EARNINGS LETTER

3rd Quarter, 2006

The overwhelming majority of your companies reported good third quarter earnings. Although the prices of most of your stocks advanced over the past four months, collectively they have lagged behind the averages. Our stocks usually behave that way when the momentum of rising stock prices propels the stock market averages higher. Upward price momentum causes aggressive fund managers to place wagers on continuing earnings momentum, which is not validated if companies’ earnings merely surpass management’s previously announced forecasts. Confirmation of the trend occurs when management raises its forecast a bit for the next quarter. That moves stocks up. The management of few of your companies readjust their earnings outlook quarterly. Most concentrate on operating challenges within their businesses’ multiple operations, not all of which function according to plan, even in the best of times.

The stock market rise of 13%, as measured by the S&P since mid-July, compels us to examine what changed to make US stocks so much more attractive. We know the economy’s growth is decelerating, productivity growth is declining, profit margins are peaking and revenue growth requires increased investments to finance new capacity, new products or new services. The changes make maintaining profit growth more difficult, which increases risk and normally lessens the willingness of investors to pay up for stocks. We are well aware of the heightened appetite for risk among hyperactive traders using computer-driven algorithmic trading strategies to manage many millions of dollars by simultaneously executing multiple trades in baskets of stocks, exchange traded funds, futures and options to earn hefty profits by making a miniscule spread. This phenomenon however, does not explain the market rise. Announced acquisitions and mergers amounting to $3.4 trillion since the start of the year undoubtedly have helped lift the prices of most public companies. Private equity funds have financed almost 20% of these transactions while remarkably increasing their fees and ratcheting down the prospective returns offered investors. We cannot recall a time when it paid to abandon our price discipline and accordingly have no intention of doing so now. Even in this market, several stocks meeting our criteria are selling near our valuation, making it seem sensible to wait for our price.

State Street Corporation

State Street’s good third quarter earnings provided no lift for its stock price which has advanced 15% since the start of the year. Operating earnings of 80¢ per share were 6.6% above the comparable year ago results, but 14% below this year’s very strong second quarter earnings of 93¢ per share, which were buoyed by a 37% year-to-year rise in foreign exchange, brokerage and securities lending fees garnered from high securities transaction volumes in that quarter. Transaction volumes are normally slow during the third quarter, but an unusual 33% sequential drop in State Street’s transaction-based fees kept the amount earned to a mere 3% more than last year’s third quarter fees. Despite the meager transaction fee growth, total revenues grew 9%. State Street’s management once again delivered positive operating leverage by holding expense growth to 8%.

Assets under custody at quarter’s end were $11.3 trillion; 15% higher than a year ago. Asset Servicing fees, which constitute 45% of total revenues, rose 10%. Investment management fees grew 27%, augmented by performance fees earned on enhanced and hedged investment products which comprise 55% of the new business added over the past year. State Street’s European business is growing at twice the rate and is twice as profitable as its US business. Revenues from European institutions now constitute 26% of State Street total, up from 23% a year ago. In discussing the third quarter results, State Street’s management confirmed that the 2006 results would surpass their earlier forecast; a conclusion most analysts had reached already. Without any further quantification, management’s comments exerted no influence on the stock price which places a reasonable valuation on State Street’s strong sustainable world-wide franchise. It is undervalued when compared to its competitors.

Express Scripts, Inc.

Express Scripts’ third quarter earnings per share of 83¢ jumped 24% above per share earnings for the same period last year. Gross profit rose 28% to $374.3 million as the company’s generic utilization rose almost 4% to 58.3%. Third quarter retail network claims declined 12% to 93 million and mail pharmacy prescriptions grew only slightly to 10.2 million because of the loss of low margin Medicaid and Medicare Discount Card claims. This loss helped lift EBITDA per claim to $1.84, a 39% increase. Express Scripts will continue to benefit from its “Generics Today” program which educates health plans about the benefits of generic drugs. The highly successful formulary strategy that promoted Zocor use in advance of its loss of U.S. patent exclusivity in June saved its customers significant amounts of money. Lipitor’s market share has declined 22% in Express’ book of business versus a 7% decline nationwide. This success has strengthened the company’s client relationships and increased their awareness of the huge opportunity to control drug prices without sacrificing health care outcomes as blockbuster prescription drugs go off patent.

