2005 Quarter 3 Update

October 15, 2005

The financial markets will always find something to worry about. This is an undeniable truth that investors must live with and investment managers must constantly be prepared for. The moment terrorism began to leave the collective consciousness of investors we have added another sort of terror to our list: natural disaster. This is not to say that global terrorism has left the forefront of our minds altogether. It is still there and will remain so for the foreseeable future. However, front and center now is the destruction wrought on the Gulf Coast by hurricanes Katrina and Rita and the likely after effects of such catastrophes. Both storms have complicated what was an already difficult situation in the energy complex and have forced us to consider the danger of our dependency on fossil fuels in this day and age. As investment managers it is not our job to decide how this issue should be handled but how we should position our clients so that they might take advantage of this reality. One way to do this of course is to have an appropriate exposure to energy in our client portfolios, something we have had for quite some time. Equally important, however, is what not to do in light of the current bull market in energy. That of course would be to abandon one’s strategy in order to chase the sector of the day, in this case energy, thereby forsaking other promising areas of the market in the process.

As we have stated before, it is anyone’s guess when/if energy will see a reversal in price. While we do not claim to have an answer to this question (and anyone who does is only guessing), we do believe that it is important to take a close look at the current macroeconomic environment and assess both the headwinds and tailwinds we are likely to experience. Except for the companies that are directly involved in the energy business, the high price of fossil fuels is clearly a headwind for both the economy and the markets. We are also facing what appears to be a hawkish Federal Reserve committed to fighting inflation at all costs. As a result, we are likely to see continued rate hikes for the next six to twelve months. The risk here is that in its quest to keep inflation under wraps the Fed goes too far and ignores the already present “tax” that higher energy prices are placing on both businesses and the consumer.

It is our opinion that the Fed’s vigilant approach to interest rates will remain measured, and while continued rate hikes are not a positive for the equity markets, we do believe that the domestic economy is strong enough to absorb such hikes as they come. It is important to remember that the Federal Reserve began it’s most recent rate hike campaign when rates were at an extremely low level. It can be argued that even after eleven sequential hikes the current short term rate is still stimulative to the economy at 3.75% and will likely remain so even between 4-5%. Also, as long as foreign dollars continue to flow into the United States we benefit from lower long term rates, thereby helping to stimulate the economy even as the Fed tries to slow it down by raising short term rates. As long as this international influx of capital persists we believe that the economy can continue to grow at a healthy clip, despite the Fed.

So what of potential market tailwinds? Just looking at the market averages and their performance year to date (virtually unchanged) would seem to indicate that participants are still hesitant to put much money to work in equities. But there is always a bull market somewhere and 2005 is no exception. With corporate balance sheets still flush with cash the mergers and acquisitions continue apace. We believe that companies will continue to look for acquisition targets and we are trying to take advantage of this. As we have stated many times before, we are not believers in relying on the major averages to produce strong returns for our clients. 2005 has been an excellent example of this as our clients have seen positive returns in an otherwise listless market. We have achieved these results by searching for special situations that are likely to be much less correlated with the overall markets, hence moving up as the market stagnates.

In short, there are plenty of opportunities in today’s market and we remain excited about the upcoming quarter and 2006 as well. We appreciate the confidence and trust you have shown in us by hiring our firm as your investment manager and we look forward to future success.

Cordially,

Paul R. Ray III Brian M. Phillips

2005 Quarter 2 Update

July 15, 2005

Is a strong economy good or bad for equities? Does it bode well for corporate earnings? Sure. Does it increase the likelihood that the Federal Reserve will continue to raise interest rates to prevent inflation, hence slowing the economy down? Sure. So which is it, good or bad? It’s hard to tell and the current market action reflects this reality as nobody can seem to make up their mind.

