Artko Capital Q4 2022 Partner Letter

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Wasan Tita

Dear Partner,

For nan 4th almanac 4th of 2022, an mean business liking successful Artko Capital LP was up 6.7% nett of fees. At nan aforesaid time, investments successful nan astir comparable marketplace indexes—Russell 2000, Russell Microcap, and nan S&P 500—were up 6.2%, 4.7%, and 7.6% respectively. For nan almanac twelvemonth of 2022, an mean business liking successful Artko Capital LP was down 33.9% nett of fees. At nan aforesaid time, investments successful nan astir comparable marketplace indexes—Russell 2000, Russell Microcap, and nan S&P 500— were down 20.4%, 22.0%, and 18.1% respectively. Our results this twelvemonth came from Currency Exchange International (OTCPK:CURN), while losses successful GAIA and warrants (POL.WS), arsenic good arsenic a wide portfolio pullback detracted from nan wide performance. We stock our outlook and afloat portfolio reappraisal for 2022 successful nan sections below.


On nan coming extremity of “weirdness”

“No, no! Sentence first—verdict afterwards!”– Queen of Hearts, Alice successful Wonderland

We are going to depart a small from nan accustomed measurement we talk our yearly results because while complete nan 12 months of 2022 our portfolio’s capacity was antagonistic 34%, successful nan first period and a half of 2023 our capacity is up adjacent to 27%. This is not to deflect from nan disappointment of 2022 but much to constituent retired that successful 2022 our portfolio was up and down 20% doubly and this is our 3rd travel successful little than a twelvemonth successful nan 20%+ category. We had written to you a twelvemonth agone that portion of our anticipation was arsenic nan system transitioned from 1 pinch astir costless superior to 1 pinch superior costs supra 5%, nan modulation would consequence successful important volatility successful our portfolio earlier nan semblance of rationality returns to nan markets and institution banal prices converge to their basal values. In January 2023 our portfolio was up 23%, nan highest monthly return we person had successful almost 8 years of existence, which is saying thing considering we person been successful business during nan tumultuous events of Grexit, Brexit arsenic good arsenic Covid and its recovery. While we are encouraged by nan beardown commencement to 2023, pinch astatine slightest a portion of this uptick yet opening to beryllium driven by individual institution fundamentals, which we are excited to stock pinch you, we do not judge we are retired of nan volatility woods conscionable yet and expect astatine slightest 1 much perchance double-digit marketplace tie down successful 2023.

We judge location is excessively overmuch mendacious dream placed successful immoderate benignant of liking complaint pause/decline and that recessionary headwinds are mostly blowing over. More be aware is needed. However, contempt our funds’ carnivore logo, we are acold from being marketplace and system bears. Our belief is that things are not arsenic elemental arsenic little ostentation and economical slowdown equaling a dovish Federal Reserve which instantly originates lowering rates. As we person written successful nan past, nan naïve, and rather embarrassing, belief by nan Federal Reserve that nan caller bout of ostentation was only “transitory” has shown itself to beryllium untrue. High ostentation has ne'er been easy to put distant and while nan important liking complaint hikes and nan clearing retired of nan proviso chains person slowed down equipment ostentation substantially, nan services portion of nan system which represents adjacent to 80%, has yet to mean its velocity to “safer” levels, coming successful astatine 7.2% successful nan latest January CPI reading. While definite sectors of nan system person shown a recessionary-like slowdown, different parts continued to turn substantially, pinch nan January payroll number coming successful astatine a reddish basking 500,000+. All of this paints a beautiful muddy and uncertain economical image and we powerfully judge that a antecedently dovish and embarrassed Federal Reserve that desperately needs to reconstruct its credibility is improbable to extremity its complaint increases successful nan adjacent future, fto unsocial revert backmost to a looser money policy. We expect rates successful 2023 to decorativeness higher than 6%, to enactment astatine those levels for galore quarters, and would beryllium amazed if ostentation slipped to debased azygous digits earlier year-end. That is nan bad economical news wherever we judge we are much hawkish than nan marketplace which would consequence successful much volatility.

On nan different hand, we are much affirmative connected economical growth, and astatine slightest from a wide meaning perspective, are apt to debar an outright recession, aliases astatine worst person a mild 2001-like recession, pinch a contraction measured successful tens of ground points alternatively of hundreds. We are besides rather bullish connected nan marketplace successful general. Our acquisition tells america that nan markets person mostly digested nan anticipation of an economical slowdown and are still substantially beneath their 2021 peaks, pinch Russell 2000 still much than 20% beneath its November 2021 high. Since markets thin to beryllium forward-looking, perversely immoderate recessionary news is apt to beryllium met pinch a affirmative guidance arsenic it would mean we are adjacent to nan opening of a caller cycle, pinch a much logical monetary policy. As we person discussed successful nan past, this is nan clip erstwhile mini headdress worth stocks thin to radiance nan astir pinch opportunities to turn their net astatine overmuch faster rates than their ample headdress brethren and we person already begun to spot immoderate decoupling from market-related banal value moves to much basal ones. It should beryllium noted that going backmost to nan 1970s nan mean mini headdress tie down from past precocious to caller precocious lasts an mean of 2 years and returns 70%+ disconnected nan bottommost and 23% disconnected nan past precocious - astir precocious past recorded successful early November 2021.

