N-CSR 1 bfifbef-ncsra.txt BAIRD FUNDS, INC. BAIRD FIXED INCOME FUNDS/BAIRD EQUITY FUNDS 12-31-06 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM N-CSR CERTIFIED SHAREHOLDER REPORT OF REGISTERED MANAGEMENT INVESTMENT COMPANIES Investment Company Act file number: 811-09997 --------- BAIRD FUNDS, INC. ----------------- (Exact name of registrant as specified in charter) 777 EAST WISCONSIN AVENUE MILWAUKEE, WI 53202 ------------------- (Address of principal executive offices) (Zip code) CHARLES M. WEBER ---------------- ROBERT W. BAIRD & CO. INCORPORATED ---------------------------------- 777 EAST WISCONSIN AVENUE ------------------------- MILWAUKEE, WI 53202 ------------------- (Name and address of agent for service) 1-866-442-2473 -------------- Registrant's telephone number, including area code Date of fiscal year end: DECEMBER 31, 2006 ----------------- Date of reporting period: DECEMBER 31, 2006 ----------------- ITEM 1. REPORTS TO STOCKHOLDERS. -------------------------------- (BAIRD LOGO) ANNUAL REPORT - BAIRD FUNDS December 31, 2006 Baird Intermediate Bond Fund Baird Aggregate Bond Fund Baird Intermediate Municipal Bond Fund Baird Core Plus Bond Fund Baird Short-Term Bond Fund TABLE OF CONTENTS PAGE ---- LETTER TO SHAREHOLDERS 1 2006 BOND MARKET OVERVIEW 2 BAIRD INTERMEDIATE BOND FUND 6 BAIRD AGGREGATE BOND FUND 22 BAIRD INTERMEDIATE MUNICIPAL BOND FUND 37 BAIRD CORE PLUS BOND FUND 45 BAIRD SHORT-TERM BOND FUND 54 ADDITIONAL INFORMATION ON FUND EXPENSES 65 STATEMENTS OF ASSETS AND LIABILITIES 67 STATEMENTS OF OPERATIONS 68 STATEMENTS OF CHANGES IN NET ASSETS 69 FINANCIAL HIGHLIGHTS 74 NOTES TO THE FINANCIAL STATEMENTS 83 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM 96 DIRECTORS AND OFFICERS 97 DISCLOSURE REGARDING THE BOARD OF DIRECTORS' APPROVAL OF THE INVESTMENT ADVISORY AGREEMENT FOR BAIRD BOND FUNDS 99 ADDITIONAL INFORMATION 103 This report has been prepared for shareholders and may be distributed to others only if preceded or accompanied by a current prospectus. CAUTIONARY NOTE ON ANALYSES, OPINIONS AND OUTLOOKS: In this report we offer --------------------------------------------------- analyses and opinions on the performance of individual securities, companies, industries, sectors, markets, interest rates and governmental policies, including predictions, forecasts and outlooks regarding possible future events. These can generally be identified as such because the context of the statements may include such words as "believe," "should," "will," "expects," "anticipates," "hopes" and words of similar effect. These statements reflect the portfolio managers' good faith beliefs and judgments and involve risks and uncertainties, including the risk that the portfolio managers' analyses, opinions and outlooks are or will prove to be inaccurate. It is inherently difficult to correctly assess and explain the performance of particular securities, sectors, markets, interest rate movements, governmental actions or general economic trends and conditions, and many unforeseen factors contribute to the performance of Baird Funds. Investors are, therefore, cautioned not to place undue reliance on subjective judgments contained in this report. (BAIRD LOGO) BAIRD FUNDS, INC. 1-866-442-2473 