Wasatch Micro Cap Fund® (WMICX)  Invest in this Fund 

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3Q18
Health-Care Stocks Lifted the Fund During a Quarter of Strong Performance
by Ken Korngiebel, CFA and Dan Chace, CFA

“Solid gains in the revenues and earnings of the companies we own drove returns across most areas of the Fund. This was especially true in health care, which was the largest source of outperformance relative to the benchmark.”

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For the period ended September 30, 2018, the average annual total returns of the Wasatch Micro Cap Fund for the one-, five- and ten-year periods were 38.04%, 15.28%, and 13.86%, the returns for the Russell Microcap Index were 13.65%, 10.51%, and 10.82%. Total Expense Ratio: 1.67%.

 

Data shows past performance, which is not indicative of future performance. Current performance may be lower or higher than the data quoted. To obtain the most recent month-end performance data available, please click on the “Performance” tab of the individual fund under the “Our Funds” section. The Advisor may absorb certain Fund expenses, without which total return would have been lower. Investment returns and principal value will fluctuate and shares, when redeemed, may be worth more or less than their original cost.

Wasatch Funds will deduct a 2.00% redemption proceeds fee on Fund shares held 60 days or less. Performance data does not reflect the deduction of fees, including sales charges, or the taxes you would pay on fund distributions or the redemption of fund shares. Fees and taxes, if reflected, would reduce the performance quoted. Wasatch does not charge any sales fees. For more complete information including charges, risks and expenses, read the prospectus carefully.

Wasatch Funds are subject to risks, including loss of principal.

Overview

The Wasatch Micro Cap Fund gained 8.23% in what was a positive third quarter for U.S. micro caps. The Fund surpassed its benchmark, the Russell Microcap Index, which rose 0.83%.

Although economic growth appeared to moderate from the 4.2% pace logged during the second quarter, government data suggested the U.S. economy continued to expand at a healthy clip. Steady business conditions and subdued inflation favored the stocks of growth companies, which outperformed value stocks during the third quarter. With micro-cap companies remaining somewhat insulated from risks related to tariffs and global trade, the micro-cap growth investment style was an advantage for the Fund.

Solid gains in the revenues and earnings of the companies we own drove returns across most areas of the Fund. This was especially true in health care, which was the largest source of outperformance relative to the benchmark. Our health-care stocks produced a combined return of over 25% for the quarter, significantly outpacing the health-care component of the Index. Other areas of substantial outperformance included information technology, consumer staples and industrials.

Reflecting the weak environment for value stocks, energy and financials were the worst-performing sectors of the Index. However, our energy stocks fell less than those in the benchmark, and our financial companies also outperformed. In short, things went well during the third quarter, as our disciplined investment approach and hard work delivered favorable results for the Fund’s shareholders.

As the Fund’s health-care and information-technology stocks extended recent gains, we trimmed position sizes in some holdings to limit exposure and reduce risk. We invested some of the sales proceeds in stocks of industrial companies. After an initial surge following the 2016 elections, industrials lagged as higher input costs squeezed profit margins and kept earnings gains in check. We think a number of industrial companies have become attractively valued relative to their growth prospects and are now better-positioned to pass higher costs along to customers.

Details of the Quarter

The strongest contributor to Fund performance for the quarter was Tandem Diabetes Care, Inc. (TNDM). The company offers insulin-delivery systems for people with diabetes. In August, Tandem launched its t:slim X2™ Insulin Pump with Basal-IQ™ Technology, a predictive feature designed to reduce the frequency and duration of low-glucose events (hypoglycemia). The new system requires no finger sticks for calibration or diabetes-treatment decisions. Encouraging financial results and improved forward guidance also helped to drive Tandem’s stock price higher during the quarter.