The past 3 years person been some maddening and frustrating arsenic things that person mattered and worked during times of rationality, specified arsenic cleanable equilibrium sheets, precocious returns connected capital, profitability aliases incentivized guidance person been replaced by “substantial opportunities” successful integer pictures of monkeys and “real estate” successful virtual worlds. The 1 upside to nan carnage of 2022 is that these fads look to person yet imploded, and pinch a higher costs of superior marketplace participants are starting to salary attraction to things that matter: fundamentals. Those are nan things that matter astir to us, and while nan value capacity of our portfolio from precocious 2021 to precocious 2022 has been dismal, nan maturation successful fundamentals has been thing but arsenic we saw a median gross maturation complaint of 20%. We astir apt devoted much room successful this missive than we would for illustration to macro and markets but returns evidently matter and it is important to stock our views of wherever we judge we are positioned successful nan upcoming year.

We person had 1 important fundamentals-based detraction successful nan portfolio from our position successful nan warrants of which costs america complete 6% successful antagonistic alpha successful 2022, but 1 wherever we judge 2023 could spot a important reversal which we talk below. The remainder of our portfolio showed bully to awesome maturation successful revenues and profitability and is apt to upwind immoderate economical slowdown successful nan intermediate word pinch only mild effects.

To stock immoderate portfolio statistic for 8 companies which correspond astir 97% of our portfolio:

  • Our median/average marketplace headdress is simply a $120mm/$235mm. These numbers see our finance successful The Shyft Group (SHYF), that has grown from $280mm to $1.1 cardinal during our holding period, and excluding this occurrence communicative some our median and mean are astatine a $102mm. These numbers comparison to $225mm/$797mm for nan Russell Microcap Index, our closest comparable index, and correspond our continued committedness to connection you an finance merchandise successful securities that for nan astir portion are incapable to beryllium included successful an scale owed to their size aliases liquidity constraints.
  • Our median/average portfolio’s nett rate equilibrium is 4.5%/12.3% of nan marketplace headdress representing our committedness to beardown equilibrium sheets.
  • Our median/average insider holding is 23.1%/26.5% astatine complete $20mm of what we telephone insider-value at-risk, which we judge is an important metric wherever we consciousness we are co-invested on broadside our guidance teams and person shared incentives and consequence tolerances.
  • Our median maturation expectations for our companies EBITDA/Cash flows for nan adjacent 3 years are astatine 75%/81% and our median valuations for 2023 EV/EBITDA and Price to Cash Flows are astatine 8.1x/7.5x for 2023 which move to 5.1x/5.8x for 2024.

As you tin spot present and beneath our portfolio continued to show awesome maturation successful its basal metrics done economical uncertainty and peculiar one-off challenges/investments. As we mentioned earlier, we person started to spot sprouts of individual institution performances opening to decouple from nan volatility of nan markets, an encouraging motion which gives america bully assurance for nan remainder of 2023. Additionally, while nan past 3 years person seen a departure from our accustomed transaction-based exits, we are besides starting to spot “non-bubble” M&A activity backmost successful nan superior markets. We person not seen important reasons to exit our positions arsenic astir of our theses are still playing out, however, we look guardant to recycling our expected gains into caller opportunities connected our increasing watchlist. As our opening quote shows nan marketplace has carried retired nan sentences connected our holdings earlier immoderate reference of nan verdicts, but arsenic nan verdicts proceed to travel successful we expect those sentences to beryllium “reversed connected appeal”.

Portfolio Review

Currency Exchange International (OTCPK:CURN) – 23% of Portfolio; $8.08 costs basis/$19.30 existent price

CURN continued to beryllium our champion performer successful 2022 notching up a ~56% return successful nan look of volatile underperforming markets, and up different 18% successful 2023. Last twelvemonth we wrote to you astir our guardant estimates for this company:

“We judge by 2024-2025 clip period, pinch nan return of nan Banknote revenues to higher than pre Covid levels of $40-45mm and continued maturation successful Payments revenues to $15mm to $25mm, nan institution tin execute a gross tally complaint of betwixt $60mm to $70mm. While we don’t expect nan costs guidelines to enactment astatine $30mm, arsenic we mentioned this is simply a important operating leverage opportunity and we expect this $60mm marketplace cap/$10mm Enterprise Value institution to make $15-$20mm successful Free Cash Flow wrong nan adjacent 24 to 36 months”

We are excited to stock pinch you, that while we expected these results a fewer years retired nan institution was capable to execute 117% gross maturation successful 2022 to $66mm, which is adjacent to 60% complete its 2019, pre-Covid, peak. How did we get there? The biggest astonishment for america came successful nan beardown capacity of its Banknotes conception increasing 136% to $53.9mm. In nan past, this was a sleepy segment, managing non-airport-based 30+ overseas speech kiosks successful nan US and Canada and generating $42mm successful gross successful 2019. With nan Covid-related North American bankruptcy exit of its biggest competitor, TravelX, CURN was capable to slow return complete airdrome locations arsenic a franchisor, i.e. nary superior commitments; helped by nan return of recreation arsenic good arsenic wide ostentation some successful speech dispersed and mean transaction size. We judge these dynamics arsenic good arsenic a adjacent monopoly successful North America, and room for branch description will proceed to substance double-digit maturation for nan unit information of nan Banknotes conception successful nan intermediate future.

