EARNINGS LETTER

2nd Quarter, 2006

Tepid investor response to the vigorous double-digit earnings growth achieved by most of your companies might be interpreted as a stock market prediction of our economy having reached the peak in this current upturn in the business cycle. Only those companies specifically raising their revenue and earnings forecasts got any responsive rise in their stock prices, and some with robust forecasts found their stock prices going lower. We are not among those who believe that the stock market reliably predicts the course of our economy. If, as Ben Graham succinctly stated, “the stock market is a voting machine not a weighing machine,” then it cannot be an economic barometer.

We think that institutional traders’ avid pursuit of short-term returns through rapid portfolio turnover determines the short-term direction of stock prices. Were this not so, momentum investing or its sophisticated variant, technical analysis, would not work. The traders’ axiom “the trend is your friend” would contain no truth.

The presence of numerous well-funded skillful traders intent on extracting above average returns by anticipating trend reversals in publicly traded stocks, often grouped by sector or statistical correlations, is increasing the use of computer analyses of the directional movement of consensus earnings estimates. If actual earnings merely confirm the trend of existing estimates, then the earnings number itself is emptied of impact. This helps explain why above trend earnings without an accompanying change in the relevant forecasts results in little immediate price appreciation. High quarterly earnings then are dismissed as statistical outliers. In computer trading strategies consensus estimates can exert more influence than the most recent actual earnings number in setting the trend. Use of these statistically based strategies increases the probability that some of the stocks of companies we own, or wish to own, will be sold by aggressive traders, not just because the consensus estimates for their earnings may start to eek down. It is more likely to occur because past price movements of our stocks might correlate with those of companies vulnerable to earnings disappointments and hence, their stocks will fall even if their earnings remain on-trend.

If that happens and our valuation work is valid, we will benefit just as we may if we more readily sell when our stocks move to prices 50% above our valuations. Traders’ interest in profiting from future trend reversals does not constitute an economic forecast. They are doing what they always have done, looking for short-term gains, albeit with more sophisticated tools.

State Street Corporation

State Street’s stock’s sluggish response to the company’s exceptionally strong second quarter results has left it 4% below its mid-May price. Operating earnings of 93¢ per share were 41% above the 66¢ earned in last year’s second quarter. During the quarter State Street booked a non-cash accrual of 25¢ per share to reflect newly legislated changes in the accounting for leveraged leases. We think management’s reluctance to raise its earnings forecast after achieving strong results for two successive quarters quelled institutional investors’ inclination toward any enthusiastic buying.

Revenues for the quarter rose 21% above a year ago to a record $1.65 billion, while management held expense growth to 14%. All the company’s operating divisions achieved substantial revenue gains during the quarter. Total fee revenue rose 20% above the amount earned a year ago and 9% above the first quarter amount. Fee revenue benefited from a 7% rise in assets under custody to $10.9 trillion since the beginning of the year. It includes a 14% increase in assets held for customers outside the U.S. where State Street earns twice the profit it does on its U.S. custody business. These non-U.S. customers help drive State Street’s foreign exchange revenues, which were 62% higher than in last year’s quarter and 16% above the first quarter. When management reported earnings, it stated that it had completed the repositioning of State Street’s securities portfolio which produced net interest income 20% higher than a year ago. The Fed’s pause in raising short-term interest rates benefits State Street slightly.

Chicago Mercantile Exchange

Average daily volume of futures and options contracts traded during the second quarter at the Chicago Mercantile Exchange reached a record 5.7 million, 31% higher than in the same period a year ago. Interest rate contracts, comprising 57% of total volume during the quarter, rose 26%, while equity and foreign exchange contracts surged 35% and 42% respectively. The overall rate per contract declined 2¢ from a year ago to 63¢. This figure, representing a 3% year over year decline, typically preoccupies analysts’ blinkered focus. The lower rate, however, is the result of strong volume increases, as active traders reach volume-based discounted price tiers. These lower prices for the most active traders boost market liquidity and generate incremental profit for the CME.