Freshpet, Inc. (FRPT) was another strong contributor. The company sells fresh, refrigerated meals and treats for dogs and cats in the U.S., Canada and the United Kingdom. Shares of Freshpet rose sharply in early August after the company reported better-than-expected net sales, which jumped 23% compared to the same quarter a year ago. Management raised its full-year guidance for 2018 as Freshpet’s core dog household penetration increased at its fastest rate in more than three years. To meet growing demand for the company’s products, Freshpet plans to expand its manufacturing facility in Pennsylvania. We reduced portfolio positions in Freshpet in response to the company’s significantly higher valuation.

Tabula Rasa HealthCare, Inc. (TRHC) also added to the Fund’s return. The company develops software that enables health-care organizations to optimize medication regimens, improve patient outcomes, reduce hospitalizations, lower costs and manage risk. By seeking to predict and prevent adverse drug events before they occur, Tabula Rasa’s Optimized Opioid Solution™ platform directly addresses the rising epidemic of accidental opioid overdoses. The company’s stock jumped in early August after quarterly earnings and revenues topped Wall Street forecasts. While we remain positive on Tabula Rasa and expect its intellectual property to find additional applications, we used the stock’s recent strength as an opportunity to trim our position and deploy the assets into more attractively valued companies.

The greatest detractor from Fund performance for the quarter was USA Technologies, Inc. (USAT). The company provides payment technology for cashless and mobile transactions at vending machines, kiosks and other unattended locations. USA Technologies saw its stock price tumble after the company announced it would not file its Annual Report on Form 10-K by the September 13th due date. Management said an investigation was underway into some of the company’s contractual arrangements and financial-reporting controls. We continue to monitor the situation closely.

Second-largest detractor nLIGHT, Inc. (LASR) is a technology holding we added during its initial public offering earlier this year. The company makes high-performance lasers for industrial, aerospace and defense applications. Shares of nLIGHT declined amid concerns that higher tariffs and a slowdown in China’s economy may impact Chinese demand for the company’s products. While we think these concerns are valid, we believe nLIGHT’s long-term prospects remain attractive. The company’s lasers are rapidly replacing older, carbon-dioxide lasers for industrial cutting and welding, particularly in the production of automobiles.

Another weak stock in the Fund was Chuy’s Holdings, Inc. (CHUY). Based in Texas, the company operates more than 90 Tex-Mex restaurants across 19 states. Rising labor costs have weighed on the stock price of Chuy’s as profit margins narrowed. Given what we consider the company’s attractive long-term prospects, we purchased additional shares for the Fund.

Small and micro-cap companies across the rest of the world were down for the quarter, as measured by the -1.51% loss of the MSCI ACWI (All Country World Index) ex USA Small Cap Index. However, most of the Fund’s international holdings posted gains, among them were software companies CyberArk Software Ltd. (Israel) and Fortnox AB (Sweden). Years of international investing have taught us that innovative micro-cap companies exist all over the world, so Wasatch devotes considerable resources to find them. Both CyberArk and Fortnox have been benefiting from the same trends that have been such strong tailwinds for many of the Fund’s U.S. technology holdings. CyberArk focuses on cybersecurity while Fortnox provides cloud-based accounting and invoice software to small businesses. (Current and future holdings are subject to risk.)

Outlook

The wage pressures faced by Chuy’s have become fairly common throughout the restaurant industry. In other parts of the economy as well, competition for workers is beginning to push labor costs higher. With the price of crude oil at multi-year highs and tariffs adding to the cost of imported goods, the inflationary backdrop has become less auspicious for businesses and consumers.

As long as inflation remains contained, we don’t think it’s likely to pose a threat to the U.S. economy. An unexpected acceleration in inflation would be more problematic. At the press conference following the September meeting of the Federal Open Market Committee (FOMC), Chairman Jerome Powell said he doesn’t see inflation surprising to the upside. When researching and analyzing companies, we’ll be keeping a close eye on wages and input costs for signs of inflationary pressures.

Thank you for the opportunity to manage your assets.

Sincerely,

Ken Korngiebel and Dan Chace

 

 

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