Q:  What drives your investment philosophy? A : We want to own the highest quality steady growth companies in the small cap market. We believe that owning high quality companies with sustainable competitive advantages is a winning strategy over the long term. We look for good returns on capital, great management teams and good businesses in growing industries. Q:  How does your team approach help your investment decisions? A : Wasatch’s investment process is very team oriented. We have what we call a “multiple eyes” approach where we are consistently consulting with each other to figure out which are the very best companies. Our experience makes us unique in this regard. Wasatch has specialized in small cap investing for over 30 years, and the current team has been investing together for well over a decade. So while I am the lead manager and work with Paul Lambert, my co-manager, to make the final investment decisions, there are more than 10 other portfolio managers and analysts that have contributed to this portfolio with idea generation and due diligence on companies. We are also continually traveling together to unearth new opportunities. Q:  How do you define “Core” in the Wasatch Core Growth Fund? A : “Core” to us is really a descriptive word. A “core” company can grow revenue and earnings at a steady clip in both good and bad economic environments. We are not focused on the high-profile, fastest growth companies in the economy. Those companies are typically heavily followed by Wall Street and have usually been bid up to valuations that make less sense to us. We will take consistent and predictable growth over high growth every day. And due to our long-term orientation, our trading tendency is to buy up even more of our types of companies when markets and stock prices get weak. Q:  What is your investment strategy? A : The types of businesses we invest in tend to be somewhat of an eclectic mix of companies with growth drivers that are not necessarily tied to the macroeconomic environment. A strong return on capital, and the financial flexibility it affords a company, is very important to us. In a weak economic environment, our companies typically have the wherewithal to continue growing by making acquisitions or they can improve earnings growth by repurchasing their stock. One metric we use that helps explain the high quality nature of our businesses is EBIT-ROA, or earnings before interest and taxes relative to (i.e., divided by) assets. It is a rough measure of how much cash a business generates with the assets that have been deployed. For instance, our portfolio average EBIT-ROA is around 35%, whereas the average company in the Russell 2000 generates an 8% EBIT-ROA. Our companies are simply much better at utilizing their assets to generate cash. We aim to buy companies with market values less than $3 billion, and will look at companies as small as $300 million. We are happy to hold companies if they exceed the upper limit as long as they are performing well, continuing to grow and have a reasonable valuation. An example would be our largest holding, Copart, Inc. It’s a company we have owned for over 14 years. They provide online auctions and vehicle remarketing solutions for the auto insurance industry. When an insurance company pays out a claim on a totaled car, they need to sell the damaged car to recoup some of their losses. Copart steps in by picking up the cars, storing them at their facilities and auctioning them off to the highest bidder. They have roughly a 40% market share and dominate this steady growth market. Copart has consistently used technology to stay ahead of its competition and it shows in the business results. By using the internet to open up their auctions to bidders all over the world, they have deepened the pool of buyers, which translates into higher prices at auction, and higher returns to the insurance company. Utilizing technology has also allowed Copart to take costs out of the business, resulting in high operating margins that are 2x that of their closest competitor. It is a great example of the type of high quality companies in which we invest. Copart’s end market is relatively stable, they have an experienced management team that owns a large percentage of the company, and they generate a great return on capital. Q:  What does “quality” mean to you? A : We define quality as the combination of a strong economic model, a high caliber management team, and the ability to grow through a tough economic environment. Quality management teams are a wonderful thing to study and track, because “management” is not a simple metric that can be screened for like EPS growth or the P/E ratio. We think our long experience in the small cap space gives Wasatch a competitive advantage here. Q:  How do you find ideas and evaluate different ideas? A : There are several ways new ideas get into the portfolio. One way is through our consistent numerical screening of the investment universe. We are routinely running screens looking for companies with solid growth and high or improving returns on capital. The second way is by getting out on the road and visiting management teams. We try to visit all the companies we own at least once each year, at their facilities. Whenever we go see a portfolio company in a given city, we look for new ideas and visit as many small cap companies in the geography as we can. The process from there is multifaceted. We want to know the company as well as any outsider possibly can, so we read everything that can be found in the public domain (Annual Reports, 10-Ks, 10-Qs, conference call transcripts). We also build all of our own earnings models, which is really when we begin to understand the important drivers of a business. We have thousands of excel spreadsheets devoted to understanding companies, and we don’t rely on Wall Street to determine our long-term forward earnings estimates. The models