EARNINGS LETTER

4th Quarter, 2005

Since the beginning of the year, and even before then, the best performing stocks in your portfolio are the shares of companies consistently executing essential daily tasks which customers rely upon them to perform ever more efficiently. Management’s ability to deliver reliable performance of mundane tasks throughout the organization is what drives productivity-producing growth. Your best companies are superb at delivering just this. The ability to execute is the factor determining whether a company succeeds in growing through the introduction of new products or services. These undertakings always contain more risk than producing more of the same and accordingly can diminish or add value to existing holdings. We continue to examine closely your companies’ abilities to realize productivity gains so we can discern whether apprehensions about a company’s growth initiatives are a warning to be heeded or an opportunity to acquire more of an excellent business at an advantageous price.

State Street Corporation

State Street’s strong fourth quarter earnings of 74¢ per share rose 30% above its year ago results which were depressed by merger and restructuring costs. Fee based income advanced 14% during the quarter while management held expense growth to 8%. The company’s 2005 earnings of $2.82 were 14% above the previous year’s operating earnings which exclude extraordinary costs booked during that year. Last year, State Street derived 80% of its revenue growth from providing added services to existing clients. Importantly, revenues from non-US customers grew 17% to reach 39% of total revenues. The margins earned on those revenues, which include transaction and servicing fees on cross-border assets, are twice those earned on US revenues. The majority of fees State Street earns from servicing hedge funds, which have almost quadrupled since mid-2002, are overseas. State Street now services 11% of all hedge fund assets. It benefits directly from the increased regulation and participation of institutional investors in hedge funds. The dominance State Street secured through near flawless execution of its acquisition of Deutsche Bank Global Services coupled with management’s determination to deliver operating leverage has strengthened investor confidence and helped lift State Street’s stock price 12% since the start of the year.

Chicago Mercantile Exchange

During the fourth quarter, revenues and earnings per share at the Chicago Mercantile Exchange reached $233 million and $2.18, gains of 24% and 33% respectively. During the quarter futures and options contracts traded increased 33%. For the full year revenues and earnings per share rose to $921 million and $8.81, up 25% and 38% respectively. CME’s operating margin rose from 50% in 2004 to 55% in 2005 as total expenses increased just 13%. During the year total futures and options contracts traded at the Merc rose 34% to 4.2 million per day of which 70% were traded electronically, up from 57% in 2004. Interest rate contracts, which comprise one-half of volume, rose 40%, equity index contracts rose 20%, foreign exchange contracts 65% and commodity contracts 23%. During the first two months of 2006 average daily volume at the Merc was 4.7 million contracts, up 26%. CME shares have risen 17% since January 1.

Express Scripts, Inc.

Express Scripts finished the year with strong growth in earnings per share and gross profit. Earnings per share for the fourth quarter leapt 45% to 77¢, while full year earnings per share rose 34% to $2.60. Gross profit rose 38% in the fourth quarter to $368 million and increased 28% to $1.2 billion in 2005. Gross profit per adjusted claim achieved a new record of $2.54, a 34% increase over the fourth quarter of 2004. Gross profit is the key top-line measure of Express Scripts’ performance because increases in highly-profitable generic drug prescriptions and changes in the mix of retail and mail prescriptions may slow revenue growth even as growth in net income accelerates.

The integration of Priority Healthcare has expanded Express Scripts’ specialty pharmacy offering which accelerates the use of this service by its existing customers and raises CuraScript’s profile with biotech companies as they select distributors for their new drugs. Express Scripts’ clients have broadly adopted the company’s formulary recommendation to remove Lipitor as a preferred brand for cholesterol lowering drugs in advance of the patent expiration of Zocor in June. In addition, 2005 was a strong sales year for Express Scripts with ten Fortune 500 wins, including two Fortune 10 and two Fortune 50 companies. Express Scripts’ stock price has risen 7% since the beginning of the year and is down from its all-time high of $95 on February 22. Disappointed fund managers sold shares the next day because the company did not raise its 2006 guidance after such strong performance in 2005.

First Data Corporation

On January 26, First Data announced it planned to separate its Western Union business into an independent publicly-traded company through a tax-free spin-off during the second half of 2006. This announcement overshadowed the mediocre results of the company. During 2005 First Data’s revenues rose 5% to $10.5 billion while its total expenses, including those for restructuring, integration and asset impairment, rose 9%, resulting in earnings per share of $2.04, down 5%.