The different information of nan Banknotes conception is nan wholesale information which was mostly nonexistent successful 2019. However, successful nan past 2 years, nan institution has been approved by nan Federal Reserve nether its Foreign Bank International Cash Services (FBICS) program, aft a lengthy owed diligence process, and is now 1 of 2 companies successful nan US that tin supply world banks pinch US currency. In different words, if you are opportunity UBS and you request $25mm of US rate CURN will happily supply this service. This business apt provided mid-single digit millions successful gross successful 2022, up from zero successful 2019, and we judge tin scope tens of millions of dollars successful gross successful nan intermediate future. The much absorbing mobility 1 has to inquire is if CURN is equilibrium expanse constrained i.e., will it request much superior to turn this business? While location are transactions successful nan $50mm to $100mm size, which requires a bigger equilibrium expanse than CURN presently has, those are fewer and acold betwixt and astir summons sizes are successful nan debased tens of millions. In different words, CURN tin proceed to turn this conception without important superior additions different than earthy moving superior growth.

In nan Payments segment, besides nonexistent successful 2019, nan institution grew 61% to $12.5mm arsenic it continued to turn its Canadian and US existing relationships. The company’s proprietary package CXIFX helped turn transaction volumes by 38% and transaction magnitude by 47% successful 2022, pinch much profitable transactions successful nan past twelvemonth driving gross maturation up of volume.

One of nan things we person talked astir substantially successful our letters successful nan past is our fondness for uncovering a business pinch important operating leverage, i.e. wherever gross maturation is substantially up of disbursal growth. CURN is simply a premier illustration of this strategy arsenic it grew its revenues by $35mm successful 2022, while expenses grew by only $17mm resulting successful a 50%+ publication separator and ~ $19mm successful operating profit. Pretty singular that this institution has been capable to execute these numbers 2 years up of our original projections. So wherever do we spell from here? We judge that successful nan intermediate future, nan institution tin proceed to turn revenues astatine 20%+ maturation rates pinch nan resulting maturation successful profits astatine 30%+. This is simply a well-run company, pinch a well-respected and incentivized laminitis CEO, a caller knowledgeable CFO, and a $100mm+ marketplace headdress which should gain complete $25mm successful operating income successful 2023. More precocious CURN’s direct, backstage equity owned competitor, Moneycorp was put up for waste by its ownership pinch asking multiples astatine 12-13x EBITDA (note, we are utilizing operating income arsenic our valuation basis). If this transaction is successful we expect this $120mm marketplace headdress company, pinch astir $40mm successful excess rate (and complete $80mm successful full cash), to re-rate successful nan $40 to $50 per stock range. However, we proceed to show nan company’s superior allocation plans arsenic we judge its conservatism and deficiency of a clear plan, different than imaginable acquisitions, whitethorn inhibit its near-term banal value appreciation. To that end, we person engaged successful important friends discussions pinch guidance connected nan company’s superior allocation plans and shareholder communication.

Research Solutions (RSSS) – 15% of Portfolio; $1.80 costs basis/$2.32 existent price

Our finance successful Research Solutions, primitively astatine sub $1.00 successful 2017, though pinch important additions complete nan years, our costs ground has drifted higher, was down 22% successful 2022, up 21% successful 2023, and down astir 5% since year-end 2021. While nan banal swings were volatile nan results continued to beryllium dependable and connected forecast. The supplier of accusation services for nan technological industry, not dissimilar Bloomberg is for finance and Lexus Nexus is for law, grew its 2022 revenues by 7.9% and what we judge to beryllium nan much important metric, its gross profit, complete 20%. This is not by mishap and is thing we are very excited about.

As a reminder, Research Solutions has a bequest Transactions business, nan waste of technological articles to complete 1,200 customers, including 70% of nan apical 25 pharma companies. This business has been a dependable $26mm to $27mm gross generator for arsenic agelong arsenic we’ve been shareholders and pinch its 23%-24% gross margins has been a accordant supplier of $6.0 to $6.5mm successful gross profit. There person been concerns that this business has been cannibalized by nan Platforms conception and a fewer worrisome antagonistic gross maturation quarters were offset by 6.9% and 5.4% maturation successful nan last quarters of 2022. The 2 main points astir this business are that it has been a bully root of backing for maturation of Platforms and that its ample gross base’s 0-1% maturation complaint has masked nan maturation of nan much important segment.

Platforms, a SaaS solution to nan technological investigation community, which has an mean value of $11,100 grew its revenues 32.5% to $7.8mm (and Annual Recurring Revenues i.e. ARR to $8.8mm) which arsenic we tin see, contempt an awesome maturation rate, is dwarfed by its Transactions counterpart. However, successful a complete flip of nan margins, Platforms gross margins are 88% and its gross profit, astatine $6.9mm is now bigger than Transactions and represents 55% of full Gross Profit of complete $13mm. This was owed to a 22% maturation successful subscriptions to 790 and a 5% summation successful mean income price. The institution had a engaged twelvemonth successful 2022, including revamping its income and trading teams which we expect large things from successful 2023. While we had hoped nan marketplace would return announcement of this institution earlier we judge nan operation of higher increasing Platforms revenues opening to beryllium a bigger portion of nan company’s gross guidelines (growing 10.7% mixed successful nan 4th almanac 4th of 2022) and crossing nan somewhat arbitrary but important $10mm ARR people successful 2023 will yet put this $70mm marketplace headdress gem connected nan radar of much managers.

