Q:  What is the investment philosophy of the fund? A : We invest in high quality growth companies. We want our portfolio holdings to grow on a consistent and predictable basis. We want to purchase these companies at a reasonable valuation. We’re bottom up stock pickers and we’re focused more on the companies growing at 10% to 15% than less predictable companies growing at a higher, unsustainable rate. Our goal is participate and protect. We believe the best way to beat the market over a full cycle is by participating as fully as possible in up markets, but protecting principal in down markets. We focus on limiting downside risk and preserving capital. Q:  How is your research process organized? A : There are three parts to our research process. The first part is evaluating the business model. The second part is evaluating the management team and thirdly, we assess the value of the company. We typically want to see a three to one upside to downside ratio at the time of purchase. We typically hold 25 to 35 stocks. Our position sizes are anywhere from 2% to 5%. We believe in this focused, concentrated approach as we don’t dilute our best ideas. We have seven members on the equity management team. I’m the lead portfolio manager on the mid-cap product. Jay Sekelsky is the lead portfolio manager on the large-cap products. We also have five analysts who have sector coverage responsibilities, but they have the flexibility to pitch ideas for the portfolio from sectors outside of their official coverage area. Q:  How do you define growth? A : We stress cash flow. Performance in the past is no indication of the future so what we’re doing is predicting the future cash flow of the company and discounting that cash flow back to present value. We’re looking for consistency and predictability in that cash flow growth. That’s what keeps us away from a lot of the more cyclical oil and energy related companies because at the end of the day the growth of those companies is tied to the price of the underlying commodity and that’s not something that we can predict. We’re interested in the steady growers that have strong competitive advantages where we can predict what that cash flow growth is going to be for many years to come. Q:  How do you go about finding them as part of your research process? A : We have a two-dimensional screening process where we have quantitative screening on one side and qualitative screening on the other side. We start with the whole market then we have databases such as Bloomberg or Baseline that we use for screening purposes. We filter this down to our universe of companies which fall into the mid-cap market capitalization range. We screen these companies for a number of different metrics quantitatively. One of the things we screen for are Returns on Equity and Returns on Capital. Generally, we like to see returns on equity 15% or higher but there can be exceptions depending on the industry. We also screen for balance sheet items such as long term debt to total capital. In addition we review earnings growth rates and quality of earnings while conducting valuation review. The qualitative screening process is where a lot of our ideas come from. We’re trying to identify the superior business models in a given industry or sector. It’s done through attending conferences, visiting the management, talking to customers and suppliers, reading trade journals and common periodicals, speaking with industry contacts. When all of this is said and done, we come up with a more manageable universe of 200 to 250 companies that our teams of analysts follow closely. This process leads us primarily to the following sectors: financial, consumer, healthcare, technology and industrials. Q:  Generally, how do you treat earnings? A : We look at what past earnings have been. We look at the characteristics of the business - the competition, the hurdles to entry, the pricing power, the strength of brand names and business franchises. There are three parts to our analysis: the business model analysis, the assessment of the management team and then the valuation work. The business model analysis is the first part of our assessment of a company. We’re looking for certain characteristics - we want companies that have a sustainable, competitive advantage. Such an example is a company we own in our mid-cap portfolio, Tiffany, the jeweler retailer. Over the last 169 years it has built an incredible brand name that represents status and high quality. The next characteristic we’re going to look for in our business model analysis is predictability and dependability of cash flow growth. We want a high degree of certainty in the future cash flow generation of the company. In some ways it ties into the competitive advantage because the greater the competitive advantage, the more dependable the future cash flow. Maybe our analysts think a company is going to grow at 12%. Well, we want to dissect that growth rate over a long period of time and see how much is going to be organic growth, how much is going to come from margin expansion and cutting operating costs. How much is going to come from acquisitions or buybacks. Is the top line revenue growth going to be sufficient to support that cash flow growth? A good example of a company we’ve owned for a long time in our mid-cap portfolio is E.W. Scripps. When we first bought the company it was