Western Union is the company’s growth engine with $4.0 billion in revenues last year and operating profit of $1.3 billion. The cross-border remittance market is growing 8% annually and Western Union has improved its market share from 10% in 2003 to 15% in 2005. Eighty percent of Western Union’s 271,000 agent locations are located outside the US. Western Union has expanded the number of agent locations through organic growth and acquisitions at a 22% compound annual growth rate during the past five years. Growth of money transfer transactions tracks agent growth.

The remaining First Data will be comprised of the credit card issuing business, the merchant acquiring and processing business, the STAR debit network and the growing international business. Execution must improve for these businesses to become an attractive stand-alone investment. FDC shares are up 10% year to date.

Automatic Data Processing

ADP’s fiscal second quarter revenues of $2.2 billion were 9% higher than a year earlier while earnings per share rose 31% to 47¢. The company forecast revenue growth of 10% for the year with earnings per share growth approaching 25%. ADP’s clients continue to steadily add at least 2% more employees monthly to their payrolls. During the quarter, ADP accelerated the hiring of new sales and implementation professionals to drive further growth in its highly profitable employer services segment which generates three-quarters of company profits.

ADP made three important announcements subsequent to the release of their earnings. First, Art Weinbach, the CEO for the past 10 years, announced his retirement. He will be succeeded by Gary Butler, ADP’s highly capable President and Chief Operating Officer. Shortly thereafter, the CFO announced her resignation. This will give Gary the opportunity to hire his own CFO. This change in the company’s executive leadership could result in more scrutiny of the company’s ancillary businesses which are growing more slowly than the core payroll business. In addition, a review of the highly conservative capital structure is likely. ADP is one of the few remaining companies with a AAA credit rating reflecting its nearly $2 billion cash and marketable securities, negligible long-term debt and strong cash generation. The third announcement was the company’s decision to sell its slow growth auto insurance claims processing business to private equity investors for $975 million in cash. This business generated $415 million in revenues last year, about 5% of total company revenues. We view all these announcements positively. ADP stock is up 4% since January 1.

Amdocs

Amdocs’ stock price has jumped 26% since the beginning of the year, reaching levels not seen since March 2002. The company’s exemplary record of executing complex projects on-time and on-budget has led to major contract wins as its customers lead the telecommunications industry’s consolidation. On January 17, Sprint Nextel announced their decision to move 46.5 million subscribers to Amdocs’ managed billing and customer care system by the end of 2007. Amdocs’ stock price rose 5.3% on March 6 on the expectation that Amdocs will expand its business with the merged AT&T-Bellsouth. On January 18, Amdocs announced that it won a contract from AT&T and Bellsouth to help YELLOWPAGES.COM manage its customer data and digital content as well as to automate all online advertising workflow and activities. Cingular Wireless, the fast-growing joint venture between AT&T and Bellsouth, uses Amdocs’ billing and customer care system. Cingular is migrating former AT&T Wireless customers to this system. Bringing this wireless business under one management is one of the major reasons the companies gave for the merger. Amdocs reported first quarter fiscal 2006 earnings per share of 36¢ and revenues of $587 million, increases of 12.5% and 25% respectively.

C.H. Robinson Worldwide Inc.

CH Robinson’s fourth quarter and full year 2005 revenues rose 30% and 33% respectively, while earnings per share for the same periods rose 50% and 47% respectively. Acquisitions in the company’s sourcing segment and in global forwarding added 10% to EPS growth for the year. Approximately one-half of the 30% gain in Robinson’s core trucking division came from transaction volume growth while one-half came from higher prices caused by scarce trucking capacity and higher fuel costs. Robinson added nearly 1,000 new employees during the year through acquisitions and new hiring, a 20% increase. Operating profit per employee rose 22%. The company intends to hire an additional 1,000 employees in 2006. Robinson raised their annual dividend payable to shareholders by 73% to 52¢ per share. CH Robinson shares have risen 24% year-to-date. This year promises to be another good year for Robinson.

Donaldson Company, Inc.