The institution has adjacent to $12mm successful rate connected its equilibrium expanse and is presently successful nan process of looking for complimentary acquisitions. In nan autumn of 2022, nan institution acquired astir 400 progressive customers from FIZ Karlsruhe's AutoDoc for a de minimis value which we expect will yet boost Transactions’ gross maturation and coming important Platforms cross-selling opportunities. With backstage marketplace valuations connected nan decline, we expect a meaningful Platforms ARR boosting transaction successful 2023 which should assistance nan CEO’s extremity of $20mm ARR successful 24 months. We person not seen immoderate logic to alteration our value targets arsenic our near-term value target for nan institution is adjacent to $5.00 pinch a three-year value target astatine $10.00+ arsenic nan institution ARR continues to grow and it originates to make double-digit millions operating profitability which thin to person 20-30x comparable multiples among comparable companies.

Acorn Energy (OTCQB:ACFN) – 8% of Portfolio; $0.30 costs basis/$0.32 existent price

Acorn’s value performance, down 45% successful 2022, and down different 9% successful 2023, has surely been disappointing but not retired of nan realm of normality of nan nanocap world, wherever moreover $10,000 worthy of measurement tin push nan value of this $13mm marketplace headdress institution up aliases down 15%. 2022 was a transitionary twelvemonth for nan institution whose main business is providing monitoring services for backmost up electrical generators successful nan United States. This is simply a nice, very precocious margin, recurring gross business pinch a bully $4mm guidelines astatine adjacent to 90% gross margins. The different half of nan $8mm+ rate revenues is nan waste of hardware, which results successful an summation successful nan monitoring gross base.

On nan 1 manus 2022 was a disappointing twelvemonth successful that nan sunsetting of 3G exertion by awesome telecom carriers has resulted successful debased azygous digit diminution of nan Monitoring conception revenue, which usually grows astatine adjacent to 20%, arsenic customers conscionable chose not to spell done nan hassle of installing caller hardware. We judge that this is simply a unique, 1 time, occurrence which has passed starting successful nan 4th 4th of 2022 and pinch precocious teens maturation rates successful Hardware not abating contempt a home business slowdown we are assured that nan institution will revert backmost to its 20% maturation successful 2023 from astir 5% rate gross maturation successful 2022.

On nan different hand, 2022 saw a signing of a transformational statement pinch CPower Energy Management to usage Acorn’s Omnimetrix package successful nan customer’s backup generators arsenic a root of power by powerfulness companies successful times of highest demand. This woody should let nan customer, dealer, CPower, and Omnimetrix to stock successful some nan standby and power usage payments by nan powerfulness companies. While this isn’t an overnight magic bullet, we judge complete clip this woody should double to triple nan Average Revenue Per Unit (ARPU) Omnimetrix receives from its 30,000+ customers from $100+ to perchance arsenic overmuch arsenic $300 and should thrust an summation successful hardware income arsenic this evidently makes owning a backup generator arsenic a lucrative proposition for immoderate early customer. Aside from 2022, nan institution has been a accordant 20% CAGR gross grower and we believe, overmuch for illustration nan Research Solutions Platforms segment, erstwhile nan institution passes nan $10mm gross people it should beryllium connected nan radar of much managers. The Omnimetrix CPower opportunity tin thrust nan company’s Monitoring gross guidelines to $12mm and hardware to $10mm wrong 3 to 5 years wherever nan institution whitethorn beryllium capable to make complete $10mm of unchangeable increasing Free Cash Flow and person a marketplace headdress of $100mm to $200mm from $13mm today. While nan institution has had accordant maturation and achieved profitability since we person owned it, nan banal value has been disappointing. We person engaged guidance successful superior discussions astir steps nan institution tin return to boost its banal price, including encouraging a imaginable transaction that would amended bespeak its basal value.

Gaia (GAIA) – 4% of Portfolio; $6.50 costs basis/$3.00 existent price

Gaia was our astir important Core Portfolio underperformer for 2022, down 70% successful 2022, up 30% successful 2023, and down 64% since nan extremity of 2021. To opportunity that this was a disappointment would beryllium an understatement particularly since we see nan institution to beryllium successful bully financial shape. While nan maturation has slowed down importantly successful 2022, to astir 7% for trailing 12 months revenues to $83mm, nan institution was capable to support its profitability astatine complete 20% EBITDA margins. 2022 was a reliable twelvemonth for astir streaming services pinch Netflix falling 55% astir nan aforesaid play arsenic astir investors questioned nan sustainability of streaming contented models and nan monolithic contented walk by Gaia’s competitors. We judge Gaia has settled into a much mature maturation shape astatine ~800,000 subscribers pinch a attraction connected nan maturation of profitable, debased disconnect subscribers and has shifted its attraction much connected inexpensive contented acquisition done nan wreckage of streaming start-up failures successful 2022.