www.bairdfunds.com ------------------ February 27, 2007 Dear Shareholders, Thank you for investing in the Baird Funds. We are pleased to report that the Funds reached a new milestone in 2006 with their combined net assets exceeding $1 billion. We appreciate the opportunity to help our investors share in the growth presented by the financial markets in 2006. In this Annual Report we review the bond market in 2006 and the performance and composition of each of the Baird Bond Funds. We hope you find this report both informative and helpful in achieving your investment goals. We thank you for your support and look forward to helping you achieve your investment goals. Thank you again for choosing Baird Funds. Sincerely, /s/Mary Ellen Stanek Mary Ellen Stanek, CFA President Baird Funds 2006 BOND MARKET OVERVIEW 2006 SUMMARY After two years and 17 consecutive rate hikes totaling 425 basis points, the Fed's tightening cycle came to a pause in 2006. Economic growth moderated and inflation remained subdued, providing a fertile environment for strong equity returns. M&A activity hit record levels and overall market volatility reached historic lows. The already-flat yield curve inverted slightly on the short end and investment grade bonds delivered solid, positive returns. Relatively tight yield spreads on non-Treasury sectors tightened further enabling spread sectors to outperform Treasuries by a significant margin. YIELDS RISE SLIGHTLY, INVERSION ON SHORT END Treasury yields rose steadily during the first half of 2006 as the Federal Open Market Committee (FOMC) raised its target for the Fed funds rate in four "data- dependent" 25 basis point moves from 4.25% to 5.25%. The FOMC held its target rate steady at 5.25% during the second half of the year and the bond market rallied as economic data (primarily housing) turned softer. The bond market delivered solid, positive returns in 2006 (thanks to a strong second half), but interest rates finished the year 25-50 basis points higher. Most of the increase came on the short end of the yield curve, resulting in a 1- to 5-year inversion of 30 basis points. The yield curve overall remained very flat during 2006 with no difference between 2-year and 30-year Treasury yields at year-end, compared to a positive difference of 14 basis points at December 31, 2005 (see chart and table below). TREASURY YIELDS Source: Bloomberg MATURITY DEC. 31, 2005 DEC. 31, 2006 1 YR. CHANGE -------- ------------- ------------- ------------ 1 4.43% 4.99% 0.56% 2 4.40% 4.81% 0.41% 3 4.36% 4.73% 0.37% 5 4.35% 4.69% 0.34% 7 4.36% 4.69% 0.33% 10 4.39% 4.70% 0.31% 15 4.58% 4.89% 0.31% 20 4.61% 4.90% 0.29% 25 4.58% 4.86% 0.28% 30 4.54% 4.81% 0.27% GOLDILOCKS ECONOMY While the pace of economic growth slowed during 2006, real or inflation-adjusted Gross Domestic Product (GDP) continued to grow at an annual rate of 3.5% through the 4th quarter despite a softening in home prices and a sharp decline in the amount of money consumers were able to extract from their homes and spend (see the following Mortgage Equity Withdrawal chart). Modest inflation accompanied moderate growth with the Consumer Price Index (CPI) gaining 2.5% in 2006. Oil prices, a key component of CPI, ended the year