Total revenues earned by the exchange increased 23.5% to $295 million while expenses rose only 12.1% to $115 million, resulting in a 32% increase in earnings per share to $3.12. During June, the CME began providing Globex electronic trade matching services for cash settled energy contracts traded after hours on NYMEX. On August 7, CME began trading physically delivered energy products traded during non-floor hours and will begin trading these contracts during floor hours on September 5. Energy contracts account for 7% of all futures and options contracts traded worldwide. CME shares were added to the S&P 500 Index on August 10. CME is up 2% since mid-May and up 26% since the start of the year.

Express Scripts, Inc.

Express Scripts reported second quarter earnings of 75¢ per share, 25% higher than the 60¢ earned in last year’s comparable quarter. Earnings per share benefited from the repurchase of 9.5 million shares during the quarter at an average price of $74.49, which reduced fully diluted shares outstanding by 4.7%. An 18% year-to-year increase in quarterly pre-tax operating profit confirms the improved profitability resulting from Express’ focus on persuading health plan customers to adopt its step therapy programs which reduce drug costs without compromising outcomes by increasing generic usage. During this year’s second quarter, generics rose to 56.3% of total prescriptions from 53.9% in the same period last year. Greater use of low cost generics caused nearly a 2% year-to-year decline in Express’ pharmacy benefit revenues because drug costs are included in revenues. Greater use of generics and Express’ decision to not renew its contracts with Georgia’s Medicaid plan and AARP’s senior drug discount card, neither of which are interested in step therapy, decreased rebates payable to branded drug manufacturers and pharmacy claims payable. Reduction in these payables resulted in a $54 million net use of cash in the quarter. Express’ decision to effectively implement the substitution of generics for branded drugs means it foregoes the use of cash provided by payables for an opportunity to increase profits on its favorable generic pricing. It is working. The cash profit Express earns per claim increased 42% in the quarter to $1.69 from $1.19 a year ago. Along with its report of strong earnings, Express’ management raised its earnings forecast for the year to a range of $3.16 to $3.28 per share, which lifted the stock price 11% above its price in mid-May.

Automatic Data Processing

ADP’s fiscal fourth quarter results were overshadowed by the announcement to spin-off the Brokerage Services division and return excess cash to shareholders by expanding their share buy-back and substantially increasing the dividend. Separation into two independent publicly traded companies will enable each management team to focus on different strategies for building shareholder value. The spin-off will boost the growth rate of ADP which will be dominated by its highly profitable Employer Services business, and will allow the Brokerage company to pursue an acquisition strategy in its Securities and Clearing Outsourcing business. The new shares of the yet-to-be named Brokerage company will be distributed in March or April 2007, after SEC and IRS rulings. We applaud these initiatives designed to boost shareholder value instituted by the incoming CEO Gary Butler.

ADP reported fiscal fourth quarter and full year revenue growth of 14% and 11% respectively, while comparable earnings per share rose 19% and 25% respectively. ADP shares have risen 5% since the announcement and are up 7% since mid-May.

First Data Corporation

First Data’s revenues of $2.9 billion and earnings per share of 55¢ each rose 10% from the year ago period. Western Union’s revenues rose 15% to $1.1 billion, but operating profit was up only 9%, causing FDC stock to fall 5% on the day the earnings were announced. Company management indicated that Western Union’s results were adversely affected by our immigrant population’s reaction to politicians’ punitive legislative proposals aimed at illegal immigrants. Money transfers from the U.S. to Mexico, which generate 7% of Western Union revenues slowed from 20% growth in the first quarter to 7% in the second quarter. The domestic money transfer business, generating approximately one-fifth of Western Union revenues, also slowed from 5% growth in the first quarter to zero in the second. International money transfer growth remained strong, rising 24%. Western Union money transfer agent locations reached 280 thousand, up 20%. The spin-off of Western Union remains on track for late September or October 2006.

First Data’s Merchant Services business generated $1 billion in quarterly revenues, up 11% with operating profit rising 12%. Total domestic merchant transactions processed reached 12.2 billion, up 13%. Financial Institution Services, formerly known as Card Issuer Services, reported revenue and profit declines of 6% and 8% respectively, reflecting the loss of three significant clients in 2005. The international processing business generated revenue and profit growth of 41% and 43% respectively.