While we expected 2022 to beryllium a debased maturation year, nevertheless we are still very disappointed successful nan banal capacity and nan slowdown successful fundamentals, starring america to statesman to mobility management’s committedness to shareholder worth creation. We person held this company’s banal for almost 8 years and while it is still a profitable finance fixed our realized gains successful nan past we are monitoring this finance pinch clear eyes and perchance taking nan realized losses and deploying nan superior elsewhere successful 2023.

HireQuest (HQI) – 21% of Portfolio; $5.50 costs basis/$22.50 existent price

HireQuest continues to beryllium 1 of our much accordant winners successful nan portfolio. While nan banal was down 20% successful 2022, mostly via a rough, antagonistic 12% December 2022, nan banal is up complete 40% successful 2023 and is up 12% since year-end 2021. The institution continued to occurrence connected each cylinders successful 2022 pinch revenues up 73% for nan trailing 12 months that ended connected September 30th, 2022, and 67% for 9 months of 2022. More importantly its Franchise Royalties, which relationship for astir of its profit, accrued almost 40% for those 9 months pinch 32% integrated growth. During that aforesaid period, gross profit grew by 50% and EBITDA complete 87% continuing to show nan operating leverage inherent successful its business model.

As a reminder Hirequest, a now $300mm marketplace headdress company, is simply a consolidator successful nan staffing industry, acquiring $34mm worthy of businesses successful 2021 and $15mm successful nan first 9 months of 2022. Led by its awesome CEO Rick Hermans, nan institution buys owned locations, sells them via franchise agreements to nan branch managers, and collects an astir 6% franchise interest of nan consequent revenues. This exemplary has been incredibly successful owed to providing nan correct entrepreneurial incentives to hereto salaried branch managers that now person an opportunity to gain six-figure incomes. Though of people a 3.4% unemployment complaint and a tight labour marketplace surely thief thrust system-wide income to a $500mm tally rate. This is why we judge successful November 2022 erstwhile nan institution announced a $13.5mm dollar acquisition of MRINetwork, nan third-largest executive recruiting web successful nan world, nan marketplace mistook it arsenic different mini tuck-in acquisition. At first glance, nan target institution generated $1.9mm successful EBITDA truthful a 6.5x aggregate seemed for illustration a normal run-of-the-mill value which should lend to 2023 earnings. However, what is hidden down nan $1.9mm EBITDA number is that MRINetwork has 232 agency locations and a adjacent to $300mm systemwide income tally complaint aliases little than a 1% operating margin. If nan past is thing to spell by, this acquisition tin dress up to $18mm successful 100% gross profit gross successful 2023, connected apical of nan existent $30mm franchise royalty tally rate. We are salivating astatine nan imaginable for this acquisition’s profitability arsenic we expect a important marginal publication to our pre-acquisition operating income/EBITDA estimates of $22mm/$29mm successful 2023.

As we mentioned earlier, while we are contrarians connected nan way of ostentation and liking rates, we are besides contrarians connected nan way of economical maturation successful nan United States and judge that nan resilience of nan home system tin proceed to nutrient debased unemployment rates, comparative to humanities averages, for astatine slightest a fewer much years. As specified we expect continued beardown integrated maturation and acquisition opportunities to turn nan company’s EBITDA to complete $50mm toward nan extremity of 2024 wherever an 8x to 10x multiple, which we judge is due fixed nan franchise economics of this business exemplary should consequence successful a adjacent word value target of $36.00. Of people we intend to proceed holding this investment, different than consequence guidance adjustments, until Rick Hermans yet sells nan company.

Shyft Group (SHYF) – 9.0% of Portfolio; $9.50 costs basis/$32.00 existent price

Shyft Group was down 50% successful 2022, up 30% successful 2023, and down 30% since year-end 2021. Our finance successful Shyft Group (formerly Spartan Motors) while disappointing connected nan banal capacity successful 2022, is still 1 of our astir awesome basal stories that we’ve invested in. Despite nan gloom and punishment of nan ne'er arriving recession, nan institution grew its revenues by 14% to complete $1 cardinal for nan trailing 12 months that ended September 30th, 2022 arsenic good arsenic its past reported backlog to ~$1.1b, a 23% maturation rate. These are awesome numbers for sure, however, for 2022 nan institution announced a $30mm Research and Development finance into nan improvement of an electrical conveyance commercialized truck, BlueArc. This one-time finance brought down reported EBITDA numbers from $95mm successful 2021 to a apt $75mm number successful 2022 (of people connected an apples-to-apples ground it is simply a $105mm number, if those costs were to beryllium capitalized) and nan short word results-oriented marketplace was not a fan.

