Download 01-0440 SmallCapGrSAR0301.lyt

The Gabelli Woodland Small Cap Value Fund
Shareholder Commentary
June 30, 2003
Elizabeth M. Lilly, CFA
To Our Shareholders,
The investment climate of the past year has been as challenging as any we can remember. Investor concerns
with the sluggish economy, lack of corporate profit growth, and eventual war with Iraq created an environment filled
with uncertainty and extreme volatility in the financial markets. This volatility is evidenced by the recent returns of the
Russell 2000 Index. The Russell lost approximately 38% of its value from the April 2002 high through the October
2002 low, testing levels not seen since October 1998. Since our last letter the markets have rallied strongly due to the
decisive “victory” in Iraq and increasingly higher investor confidence that the economy is gradually improving. From
the October 2002 low through the June high the Russell 2000 had a gain of 43%.
We are now more encouraged about our prospects than at any point during the past two years. The economy,
although still somewhat sluggish, is beginning to show signs of life due partly to the Federal Reserve’s
accommodative monetary policy and President Bush’s economic stimulus plan.
Investment Performance
Fund performance for the quarter ending June 30, 2003 was disappointing. The Fund gained 8.8% versus a gain
of 23.4% for the Russell 2000 Index, which had its best quarter since 1991. Calendar year-to-date, the Fund is up
0.1% versus a gain of 17.9% for the Russell 2000. The Russell 2000 is an unmanaged indicator of stock market
performance.
The performance gap began to widen in March and continued through the end of this most recent June quarter.
The current investment climate is reminiscent of late 1999 and early 2000 when the market peaked and technology
stocks, with little hope for positive earnings, were being driven higher. A study by Steve DeSanctis of Prudential
Financial noted that companies not expected to make money over the next year had gains of close to 40% during the
most recent June quarter. DeSanctis writes that, had the index excluded these non-earnings companies, it would have
returned 12.0%. In a separate study, he also concluded that nearly one-half of the Russell 2000 performance during
the quarter could be attributed to the performance of stocks with market capitalizations below $500 million. The
combination of investors favoring these non-earning and “micro-cap” companies was the main driver behind the
Russell’s significant out-performance.
Let’s Talk Stocks
Strong performance this past quarter came from Northwest Airlines, The Sports Authority, IHOP, and National
Service Industries. Northwest Airlines rebounded 61% as investors became more confident that the company was
going to be one of the long-term survivors in this beleaguered industry. CEO Richard Anderson is making great strides
in streamlining the organization and taking out a significant amount of fixed costs. The Sports Authority gained 53%
as Garts Sports announced they would be acquiring the company for $11 per share in a stock-for-stock acquisition.
This merger will mark the combination of the two largest sporting goods retailers in America and will provide
significant opportunities to reduce redundant costs and to benefit from economies of scale. IHOP, which gained 41%
during the quarter, develops, operates, and franchises International House of Pancakes restaurants. CEO Julia
Stewart is transitioning IHOP’s business model from company-owned and developed locations to franchisee
development where the franchisee bears most of the upfront expenses. The result is a less capital-intensive business
that generates higher free cash flow and return on capital. Finally, as mentioned in our previous letter, National
Service Industries was acquired by a private investor group for $10 per share and was a positive contributor during
the quarter.
Weaker performers during the quarter included Cytyc Corporation and H.B. Fuller. Cytyc suffered during the
quarter when a competitor announced they had received FDA approval for their cervical cancer detection system.
Investors fear future pricing pressure and market share battles. Cytyc is the dominant player in cervical cancer
detection with 64% market share for Pap tests in the United States with a promising product pipeline. We believe the
pressure on the stock will prove to be short term in nature because Cytyc has a far more effective product. H.B. Fuller
was another of the weaker performing stocks during the quarter. We are confident in CEO Al Stroucken and his
management team’s ability to grow H.B. Fuller’s specialty chemical assets and also take out additional costs.
During the quarter we eliminated positions in Wild Oats, Axcelis Technologies, and Paxar Corporation. For a
variety of reasons, we lost confidence in each of these companies and sold them at a discount to their original cost.
We continue to believe that owning companies with positive and growing earnings and free cash flows will serve
us well. In addition, we aim to invest in companies with a sustainable competitive advantage that are run by good
operating managers with strong capital allocation abilities. During the market’s recent ascent, we have not chased
rising technology stocks that have no foreseeable earnings, which has cost us in terms of near-term performance.
Instead, we initiated new positions in Cole National, Orthodontic Centers of America, Griffon Corporation, Apogent
Technologies, and CNS, Inc. Each of these companies has enormous potential to expand margins, earnings, and free
cash flow from an already significant base (with the exception of Cole National, which is undergoing a turnaround).
Our investment philosophy focuses on buying companies with “real” earnings and free cash flows at prices we
believe are significantly below our estimate of their worth. It is this patient and disciplined approach to investing that
will continue to pay dividends, both literally and figuratively, for long-term investors in the future.
Conclusion
The past six months have been challenging, but we are optimistic about the outlook for both the economy and
the Fund going forward. Although the economy remains somewhat sluggish, there are signs that a rebound may be
under way. The current low-interest rate environment and the economic stimulus plan should help lift the economy
back to more normalized growth levels. With money market funds yielding less than 1% and long-term bond yields
now sharply on the rise, stocks look like the place to be in the coming months.
As always, we appreciate your loyalty and support.
Sincerely,
Elizabeth M. Lilly, CFA
Portfolio Manager
August 13, 2003
NOTE: The views expressed in this report reflect those of the portfolio manager only through the end of the period stated in
this report. The manager’s views are subject to change at any time based on market and other conditions.
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