EARNINGS LETTER

1st Quarter, 2006

Although your companies’ first quarter earnings were good in almost every instance, only the few reporting year to year gains greater than 20% experienced any appreciation in their stock prices over the past two months. The absence of an upturn in stock prices in response to earnings that in normal times would lift stocks, might be interpreted as evidence that institutional fund managers, whose trading activity determines short-term stock prices, have concluded that business profits are not going to get any better. If our reading is correct, the pessimistic conclusions drawn from the earnings reports are influenced greatly by movements in metal and oil prices which have shown evidence of decelerating momentum. Seemingly in consonance with a lack of market confirmation of a continuing ascent in commodity prices, few companies, including many reporting better than 20% earning gains for the quarter, are willing to raise their earnings forecasts for the remainder of the year.

Trend reversals in commodity and stock prices, here and abroad, belie widely held views which until weeks ago had driven prices higher. Asset allocation decisions based on macro-economic perceptions invariably incorporating interest rate, foreign currency, and commodity price predictions dominate most institutional portfolio managers trading. Recent price fluctuations seemingly contravene the assumptions underlying widely held beliefs in the sustainability of the current global economic expansion. We think our stock-market may pause while fund managers recalibrate their forecasts. A change in the direction of stock prices in itself does not falsify or validate any economic forecasts. As Benjamin Graham eloquently said, “The stock market is a voting machine, not a weighing machine.” We know voters are not prescient.

The capable business managers running the prosaic operations of the companies we own tell us business is good, but difficult. Government regulations are ever more burdensome. We expect however that the managers of these good businesses can adapt more skillfully than their competitors as economic conditions replace yesterday’s problems with new ones. During the current market decline we intend to buy shares in these companies, and others like them, when they sell at our prices.

State Street Corporation

State Street’s stock price leapt 7.5% to $65 immediately after the company reported exceptionally strong first quarter earnings of 84¢ per share, 25% higher than last year’s results. During the quarter all of the company’s operations achieved substantial revenue gains above the levels attained during the comparable year ago quarter. Asset servicing revenues, which constitute half of State Street’s fee revenues, were 10% higher as assets under custody increased 12.5% to $10.7 trillion. Investment management fees grew 24% while trading service revenues, which include the spread earned on foreign exchange executions for customers, increased 38%. Even net interest income registered the first significant increase in years rising 24%, although management cautioned analysts against extrapolating comparable improvements into estimates for future quarters while interest rates continue rising. Importantly, State Street’s management once again delivered positive operating leverage by containing expense growth to 13% while total revenues advanced 16%. During the quarter, European revenues grew almost three times faster than State Street’s less profitable US revenues. Despite the impetus given by its strong earnings State Street’s stock price by mid-May fell back to only 3% higher than its mid-March price before it reported its quarterly results.

Chicago Mercantile Exchange

Average daily volume at the Chicago Merc reached a record 5.0 million contracts during the first quarter, a 26% increase from a year ago, led by a 30% increase in interest rate contracts and a 38% increase in foreign exchange contracts. Revenues rose 23% to $263 million while earnings per share rose 28% to $2.61. CME shares have risen 6% from mid-March to mid-May.

CME announced two important agreements after the end of the first quarter. In April, the Chicago Merc reached an exclusive agreement with NYMEX to trade energy contracts on GLOBEX, the CME’s electronic trade matching platform, beginning June 12. This agreement will allow side by side trading of crude oil, natural gas, heating oil and gasoline with NYMEX’s pit traded contracts. This deal will augment CME’s growth beginning the second half of 2006. In May, the CME announced a joint venture with Reuters to create the first centrally cleared global FX market place. The joint venture, aimed at garnering a piece of the $2 trillion a day over-the-counter foreign exchange market will require each company to contribute $45 million to fund the venture to profitability, anticipated in 2008. CME will provide clearing and GLOBEX trade matching services to the joint venture. By offering anonymity, central counter-party clearing and electronic execution, the venture will attract hedge funds as initial customers. Break-even is forecast after capturing just 2% of the OTC market.

Express Scripts, Inc.