Amdocs

Amdocs reported respective fiscal third quarter revenue and earnings increases of 23% and 17% over the comparable year ago periods. Importantly, operating free cash flow amounted to 70% of fully diluted earnings of $1.16 for the past nine months. During the quarter Amdocs secured eleven new contracts, including one from Telstra, a leading Australian telecom provider that has embarked on a $7 billion capital spending program to upgrade and integrate its wireline, wireless, broadband, data and directory services. It engaged Amdocs to provide business and support services to enable it to rapidly deploy new services which offer customers flexible service choices and provide combined billing.

In conjunction with the earnings release Amdocs management announced their revenue and earnings forecasts for the fiscal fourth quarter and the coming fiscal year. While the quarterly figures confirmed previously available numbers, the forecast that 2007 revenues would exceed $2.9 billion with fully diluted earnings surpassing $1.90 per share were better than most analysts envisioned. Amdocs stock price jumped 7% immediately after the announcement The rally soon was dampened by concern about the effect of the Hezbollah-instigated war on the 34% of Amdocs’ software and information technology employees who work in Israel. The current stock price is 3% lower than in mid-May.

C.H. Robinson Worldwide Inc.

Once again, CH Robinson reported excellent quarterly results as earnings per share rose 36% to 38¢ per share on net revenue growth of 26% to $271 million. Robinson’s core trucking business, which generates three-quarters of its revenue, rose 24%. Consistent with the first quarter, volume additions from new and existing customers generated 15% of the revenue gain while higher prices boosted revenue by 9%. Fuel costs accounted for one-half of the price increase, while tight industry capacity caused by strong customer demand and driver shortages resulted in the rest of the increase. Robinson continues to find new capacity from small and mid-size truckers and passes along price increases to its customers. Robinson’s Sourcing business, T-Check information services and Global forwarding expanded 14%, 17% and 53% respectively during the quarter. On May 18, 2006, Robinson purchased Payne, Lynch & Associates, a non-asset based, third party logistics company based in Minnesota which specializes in flat-bed freight brokerage, providing Robinson with a stronger capability in this growing market segment. Robinson stock is up 3% since mid-May, and is up 26% since the start of the year.

Donaldson Company, Inc.

Donaldson’s fiscal third quarter earning per share of 43¢ rose 19% as revenues reached $430 million, up 7.6% in constant currencies. Donaldson expanded its operating margin through company-wide cost reduction and process improvement initiatives. Engine filter product sales rose 6% during the quarter, while Industrial filter products increased just 2% due to a 7% decline in shipments of gas turbine filters. The company’s total open order backlog at the end of the quarter was $493 million, 19% higher than a year ago. Donaldson continues to reduce shares outstanding 2% annually through share buybacks. It purchased 745,900 shares for $25 million during the quarter. Demand remains strong for products that use Donaldson filters in construction and mining equipment, truck engines, gas turbines and disk drives. Donaldson shares are up 4% since mid-May.

Caterpillar Inc.

Caterpillar’s second quarter revenues of $10.6 billion rose 13% while earnings per share surged 41% to $1.52. Based on the strong first half results, CAT management boosted their outlook for the full year to revenue growth of between 12 to 15% and earnings per share growth of between 30 to 36%. CAT stock did not move higher after the results were announced, though it has gained 18% since the start of the year. During the quarter, machinery sales gained 14% while operating profit rose 46% and Engine sales gained 12% while operating profit surged 64%. Profit from financing CAT products increased 11%. CAT continues to experience strong demand throughout the world, especially in energy, mining and infrastructure development.

Varian Medical Systems, Inc.

Varian Medical Systems’ fiscal third quarter diluted earnings increased to 46¢ a share 12% and 24% above the respective amounts earned in the prior quarter and the comparable period last year. Year to year revenues increased 14% to $396 million. Oncology systems provided 83% of revenue. During the quarter net orders for oncology systems and x-ray products rose 19% to $443 million. Half these orders came from international customers. In the US, Varian is experiencing strong demand for its on-board imager which permits ultra precise control of the radiation beam to tolerances of less than half a centimeter. Along with the earnings report, Varian’s management raised its forecast earnings growth for fiscal 2006 to 18%. The stock price is up 24% since the earnings announcement which has brought it to 7% above its price in mid-May.

