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Staying above the market noise with a long-term focus

By Ironwood Investment Management

Following the strong absolute and relative performance for 2013 (our inaugural year), the Ironwood SMID Cap Value Equity Strategy returned 2.27% in the first quarter of 2014. This return trailed the Russell 2500 Value Index while slightly outperforming the S&P 500 Index (SPX).

Our strategy has a long-term focus. We invest in companies undergoing major transitions to how they utilize their assets, including new management, being part of a spin-off transaction, emerging from Chapter 11 bankruptcy, undertaking a major restructuring, and other types of strategic-level changes. Our ideal holding period is three to five years.

This extended investment horizon allowed us to look well-beyond the noise of the market's first quarter volatility, which displayed a late-January sell-off followed by an rally to new highs. We took advantage of some of the sentiment-driven gyrations to add to a few of our positions at bargain prices.

We purchased two new names in the quarter: Eastman Kodak (KODK) and Platform Specialty Products (PAH). Both are undergoing transitions designed to create value for equity holders.

At quarter-end we had 34 positions, including twelve CEO transitions, five spin-offs, three post-Chapter 11 exits, and fourteen companies with other types of strategic-level changes underway.

Reflecting the importance of focusing your capital on our most attractive ideas, portfolio concentration is high, with the top 10 holdings comprising 40% of our weighting. Consistent with our long-term investment approach, 24 of the 34 holdings are companies that we have held since our inception at the start of 2013.

Holdings Review

Brocade Communications Systems (BRCD) - Under new CEO Lloyd Carney, the company's comprehensive restructuring program is progressing. In my opinion, operating margins are on track to expand over 500 basis points and revenues look poised to increase for the first time in two years.

With its post- transition valuation remaining higher than the current share price even after its strong gains, we are maintaining our sizeable position in Brocade.

Carrizo Oil & Gas (CRZO) - Carrizo continues to transition its asset base away from lower-profit natural gas toward much higher-profit oil and liquids in the Lower 48 states.

Led by CEO Chip Johnson, the company's oil/liquids production is headed toward 70% of total output, up from 40% in 2012. We expect this transition to more than double Carrizo's cash flow. Despite the strong share price gains, we believe the company's substantially higher value is still not fully recognized by the market, and we remain holders.

Eastman Kodak (KODK) - The "new" Kodak has shed its iconic consumer film and camera businesses, photo kiosks and several industrial products. It is in the process of winding down its consumer inkjet printer and entertainment/ commercial films businesses and selling a large part of its real estate holdings.

The bankruptcy process reduced over $5.1 billion of debt and pension/post-employment liabilities to a readily-manageable $1.25 billion and leaves $840 million in cash on the balance sheet. The new core of Kodak includes digital printing, packaging, services and graphics businesses.

New CEO Jeff Clarke, named to the position on March 12th, has considerable and successful experience leading technology-related companies and has outlined plans to improve the company's growth and margin profile. We purchased the stock as we believe the shares trade at a considerable discount to the post-transition value.

Platform Specialty Products (PAH) - This company was recently created by an investor group led by Martin Franklin, who has impressive experience building shareholder friendly companies. The foundation company is the well-run specialty chemical maker MacDermid, which went private in 2007.

When MacDermid was acquired by Platform in October, 2013, MacDermid's CEO and CFO rolled their entire stakes into Platform equity. We believe that Franklin's deal-making ability will transform the company over the next 3 years into an industry leader. Platform began trading on January 25th and, given our confidence in the management team and their ability to execute on the strategy, we purchased the stock in January.

First Niagara Financial Group (FNFG) - – Following a failed acquisition-driven strategy, First Niagara is transitioning to a much-needed operational-improvement strategy. The board removed the CEO in early 2013 and promoted CFO/interim CEO Gary Crosby to new CEO in December.

Crosby brings considerable operations expertise to the top job, but investors had wanted an outsider. We purchased shares on the subsequent price decline, and again added to our position one week later as investors punished the stock price when Crosby announced a large capital spending program.

We will patiently hold a stock, monitoring the company's progress through its transition. However, in our opinion not all price declines are buying opportunities. If a company struggles during its transition and its long-term prognosis materially deteriorates, we will exit that position to limit our risk.

ADT (ADT) - ADT was spun-off from Tyco in October 2012. In addition to having a strong name in residential alarms, ADT had an underutilized balance sheet and a new high-margin product (Pulse home security automation) that was finding impressive market reception.

However, the company stumbled badly in its transition to a public company, particularly its dealing with activist investor Corvex, and failed to defend its franchise against aggressive new competition.

Itron (ITRI) - For many years, Itron had focused on making acquisitions and landing large contracts in its water, gas, and electricity metering systems businesses. However, these acquisitions were poorly integrated and the contracts left a large revenue hole as they wound down.

We saw potential in the new CEO, Phil Mezey, to remedy these issues with tighter management and new products. However, this transition was permanently impaired by increasingly aggressive competition in their electric metering business (40% of revenues) and poor execution on operating improvements and product development.

The New York Times Company (NYT) had struggled for years with steadily declining advertising revenues, and was burdened with too much debt, unprofitable non-core operations, and a bloated cost structure.

We believed that new CEO Mark Thompson, who arrived in late 2012, would bring a fresh perspective to renewing the company's growth as well as a dedicated focus on operating and capital improvements. Underpinning this transition were positive cash flows, a hidden real estate asset and an iconic national brand. Despite these attractive attributes, the market was unimpressed.

During our holding period, the company's digital subscription (online) revenues grew impressively, it re-branded its old-line international paper into The New York Times International Edition, sold the Boston Globe operations, and began developing an exciting new video business that could create a valuable cable channel. By early January, the transition became fully reflected in the share price. We sold our position in early January 2014.

Mallinckrodt Pharmaceuticals (MNK) - We purchased Mallinckrodt in June 2013 when it spun-off from Covidien. The company appeared to be an unfocused, under-earning collection of pharmaceutical and medical products.

We saw something different - several high-growth specialty pharmaceuticals, strong market shares and an outstanding brand, led by a sharp new management team and supported by a clean balance sheet and healthy cash flows.

Over the next six months, management successfully executed the transition to an independent, faster growth company. As investors fully factored this into the share price in a relatively short time period, we exited our position.

DISCLAIMER: The investments discussed are held in client accounts as of April 30, 2013. These investments may or may not be currently held in client accounts. The reader should not assume that any investments identified were or will be profitable or that any investment recommendations or investment decisions we make in the future will be profitable. Past performance is no guarantee of future results.

Ironwood Investment Management

Ironwood Investment Management

Ironwood Investment Management is an employee-owned investment management firm based in Boston that formed in 1997. It invests in undervalued

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