Growth in generic drug usage, mail prescriptions and specialty drugs along with lower drug purchasing costs lifted Express Scripts’ first quarter earnings to 70¢ per share, 26% above last year’s results. Quarterly revenues increased 16% because the successful integration of the Priority Healthcare acquisition added $550 million of specialty sales bringing total sales up to $4.4 billion. The leading specialty drugs distributed by Express directly to physicians or patients treat cancerous tumors, hepatitis C, infertility, multiple sclerosis and psoriasis. Since the acquisition the company has added 813 new customers bringing penetration of specialty services up to 42% of Express’ health plan customers.

Express’ pharmacy benefit management business which produces 80% of company revenues experienced a 7% year to year revenue decline during the quarter caused by the growth of generic drug usage from 53.7% of prescriptions filled to 56.3%. Express’ pharmacy benefit formulary management encourages generic usage because the plans it administers save 1% in cost for every 1% shift to generic drugs from branded prescription drugs. Because the terms of many plan contracts require booking drug costs in Express’ sales figures, higher generic usage diminishes reported revenues. Lower PBM sales ignited a sell off in Express stock which has left the stock price 18% below where it was selling in mid-March. The stock currently sells below our valuation even though its pervasive focus on execution gives it the strength to improve profitability in all three of its operating divisions while providing customers greater value. It is well positioned to profit from patent expirations on $10 billion of branded drug sales in each of the next four years.

First Data Corporation

First Data’s first quarter revenues of $2.7 billion and earnings per share of 48¢ were up 10% and 7% respectively. Western Union generated 16% revenue growth to $1.06 billion while operating profit rose 13% to $337 million. First Data’s remaining businesses generated 7% revenue growth and double-digit growth in operating profit. These good results were led by Merchant and International which improved profit by 24% and 35% respectively while Card struggled with a 4% decline in profit. The spin-off of Western Union is expected early in the fourth quarter of 2006. FDC stock has slid 4.6% since mid-March, cutting its year-to-date gain to 6.5%.

Automatic Data Processing

ADP’s fiscal third quarter revenues of $2.4 billion were 10% higher than a year earlier while comparable earnings per share of 61¢ rose 24%. These strong results were underpinned by a pick up in pays per control, the number of employees on each client’s payroll, to 2.7%, the highest rate in five years. The increase in profitability during the quarter came entirely from the company’s payroll and human resources management businesses and from the 33% increase in interest earned on funds held for payroll clients. Brokerage reported a slight profit decline and Dealer profit was flat during the quarter. Investors chose to focus on the weak results at these two business units which generate 18% of ADP’s profit driving the stock down 6% since mid-March. ADP has $2 billion in cash before receipt of $760 million after-tax in April from the sale of its Claims processing business. We look forward to Gary Butler’s elevation to the CEO position scheduled after the end of ADP’s June 30 fiscal year.

Amdocs

Amdocs reported eleven key sales wins during the second quarter of fiscal year 2006, up from the typical seven to nine. The company reported two wins in the cable industry. In addition, a large directory publisher chose Amdocs’ technology to support its move into digital advertising. Amdocs strengthened its position in the growing digital commerce market with the announced acquisition of QPass for $275 million in cash. QPass is a privately-held company that helps both content and service providers make money from the sale of digital content. The market for mobile content is expected to grow from $15 billion today to nearly $70 billion in 2009. Amdocs reported second quarter revenues of $601 million and earnings per share of 38¢, 23% and 12% above the comparable period last year. After reaching a new high of $39.15 on May 5, Amdoc’s stock price has drifted down to $38, 10% higher than the price in mid-March.

C.H. Robinson Worldwide Inc.

Gross revenues at CH Robinson which include the cost of third-party transportation rose 23% to $1.5 billion, while net revenues rose 28% to $255 million during the first quarter. Earnings per share of 33¢ surged 38% from a year ago as Robinson continues to deliver the operating leverage inherent in its business model. Robinson’s core trucking business continued to deliver mid-teens volume growth with high single digit pricing. The price component, which quickly adjusts to even slight fluctuations in supply and demand as well as permissible fuel cost surcharges, is down slightly from the double-digit rate realized during the fourth quarter of last year. Sourcing and international freight forwarding growth of 33% and 55% respectively were driven by double-digit gains from existing customers augmented by acquisitions. Robinson’s share price has declined 11% from the high of $52.50 reached on April 12, bringing it back to its mid-March price.

Donaldson Company, Inc.