So based on the market action in the first two quarters of 2005 it would appear to be a fairly disappointing year thus far for investors. The markets have fallen, shot back up and fallen down again, alas finishing the first half of the year lower by anywhere from 1% to 6%, depending on the market average you adhere to. Oil has maintained its upward trajectory, as have short term interest rates controlled by the Federal Reserve. Inflation continues to show up in different economic numbers, however it is far from alarming at this point. And bond market yields continue to indicate a slowing economy in our not too distant future. But underneath the surface there is quite a bit of exciting activity out there if one looks in the right places. In our last few updates we have discussed the promising mergers and acquisitions climate in 2005 as well as the “value” opportunities we continue to find. This focus has helped us to stay ahead of the markets this year and has kept us excited about the second half as well.

As we stated above, we have already reaped the rewards from this M&A investment thesis a number of times in 2005. Ameritrade Holdings (AMTD) is now in the process of acquiring TD Waterhouse in an extremely attractive deal for shareholders. We sold the position for a nice profit shortly after that announcement and the subsequent run-up. Charles Schwab (SCH), another one of our holdings, has been very strong as of late as it may also find itself taking part in this recent consolidation trend. And of course Midway Games (MWY) remains a core holding for our clients as Sumner Redstone continues to add to his over 80% ownership in the company, presumably to affect a buyout or takeover of the company.

Of course the fact that we are so excited about the M&A climate does not mean that we abandon our core investment philosophy: value. We are finding many opportunities to put money to work in companies that we believe to be undervalued and definitely underappreciated. As the market indices have struggled for most of the year we have continued to refine our “shopping list” and have put money to work in companies that show the potential for a great deal of upside and considerably little downside.

Finally, one of the more consistent topics mentioned in the financial press today, and subsequently in our updates to you given the market ramifications, are terror and its effect on both the domestic and global economies. The recent bombings in London have played out in a very interesting manner, and while horrific and unjustifiable, have shown us something very important. It would appear that the world has chosen to live with the reality of terror rather than be controlled by it. While this by no means marginalizes the horrible consequences of these attacks, it does show the perpetrators that global society will not let them win. This seemingly new outlook and attitude was evident in the action of the U.S. equity markets following the attacks. Most believed that we would see a drastic drop off in value following the attacks. Instead what we saw were four consecutive days of very strong equity markets. Again, this action does not indicate a lack of concern but instead would seem to represent a change in sentiment toward terror that could be very important going forward.

In closing, we remain confident and excited about the second half of 2005 and feel very good about the way in which our client portfolios are positioned. We appreciate the confidence and trust you have shown in us by hiring our firm as your investment manager and we look forward to future success.

Cordially,

Paul R. Ray III Brian M. Phillips

2005 Quarter 1 Update

April 15, 2005

Anyone paying attention to the financial markets since the beginning of the year is aware of their poor performance in the first quarter. All of the major averages are down for the year as participants grapple with higher oil prices, rising inflation and the prospect of continued vigilance on the part of the Federal Reserve as it relates to their interest rate policies. The mix of these headwinds has created a cocktail that market participants find bitter and unappealing. Fortunately for us we have fared better than the overall markets during the first quarter.

So it might surprise you that we still remain excited about 2005, not because we believe that the overall markets will perform particularly well however. We don’t. What we do feel good about are the increasingly exciting prospects in the mergers and acquisitions arena. As we pointed out in our last update, corporate America is flush with cash and will be looking for ways to put that money to work. We believe that much of this work will come in the form of stock buybacks and, more importantly, acquisitions. While we are not simply counting on takeovers of the companies in the portfolio, we feel the overall M&A trend will help buoy the types of stocks that we own. A couple of examples of these special situation names include Midway Games (MWY) and Instinet (INGP). Sumner Redstone of Viacom continues to add daily to his 80% plus ownership position in Midway, presumably with the intention of having Viacom buy the business or taking it private himself. Instinet is already in talks with potential buyers and has made it clear of its intention to sell. And the list goes on. In short, we believe that the current economic climate bodes well for these types of transactions and we expect to profit from it as a result.