unchanged at $61 per barrel after peaking at $77 per barrel in August (see the following Crude Oil chart). Core inflation (CPI excluding food and energy prices) increased over the year to 2.6% but was still modest given a very low year-end unemployment rate of 4.5% and a 3.3% increase in the Employment Cost Index during 2006. Goldilocks conditions (moderate growth with modest inflation) proved to be just right for good overall investment returns in 2006. MORTGAGE EQUITY WITHDRAWAL as of 9/30/06 Mar-80 41 Jun-80 23 Sep-80 51 Dec-80 50 Mar-81 22 Jun-81 35 Sep-81 18 Dec-81 15 Mar-82 20 Jun-82 6 Sep-82 2 Dec-82 23 Mar-83 34 Jun-83 34 Sep-83 44 Dec-83 45 Mar-84 62 Jun-84 40 Sep-84 35 Dec-84 52 Mar-85 100 Jun-85 46 Sep-85 117 Dec-85 77 Mar-86 69 Jun-86 69 Sep-86 122 Dec-86 125 Mar-87 118 Jun-87 131 Sep-87 87 Dec-87 90 Mar-88 84 Jun-88 113 Sep-88 98 Dec-88 101 Mar-89 52 Jun-89 89 Sep-89 126 Dec-89 164 Mar-90 93 Jun-90 102 Sep-90 86 Dec-90 84 Mar-91 102 Jun-91 91 Sep-91 -35 Dec-91 101 Mar-92 101 Jun-92 -32 Sep-92 75 Dec-92 41 Mar-93 -6 Jun-93 59 Sep-93 42 Dec-93 28 Mar-94 29 Jun-94 24 Sep-94 41 Dec-94 86 Mar-95 63 Jun-95 80 Sep-95 71 Dec-95 42 Mar-96 107 Jun-96 82 Sep-96 59 Dec-96 108 Mar-97 102 Jun-97 77 Sep-97 169 Dec-97 54 Mar-98 175 Jun-98 150 Sep-98 108 Dec-98 262 Mar-99 203 Jun-99 177 Sep-99 262 Dec-99 201 Mar-00 166 Jun-00 238 Sep-00 194 Dec-00 198 3/31/2001 225 6/30/2001 293 9/30/2001 222 12/31/2001 249 3/31/2002 334 6/30/2002 324 9/30/2002 404 12/31/2002 502 3/31/2003 475 6/30/2003 433 9/30/2003 411 12/31/2003 374 3/31/2004 646 6/30/2004 477 9/30/2004 761 12/31/2004 647 3/31/2005 550 6/30/2005 719 9/30/2005 869 12/31/2005 807 3/31/2006 713 6/30/2006 542 9/30/2006 380 Source: ISI CRUDE OIL (US$/BARREL) as of 12/31/06 1/2/2004 $32.52 1/9/2004 $34.31 1/16/2004 $35.07 1/23/2004 $35.04 1/30/2004 $33.05 2/6/2004 $32.48 2/13/2004 $34.56 2/20/2004 $35.60 2/27/2004 $36.16 3/5/2004 $37.26 3/12/2004 $36.19 3/19/2004 $38.08 3/26/2004 $35.73 4/2/2004 $34.39 4/9/2004 $37.14 4/16/2004 $37.74 4/23/2004 $37.06 4/30/2004 $37.38 5/7/2004 $39.93 5/14/2004 $41.38 5/21/2004 $39.93 5/28/2004 $39.88 6/4/2004 $38.49 6/11/2004 $38.45 6/18/2004 $38.75 6/25/2004 $37.42 7/2/2004 $38.39 7/9/2004 $39.96 7/16/2004 $41.25 7/23/2004 $41.76 7/30/2004 $43.80 8/6/2004 $43.95 8/13/2004 $46.58 8/20/2004 $47.86 8/27/2004 $43.18 9/3/2004 $43.99 9/10/2004 $42.81 9/17/2004 $45.59 9/24/2004 $48.83 10/1/2004 $50.12 10/8/2004 $53.31 10/15/2004 $54.93 10/22/2004 $56.17 10/29/2004 $51.76 11/5/2004 $49.61 11/12/2004 $47.32 11/19/2004 $48.44 11/26/2004 $49.26 12/3/2004 $42.54 12/10/2004 $40.71 12/17/2004 $46.28 12/24/2004 $44.03 12/31/2004 $43.45 1/7/2005 $45.43 1/14/2005 $48.38 1/21/2005 $48.33 1/28/2005 $47.18 2/4/2005 $46.48 2/11/2005 $47.16 2/18/2005 $48.35 2/25/2005 $50.92 3/4/2005 $53.78 3/11/2005 $54.43 3/18/2005 $56.72 3/25/2005 $51.29 4/1/2005 $57.27 4/8/2005 $53.32 4/15/2005 $50.49 4/22/2005 $54.39 4/29/2005 $49.72 5/6/2005 $50.96 5/13/2005 $48.67 5/20/2005 $46.80 5/27/2005 $51.85 6/3/2005 $55.03 6/10/2005 $53.54 6/17/2005 $58.47 6/24/2005 $59.64 7/1/2005 $58.75 7/8/2005 $59.63 7/15/2005 $58.09 7/22/2005 $56.65 7/29/2005 $60.57 8/5/2005 $62.31 8/12/2005 $66.86 8/19/2005 $65.35 8/26/2005 $66.13 9/2/2005 $67.57 9/9/2005 $64.08 