Donaldson reports their fiscal third quarter earnings ending April 30 on May 25. On May 15, Donaldson announced that they have been selected the exclusive U.S. supplier of medium-duty exhaust and emissions devices starting in 2007 for DaimlerChrysler, maker of Detroit Diesel and Mercedes Benz engines. EPA regulations call for a 90% reduction in diesel particulate emissions beginning July 2007. Donaldson’s stock price is down 3% since mid-March.

Caterpillar Inc.

Caterpillar’s revenues of $9.4 billion rose $1.0 billion or 13% while management held operating expense growth to $591 million, yielding operating profit of $1.2 billion, up 61%! Earnings per share of $1.20 climbed 48%. Materials costs were flat during the quarter after rising during the past two years, while price increases implemented during this two year period were fully realized. Demand for CAT’s products remains strong especially from customers in global mining, infrastructure construction, oil and gas, and energy. CAT is on track to report full year revenues of $40 billion and earnings per share of $5.00. CAT’s stock price has risen 4% since the middle of March.

Varian Medical Systems, Inc.

Varian Medical Systems reported fiscal second quarter revenues of $414 million, 18% higher than a year ago. Earnings per share of 41¢ after stock option expense amounting to 5¢ per share reduced the reportable earnings gain to 5% from 18% otherwise. Customer demand for the company’s new products remains strong lifting oncology orders in North America 20% and 2% in international markets. A weak euro and exceptionally strong sales in Asia last year lowered international order growth for the quarter. More than 50 top-of-the-line Trilogy systems have been installed since its launch two years ago. Hospitals see the opportunity to have a versatile machine for radiation therapy that can also capture extra income from radiosurgery procedures that treat patients with brain or spine metastases in house instead of sending them to other clinics. Revenues from the flat-panel digital image detectors nearly doubled during the quarter. The company expects sales of this 50% gross margin product to reach $50 million in fiscal year 2006. Varian’s stock price has been caught in a downdraft since its high of $61.70 in January. Since mid-March Varian’s stock price is down 12.5%.

Walgreen Company

Walgreens reported second quarter earnings per share of 51¢, an increase of 9% over the last year’s results. Revenues for the quarter rose 10.7% to $12.2 billion with total sales in comparable stores, those open more than one year, up 6.5%. The company continues to increase its share of prescriptions filled in retail outlets. Prescriptions filled in Walgreens’ stores rose 6.3% during the quarter, compared with growth of 2.1% for the industry as a whole. Digital photofinishing continues its strong growth as customers upload their digital photos to Walgreens’ website and can then obtain digital photo prints one-hour later from any of the company’s 5,100 stores. Walgreen’s shares have fallen 10% since the middle of March.

Patterson Companies, Inc.

Patterson’s fiscal fourth quarter earnings scheduled for release at the end of this week should mark an end to a string of three sub-par quarters of single digit earnings growth and a resumption of 10% plus growth. Management from the beginning of this doleful period consistently said that they slowed sales and profit growth by mistakenly changing the compensation goals for dental branch managers and sales representatives from a straightforward formula focusing on maximizing returns on operating assets, to a more complicated one. After struggling last year to introduce incentives without scrapping the new compensation scheme, management, on January 1, reinstated the old formula. Slowing equipment sales, which constitute 30% of Patterson’s dental sales, likewise are viewed by management as self-inflicted and not the result of disruptions caused by Danaher’s acquisition of some Patterson suppliers nor competition from other distributors such as Henry Schein. Patterson’s stock over the two months since mid-March is unchanged at $35.

Stryker Corporation

Stryker reported first quarter net sales and earnings per share of $1.3 billion and 49¢, increases of 9.8% and 20% respectively over the first quarter of 2005. Worldwide sales of orthopedic implants increased 10.6% in local currencies during the quarter with continued strong growth in the knee, spine and trauma businesses. Higher than forecast shipments of powered operating room instruments and strong international sales contributed to 16.6% revenue growth in local currencies for Stryker’s MedSurg business during the quarter. International customers account for 35% of Stryker’s sales with European and Japanese customers providing 18% and 8% respectively of total company sales. On March 20 Stryker announced the acquisition of Sightline, a privately-held Israeli company that makes flexible endoscopes for the gastrointestinal and other surgeries. Stryker has seen the data from the pivotal U.S. clinical trial for OP-1, its biologic bone growth product, and is pleased with the clinical efficacy and the safety of the product. Stryker’s stock price is down 12% since the middle of March.

