Adam Friedman and Bryan Tinsley of Armada Small Ca

Hercules yesterday reported a fourth quarter profit, up from breakeven a year ago, on higher revenues.

The managers began buying Hercules in early January and added more shares this month, paying $8.50-$9, on average. They closed at $8.09 today.

Another of the fund’s recent investments is software maker Progress Software (PRGS), which Friedman says he likes because it has a “huge” customer base of a couple of thousand users, and a “cash-rich balance sheet.” In addition, the Bedford, Mass.-based company derives about 50% of its profits from services, so its earnings tend to be predictable, he says.

The managers began buying buying Progress’s stock late last month at an average cost of $13.90. They closed today at $15.34.

The No. 1 stock in the fund at the end of last year was GrafTech Intl (GTI), formerly known as UCAR International Inc., which makes natural and synthetic graphite and carbon-based products. The stock has fallen this year because investors fear the company will be unable to raise prices due to the sluggish economy, Friedman says. However, he does not share those concerns and expects GrafTech to be profitable, provided the economy strengthens once problems stemming from the situation in Iraq are resolved.

The second-largest holding in the portfolio in December was Westinghouse Air Brake Technologies Corp., which does business as Wabtec Corp (WAB). The company, which provides equipment and services for maintaining locomotives and railroad cars, stands to gain as railroads increase their capital spending, Tinsley says.

Armada Small Cap Value’s major investments also included athletic footwear and apparel maker Reebok Intl (RBK), which the fund managers began buying after the terrorist attacks of September 11, when they thought it was attractively priced. The stock’s multiple of price to cash flow still looks good, says Friedman. However, the managers trimmed the position a few weeks ago because the stock had run up to about $32, he noted.

At the end of 2002 Friedman says the fund’s four managers were finding the kind of valuations they prefer among financial services companies, which accounted for about 25% of the fund’s assets. Investments in this sector included Odyssey Re Holdings (ORH), Affiliated Managers Grp (AMG), Everest Re Group (RE), and Phoenix Companies (PNX).

Friedman says he is optimistic about prospects for small-cap stocks this year. Their multiples and earnings growth look better than those for large companies, he argues.

Still, until investors have a clearer picture of what will happen in Iraq, small stocks could bounce around, and investors may seek safety in large-cap stocks, he acknowledges.

“With the geopolitical environment kind of touch and go, you might see small-caps be very volatile and underperform here as people are looking for more stability in their portfolios,” he says.