Q:  What is the history of the firm? A : Rice Hall James is an independent, investment management firm that is headquartered in San Diego, California. Established in 1974, the firm has been providing investment management services to institutional investors as well as private clients through its separate account management and mutual funds. Today, the firm manages $1.2 billion in assets. The Rice Hall James Micro Cap Fund was launched on July 1, 1994 with the investment objective to seek maximum capital appreciation, consistent with reasonable risk to principal, by investing primarily in small companies that are largely not followed. Q:  What are the tenets of your investment philosophy? A : The guiding investment philosophy is that, ideally, we want to buy small companies at the inception of their growth phase without paying too much for that growth rate. Our goal is to invest for growth. To accomplish that, we search for growing companies whose value has not yet been fully appreciated in the marketplace. In other words, we scour the investable universe to discover unrecognized growth among the least followed and smallest U.S. public companies. Fundamentally, we strive to recognize opportunity early and to optimize appreciation within a framework of disciplined risk control. Q:  How does your philosophy translate into an investment strategy? A : With our investments we seek maximum capital appreciation, consistent with reasonable risk to principal. The fund normally invests at least 80% of assets in equity securities of micro cap companies. It focuses on U.S. companies with total market capitalizations which fall within the range of $50 million to $375 million at the time of initial purchase. We emphasize smaller, emerging companies that possess the potential to become market leaders in their industries. The micro cap equity strategy seeks to uncover and capitalize on smaller, growing, undervalued companies that offer higher return potential while adhering to disciplined risk controls. Our fund uses a company-specific approach to making investment decisions, which focuses on identifying stocks of growth companies that are selling at a discount to the companies’ projected earnings growth rates. As part of our strategy, the fund looks for companies undergoing fundamental changes that will lead to increases in revenue growth rates, expanding profit margins, and/or increases in growth rates. The fund typically invests in a company -when the manager believes that such changes will lead to greater investor recognition and higher stock prices within a 12- to 24-month period. In terms of valuation, we like to buy a company at price-to-earnings ratio less than the three-year projected growth rate. Q:  How do you execute your research process? A : We employ a bottom-up, fundamental approach to identify attractively valued growth companies that demonstrate growth potential and are reasonably priced. We invest in undervalued companies and grow with them until they either become fully valued or no longer meet our exacting criteria. Our investment process accentuates individual security selection as opposed to betting on sectors or industries, market timing, or economic forecasting strategies. Internal research is vital to our investment process in that it enables us to independently evaluate and verify information from external sources, as well as judge the appropriateness of stocks for our portfolio. All team members are generalists who research and select stocks from across all market sectors. We focus on companies with very good growth potential, good management, unique positioning, dominant market share, a good business model, and high returns on capital. We can look at the company website,to presentation materials or arrange to go to a conference, sit down with management in our offices, discuss the outlook and plans they’ve made, for instance the R&D productivity, how they are building up the sales force, and new product flow, and competition obviously. In other words, try to figure out why it is going to be a good stock in the next one to two years, which is - our ideal timeframe to look at investing. We use different types of screens to narrow the search process, ranging from valuation or return-on-capital and margin change screens. One of the most significant advantages at RHJ is the blend of our small size and entrepreneurial culture. The smooth flow of communication among team members results in timely investment decisions. Q:  Could you illustrate your research process with some examples? A : We owned Healthcare Services Group, Inc., a provider of housekeeping, laundry, linen, facility maintenance and dietary services to nursing homes, located throughout the United States. They have very solid cash flows, grown methodically at 15% to 20%, and the market itself is probably 5% or 6% top-line growth. They have been able to gain market share and the business has grown with a consistent margin over the years. We bought it in early 2004 and we had a five-year holding period. It is a name with a sound business model, proven track record, good cash flows, and a stable management team. What is more, they are dominant yet they can take up market share. The company competes, to an extent, with larger players in the market like some of the stadium food services. What they managed to do, though, was to pick up market share by concentrating on nursing homes. Eventually, the stock got a little bit expensive when it hit the low 20s about four or five months ago, so we sold the remaining position. Another example of our holdings would be AeroVironment, Inc., a company that designs, develops, produces and supports a portfolio of unmanned aircraft systems. They attracted our attention in early 2008 when they won several important military contracts that dwarfed some of the side businesses that are not as core but still throwing off some cash flow. The stock did well in a short period of time but we ended up selling it six months later. Q:  How do you build your portfolio? A : We construct portfolios that invest in attractively valued small companies. The micro cap portfolio is comprised of reasonably priced, less visible companies with unique business concepts or niche products that we feel are ripe for growth. The bottom-up, fundamental stock selection process singles out companies with a market capitalization ranging between $50 million and $375 million. The portfolio typically has between 80 and 85 stocks. We employ disciplined analytic methods to validate a stock’s merit for investment consideration. Each portfolio candidate must demonstrate a catalyst for change that can contribute to sustainable earnings growth. Moreover, stocks must have reasonable valuations to qualify for purchase. From a sector perspective, we typically do not own utilities because they do not have very high growth rates. Also, we do not own any REITs in the portfolio. We try to keep a balanced outlook across all sectors of the micro cap market. We will not allow overweights beyond 30% in any one sector. The main risk control feature is that there is a downside limit in each stock and if it goes to that limit, the stock gets sold. We prefer companies which can grow at 20% but do it sustainably with a high returns on capital and steady cash flow. We want to have at least a three to one upside/downside ratio in every stock in the portfolio. Q:  What is the benchmark of the fund? A : We use the Russell Microcap Growth Index as the fund’s primary benchmark. We also consider the Russell Microcap Index and the Russell 2000 Growth Index. Q:  What is your sell discipline? A : The fund may sell stocks for one of the following reasons - the stock reaches the target price set by the fund, or falls below the downside price limit, or the fundamentals of the stock have deteriorated and a more attractively valued alternative is available for purchase. Q:  What is your definition of risk and how do you measure it? A : Above all, we minimize risk in the portfolio through diversification. Our initial purchase price also acts in some ways as a risk control because we buy companies when they are trading at a discount to their intrinsic valuations.