Biosite Incorporated

Biosite’s first quarter revenues rose 10% to $79.3 million. Earnings per share for the quarter were 68¢ after expensing employee stock option costs. Excluding this expense, which is real but not accounted for in last year’s earnings statement, operating earnings increased 21%. Sales of Biosite’s principal product, its BNP test for diagnosing congestive heart failure, rose 5.6% year- to-year. Strong orders for the BNP test on Beckman Coulter’s immunoassay systems lifted central laboratory sales 68% above last year’s volumes. The success with Beckman combined with a 32% rise in sales to physician office labs and stable emergency room volumes enabled Biosite to retain its 67% overall share of this test market despite competition from large diagnostic companies. Quarterly sales of other cardiac tests rose 50% above last year’s levels and are on track to contribute almost $50 million to 2006 revenues.

On May 10 Biosite announced that FDA requests for data would delay approval of its stroke panel measuring multiple biomarkers to quickly test for stroke until a new clinical study is completed. This postponement caused the company on May 17 to withdraw its US application for this promising test which is used in hospital emergency centers in France, Belgium and Germany. The FDA failure to approve the stroke panel removes a likely catalyst for a quick rebound in the stock price. The stock price dropped 13% on this disappointing regulatory setback. As a consequence, Biosite stock is down 10% over the two months since mid-March.

Johnson & Johnson

Johnson & Johnson’s stock price, which has fluctuated narrowly over the two months since March 15, was unaffected by its first quarter earnings report. The lackluster results met management’s forecast. Earnings of 99¢ per share rose 5% above last year’s first quarter results while adverse foreign currency translation of the 44% of J&J sales derived from international markets reduced quarterly sales growth to a measly 1.2%. J&J’s fastest growing businesses, its medical devices and diagnostic group, obtains 50% of its sales from international markets. This group includes Cordis, which during the quarter increased its worldwide share of drug eluting stent sales to 51%, regaining its position as the leading supplier from Boston Scientific. The latter is expected by several prominent analysts to regain the lead in stent sales with the aid of devices supplied by Guidant which was acquired in a publicized bidding contest with J&J. Guidant’s products currently are ensnarled in FDA regulatory compliance proceedings. Foreign exchange translation also deflated sales and earnings from J&J’s predictably profitable consumer divisions which obtain 52% of its sales from international markets. During the first quarter, J&J strengthened its rapidly growing skin care business by acquiring a privately owned French marketer of wound, baby and child care products. J&J’s pharmaceutical sales continue to languish, dropping 2.2% during the quarter. At the end of the first quarter, J&J’s net cash exceeded $14.5 billion.

Merck & Company, Inc.

Merck reported first quarter earnings per share of 78¢, not including restructuring charges. Revenues for the quarter were $5.4 billion. U.S. sales of Zocor grew 13% over the same period last year as a result of overall growth in the statin market and managed care initiatives to encourage Zocor use before the drug loses patent exclusivity in June.

On May 18 the FDA’s Vaccines and Related Biological Products Advisory Committee voted unanimously that the “data from Phase II and Phase III clinical trials support the efficacy and safety of Gardasil for the prevention of cervical cancer and cervical, vulvar and vaginal pre-cancers, caused by the human papillomavirus.” June 8 is the scheduled date for FDA review of Merck’s Biologics License Application for the vaccine. Because publicized scares about infections arising from vaccinations have frightened many parents from allowing their children to receive vaccinations, initial sales estimates for Gardasil are tentative and low, at $500 million in 2007 if the cost per treatment regimen is $300 for the three required injections. Even if the uptake is slow, annual worldwide sales of this cancer preventing vaccine should surpass $2 billion within three years. News about this scientific breakthrough from Merck’s laboratories however is overshadowed by punishing news from the courtrooms in New Jersey and Texas where Merck has lost Vioxx liability suits reviving investor worries about the eventual litigation costs. Remarkably Merck’s stock price is undamaged and down only 1% since mid-March.

PepsiCo, Inc.

During the first quarter PepsiCo achieved sales and profit growth in all its divisions and in almost all its geographic markets. Volumes of “better-for-you” snacks in the U.S. and non-carbonated drinks worldwide grew at least 30% over the comparable period last year. PepsiCo reported first quarter revenue growth of 9% to $7.2 billion and earnings per share growth of 13% to 60¢. Division operating profit rose 8% as productivity improvements and disciplined pricing actions offset increased energy, orange and cooking oil costs. PepsiCo’s stock price is even with its price on March 15.