Walgreen Company

Walgreens’ fiscal third quarter diluted earnings per share were 46¢, 14% above earnings for the same period last year. Revenues, which increased 12% to $12.2 billion, were boosted by a 13.5% increase in prescription sales even though a greater volume of generic drugs dispensed reduced the average price per prescription by 2%. Prescriptions accounted for 65% of drugstore sales during the quarter which rose 7.6% in stores open at least twelve months. Over the past twelve months Walgreens has added 414 stores bringing the number operated up to 5,251. Next month, Walgreens will complete the acquisition of Happy Harry’s, a privately owned operator of 76 drugstores in or bordering Delaware. It is the largest acquisition Walgreens has made in the past five years. Walgreens stock price has risen almost 20% since the end of May.

Stryker Corporation

Stryker’s second quarter revenues and earnings per share of $1.3 billion and 52¢ respectively rose 9% and 21% above the results for the comparable year ago period which included two more selling days. When it reported earnings, management projected that Stryker’s earnings for this year would rise 21% above the $1.67 per share earned last year. CEO Steve MacMillan also stated that the second quarter 14% year-to-year increase in MedSurg sales would prove the lowest percentage increase for the year. MedSurg, which produces 37% of Stryker’s total sales and benefits from rising demand for minimally invasive surgery, is introducing a new high definition digital camera, light source and monitor to augment its technology lead in endoscopic imaging. The second quarter marked the third successive quarter that Stryker managed to improve its US orthopedic sales which were 10% above last year’s despite no growth in hips. Stryker’s stock price began rising before its earnings announcement when a competitor revealed that the Department of Justice investigation into the orthopedic implant industry’s sales practices provoked by e-mailed allegations from a disgruntled sales representative at a competitor would be narrowed. Since mid-May, Stryker’s stock price is up almost 10%.

Johnson & Johnson

Johnson & Johnson’s stock has risen 6% since the company reported a sales gain of 5% during the second quarter to $13.4 billion and comparable earnings per share of 98¢, up 9% from a year ago. Minimally invasive surgical products from Ethicon Endo-Surgery, the CYPHER stent and Vistakon’s Acuvue disposable contact lenses helped drive Medical Devices and Diagnostics sales growth up 6.7% to $5.2 billion. Pharmaceutical revenue growth was a tepid 3.2% reaching $5.8 billion.

J&J’s Consumer segment generated revenues of $2.4 billion, up 4.5%, reflecting strong sales of AVEENO skin care products, Baby & Child care products and SPLENDA sweetener. On June 26, J&J announced its $16.6 billion all cash acquisition of Pfizer Consumer Health which generated sales in 2005 of $3.9 billion. The transaction doubles J&J’s OTC business overall, and triples its European OTC business. The Pfizer Consumer acquisition adds brands including Benadryl and Sudafed as well as the OTC switch rights to the antihistamine Zyrtec whose patent expires in December 2007. The addition of Listerine to J&J’s floss and toothbrush business creates a $1.1 billion oral care franchise, while Visine will complement J&J’s Acuvue franchise. The purchase will be completed by year-end. J&J shares are up 7% since mid-May.

Patterson Companies, Inc.

At its August 3rd analyst meeting Patterson Companies’ management explained the strength of its dental, veterinary and physical rehabilitation businesses while addressing the problems, the corrective actions taken and opportunities realizable in each. Patterson has moved to rectify the falloff in the growth of its dental business, which produces 80% of the company’s profits by re-establishing branch manager control and accountability for all operating decisions. Sales of consumables and all the equipment lines except CEREC, the chair-side tooth restorative system exclusively distributed by Patterson in the US, have revived. Last month, Patterson began offering 2.9% financing to stimulate CEREC sales, a clear indication that problems persist. Webster, Patterson’s veterinary business which grew operating profit 23% over the past twelve months, has begun to successfully distribute and service digital x-ray, practice management, and electronic order entry systems. The vet business needs no fixing. Meanwhile the physical rehabilitation business has shown evidence that its profitability will improve as it concentrates on developing a professional sales force that can build relationships, comparable to those with dentists, with owners and operators of rehabilitation clinics affiliated with hospitals or outpatient surgery centers, sports medicine specialists and chiropractors. Patterson’s stock price has gone nowhere since the beginning of the year.