Express Scripts’ third quarter performance demonstrates that the company is operationally and financially sound. We enclose a note describing events from September 21 to November 1 that knocked the stock price down 29%. It has recouped about 12% of that decline since November 14 when Express Scripts’ announced its 2007 forecast of earnings per share growth of 20% to 24%, but the stock price is still down 20% since the beginning of the year.

Chicago Mercantile Exchange

Shares of the Chicago Merc have risen 46% this year. During the third quarter, average daily volume of futures and options contracts traded increased 28% to 5.4 million with 71% executed electronically. Revenues during the quarter rose 22% to $275 million while the increase in expenses was held to 11%, resulting in earnings per share of $2.95, up 33%. Futures and options volume growth was strong across each major product group. Interest rate contract volume rose 26%, equity index products rose 32%, foreign exchange gained 26% and the smaller commodities business was up 39%. Fees collected from CME’s common clearing link with the Chicago Board of Trade reached $18.5 million, up 20%, while fees from executing NYMEX energy contracts on GLOBEX were $5 million in the first full quarter under their 10 year electronic transaction execution arrangement. On October 17, 2006 the CME announced an agreement to buy the Chicago Board of Trade for $8 billion in cash and stock. This is a good acquisition for CME shareholders.

Automatic Data Processing

ADP’s fiscal first quarter revenues and earnings per share rose 15% and 13% respectively to $2.2 billion and 43¢, excluding a 3¢ per share one-time gain and costs to restructure its Brokerage operations in anticipation of next year’s spin-off. Revenues at the Employer Services division rose 12% as its traditional payroll and tax filing revenues increased 9% and revenues from add-on services rose 18%. The growth of the number of employees on each client’s payroll accelerated, rising 2.5% during the quarter. Average clients’ fund balances, on which ADP earns interest, rose 9.6% to $12.5 billion. The elevation of Gary Butler to CEO marks the beginning of a more aggressive operating strategy for the company. In addition to the spin-off of its Brokerage operations, ADP has stepped up share repurchases and made four small complementary acquisitions during the quarter. These acquisitions expand the range of services offered to its payroll clients and will generate more than $100 million in annual revenues. During the quarter, the company repurchased 12.6 million shares at an average price of $46.80. ADP shares are up 8% since January 1.

First Data Corporation

First Data spun-off Western Union as an independent publicly traded company on September 29, 2006. Shareholders of First Data received one share of Western Union for each share of First Data held. The tax treatment of the spin-off allocates 45.55% of the original cost of your First Data shares to the Western Union shares received. First Data is left with its slower growth credit card processing business which has been beset with execution difficulties. Businesses which are unable to grow by selling additional value-added products and services to their customers are destined for mediocrity. Western Union, which has been driving First Data’s overall growth for the last five years, is well worth keeping. First Data is not.

Western Union

Western Union is the dominant money transfer network with 285,000 agent locations worldwide. During the third quarter, Western Union’s revenue of $1.1 billion increased 12% while earnings per share reached 34¢. This growth was achieved despite transactions from the US to Mexico rising only 2% and domestic transactions declining 5%. Internationally, transfers which do not touch a US location remained strong, growing 23% during the quarter. Consumer to business transactions, which generate nearly one-fifth of profit, rose 8%. Western Union shares are up 20% since they were distributed at the end of September.