Donaldson reported lackluster fiscal second quarter results with sales rising only 1% and earning per share rising one penny or 3% above the prior year. Revenues were reduced by 4% through the translation impact of a strong dollar on overseas sales which constitute 53% of Donaldson’s total. Earnings per share were reduced by 2¢ or 6% by accelerating the full year expected stock option expense. Nonetheless, demand for Donaldson filters remains robust. The company’s order backlog increased to $459 million, up 6% compared to three months ago and up 10% from a year earlier. Donaldson’s PowerCore filters were adopted on six additional product platforms during the quarter, bringing the total to 53 with 29 in production. The company has a 90% win rate with PowerCore. There are an additional 60 platforms currently out for bid. PowerCore sales rose 54% during the quarter but remain less than 5% of total company sales. DCI stock is up 5% this year.

Caterpillar Inc.

Caterpillar’s fourth quarter and full year revenues rose 13% and 20% respectively while earnings per share for the same periods increased 56% and 40% respectively. With a growing backlog, continued strong global demand and higher prices for CAT machinery and engines, the company has forecast a 10% sales gain and 15 to 24% earnings per share growth in 2006. CAT is experiencing strong demand for mining, road construction, infrastructure, non-residential construction equipment and petroleum production, marine and truck diesel engines. The company is working to meet increased demand without adding to its long-term fixed cost base. CAT stock is up 25% year-to-date.

Varian Medical Systems, Inc.

Varian Medical Systems reported its strongest first fiscal quarter since becoming a public company in April 1999. All divisions contributed to a 12% increase in revenues to $334 million, a 20% increase in net orders to $402 million and a 3% increase in earnings per share of 30¢. Oncology Systems’ net orders rose 18% with orders up 15% in North America and 21% in international markets. Revenues for X-ray Products also rose 18%, driven by increased demand for the company’s flat panel-displays that provide filmless X-ray images for veterinary, dental and medical markets. Varian also reported that first quarter net orders for its security and industrial x-ray sources almost tripled because of strong global demand for cargo screening and border protection. Varian’s strong quarterly performance lifted its stock price to an all-time high of $61.70 on January 26. The stock price has pulled back from the high to a 10% gain since the beginning of the year. It has fallen back because lower reimbursement rates for advanced radiation oncology treatments have rekindled fund managers’ fear that Varian cannot maintain strong growth in its North American markets.

Walgreen Company

Walgreens reported first quarter 2006 earnings per share of 34¢, a 10% increase from the first quarter of 2005, not including one-time charges. Revenues for the first quarter rose 10% to $10.9 billion. Prescription sales rose 8% in stores open more than one year, while sales of non-prescription goods rose 6%. The company opened its 5,000th store in Richmond, VA in October 2005. Walgreens acquired Schrafft’s Specialty Pharmacy, one of the top fertility drug providers and entered into a joint venture with SeniorMed, an assisted living prescription business that allows the company to continue to fill prescriptions for its customers who move into assisted living facilities or nursing homes. The company expects the Medicare drug benefit to increase the traffic of senior citizens into its stores as a shift to co-pays from cash encourages them to fill more prescriptions and seek the convenience of drug stores. Walgreens’ stock price is up less than 4% since the beginning of the year.

Patterson Companies

Patterson Companies reported an 8% year-to-year increase in earnings to 39¢ per share for its fiscal quarter ending January 28. The company continues working to revive the growth of its profitable dental equipment distribution business where sales came within 1% of the quarterly volume a year ago when 30% growth was achieved. Meanwhile, the internal growth of dental consumable sales remained near a historically high 6% and Patterson’s veterinary distributor Webster, aided by successful implementation of a pharmaceutical distribution agreement with Pfizer, achieved record sales growth of 14%. During the quarter, Webster strengthened its product offering through the acquisition of IntraVet, a provider of digital x-ray software for veterinarians. The absence of any reacceleration of profit growth from dental equipment sales limited Patterson’s stock price gain to only 6% since the beginning of the year.

Stryker Corporation

Stryker continued its 25-year record of 20% earnings per share growth while investing heavily in research and development and its sales force. Earnings per share without one-time charges for the fourth quarter and the year rose 20% and 22% to 48¢ and $1.75 respectively. Revenues rose 13% and 14% in local currencies for the quarter and the year. With the exception of hip implants, Stryker’s Orthopedic Implant and MedSurg businesses reported double-digit revenue growth in local currencies for the year with 16% revenue growth in knee implants, 18% growth in Spine and more than 20% growth in the three MedSurg businesses, powered instruments, endoscopy and operating room equipment. Stryker remains optimistic about OP-1, its bone morphogenic protein, a biologic product that speeds bone growth. The company expects to file with the FDA by June 2006. Stryker’s stock price has risen 10% since the beginning of the year.