We are not complaining arsenic nan BlueArc motortruck is incredible. Unlike galore of its electrical conveyance start-up competitors that person small to nary acquisition successful manufacturing and conscionable person beautiful renderings to hype up their stock, Shyft Group has extended acquisition successful building and scaling prototypes having built dozens of caller models complete nan years and successful September 2022 announced a important 2,000 motortruck bid which they expect will beryllium adjacent to 3,000 by 2025. The company’s Fleet Vehicle and Services conception whose mean motortruck assemblage bid is astir $30,000 to $40,000 per, expects that each Blue Arc motortruck will bring successful complete 4x those amounts astatine complete $150,000. In different words, they expect this to beryllium a $500mm gross contributor astatine 12% margins wrong a fewer years. While astir companies pinch specified bluster tin and should beryllium taken pinch a atom of salt, our agelong acquisition pinch Shyft Group and its guidance squad has shown them to beryllium thing but boastful and they thin to err connected nan blimpish broadside of their estimates.

We proceed to look past nan short term, particularly pinch this company, which has proven to beryllium a accordant grower done short-term economical challenges. We expect its income growth, excluding nan BlueArc segment, to inclination successful nan 15-20% scope connected nan backmost of continued request for last-mile transportation vehicles driven by maturation successful e-commerce. Including nan Blue Arc conception and further tuck-in acquisitions should lead nan Shyft Group to make complete $2 cardinal successful revenues and adjacent to $250mm successful EBITDA by 2025-2026. We do not expect this institution to enactment nationalist everlastingly and astatine those levels is wherever we expect nan company’s awesome CEO Daryl Adams to waste nan institution astatine its humanities trading averages of 10x EBITDA aliases astir $75 per share.

Northern Technologies (NTIC) – 6% of Portfolio; $8.80 costs basis/$13.00 existent price

Northern Technologies was down 13% successful 2022, and level successful 2023 frankincense far. This is our astir cyclical finance and we’ve made a mini simplification to our holdings successful 2022. However, nan specialty chemic shaper of rust prevention and bioplastic chemicals pinch a world web of associated ventures was capable to turn its revenues by complete 32% successful 2022 and 13% connected an integrated basis. These header numbers are somewhat misleading arsenic nan company’s worldwide strategy revenues only had ~1% maturation successful 2022, mostly owed to nan China Covid-related lockdowns, and a large portion of nan quality was reclassifying nan India associated task arsenic a consolidated institution segment.

The institution tends to beryllium connected an offset reporting its fiscal year, which ends successful August, versus a almanac twelvemonth truthful much precocious it reported its 1st fiscal 4th results ended November 30th, 2022, which showed unchangeable request crossed its Zerust business products, pinch important maturation successful its Zerust Oil & Gas products and NaturTec bioplastics merchandise statement for a 10% topline gross growth. The China associated task revenues were down 10% resulting successful a akin simplification successful wide associated task income. We proceed to position NTIC arsenic an opportunity to put successful a stable, semipermanent Zerust business, pinch important optionality connected nan maturation of nan bioplastics NatureTec merchandise statement which has an $18mm-20mm gross tally rate, which was nonexistent a fewer years ago. This is not dissimilar our thesis for Research Solutions and Currency Exchange International wherever a unchangeable bequest business pinch bully maturation underpins a high-growth caller merchandise conception that is nether appreciated by nan markets. We expect NTIC, astatine a ~$120mm marketplace headdress ($13 per share) and ~$100mm Enterprise Value ($11 per share) to make complete $15mm successful operating income/$1.50 per stock successful EPS by year-end 2024, while increasing done impermanent economical headwinds which subdue system-wide gross maturation to debased double digits versus nan 20%+ longer-term expectations we person for nan company. We person a near-term anticipation of a $20 per stock value target, which we proceed to reassess connected an ongoing basis.

Potbelly (PBPB) – 8% of Portfolio; $3.70 costs basis/$7.60 existent price

Potbelly was level successful 2022 staying astir nan $5.60 value for astir of nan year, however, arsenic nan institution pre-announced its 4th 4th 2022 results up of guidance successful early January, nan banal has surged adjacent to 40% successful 2023. Our finance successful PBPB was primitively a post-Covid betterment typical business pinch a important opportunity to alteration its business exemplary from 1 of managing 400 specialty sandwich shop locations to 1 managing 2000+ franchises arsenic nan institution hired a erstwhile Wendy’s COO, Robert Wright, to execute connected nan strategy.

We are beautiful excited to study that our thesis truthful acold is playing retired conscionable arsenic we had hoped. For 2022 nan company’s same-store income are expected to travel successful astatine 18.5%, up of nan 16-18% scope provided by nan institution a twelvemonth ago. Additionally, shop-level margins are expected to beryllium 10.4%, up of nan 10% forecasted range. The wide 2022 revenues should beryllium supra $450mm aliases 54% higher than year-end 2020 showing a important rebound from nan uncertain times during nan pandemic. While 20% maturation rates will beryllium harder to travel by going guardant we judge pinch nan franchising strategy discussed successful nan adjacent paragraph, ostentation sticking astir for longer than expected and maturation successful measurement should consequence successful precocious single-digit/low double-digit gross maturation for nan adjacent fewer years, arsenic good arsenic hitting nan 16% shop level margins goal, resulting successful $50mm successful EBITDA by year-end 2024/mid-2025 and utilizing comparable teens multiples tin consequence successful a $20+ value target. This does not return into relationship nan important optionality connected nan occurrence of nan re-franchising strategy.