Amdocs

Amdocs finished its 2006 fiscal year with revenues of $2.5 billion and earnings per share excluding one-time items of $1.57, increases of 22% and 12.9% respectively. Revenues and earnings for the fourth quarter grew 16% and 12.9% to $655 million and 41¢ per share. The company announced the extension of two large managed services contracts, one with Bell Canada and one with DirecTV. The extension and expansion of the DirecTV contract affirms the value of Amdocs’ offering to broadband cable providers. Amdocs completed the acquisition of Cramer Systems for $375 million in cash on August 18. Cramer is a leading provider of operation support services (OSS) which facilitate the management of new services on a communication providers’ network. Amdocs seeks to improve the “order-to-activation” process for providing new services with the addition of Cramer’s software products. Ideally, a customer places an order for a new service and has it activated and billed properly without any additional calls to customer service or technical support. Amdocs will offer the first and only end-to-end system that gives its customers a view of both network and customer information on one platform. Amdocs’ stock price has risen 38% since the beginning of the year.

NeuStar Inc.

On September 21, 2006, NeuStar announced that it had extended its important contracts to provide US telephone number portability service for four additional years to June 15, 2015 and would reduce the price charged per transaction beginning in 2007. Transactions processed by NeuStar under these contracts have grown at an annual rate of 35% since 2004. NeuStar reiterated its forecast of 25% revenue growth and a mid-30% operating margin for 2007.

On November 2, NeuStar reported that third quarter revenue and earnings per share rose 39% and 29% respectively. Reflecting these strong results, NeuStar shares rose 3.6%. Current trends in the telecommunications industry benefit NeuStar. Carrier network expansion, new entrants into the market and growth in new services, such as VoIP (Voice over Internet Protocol) and US Common Short Codes led to strong transaction growth during the quarter. NeuStar shares are up 9% since September 21.

C.H. Robinson Worldwide Inc.

CH Robinson’s third quarter net revenues and earnings rose 22% and 29% respectively to $278 million and 40¢ per share, a modest slowdown from the rate of growth achieved during the past six quarters, but well above their long-term 15% forecast. The total value of transportation services provided during the quarter reached $1.7 billion, up 15% from a year ago. Robinson’s core trucking business slowed just 1% from the second quarter to 23.5%. Robinson’s management indicated that the market for trucking services loosened during the quarter and they are experiencing wider daily pricing swings reflecting larger fluctuations in supply and demand. Robinson’s sourcing, global forwarding and transaction services businesses rose 11%, 21% and 12% respectively during the quarter. Robinson’s shares are 20% lower than the high reached on July 3rd, but remain up 18% for the year.

Donaldson Company, Inc.

Donaldson’s fiscal fourth quarter and full year revenues at constant exchange rates rose 10% and 8% respectively while earnings per share during the same periods gained 10% and 13%. This marks Donaldson’s 17th consecutive year of double-digit earnings per share growth. During their fiscal fourth quarter, sales of engine filters to off-road and on-highway original equipment manufacturers rose 9% while replacement filters sales gained 11%. Gas turbine filter sales surged during the quarter, gaining 35%, marking the beginning of an upturn in this segment. The timing could not come at a better time for the company because the effective date for more stringent EPA regulations for on-highway diesel engines is January 1, 2007, which will depress filter sales to engine manufacturers during the first half of 2007. Continued high equipment utilization will result in strong sales of the company’s replacement filters which generate half of total sales and more of profits. Donaldson’s shares have gained 16% this year.

Caterpillar Inc.

Caterpillar earned $1.14 per share during the third quarter, 21% more than the amount earned a year ago. The profit, however, fell below management’s forecast causing them to trim their revenue and profit forecast for the remainder of this year and next. The stock price promptly dropped 14.5%, leaving it 5.5% above its price at the beginning of the year. The revised forecast recognizes reduced demand for CAT equipment used for residential construction in the US, higher material and labor costs and the persistence of production constraints, which impede production of larger machines such as mining trucks. CAT cannot deliver mining trucks ordered today until 2010! At the start of next year, CAT must abruptly stop producing the engine it currently sells to Class 8 heavy duty truck manufacturers because it, like the engines delivered by other manufacturers, does not comply with the EPA’s new regulations taking effect on January 1, which severely restricts the particulate levels permissible in diesel engine exhaust. Because truck manufacturers will take delivery of all the non-compliant engines CAT can produce before year-end, CAT knows deliveries of its new compliant engine will not commence until the second quarter of 2007. During the third quarter, all the increase in CAT’s earnings came from improved engine profits which were lifted by a better than 50% increase in sales for oil and gas production and transport in North America and Asia. We cut and probably will eliminate the Caterpillar position. Its managers, after a four-year expansion, still cannot gain control over costs. It’s an even harder task during a contraction.