Biosite

Biosite, a leading producer of diagnostic tests for hospital emergency rooms, reported earnings per share of 73¢ for the fourth quarter and $2.92 for the year, increases of 7% and 21% respectively. Revenues grew 9% during the fourth quarter to $72.4 million and 2005 revenues rose 17% to $287.7 million. Biosite’s most important products, which are tests for B-type naturietic peptide (BNP) levels in the blood, accounted for two-thirds of 2005 revenues. High blood levels of BNP indicate reduced pumping capacity of the heart. Revenues for this test grew 17% in 2005 despite increased competition from the major diagnostics companies Roche, Abbott and Dade Behring. Beckman Coulter offers Biosite’s test to hospital laboratories and contributed 28% of the BNP revenues for the year. The Biosite and Beckman tests hold #1 and #2 market share positions. Though the market share for Biosite BNP test declined 4% during 2005 it still retains a commanding 67% share.

The company’s other tests, including panels for Cardiac function and Drugs of Abuse, grew strongly during the fourth quarter, contributing 53% of the revenue growth. Biosite plans to meet its 2006 revenue growth target with these products contributing about two-thirds of the growth. Early feedback from community hospitals in France indicates that the company’s stroke panel offers a diagnosis of stroke similar to the quality of an expert neurologist. Few community hospital emergency rooms have access to these specialists on a timely basis. Biosite expects to submit additional data requested by the FDA for this panel by the end of March. The company’s stock price has declined 7% since the beginning of the year.

Johnson & Johnson

Johnson & Johnson reported fourth quarter earnings of 73¢ per share 9% above comparable results a year ago, which amounts to the slowest quarterly earnings growth since 1993. Once again J&J drugs were beset by intense competition with generics diverting significant sales from three and Amgen successfully cutting into Procrit’s sales. Overall J&J’s pharmaceutical sales registered a 1% year-to-year decline in the fourth quarter. During 2005 pharmaceutical sales rose a mere 1% while medical device and diagnostic sales grew 13%.

J&J’s stock price dropped 6% during the ten trading days following its earnings announcement. In our opinion, the drop was precipitated not by the company’s mediocre earnings but instead by Boston Scientific trumping J&J’s $24.2 billion offer for Guidant with a bold victorious $27 billion bid. J&J formally conceded defeat the day after it released its earnings. During the public bidding contest, many analysts convinced themselves and their customers that J&J needed Guidant to accelerate the growth of its medical device businesses which have compensated for stalling pharmaceutical sales. As a consequence, many holders of J&J stock sold when their assumptions about Guidant’s prospective contribution were confounded. J&J’s decision to resist the temptation to overpay resonates with us. Now it finds itself in the enviable position of possessing $13.5 billion in cash equal to $4.50 per share. Since the beginning of the year J&J’s stock price has fallen 1%.

Merck & Company, Inc.

Merck reported fourth quarter and full year 2005 earnings per share of 64¢ and $2.53, not including non-recurring charges. Revenue growth for 2005 declined 4% to $22.0 billion. Full year revenues for the Merck Schering Plough joint venture cholesterol-lowering drugs were $2.4 billion with Vytorin, the Zetia/Zocor combination pill, achieving worldwide sales of $1.0 billion in its first full year on the market. Merck’s new products are moving towards the market with FDA approval of Rotateq, the company’s pediatric vaccine for rotavirus gastroenteritis, FDA acceptance of the HPV vaccine Gardasil for six month priority review and of Januvia, its once-daily drug for Type II diabetics that controls blood sugar levels without weight gain or other unpleasant side effects. Merck’s stock price has risen 10% since the beginning of the year. While Merck won its first Vioxx trial in Federal Court on February 17, opening arguments for two cases where the plaintiffs claim they had heart attacks after taking Vioxx for more than 18 months began in New Jersey on March 6. The company’s stock price probably will fluctuate in response to reports on the progress of trials where plaintiffs allege harm from using Vioxx for more than 18 months.