Merck & Company, Inc.

Merck reported diluted second quarter earnings of 69¢ per share compared to 33¢ earned it the same period last year. Sales rose 5.5%, led by a 30% rise in Singulair, Merck’s treatment for chronic asthma. Management’s reaffirmation that Merck would lose as much as one-third of its operating profit as a result of the June 23 expiration of Zocor’s patent coupled with adverse rulings and verdicts in Merck’s ongoing Vioxx litigation robbed the earnings of any significance. Loss of Zocor profits means Merck’s current dividend will absorb 80% of its earnings. Patent and litigation issues diverted attention from FDA approval of Merck’s vaccine Zostavax, the only medical option available for prevention of shingles, as well as the unanimous recommendation by the CDC’s Advisory Committee on Immunization Practices that girls 11 to 26 years old be vaccinated with Merck’s Gardasil, which prevents cervical cancer. Promising clinical trial data released in June about the efficacy of Merck’s Januvia, a once-a-day pill for treating type 2 diabetes received some notice but had little effect on Merck’s stock price, which remains unchanged following the earnings report. It, however, is up almost 20% since the beginning of the year.

PepsiCo, Inc.

PepsiCo’s revenues of $8.6 billion and earnings per share of 80¢ rose 12% and 15% respectively from the year earlier period. PepsiCo International generated growth in revenue and profit of 15% and 21% respectively. Continued growth from the company’s portfolio of leading non-carbonated beverages and solid growth in Frito’s salty snacks led to 10% revenue and profit growth in North America. PepsiCo shares are up 5% since mid-May. On August 14, PepsiCo announced that Steve Reinemund, Chairman & CEO for the past five years, would retire. He will be replaced by Indra Nooyi, Pepsi’s President, CFO and member of the Board since 2001.

Harte-Hanks, Inc.

Harte-Hanks’ revenues of $298 million rose 5% and earnings per share of 37¢, which includes a 3¢ contract termination fee, rose 9%. Direct marketing revenues of $174 million rose 3% and operating cash flow rose 13%. These measures were bolstered by the receipt during the quarter of $7 million from a financial services customer which cancelled its database management contract after it was acquired by a large bank. Retailer revenues rose low single digits, Finance and Tech/Telecom were down in the low double digits while Pharmaceutical company spending was up more than 20%.

Shopper revenues of $125 million gained 8% and operating cash flow was flat. Profitability suffered as postage and newsprint rate increases were not offset commensurately by higher advertiser fees. In addition, Shoppers incurred the cost of expanded distribution in California and Florida as it added 600,000 in circulation during the past twelve months and prepares for an additional 400,000 circulation increase in the third quarter. During the quarter the company repurchased 1.5 million shares of stock. Diluted shares outstanding declined 5% or 4.4 million shares from a year ago to 81.9 million shares. Harte-Hanks’ has acquired 45.9 million shares since 1997 using a portion of its abundant free cash flow. Harte-Hanks shares have fallen 5% since mid-May.

Getty Images

Getty Images reported second quarter revenue growth of 10.5% to $204.8 million and earnings per share of 64¢, up 10% on a comparable basis, which excludes certain one-time expenses. Management also reduced its 2006 forecast revenue and earnings growth to 12% which would produce annual revenues of $820 million for this year and earnings of $2.50 per share after option expense. The lower forecast growth is caused by changes in the market for images, many of which result from Getty initiatives. Getty shares declined 18% on the day the results were reported.

Eighty percent of Getty’s revenues come from the licensing of stock imagery with slightly more than half coming from rights managed and the remainder coming from royalty free imagery. During the second quarter, rights managed revenues rose 6% from a year earlier while royalty free revenues gained 11%.