Varian Medical Systems, Inc.

Radiation oncologists have expanded the uses of radiation therapy with Varian Medical Systems’ advanced products, such as the on-board imager, the Trilogy accelerator and respiratory gating systems, successfully treating patients with inoperable brain tumors, lung tumors and small metastases. More than 60% of new equipment orders in 2006 included the on-board imager, driving the fastest new technology adoption rate the company has seen. Oncology Systems orders rose 13% during fiscal year 2006, 19% in North America and 6% internationally. The company also reported a software backlog of $150 million as more clinics around the world use Eclipse, Varian’s leading treatment planning software, and ARIA information software that allows a clinic technician to manage all aspects of a clinic’s operations from updating patient data to automatically adjusting a patient’s position before each treatment. Varian’s upgrades of these programs continue to reduce the time required to plan and deliver complex cancer treatments. The company reported earnings per share of 59¢ and $1.85 excluding options expense for the fourth quarter and the fiscal year, increases of 31% and 23% respectively. Sales rose 18% in the fourth quarter and 16% for the year to $454 million and $1.6 billion. Varian’s stock price jumped 12% on the day after its earnings announcement. The stock price is up 0.4% since the beginning of the year.

Walgreen Company

Walgreen’s fourth quarter and fiscal year 2006 earnings per share of 40¢ and $1.71 rose 13% and 11% over the same periods last fiscal year not including one-time charges associated with Hurricane Katrina. Revenues for the quarter and the year were $12.2 billion and $47.4 billion with pharmacy sales in stores open one year rising 12.3% and 9.2% respectively. Walgreen’s 5,461 stores filled 529 million prescriptions during the year, an increase of 8.1% over fiscal year 2005. Third party plans accounted for over 93% of all prescription sales in the quarter and the year. Gross profit for the fourth quarter grew 14.7% to $611.2 million over the same period last year driven by increased prescriptions filled by Medicare drug plan beneficiaries, increased generic drug sales and a higher margin product mix in the front-end. Fourth quarter gross margin declined 0.3% to 27.6% because sales of higher margin products did not fully offset the lower margin Medicare prescription drug sales.

Walgreen’s stock price dropped 8.5% on September 21, the day that Wal-Mart announced the availability of a 30 day supply of 291 generic drugs for $4 in its stores in Tampa, FL. As Walgreen’s management predicted, this offer has had little effect on their business. Walgreen is losing only one prescription per store per day in the Florida markets where the Wal-Mart generics are available. Walgreen’s stock price dropped an additional 5% on September 25th, the day of its earnings announcement because the company missed the consensus earnings per share target by one cent. Walgreen’s stock price has fallen 5% since the beginning of the year.

Stryker Corporation

Stryker’s largest and most profitable division, U.S. Orthopaedics, is back on track. It delivered revenue growth of 11% over the third quarter of 2005, its fourth straight quarter of accelerating revenue growth. The company reported third quarter revenue of $1.3 billion, an increase of 10.4%. The global orthopedics business grew 9.6% to $741.6 million. The MedSurg business grew 14% to $489.5 million. Sales of video equipment in the Endoscopy business rose 20% during the quarter, offsetting slower than expected instrument sales. Stryker delivered earnings per share of 46¢. The company realized 24.3% growth in earnings while increasing its investment in research and development by 11.7% and in its orthopedic sales force which comprised the largest component of a 10.8% increase in selling, general and administration expenses. Stryker’s stock price has risen 17.5% since the beginning of the year.