Pepsico

PepsiCo reported fourth quarter earnings per share of 65¢, 13% above the year ago quarter. Full year 2005 earnings per share rose 15% to $2.66, excluding non-recurring items in both years. Revenues for the quarter and the year rose 15% and 11% to $10.1 billion and $32.6 billion respectively. Quaker Foods North America, the company’s smallest and most profitable division, had its strongest year as a part of PepsiCo with demand for hot cereal products driving 2005 volumes up 7%, revenues up 10% and operating profit up 11%. The company invested half of its “innovation budget” in health and wellness products. Revenues from “SmartSpot” labeled products grew twice as fast as those from other products. 70% of PepsiCo’s beverages qualified for a SmartSpot label in 2005, up from 15% the year before. The company’s stock price has risen 2% since the beginning of the year, nevertheless, it reached a 12-month high of $60.55 on March 13.

Harte-Hanks, Inc.

Revenues at Harte-Hanks rose 9% and 10% for the fourth quarter and full year respectively. Earnings per share rose 19% and 21% respectively and operating cash flow was ahead by 9% and 14% respectively. Direct Marketing revenues rose 4% in the fourth quarter and operating cash flow gained 8%. Shoppers reported fourth quarter revenue growth of 16% and operating cash flow was up 6%. More than one-half of the Shopper revenue gains came from the Tampa Flyer acquisition. Harte-Hanks shares are up 7% since January 1.

Kronos, Inc.

We sold Kronos stock after the company reported an 18% decrease in earnings before including stock option expense for the quarter ending December 31, its fiscal first quarter. Reported per share earnings, after deducting 8¢ for stock option expenses, were 19¢ compared to 33¢ a year ago without any accrual for options. The stock barely declined on the news and we got a price, which was $2 above where it now trades and 2% below its price at year-end.

During the quarter Kronos’ new product sales fell 10% below the year ago level. Software license revenues declined 17%. Retailers constituted Kronos’ only growing customer segment while sales to hospitals, which we consider its most promising market, declined. Sales through ADP, which resells Kronos time and labor management software to small and mid-sized businesses, declined 25%! Remarkably, Kronos announced it intends to introduce a monthly subscription payment option for smaller customers which if successful would drain cash, whereas ADP pays a fee for the sales it makes. We conclude from the results that management’s reorganization of its sales force last year created lingering execution difficulties which may remain unresolved as management turns its attention to exploiting new found international opportunities including those it thinks exist in China.

Intel Corporation

Intel’s stock price has fallen 21% since the beginning of the year on news that demand for its microprocessors continues to be soft. Factors contributing to slower sales include excess inventory at PC manufacturers, primarily in Asia, and a point or two of share loss to competitor AMD. While Intel successfully launched and shipped over one million dual core microprocessors built with 65 nanometer technology during the fourth quarter, chipset supply for desktops remained tighter than expected and constrained desktop microprocessor sales. Every microprocessor is sold with a chipset that allows the microprocessor to access memory and to communicate with other parts of the computer. The company reported fourth quarter and 2005 earnings per share of 40¢ and $1.40, increases of 25% and 15% over the same periods last year. Revenues for the quarter rose 6% to $10.2 billion, while revenues for the full year increased 13% to $38.4 billion. This stock should be held.

Microsoft Corporation

Microsoft reported second quarter earnings per share of 33¢ and revenues of $11.8 billion, increases of 3% and 9% respectively. Six of the seven business units contributed to operating income of $4.7 billion this quarter. Strong sales of Dynamic CRM 3.0, customer relationship management software for small businesses, lifted revenues for Microsoft Business Solutions 17% over last year’s second quarter. Dramatic increases in Windows Mobile licenses for smart phones and embedded Windows operating systems for a wide range of smart devices such as point of sale devices drove revenues for Mobile and Embedded Devices up 40%. Both business units posted positive operating profits for the first time, a sign that they are on-track to achieve full year profitability in fiscal year 2007. Microsoft’s share price has risen 4% since the beginning of the year, but continues to fluctuate between $24 and $28 per share.

Client portfolio holdings may change, and stocks of companies noted may or may not be held by one or more client portfolios from time to time. Investors should not consider references to individual securities as an endorsement or recommendation to purchase or sell such securities. Transactions in such securities may be made which seemingly contradict the references to them for a variety of reasons, including but not limited to, liquidity to meet redemptions or overall client portfolio rebalancing. Investing in the stock market involves gains and losses and may not be suitable for all investors. Investment return and principal value of an investment will fluctuate.

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2006 – 1st Quarter EARNINGS LETTER 2005 – 3rd Quarter EARNINGS LETTER