The mix of royalty-free revenues has been shifting toward micropayments, a newer licensing model where photographers post non-professional quality images for sale for as little as one dollar. Getty now owns the leading provider of this imagery through its acquisition in April of iStockphoto, which lifted micropayment sales to 16% of Getty’s second quarter royalty-free revenues from 11% a year ago. We expect micropayment sales to become a rising percentage of Getty’s royalty-free image sales which may slow overall revenue growth while customers experiment to find the proper use for these readily available low cost images. Rights managed imagery sales should not be impacted by this shift, but are affected by the growth in print advertising worldwide and Getty’s ability to retain and build its industry leading market share position.

We bought Getty shares too soon. The company is experiencing a slowing rate of revenue growth from the mid-teens to low double digits, though it continues to generate abundant free cash flow which exceeds reported profit. Getty’s stock price is below our calculation of its value because the market’s tendency to overshoot is accentuated by aggressive fund managers’ extrapolating changes in quarterly earnings estimates as though they were predictive numbers. Getty’s scaling back its forecast led to more selling because the successive drops in earnings estimates reduce the slope of the numbers plotted. Getty’s shares may remain at their current level until the company produces earnings that contravene the downward trend evidenced by the declining estimates.

Intuit Inc.

Intuit’s fiscal fourth quarter revenues of $343 million rose 14% while its per share loss of 6¢ equaled the loss reported during the year ago period. The fiscal fourth and first quarters are loss quarters for the company due to the seasonality of the tax business. For the fiscal year, Intuit generated 15% growth in total revenues and earnings per share, reaching $2.3 billion and $1.16 respectively. The company forecast revenue growth of 8 to 10% and operating earnings per share growth of 12 to 16%. During the past fiscal year, Quickbooks sales rose 6%, while payroll and payments sales to the Quickbooks small business customer base rose 24%. Small business overall generated just under $1 billion in sales. Consumer tax had an excellent year with revenues increasing 25% to $710 million while Professional tax revenues of $273 million increased 3%. Intuit stock is up 17% since mid-May.

Intel Corporation

Intel’s stock price, which is down 28% since the start of the year, began inching up after management reported the company’s poor second quarter results and reduced their revenue and profit forecast for the year. Revenues of $8 billion were sequentially 10% below the first quarter’s and 13% lower than last year’s second quarter. Every geographic market experienced a sequential revenue decline. Asia-Pacific fell 6%, the Americas 10% and Europe 19%. Diluted second quarter earnings of 15¢ per share was 35% below the first quarter’s 23¢ and 55% below last year’s second quarter’s earnings of 33¢. Intel has begun shipping its new dual core energy efficient microprocessors for PC’s, servers and laptops, the latter two ahead of schedule. This proves Intel’s manufacturing prowess is undiminished. Regaining market share and better selling prices for the new microprocessors may prove daunting. Dell’s woes, which hurt Intel, provide ample evidence of difficult market conditions. Moreover, Intel holds a record $4.3 billion of inventory, equal to 103 days of sales, which either must be released into a saturated market or written off. Intel must reckon with the financial consequences of the past even though it may be through the worst. While its financial condition remains strong, its balance sheet shows it has spent half its year-end $15 billion of cash and equivalents while total assets remain unchanged at $46 billion.

ExxonMobil

ExxonMobil’s revenues and earnings per share of $99 billion and $1.72 respectively rose 12% and 40% above the year ago period. Total production on an oil-equivalent basis increased by 6%, driven by higher liquids production from projects in West Africa and Abu Dhabi. The slight increase in overall natural gas production came as higher volume from projects in Qatar were offset by mature field decline and planned maintenance activity. A 12% increase in downstream earnings were generated from higher refining margins despite lower volumes and were offset partially by weaker marketing margins. During the quarter, ExxonMobil increased spending on capital and exploration projects by 8% to $4.9 billion and distributed $5 billion to shareholders in share repurchases and $1.9 billion in dividends. Fully diluted shares outstanding fell 5.3% during the second quarter from a year ago. The company announced it would spend $7 billion repurchasing shares during the third quarter. ExxonMobil shares have risen 12% since mid-May.

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