The institution presently has 429 locations including 45 franchises aliases astir 10%. The near-term extremity is for nan existent guidelines to beryllium astatine 25% franchised meaning location are astir 60 presently owned locations that tin beryllium sold to franchisees astatine what we judge tin beryllium $500k to $1.5mm per location resulting $30mm to $90mm successful rate inflow to this $215mm marketplace headdress company. Additionally, nan institution has a extremity to turn to 2,000 shops, increasing franchised locations astatine astir 10% per year. To that end, nan institution has signed Shop Development Area Agreements for 51 early locations (which whitethorn return up to 7 years to open) successful 2022. We judge this pillar of nan company’s strategy to beryllium nan astir important one, and nan cardinal to our thesis arsenic we judge it whitethorn adhd $10 to $50 much per stock to nan worth of nan institution successful summation to its ongoing business valuation. So acold nan strategy continues to beryllium connected way and we’re excited to beryllium on for nan ride. 6/26 $2.25 Warrants (POL-WS) – 3.5% of Portfolio; $0.42 costs basis/$0.10 existent price

On nan 1 hand, this finance has been a disaster, of nan benignant we effort to avoid. In 2022 nan institution hasn’t been capable to people its financial statements owed to what tin only beryllium called shenanigans by its laminitis and now erstwhile CEO, Albert Fouerti, wherever he charged nan institution complete $800,000 successful individual expenses. In his dismissal and astatine nan conclusion of nan investigation he agreed to reimburse nan institution $3.7mm for nan expenses and nan costs of nan investigation. Sadly, while this doesn’t look great, these are emblematic inexperienced behaviors of microcap guidance teams that frankly do not cognize really to modulation from backstage to nationalist institution executives. This is not dissimilar nan business pinch our erstwhile holding USA Technologies (USAT), now Cantaloupe (CTLP), wherever its CEO ran nan institution for illustration a individual fiefdom pinch a pliant CFO and board, which resulted successful his firing, financial connection restatements and an eventual activistic conflict resulting successful a caller guidance squad and board. A bully business ran by inexperienced management. As a nosy reminder, nan USAT CEO Stephen Herbert, anterior to his firing, erstwhile chased your portfolio head down nan hallway of a convention to shriek astir embarrassing him connected a nationalist webcast erstwhile we asked astir an unnecessary and dilutive secondary offering.

To adhd reproach to wounded while nan institution has communicated nan investigation findings, hiring of nan caller auditor, and moreover wide strokes of its subdued financial guidance, it has refused to supply its nett rate position, resulting successful accordant worries by nan marketplace astir its indebtedness levels. For what its worth, we estimate that nan institution apt has $40mm successful rate and a $100mm word loan, aliases astir $60mm successful nett indebtedness today. Of people this number tin beryllium disconnected by $10mm to $20mm. And truthful successful 2022 nan banal dropped from astir $1.50 trading levels to a debased of $0.50, and nan warrants dropped to astir $0.10 costing america 600 to 700 ground points successful performance.

This each seems bad. And yet contempt nan disappointment, we are really a spot excited. In precocious January 2023, nan institution seems to person gotten nan connection from its ((very)) angry shareholders: waste nan company.

While nan shareholders approved a caller board, they refused to o.k. an summation successful issuable shares from 200mm to 250mm, wherever location are presently 105mm outstanding and 92mm warrants, which count against nan cap. The volition of nan ballot was to let nan committee to rumor much options to pull caller management, while nan shareholders sent a connection that it is clip for to extremity its short-lived tally arsenic a publically traded company. So nan institution announced that aft receiving “multiple expressions of interest” it has hired nan Jeffreys finance slope to thief negociate nan process. Positive news successful a oversea of disappointment and distrust.

Of course, everything is not arsenic easy aliases arsenic simply predictable arsenic a waste of a institution pinch unpublished financials amid an economical slowdown pinch a strained consumer. What is POL worthy today? What are our warrants worth? This is an e-commerce institution that tin make $500mm to $600mm successful gross and $30mm to $50mm successful profitability, providing its moving superior levels are nary longer underfunded. This tin consequence successful offers of $200mm to $600mm, wherever perchance up to $100mm would spell toward paying backmost nan word loan. What happens pinch nan warrants that person 3.5 years near and a $2.25 onslaught value if nan connection is beneath nan onslaught price?

These are each questions we’ve spent nan past fewer weeks trying to answer. We’ve travel distant affirmative pinch astatine slightest 1 information of nan situation: our warrant holder rights. Much for illustration our US Ecology warrants which were bought retired by Republic Management successful 2022, nan POL warrants successful immoderate basal transaction are required to beryllium converted into nan warrants for nan equity of nan caller owner. This is awesome and easy if nan acquirer is simply a nationalist institution and this is simply a strategical acquisition for personification fetching a higher price, but it is apt to beryllium a backstage equity company. In fact, we wouldn’t beryllium amazed if nan erstwhile CEO comes backmost pinch a backstage equity backing to bargain nan institution back. This would evidently beryllium a concern. However, since nan warrants are improbable to beryllium converted into caller equity, they will person to beryllium bought out, moreover if nan last waste value is beneath workout price. The adjacent interest that comes: astatine what value? While nan company’s filings connected nan warrant supplier statement thin to beryllium poorly written astatine best, it seems apt that they would beryllium bought retired astatine “fair value” which thin to person varying ranges owed to nan volatility input into nan Black Sholes formula. We person a beardown interest that that is nan portion wherever location whitethorn large differences betwixt nan warrant holders appraisal of adjacent worth and nan company’s acquirer. So successful nan extremity we judge that these warrants possibly worthy arsenic small arsenic $0.40, astir our caller costs mean arsenic we’ve added immoderate much recently, but up from $0.10 today, to good complete $2.00 if nan business is successful bully shape. The existent downside is of people that they enactment astatine nan $0.10 level for a agelong clip if nary woody is consummated, and we suffer a small connected liquidation, different realistic risk. For what it is worth, we person communicated our concerns and reminded guidance of warrant holder authorities successful a backstage letter. We are mostly excited that nan extremity of this saga is adjacent and look guardant to updating you soon.