Johnson & Johnson

Johnson & Johnson reported third quarter revenues of $13.3 billion, an operational increase of 6.7% over the same period last year. The company’s cost control program reduced growth in selling, general and administrative costs as a percentage of sales by 1.5%, which contributed to the strong earnings per share increase of 15.3% to 98¢ during the quarter.

Worldwide Medical Devices and Diagnostics’ posted 6.1% operational revenue growth over the third quarter of 2005 with double-digit revenue growth in Ethicon Endo-Surgery’s miniminally invasive products and Vistakon’s disposable contact lenses, especially those that correct astigmatism. The pharmaceuticals division posted strong operational sales growth of 6.7% during the quarter. Three drugs delivered sales growth above 20% including Concerta, a treatment for attention deficit hyperactivity disorder. Concerta sales have continued to grow because generic manufacturers have been unable to develop a product with equivalent biologic activity without violating Johnson & Johnson’s patents. Strong sales of baby products and skin care products in Europe primarily associated with the acquisition of Groupe Vendôme contributed to the consumer division’s operational revenue growth of 8.1%. Johnson & Johnson’s stock price is up 12% since the beginning of the year.

Patterson Companies, Inc.

Patterson Companies is scheduled to report its fiscal second quarter earnings for thirteen weeks ending October 29 on the Wednesday before Thanksgiving. We expect sales growth will be less than 10% above the comparable period a year ago with profit improving even less. Most of the modest earnings increase should come from a near 8% sales increase from Patterson’s predictably profitable dental distribution business which generates over 40% of overall company sales. Dental equipment sales growth, which continues to benefit from dentists’ growing adoption of digital x-rays, remains hobbled by their reluctance to buy the CEREC chairside tooth restorative system distributed by Patterson until they evaluate a new system not yet in production, offered by a competitor. CEREC’s announcement of a pending system upgrade adds another reason for delay. A contribution of solid double digit sales and earnings growth from Patterson’s veterinary distribution business, which has grown to provide 15% of overall sales, probably will be offset by sales and profit growth of no more than 5% from Patterson’s rehabilitation equipment distribution business, which Patterson is transforming from a business dependent on catalog sales to one reliant on commission sales representatives. In mid-September, Patterson agreed to lend its Employee Stock Ownership Plan (ESOP) $105 million to purchase shares. At the current stock price the ESOP could increase its ownership in the company by a third. It already owns 6.8% of Patterson’s outstanding shares. Patterson’s stock price has declined 2% since the beginning of the year.

Merck & Company, Inc.

Merck’s third quarter earnings per share of 51¢ include a $598 million addition to the reserve for future Vioxx litigation expenses. On November 15, Merck won its third federal Vioxx liability case out of the four tried in the Eastern District Court in New Orleans. Revenues for the quarter of $5.4 billion were unchanged from the same period last year as sales of Merck’s vaccines and existing drugs offset the revenue decline caused by the loss of US patent exclusivity for Zocor and Proscar, a treatment for benign prostate enlargement. Vaccine sales jumped 64% to $555 million with the four new vaccines contributing $226 million in sales. Gardasil alone had sales of $70 million. Private health insurers have agreed to cover Gardasil for 94% of their covered lives and on November 1, the CDC added Gardasil to the Vaccines for Children program which will provide the vaccine to children who are eligible for Medicaid or are uninsured. On October 16, the FDA approved Januvia, Merck’s once daily oral drug that controls blood sugar levels in patients with type 2 diabetes without weight gain or increased incidence of hypoglycemia. The drug was available at pharmacies on October 20. In addition, the FDA approved Zolinza, a once daily oral treatment for a type of non-hodgkins lymphoma. Zolinza is the first new treatment for this disease since 1999. Merck’s stock price has risen 42% since the beginning of the year.

PepsiCo, Inc.