are also a great generator of questions for management. Over time, we establish an ongoing dialogue with management through visits and conference calls. Looking back, almost all of our biggest winners can be traced back to identifying, in real-time, a world-class management team. Q:  Can you give examples that illustrate your investment preferences? A : An example would be IDEX Corporation. IDEX is an industrial manufacturer, specializing in fluidics. They sell an array of pumps, flow meters, fluid dispensing equipment, as well as industrial pumps and air motors and compressors. IDEX is interested in any growing industrial market where there is a need for a complex technology solution. Many of their solutions end up in the healthcare, chemical processing and energy markets. However, we really view IDEX as a management story. They have a tremendous track record of efficiently running their basket of businesses, focusing intensely on return on invested capital. We have known IDEX for a long time and it is a large portfolio weight. The stock has recently been weak due to larger macroeconomic fears, but possibly also due to the recent departure of their well-respected CEO. We did as much research as we could about the newly named CEO, and then visited the company. The visit reinforced our view that IDEX had a very strong succession plan in place, and that the company is still poised to succeed. We used the market weakness to increase our stake. Life Time Fitness, Inc. is another holding of ours. It is a national chain of fitness centers. Life Time Fitness builds fitness clubs that are superior to anything in the market. They deliver the best experience to the customer, but for a reasonable price. Their competitors are typically the small gyms, “or a bunch of weights in a small room” as Life Time’s CEO might call them. By contrast, Life Time’s centers are over 100 thousand square feet, with full-court basketball courts, several Olympic-size swimming pools, a café, a spa and a kids’ center offering free babysitting. They offer a “country club lifestyle” for the masses. These clubs go into new markets and take massive amounts of market share. We found Life Time Fitness back in 2005, when screening through companies with interesting growth numbers. We had some initial concerns as these centers were quite expensive to build - $30 million to $40 million- and they relied heavily on mortgage financing to fund growth. As we delved deeper into the company we found that Life Time Fitness had less than 300,000 members, so they were tiny considering there is a market of over 40 million paid fitness memberships in the U.S. We visited their centers in several cities and talked to the employees and customers and found they truly viewed Life Time as being unique: centers could draw members from a wide geographic net wherever they went. They were consistently pre-selling upwards of 3000 memberships before opening a new club. And while Life Time’s return-on-capital was well below our portfolio average, we knew that metric would rise as each club steadily ramped up membership in excess of 12,000 members. A key early modeling insight was that Life Time’s customers consistently spent higher and higher amounts inside the clubs on personal training, healthy food and spa services. This continued right through the recession and I believe is evidence that Life Time has carved out a niche of serving the most profitable customers in the industry. Q:  What is your sell discipline? A : We sell a stock if a company breaks thesis or has competitive weaknesses that make it no longer one of the highest quality growth stories in the small cap universe. We are also quite disciplined about valuation, and will sell as the P/Es of our companies start to move well above the long term sustainable earnings growth rate. We never count on a high expected future P/E in calculating our return assumptions. Q:  How do you execute your portfolio construction? A : Typically, we own between 50 and 60 companies. A typical starter position for us is .75 to 1%, and our top 10 holdings are typically 3% to 5% weights. We don’t use the benchmark to construct our portfolios. The portfolio is the expression of our bottom-up stock picking. We never use the words “exposure to a sector” or “exposure to a theme” in order to make investment decisions. A portfolio company has to stand on the merits of its business model and the future earnings we expect that company to generate, irrespective of what themes or sectors may be strongest in the market at any given time. For example, we have been chronically underweight energy and high technology, two of the more volatile--both to the positive and the negative--sectors of the market over the last year. In the energy sector, it is difficult to find sustainable competitive advantage stories, especially when the bulk of the economics are predicated on the direction of the commodity price. In high technology, it’s difficult to predict what a company will earn 6 months from now, let alone over the 5-year time frame we use in our models. Q:  What do you consider risk and how do you manage it? A : The biggest risk that I consider is misreading a company and investing in a business and management that I think are high quality and then realizing they are not. These are tough lessons, but they are invaluable teachers. We have a deep file of lessons learned. We safeguard against risk with our due diligence and by focusing on quality. When stock prices are down, we use it as a signal to recheck our thesis and make sure we understand a businesses and its growth potential. Then, we will typically buy more. Lastly, a great advantage of investing in high-quality businesses that grow organically is that when the economy weakens, and markets sell off, our companies typically outperform. It tends to be a good risk control for us as well as anyone looking to invest in our fund.