Portfolio Sales

In 2022 we’ve exited our position successful US Ecology warrants owed to a buyout and sold our leftover de minimis holdings of Flotek and Societal CDMO. We expect immoderate income successful 2023.

Partnership Updates

We welcomed 2 caller partners to nan business this twelvemonth and mislaid 2 bringing our full to 43 astatine nan extremity of December. As we are not having an in-person business arena successful 2022 we will extremity up having a virtual portfolio update position successful summertime of 2023. Please beryllium connected nan lookout for an invitation successful your email inboxes sometime successful nan adjacent fewer months. Despite nan existent economical challenges, we are excited astir nan continued maturation successful partners and betterment successful assets nether guidance and, arsenic always, are thankful for your business.

Next Fund Opening

Our adjacent business openings will beryllium March 1 and April 1, 2023. Please scope retired for updated offering documents and presentations astatine aliases 415.531.2699.

Legal Disclosure

The Partnership’s capacity is based connected operations during a play of wide marketplace maturation and bonzer marketplace volatility during portion of nan period, and is not needfully suggestive of results nan Partnership whitethorn execute successful nan future. In addition, nan results are based connected nan periods arsenic a whole, but results for individual months aliases quarters wrong each play person been much favorable aliases little favorable than nan average, arsenic nan lawsuit whitethorn be. The foregoing information person been prepared by nan General Partner and person not been compiled, reviewed aliases audited by an independent accountant and non-year extremity results are taxable to adjustment.

The results portrayed are for an investor since inception successful nan Partnership and nan results bespeak nan reinvestment of dividends and different net and nan conclusion of costs, nan guidance fees charged to nan Partnership and a pro forma simplification of nan General Partner’s typical profit allocation, if applicable. The General Partner believes that nan comparison of Partnership capacity to immoderate azygous marketplace scale is inappropriate. The Partnership’s portfolio whitethorn incorporate options and different derivative securities, fixed income investments, whitethorn see short income of securities and separator trading and is not arsenic diversified arsenic nan indices, shown. The Standard & Poor's 500 Index contains 500 industrial, transportation, inferior and financial companies and is mostly typical of nan ample capitalization US banal market. The Russell 2000 Index is comprised of nan smallest 2000 companies successful nan Russell 3000 Index and is mostly typical of nan mini capitalization U.S. banal market. The Russell Microcap Index is comprised of nan smallest 1,000 securities successful nan Russell 2000 Index positive nan adjacent 1,000 securities (traded connected nationalist exchanges). The Russell Microcap is mostly typical of nan microcap conception of nan U.S. banal market. All of nan indices are unmanaged, marketplace weighted and bespeak nan reinvestment of dividends. Due to nan differences among nan Partnership’s portfolio and nan capacity of nan equity marketplace indices shown above, however, nan General Partner cautions imaginable investors that nary specified scale is straight comparable to nan finance strategy of nan Partnership.

While nan General Partner believes that to day nan Partnership has been managed pinch an finance accuracy and methodology akin to that described successful nan Partnership’s Offering Circular and to that which will beryllium utilized to negociate nan Partnership successful nan future, early investments will beryllium made nether different economical conditions and successful different securities. Further, nan capacity discussed herein does not bespeak nan General Partner’s capacity successful each different economical cycles. It should not beryllium assumed that investors will acquisition returns successful nan future, if any, comparable to those discussed above. The accusation fixed supra is historical and should not beryllium taken arsenic immoderate denotation of early performance. It should not beryllium assumed that recommendations made successful nan early will beryllium profitable, aliases will equal, nan capacity of nan securities discussed successful this material. Upon request, nan General Partner will supply to you a database of each nan recommendations made by it wrong nan past year.

This archive is not intended arsenic and does not represent an connection to waste immoderate securities to immoderate personification aliases a inducement of immoderate personification of immoderate connection to acquisition immoderate securities. Such an connection aliases inducement tin only beryllium made by nan confidential Offering Circular of nan Partnership. This accusation omits astir of nan accusation worldly to a determination whether to put successful nan Partnership. No personification should trust connected immoderate accusation successful this document, but should trust exclusively connected nan Offering Circular successful considering whether to put successful nan Partnership.

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Editor's Note: This article discusses 1 aliases much securities that do not waste and acquisition connected a awesome U.S. exchange. Please beryllium alert of nan risks associated pinch these stocks.

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