As for the overall financial markets, they have their work cut out for them. It has become increasingly likely that oil prices will remain high and could see even further appreciation as the summer driving season approaches. It doesn’t appear that the Saudi’s and other members of OPEC have the ability to pump much more supply into the system, creating a virtual floor on energy prices over the near term. And as for inflation, it seems that the first quarter saw some acceleration in pricing power, something that should keep the Federal Reserve hawkish over the next few quarters, in turn putting pressure on the overall equity markets. While the above might paint a gloomy picture for the equity market’s near term future, not all is so dreary if one can find the successful themes in which to invest. By approaching the market from this “mergers and acquisitions” and “special situations” standpoint, we can better navigate a declining market by identifying opportunities in which certain take out candidates find their stock supported by the increasing likelihood that they will be acquired sometime in the near future. In other words, little downside, lots of upside.

In closing, we are keeping a very close eye on the above mentioned headwinds and positioning the portfolio accordingly. As always, we will be searching for value, some of which will come in the form of special situation and merger and acquisition candidates. We are confident that this approach is the prudent one and will prove to be the most profitable one during 2005. We appreciate the confidence and trust you have shown in us by hiring our firm as your investment manager and we look forward to future success.

Cordially,

Paul R. Ray III Brian M. Phillips

2004 Year-End Update

January 15, 2005

We hope that you enjoyed the holidays and have had a good start to 2005. With another year behind us we are ready to look forward, but first a look at the fourth quarter of 2004.

The fourth quarter of 2004 proved to be a lucrative one for most market participants as many issues were resolved and what appeared to be a cloud of uncertainty finally lifted. As we had stated in our last update, a number of issues came to a conclusion and helped propel the financial markets to their highs of the year. First and foremost, the clean and uncontested victory for President Bush was a huge relief for the markets for two reasons: financial markets tend to dislike uncertainty and market participants appear to have favored a Bush victory which might translate into a more pro-business and therefore pro-market economy. The second sigh of relief came from the lack of any significant terror incident at home or abroad. While the struggle in Iraq continues to weigh on everyone’s mind, the fact that terrorists were unable (or chose not to) stage a significant attack was a huge relief. This is not to say that future incidents are less likely or even diminished at this point, however it was a concern during the fourth quarter surrounding the election and the holidays. Another positive for the markets was the retreat in oil prices to more sustainable levels. While few would argue that the price of oil and natural gas are cheap, it was clearly a move in the right direction for the markets and consumers alike. Whether the current price levels are sustainable is a topic of debate, however the fourth quarter proved to be a leveling off period for energy. Finally, the domestic economy showed some signs of life again, a major concern during the third quarter of last year. We began to see what appears to be an improving job market and earnings came in stronger than many had anticipated. The weak third quarter allowed us to pick up a number of what we considered “good values” and we were able to take advantage of the much improved market climate as a result.

This brings us to the first quarter of 2005. Again, we are optimistic about the macro-economic environment going forward, however we are not without some concerns. As stated above, the uncertainly surrounding the political front has been erased, at least for another four years. Whether or not one believes President Bush is the right man for the job, the choice has been made and the market likes this certainty. Should Bush be successful in implementing his plans to make tax cuts permanent and overhaul the Social Security system, the financial markets should view this as a positive for the near term. On the energy front, we believe that the price of oil has reached a more sustainable level, at least under current circumstances. The possibility of the much talked about “terror premium” becoming an issue once again is yet to be seen. However, barring any major supply disruptions it would appear that energy prices have stabilized for the time being. Unfortunately, it is likely that we will be listing terrorism as a concern for a long time to come. Again, as we stated in our last update, it does appear that our government, along with others across the globe, have made substantial progress in reducing the probability and severity of any future attacks. That being said, it cannot be ruled out and we can only hope that any future attacks are mild at worst. One potential headwind in the macro-economic forecast is the falling dollar. While a cheaper dollar has both benefits and drawbacks, our view is that any large scale damage to the global economy will be minimal as long as a change in the dollar’s value is gradual. In other words, it is the speed in which the change occurs that is more concerning than the direction itself. Making bets on the direction of currencies is a tricky business and one we do not participate in, however we are of the opinion that the movement in the dollar will be gradual and therefore will have a fairly benign effect on the world’s economies.