Harte-Hanks, Inc.

Harte-Hanks’ revenues of $278 million rose 4%, while earnings per share of 29¢ were flat versus a year ago when the company’s earnings surged 38%. That extraordinary increase came as Harte-Hanks executed a large, global and complex one-time project for a significant technology customer. As a result, the company’s technology vertical in Direct Marketing declined more than 20% this quarter, dragging total Direct Marketing revenues down 3%. The pharma/healthcare vertical grew more than 20% while the important retail business was up in the low single digits. Financial was down more than 10%. Shoppers’ revenues rose 16% while operating cash flow rose 7%. Harte-Hanks purchased 0.8 million shares of common stock during the first quarter and has purchased 44.4 million shares under its repurchase program since January 1997. At the end of the first quarter there were 83.0 million diluted shares outstanding, 4% lower than a year ago. Harte-Hanks’ stock is down 3% during the past two months.

Intuit Inc.

Intuit’s fiscal third quarter ending April 30 includes the important tax season for its consumer software franchise, Turbo Tax and its professional tax software sold to accountants. During the quarter, total revenues rose 14% to $953 million and cash earnings per share rose 16% to $1.79. Intuit’s GAAP earnings per share of $1.68 reflects 10¢ of stock option expense. During the quarter Turbo Tax revenue rose 19% to $499 million reflecting a 20% overall increase in Federal Income Tax software units driven by growth on the web of 58%. Turbo Tax garnered a 79% unit market share and 85% dollar market share of the consumer tax software market. Professional tax revenue was up 5% to $105 million.

QuickBooks related revenue was up 8% to $212 million. Intuit maintained its 90% unit share and 92% dollar share of the small business accounting software market even as Microsoft introduced their small business accounting software product which has garnered less than 5% of the market. During the quarter, Intuit added 11,000 new Merchant services clients and 9,000 new payroll clients. These add-on services generate recurring revenues and improve client retention and profitability. Intuit stock closed at $53.21 on May 15. We remain buyers of the stock at this price. Intuit approved a two-for-one stock split payable July 6, 2006.

Intel Corporation

Intel’s first quarter earnings were disappointing. Compared to the quarter a year ago, revenues of $8.9 billion were 5% lower while net income of 23¢ per share including option expense and the benefit of a lower tax rate fell 34%. Except for Japan, Intel revenues declined in all its markets worldwide. Intel’s management forecasts another drop in revenues of as much as 10% sequentially and further profit deterioration. The predicted sales and profit declines are attributed to customers’ excess inventories of micro-processors caused by slowing PC sales growth which will depress sales and prices for Intel’s existing microprocessors. This slowdown comes just as Intel launches new high performance microprocessors for servers in June, desktop PC’s in July and laptops in August. Despite poor results and a dismal profit forecast, Intel’s stock price registered a decline of only 3% between mid-March and mid-May which perhaps indicates institutional investors’ confidence that once again, Intel will revive its sales growth by skillfully managing the introduction of new high performance microprocessors. Optimism about this possibility dimmed on May 19 when Dell announced it no longer would rely solely on Intel multi-core processors in its high end servers. The news knocked an additional 5% off Intel’s stock price. The gloom engulfing Intel’s stock as the work of its proven managers to reinvigorate its products comes to light provides ample reason for continuing to own the stock.

Microsoft Corporation

Microsoft’s share price dropped 15% following its inexplicable announcement that the company would invest an additional $2 billion in its Internet search and web-based Windows and Office subscription services in fiscal year 2007. This news surprised the investment community which expected more than 15% earnings per share growth from a strong new product launch cycle. Third quarter revenues rose 13% to $10.9 billion and earnings per share grew 10% to 31¢, not including legal fees, in both 2005 and 2006. Microsoft continues to see strong demand for its new products such as XBOX 360, and the new version of its database program SQL Server 2005. Expenses were higher than forecast because of higher XBOX 360 product costs and accelerated execution of the company’s services and marketing strategies. Microsoft should provide more clarity about its investment plans for fiscal year 2007 at its analyst meeting at the end of July. We intend to maintain our current holdings until we have a clearer picture of their investment strategy.

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 – 2nd Quarter EARNINGS LETTER 2005 – 4th Quarter EARNINGS LETTER