PepsiCo’s third quarter revenues rose 9% to $9.0 billion over a strong third quarter in 2005 when revenues increased 13%. Although increased cooking oil, orange and energy costs were higher than expected, the company delivered division operating profit growth of 14% and earnings per share growth of 12% to 88¢ in the quarter. Pepsi International’s growth remains robust with the quarter’s revenue and operating profits up 16% and 17% respectively. PepsiCo continues to increase its stable of snacks and beverages targeted at health conscious consumers with the acquisition of Izze sparkling juice drinks, Stacy’s Pita Chips and Mother’s Natural Cereals. Whole Foods sells all of these products. Pepsi’s stock price has risen 5% since the beginning of the year.

Harte-Hanks, Inc.

Harte-Hanks’ third quarter results were poor. Total revenues rose 4.6% to $295 million while expenses expanded 7.3% to $251 million, resulting in a decline in operating profit of 8.2%. Earning per share of 35¢ rose 3% or 1¢ per share from a lower tax rate and fewer shares outstanding. Direct Marketing and Shoppers experienced declines in operating income of 4.2% and 11.6% respectively. It is the marked deterioration in the profitability of the Shopper business which is most worrisome. As in the second quarter, the company cited three primary reasons for higher costs: expansion into new zones, higher paper costs and a postage rate increase. None of these issues are new. Management evidently decided not to reign in operating expenses during the third quarter. While revenues fell $4 million from the second quarter, expenses remained constant. We had come to rely on consistent execution at Harte-Hanks, especially in the Shopper business, but now suspect the focus has blurred. Harte-Hanks’ shares fell about 5% in the days following the earnings announcement and are down 2% for the year.

Intuit Inc.

Intuit’s fiscal first quarter revenues rose 19% to $362 million while its net loss on a GAAP basis was 17¢ per share. Intuit’s fiscal first quarter which ended October 31, is seasonally the weakest, primarily because there are minimal sales of tax products. The company cited a $20 million revenue contribution during the quarter resulting from the September launch of QuickBooks 2007, which occurred one month earlier than last year’s launch of QuickBooks 2006. Revenues from add-on services to small business customers such as payroll and payments rose 21% to $125 million during the quarter. Intuit shares fell 6.7% after the announcement as an analyst downgraded the rating suggesting the early tax season numbers “could put pressure on the stock”. Indeed, this did occur this past year as the shift to online tax return filing shifts more revenues into the fiscal third quarter. This shift, however, is now well understood by investors and company management and should come as a surprise to no one. Intuit shares have risen by one-third since early March.

Intel Corporation

Intel’s stock price has climbed almost 30% from its low in June and is now down 11.5% for the year. While third quarter earnings per share of 22¢ and revenue of $8.7 billion were significantly lower than those reported a year ago, they grew 47% and 9% respectively from the second quarter, a significant improvement, albeit from a fairly low base. Sales of microprocessors for servers were particularly strong with record unit shipments and higher unit selling prices. On November 14, Intel introduced the first “quad-core” microprocessors for servers and high-performance PCs. These processors have four computing units that deliver twice the computing power of their dual-core predecessors without increased power consumption. Manufacturing process development remains on-track with the company making more chips with its 65 nanometer process than with its 90 nanometer process this quarter.

ExxonMobil

Exxon Mobil reported strong third quarter earnings of $1.77 per share, 34% higher than the comparable amount earned in the year ago quarter. The magnitude of the percentage gain was increased by stock repurchases costing $8.4 billion during the quarter, which reduced the outstanding shares by 6%. Operating earnings rose 26% above last year’s quarterly results propelled by a near three fold improvement in petrochemical earnings in the US and abroad. Refining profit, 73% of which is earned outside the US, rose 73% which helped offset a 28% decline in the net income derived from Exxon Mobil’s maturing US oil and gas production. In reviewing the quarterly results, management stated that they expect refinery margins will contract, but expressed confidence that petrochemical margins would not deteriorate soon. The confidence expressed, which we believe is attributable to Exxon’s exceptional proficiency in controlling costs, helped lift Exxon Mobil’s stock 5% after its earnings report, bringing the stock’s rise up to 30% since the beginning of the year.

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 – 4th Quarter EARNINGS LETTER 2006 – 2nd Quarter EARNINGS LETTER