In conclusion, while we are pleased that 2004 was generally a positive year, we are disappointed that our results were not better. The reason for our dissatisfaction is due primarily to the difficult third quarter that we experienced. While we quickly recovered from this setback it was a definite hurdle that weighed on 2004 results. On the bright side however, we are extremely optimistic about the outlook for 2005 for many reasons. One example not mentioned above is the improved climate for merger and acquisition activity. Corporate balance sheets are flush with cash and it’s most likely use will come in the form of either stock buybacks, good for the market as well, or M&A activity. We welcome this opportunity as it provides a backdrop much like 2000, a year in which the indexes were down sharply, whereas our clients performed extremely well. We have our clients’ accounts well positioned for this market and we will continue to work hard to make money for each and every one of them. We appreciate the confidence and trust you have shown in us by hiring our firm as your investment manager.

Cordially,

Paul R. Ray III Brian M. Phillips

2004 Quarter 3 Update

October 15, 2004

The quarter of 2004 has been a challenging one for the markets and its participants, our clients included. The specter of a slowing economy, higher oil prices, fears about terrorism, election uncertainty and rising interest rates all contributed to a decline in equities in the third quarter. As indicated in our August letter, we felt that the prudent thing to do during this period of time was to begin raising cash in our client accounts and take a more defensive posture in the event that the markets continued to erode. Fortunately the period from mid-August through September turned out to be a more benign climate and even saw some strengthening in the indexes. With the Olympics and the political conventions passing with no major terrorist activity it appears that the markets breathed a sigh of relief and resumed an upward trajectory. Oil prices also weakened somewhat during late August and early September, another tailwind for the markets during this period of time. Since mid-September, however, oil has resumed its climb and sits at roughly $51/barrel at the time of this letter. This far the markets seem to have taken this price increase in stride. And what of the current economic outlook? It would appear that people are divided over whether or not the summer “soft patch” was transient or in fact a true correction in the direction of the recently strong economy. In either case, it would appear that the Federal Reserve will be moving gradually to raise interest rates over the near term, something for which equity market participants are grateful.

While many of our clients may be aware of our firm’s overall investment strategy and philosophy, we feel that it is prudent to explain our approach to investing here in order to provide you with more insight into our thinking and decisions going forward. While at times we feel compelled to alter client accounts based on market direction and the current reality, we are not market timers and therefore have a much longer term view of investing. We are constantly searching for good value in the marketplace, often times in places that might be ignored by many market participants and therefore underappreciated in our opinion. In order to execute this strategy we must have a longer time horizon in order to realize those values, giving other investors time to come to the same conclusion, thereby driving up the value of the companies in question. Certainly there will be times when our approach does not move in lock-step with the overall equity markets, however over the long term we are confident in our ability to identify undervalued opportunities that will outperform the overall markets over time. In short, we realize that it is virtually impossible to be right in all of our investment decisions; however we believe that in the majority of instances we will be able to realize increased value over time.

This brings us to the coming quarter and the end of the year. While there remain a number of unresolved issues on the macro-economic and political fronts, we are optimistic about the opportunities in equities going forward. There is no question in our minds that the weak markets in July and early August have created some value opportunities in individual equities and, as always, we will look to take advantage of these situations. We feel confident that the economic “soft patch” witnessed over the summer will have been transient and that the economy will prove to be stronger in the near term. We’re also confident that the national election in November will remove a fairly substantial obstacle to the markets and should open the door to more upward momentum into the close of the year. Terrorism always remains a concern, and while it is impossible to know for sure whether or not a future incident can/will be prevented, we do believe that our government, along with others across the globe, have made substantial progress in reducing the probability and severity of any future attacks. Finally, we do believe that the price of oil will stabilize, thereby diminishing some of the market participants’ concerns over inflation and consumer spending. In short, we’re positive about the upcoming quarter and feel confident in our ability to take advantage of an improved environment.

In conclusion, the third quarter of 2004 has been a challenging one. While we are not satisfied with the short term performance we are confident that our overall approach is sound and will allow us to achieve excellent results going forward. We continue to work hard to make money for our clients in all market environments and are optimistic about the future. As always, we appreciate the opportunity to work with you.

Cordially,

Paul R. Ray III Brian M. Phillips