Q:  Could you give a historical overview of the company? A : Since its founding in 1986, Tanaka Capital Management (TCM) has provided investment management services to high net worth individuals, mutual funds and more recently pension funds and endowments. In 1998 TCM launched the flagship TANAKA Growth Fund as a public mutual fund (ticker TGFRX) that invests in small cap, midcap and large cap undervalued growth stocks. High Net Worth individuals are offered All Cap Equity and Balanced (equity and fixed income) portfolios management services. Pension and Endowment funds are provided with more focused Small Cap and Midcap Growth portfolio management. Q:  What drives your investment philosophy? A : Tanaka Capital Management’s goal is to deliver above average risk-adjusted returns over the long term. We assume that at any one point in time, there are undervalued, underappreciated companies undergoing fundamental change that may result in better-than-expected earnings growth and excess cash generation over the ensuing 2-5 years. We see 200- 300 company managements per year and believe that a continuous, consistent application of screening, rigorous financial analysis and face-to-face meetings with these company managements afford us the opportunity to identify target investments with significant opportunity for positive earnings surprises and ideally double digit returns over several years. While it is relatively easy to find high quality investments, it is more challenging to find them at value prices. Over the years we have found the best values in high quality growth companies that have fallen “out of favor” for reasons we can identify and where the management’s strategies for improving revenue growth and profitability can be validated. We have found this validation process to be most critical to our success over the years. This would include our “Kick-the-Tires” research – meeting one-on-one with company managements, speaking with competitors, as well as “shopping” the product or service as would a customer. As we are often looking for companies undergoing strategic fundamental change (restructuring, new manufacturing, new product development, revised marketing or distribution channels, etc) our analysis and questions are often more strategic than those asked by other investors. One benefit is that it often takes 2 or 3 years for the anticipated fundamental change to occur, so our investment time horizon can be 3 years or more. This results in less portfolio turnover and is more tax efficient for our investors. Q:  How do you execute your investment strategy? A : Our investment process represents a blend of top-down macroeconomic work and bottoms-up individual stock selection. While our macroeconomic analysis includes input from outside economists, we do our own proprietary macroeconomic work in areas where we can provide added value. For example, our macroeconomic research encouraged us to raise cash and reduce portfolio risk in 2008 and early 2009, and to become fully invested in March of 2009. We have also been able to leverage our original macro research in the areas of demographics, inflation, productivity, monetary policy and fiscal policy to guide our over and underweighting of industry sectors. For example, during early 2009 we reduced healthcare and increased portfolio weightings in financial services, technology and telecom. More recently, we have added to energy and alternative energy sectors. Our stock selection process starts with industries that will benefit disproportionately from fundamental change – for example, the aging of the Baby Boomers, the expanding need for better and lower cost healthcare, the increasing importance of productivity gains, and the urgent need for the financial sector to rebuild balance sheets by expanding profit margins greater than normal. Individual companies must be able to generate real sales and earnings growth, with a focus beating expectations over the next two to three years. This time horizon differs from many other institutional investors who may focus on the next one or two quarters. Q:  What is your definition of “value”? A : At Tanaka Capital Management, finding value has always been about finding a growth company at a discount. While this generally means seeking companies where their Price/Earnings ratios are below their long term EPS growth rates, we have been focusing even more assiduously on net cash as a percent of capitalization and free cash flow per share. We also risk-adjust our analysis with an overlay assessing the probability that a candidate will exceed revenue and earnings expectations versus the likelihood of falling short, as well as to determine if growth rates will be accelerating or decelerating. In aggregate, we also perform proprietary models analyzing the relative attractiveness of stocks versus bonds (P/Es versus Equity Risk Premiums) and the attractiveness of financial assets versus tangible assets. Q:  What are the analytical steps of your research process? A : While investment candidates may originate from a variety of sources, even before they are subjected to our thorough research and questioning, they must first pass through our “Screening Filters” and then our processes for identifying key “Triggers of Value Creation.” There are always companies in the process of cutting costs, developing new products, adding new distribution or instituting new manufacturing processes, and it is our job to find these companies early. Our Screening Filters include: double digit long term growth characteristics, superior products and services, leading or rising market shares, honest and conservative management, low P/E relative to future earnings growth, accelerating or stable long term growth, strong balance sheet and cash generation and a company which appears to be under-followed or misunderstood. It is nice to find a cheap stock, but it is even nicer to find one where we can specifically identify how the company can generate better than expected earnings going forward. To help us in this process we like to identify specific “Triggers of Value Creation” which will improve future profitability – and surprise on the upside. These triggers include: heavy investment spending which is impacting current earnings but will lead to greater profit margins in the future, an expected increase in sales in high incremental margin products, a strong R&D or new product pipeline that is too far out for current investors, a cost-cutting program which will generate surplus cash and a removal of a major threat to the industry. Once a buy candidate survives our screening processes, we begin our Dynamic Questioning step where we probe managements to determine the likelihood of successful execution of strategic programs to improve profitability going forward. We like to “ask better questions to get better answers” and this is where our years of experience help us identify the companies that are most likely to succeed. This is where we hope to produce a more accurate understanding of what will happen to a company’s revenue and earnings growth before the rest of the market. Q:  How do you do your portfolio construction? A : Within the context of a top-down macroeconomic view of the next 12-24 months, we determine how much cash to keep in reserve, how much to allocate to small, midcap or large cap stocks and which sectors we seek to overweight and underweight. We generally hold about 25 to 30 names in the Fund as studies have shown that there is little incremental diversification benefit to holding more than 30 companies and we want to hold our most attractive stocks. As a smaller fund, we have the flexibility to move efficiently and the ability to trim holdings that begin to approach full valuations or eliminate those that are not meeting their specific Triggers of Value Creation. Over the years, our most important portfolio discipline has been to challenge existing holdings with a steady stream of new investment candidates that are even more attractive. This dynamic process has helped us keep the portfolio fresh and imposes an added discipline to flush out those holdings that are beginning to not meet expectations. Q:  What risks do you perceive in the portfolio and how do you control them? A : Historically, the Fund has had above average volatility as there is inherently greater price volatility in higher growth companies and in smaller capitalizations stocks. This is because more of the net present value of future returns is indeed in future years and therefore less certain. In addition, technology and healthcare sectors have historically generated above average growth rates but have also tended to carry greater risk. Accordingly we are constantly working to offset this volatility with diversification, cash and other portfolio counter balances. We have been increasingly employing statistical analysis to help us identify companies that tend to naturally offset the price movements of other stocks in the portfolio. This co-variance analysis should aid our efforts to reduce overall portfolio volatility as equity valuations become more normalized over the next few years.