primarily a newspaper and broadcast television company with very dependable cash flow. Most of their newspapers have a dominant market position. The only issue with newspapers is that the growth isn’t great. What Scripps has done is take strong cash flow from the newspaper business and they invest it in cable television networks such as Home & Garden TV and The Food Network. Now they have the Do It Yourself Network that has grown at impressive rates. They’ve done a good job taking this predictable, dependable cash flow from the newspaper and broadcast TV business and investing it in faster growing initiatives. The third part of our business model analysis is our balance sheet assessment. We want to buy companies that only have solid balance sheets so we’re going to avoid highly leveraged companies. It’s not just the absolute level of debt to total capital, but that the debt can easily be serviced by the cash flow. We’re going to look at things such as the inventory situation and working capital; makeing sure there’s enough cash on hand to run the company. The next part of our analysis is the assessment of the management team. And this is a lot of detective work, sometimes the more difficult part of our process. The real tool that a management team has is their cash flow. They can do a number of different things - they can buy back stock, they can reinvest in the business, they can pay down debt or make acquisitions, they can pay the cash back to shareholders in the form of a dividend. Any one of these might be a wise use of the cash but not at all periods in time. You’d frown upon a technology company that was buying back stock at all time high valuation levels in late 1999. The bottom line is we want wise allocation of capital. Another thing we look for in the management team is we want a strong, proven track record of enhancing shareholder value. We want to be associated with management teams that have their interests aligned with shareholders either through ownership or through incentives. This gives us confidence that they’re going to make decisions and choices that benefit the shareholder. The final part of the process is the valuation assessment. Companies might meet all the criteria I’ve discussed, but they’re not going to make it in the portfolio unless the valuation is attractive in our eyes. The main method we use for valuing companies is discounting cash flow analysis where we’re going to forecast a future stream of cash flow and discount that back to present value. Another thing we do is we want to determine what the weighted average cost to capital is for a company. Then we want to buy companies where their return on capital is in excess of the cost of capital and most importantly the return on capital can remain in excess of the cost of capital for a long period of time. It’s easier said than done, but if you can fill a portfolio with companies that are going to maintain a return on capital over and above the cost of capital for long periods of time, it’s going to be a winning portfolio. Our analysts are free to write 10- 15 page reports, and sometimes they get well in excess of that on a company. But, we want the whole big story summed up on one page, called the Investment Thesis Report, where there’s on average 5-6 bullet points that represent the reasons behind the purchase of the stock. We assign a confidence level to each one of these reports, 1 through 5. We won’t buy stocks with 1 or 2 confidence levels. What these confidence levels represent is the analyst’s conviction in the thesis. At the bottom of the thesis report they’re also required to list a number of bullet points on why we might possibly sell the stock in the future - what are the risks, what to watch closely that could invalidate the thesis on the stock. These confidence levels help us in a couple of ways. For instance, they influence the ultimate position size of the stock in the portfolio. There are 3 events that would trigger a sale of a stock generally. One, the price target is achieved. Two, there’s a breakdown in fundamentals, maybe a key member of the management team leaves or a significant product turns out to be a flop or doesn’t make it to market. And third, there’s a more attractive alternative out there and we don’t have enough cash to buy it, so we sell a stock that’s not as attractive as a source of cash. Q:  What are the key elements of your portfolio construction? A : We’re bottom up concentrated investors. We won’t have more than 25% in one industry. We have quite a bit of flexibility. When we buy or sell a stock, we are going to consider the overall impact on our portfolio. For instance, in the consumer discretionary sector, we recently purchased Apollo Group, which is a for-profit education company. They have the University of Phoenix brand. We also own retailers like CarMax and Foot Locker, and an international media company like Liberty Global. There’s a lot of diversity within each sector. Apollo Group is categorized in consumer discretionary but it actually benefits when the economy is weak because then more people are out of jobs and need to retrain for the shifting job market. So in some aspects it’s counter consumer discretionary even though it’s categorized there. Q:  What is the turnover ratio of the fund? A :Our turnover has averaged 30% to 35% so that would imply holding a stock three years on average.