruption in the local market from recent merger activity, as well as the expectation of more favorable regulations following the election, has also helped drive up the stock.

Barrett Business Services (“BBSI”), a provider of human resource outsourcing, reported strong third-quarter results that helped drive the shares of this long-term and sizeable holding 29% higher.Significantopportunities for growth and margin expansionremain, thanks toan asset-light geographic expansion model, a new health care insurance offering that has facilitated engagements with a broader range of white-collar clients, and a significantly reduced risk profile within its workers’ compensation exposure structure.

Top Detractors

Hamilton Beach Brands (“HBB”) is a marketer of residential and commercial kitchen appliances, and a growing division focused on home healthcare and wellness. After reporting improved results during the post-covid spending boom, a series of actions caused some skittishness among investors; most notably, slowing growth of the top line and continued investment in HBB’s loss-generating healthcare business. Operating margins remain well below our target levels for this year. Above market growth in kitchen appliances and reduced losses in the healthcare business should result in share price improvement.

DMC Global (“BOOM”), a diversified manufacturer of oilfield service equipment and architectural building products, has been negatively impacted by soft commercial construction and well completion activity that caused revenue and earnings contraction in 2024. The stock price faced additional pressure after the company terminated its strategic review without proceeding with a sale of part or all of the business, despite receiving a public offer from its largest shareholder. Fortunately, the balance sheet is much improved following a healthy amount of free cash flow, providing good runway to a recovery in end markets.

Office Properties Income Trust (“OPI”) is a real estate investment trust that owns and operates office buildings around the country. The stock faced significant distress in recent years as the company had significant debt that was maturing early this year. The stock initially rallied following a new refinancing agreement but has since sold off as interest rates have rebounded from recent lows.

Sleep Number (“SNBR”) designs, manufactures and sells mattresses and bedding accessories. Shares have been volatile over the past few years, moving erratically with any macroeconomic or interest rate news. The stock declined in the quarter without any material announcement from the company. We expect this volatility to continue until there is a sustained return in US mattress demand. Shares continue to trade at a sizable discount to our implied price, despite our modest expectations of SNBR’s long-term economics.  

BGSF (“BGSF”), also known as BG Staffing, is a provider of professional staffing services, specifically in the areas of IT, finance, and accounting. Staffing has been a tough industry over the past year, resulting in revenue declines of over 10% year-to-date and meager operating profits. Amid industry weakness, BGSF’s sub-scale position led management to implement cost-cutting measures as part of an ongoing strategic alternatives review set to conclude this year.

Market Review and Outlook

Recently, the yield curve steepened significantly. The 10-year rate increased to 4.8%, reflecting strong economic growth and tight labor market conditions. Projections for US GDP growth in 2025 range between 1.9% and 2.5%, supporting optimism about a sustained expansion. However, the Federal Reserve’s announcement on December 18 to reduce the number of planned 2025 rate cuts from four to two introduced uncertainty. This decision contributed to December’s market sell-off, particularly impacting small-cap and microcap stocks.

Core equity market performance was mixed in the fourth quarter. The Russell Microcap Index led with a return of 5.9%, while the Russell 2000 Index lagged with a 0.3% return. Within the Russell 2000 Index, the Information Technology sector was the top performer with a 9.3% return. Biotechnology stocks lagged, with the industry posting a decline of -9.1% amid heightened investor caution. For the twelve-months ending December 31, 2024, large cap stocks outperformed their small cap counterparts, with the Russell 1000 Index returning 24.5% compared to the Russell 2000 Index returning 11.5%.

The ISM Services PMI increased to 54.1 in December from 52.1 in November, indicating modest demand supported by business activity and new orders. The ISM Manufacturing PMI, while still in contraction, improved to 49.3 in December from 48.4 in November, highlighting cautious sentiment amid weaker demand. The labor market exceeded expectations, with nonfarm payrolls adding 256,000 jobs in December, significantly above estimates of 150,000–160,000 jobs. The unemployment rate fell slightly to 4.1%.

Inflation, while easing, remains a concern for policymakers. Core PCE inflation is projected to stay above the Federal Reserve’s 2% target through 2025. This persistent inflationary environment, combined with strong economic data, reinforces the view that rates will remain elevated for an extended period. The Federal Reserve’s dot plot indicates a benchmark rate of 3.9% by the end of 2025, suggesting a gradual approach to monetary easing.

Looking forward, analysts forecast nearly 20% profit growth from mega-cap tech companies in 2025, outpacing the broader market’s expected growth of less than 12%. Small-cap stocks, often more sensitive to policy shifts, could benefit from the new administration’s focus on deregulation, lower taxes, and increased M&A activity. While opportunities exist, risks from higher interest rates, inflationary pressures, and geopolitical uncertainty remain.

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, 2024. 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, 2024. 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 the 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.