Q4'24 Small Cap Value Strategy (revised)

Performance Review

The Pacific Ridge Capital Partners Small Cap Value strategy (the “Strategy”) returned 2.2%* (1.9%* net of fees) during the fourth quarter ended December 31, 2024, outperforming the Russell 2000® Value Index (the “Index”) return of -1.1%. For the twelve-month period, the Strategy returned 11.7%* (10.6%* net of fees) outperforming the Index return of 8.1%.

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 moderate tailwind driven by its size bias, as smaller companies within the Index outperformed larger ones. Companies with market capitalizations below the Index median of $787 million returned 2.5%, outperforming the -1.7% return for companies above the median. The Index allocated 14.2% of its weight to companies below the median, while the Strategy had a significantly higher allocation of 49.0%.

Style Analysis

The Strategy benefited from a modest style bias tailwind from unprofitable companies (PE ratio below 0x) during the quarter, as these stocks posted the worst return in the Index of -4.7%. The Index had a 13.8% weighting, compared to the Strategy’s lower weighting of 8.8%. Profitable companies with lower valuations (PE ratio below 15x) were the second worst segment, with a return of -0.5%. The Strategy was overweight at 56.7% compared to the Index’s 44.7%. Lastly, profitable companies with PE ratios above 15x returned -0.3% in the Index, where the Strategy was underweight.

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

The top two contributing sectors to the Strategy’s performance were Financials and Health Care. A moderate overweight in Financials, combined with positive stock selection scores, benefited the Strategy. The Strategy’s lack of Health Care investments provided a modest tailwind, as the Index returned -7.1%. Conversely, the two sectors that most negatively impacted the Strategy’s performance were Energy and Industrials. While the Strategy’s underweight position in the Energy sector made a slight contribution, this was more than offset by poor stock selection scores, thus detracting from overall performance. In the Industrials sector, negative stock selection scores neutralized the benefits of a modest 1.9% return in the Index and the Strategy’s overweight allocation.

Portfolio Characteristics (as of 12/31/24)

Top Contributors

Coastal Financial (“CCB”) is a bank based in Everett, WA. The company has two segments: a traditional community bank, and CCBX, a banking as a service (BaaS) provider that enables fintech companies to offer some banking services. The stock rallied during the quarter after a capital raise and strong suggestions that the growth rate would accelerate in 2025. The company increasingly benefits from a wide regulatory moat in the BaaS space that has led to a supply/demand imbalance.

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.

DXP Enterprises (“DXPE”), a distributor of maintenance, repair, and operations products and services specializing in pumps and rotating equipment, reported strong results in the latest quarter that set internal records for revenue and profitability, and earnings that handily beat expectations. The company has long been an industry consolidator, with nine deals closed last year that further diversify DXPE into growing markets such as wastewater recycling and food/beverage. With minimal capital spending requirements, DXPE should continue to generate significant free cash flow.

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 expansion remain, thanks to an 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.

Ribbon Communications (“RBBN”) is a provider of telecom and networking solutions to large service providers and enterprises. The company is benefiting from multiple telecom carriers that are increasing capital expenditures on voice modernization projects. RBBN recently won a significant multi-year deal with Verizon, boosting the stock. Another potential growth driver that has been slow to develop is funding for rural broadband deployment in the US.

Top Detractors

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.

Designer Brands (“DBI”) owns a portfolio of shoe brands and operates a shoe retailer under the name DSW. Shares underperformed this quarter as the company reported results for the latest quarter that fell short of expectations and management lowered its near-term guidance. DBI is operating at historically low margins and store productivity, and we expect that its recent cost-cutting activities and brand acquisitions will help with the turnaround. While the cyclical low in operating results has resulted in a trough valuation, share stabilization should lead to significant upside. 

Kelly Services (“KELYA”), a diversified provider of temporary staffing services, saw its shares decline[MT1] over 30% this quarter. Reported revenue fell[MT2]  7% year-over-year. After adjusting for a divestiture, revenue was nearly flat but still short of expectations for modest growth. The culprit was KEYLA’s IT and sciences practice, which is tied to ongoing weakness in tech spending. On the positive side, the company’s outsourcing/consulting and education segments continue to perform well. With the stock trading at a PE of 6x on 2025 estimates, we have been adding to our position.

ePlus (“PLUS”), an IT solutions provider and specialized value-added reseller, posted its first quarterly miss against expectations in quite some time. We have been trimming our position over the past several quarters, following a strong multi-year positive move. Despite management’s impressive focus on growth areas like security and cloud migration, the broader tech spending slowdown has led to guidance for flat 2025 results, following years of strong margin improvement.

Hudson Technologies (“HDSN”)is a refrigerant services company that processes and sells refrigerants for HVAC providers. Regulations that mandate the increased use of reprocessed refrigerants were expected to correct a supply-demand imbalance, leading to increased prices and expanded margins. This has yet to happen, as some observers believe that certain industry participants are skirting the rules, resulting in lower overall pricing.

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.

PRCP GIPS Report

*Information is not statistically meaningful due to an insufficient number of portfolios in the composite for the entire year.

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 Small 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 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. 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 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. 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 Small 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 1.00% 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 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 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 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 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.