9/16/2005 $63.00 9/23/2005 $64.09 9/30/2005 $66.24 10/7/2005 $61.84 10/14/2005 $62.63 10/21/2005 $61.23 10/28/2005 $61.22 11/4/2005 $60.58 11/11/2005 $57.53 11/18/2005 $56.14 11/25/2005 $58.46 12/2/2005 $59.32 12/9/2005 $59.39 12/16/2005 $58.06 12/23/2005 $58.23 12/30/2005 $61.04 1/6/2006 $64.21 1/13/2006 $63.92 1/20/2006 $68.35 1/27/2006 $67.76 2/3/2006 $65.37 2/10/2006 $61.84 2/17/2006 $59.88 2/24/2006 $62.26 3/3/2006 $63.67 3/10/2006 $59.96 3/17/2006 $62.77 3/24/2006 $63.95 3/31/2006 $66.63 4/7/2006 $67.39 4/14/2006 $69.32 4/21/2006 $73.67 4/28/2006 $71.88 5/5/2006 $70.19 5/12/2006 $72.04 5/19/2006 $68.53 5/26/2006 $71.37 6/2/2006 $72.33 6/9/2006 $71.63 6/16/2006 $69.88 6/23/2006 $70.69 6/30/2006 $73.93 7/7/2006 $74.09 7/14/2006 $77.03 7/21/2006 $74.06 7/28/2006 $73.24 8/4/2006 $74.76 8/11/2006 $74.35 8/18/2006 $71.14 8/25/2006 $72.13 9/1/2006 $69.19 9/8/2006 $66.25 9/15/2006 $63.33 9/22/2006 $60.08 9/29/2006 $62.91 10/6/2006 $59.76 10/13/2006 $58.57 10/20/2006 $56.82 10/27/2006 $60.75 11/3/2006 $59.14 11/10/2006 $59.59 11/17/2006 $55.81 11/24/2006 $58.44 12/1/2006 $63.43 12/8/2006 $62.03 12/15/2006 $63.43 12/22/2006 $61.86 12/29/2006 $61.05 Source: Bloomberg M&A SURGE, VOLATILITY DECLINES The value of announced mergers and acquisitions surged in 2006 to a record $3.8 trillion in market value (see chart below left). Awash in cash and searching for higher returns, private equity and hedge fund managers played a major role in driving deals. Transactions involving private equity totaled $750 billion, a 170% increase from 2005. In addition to aiding deal flow, liquidity also contributed to lower market volatility. Equity investors in particular enjoyed strong returns and smooth sailing in 2006 as stock market volatility declined to its lowest level in over 10 years (see VIX chart below right). GLOBAL M&A ANNOUNCED DEALS Year US $ Billions No. of Transactions ---- ------------- ------------------- 1996 $1116.7 23,853 1997 $1640.0 25,898 1998 $2493.1 29,376 1999 $3265.4 32,183 2000 $3400.0 38,716 2001 $1687.0 30,174 2002 $1208.6 26,482 2003 $1360.9 28,830 2004 $1888.0 31,484 2005 $2744.2 33,563 2006 $3803.4 37,285 Source: Thomson Financial CBOE S&P 500 VOLATILITY INDEX (VIX) 1/31/90 25.36 2/28/90 21.99 3/30/90 19.73 4/30/90 19.52 5/31/90 17.37 6/29/90 15.5 7/31/90 21.11 8/31/90 29.9 9/28/90 29.11 10/31/90 30.04 11/30/90 22.16 12/31/90 26.38 1/31/91 20.91 2/28/91 21.23 3/29/91 16.88 4/30/91 18.24 5/31/91 15.93 6/28/91 19.55 7/31/91 15.18 8/30/91 14.46 9/30/91 15.85 10/31/91 15.48 11/29/91 20.26 12/31/91 19.31 1/31/92 17.4 2/28/92 16.68 3/31/92 16.18 4/30/92 15.53 5/29/92 13.86 6/30/92 13.35 7/31/92 13.17 8/31/92 13.58 9/30/92 14.28 10/30/92 16.15 11/30/92 13.01 12/31/92 12.57 1/29/93 12.42 2/26/93 13.16 3/31/93 12.53 4/30/93 12.42 5/31/93 13.47 6/30/93 11.26 7/30/93 11.73 8/31/93 11.85 9/30/93 12.99 10/29/93 11.46 11/30/93 13.76 12/31/93 11.66 1/31/94 10.63 2/28/94 14.87 3/31/94 20.45 4/29/94 13.77 5/31/94 13.03 6/30/94 14.97 7/29/94 11.13 8/31/94 11.97 9/30/94 14.28 10/31/94 14.56 11/30/94 15.95 12/30/94 13.2 1/31/95 11.96 2/28/95 11.75 3/31/95 13.37 4/28/95 11.75 5/31/95 12.85 6/30/95 11.38 7/31/95 13.49 8/31/95 11.52 9/29/95 12.74 10/31/95 13.83 11/30/95 11.58 12/29/95 12.52 1/31/96 12.53 2/29/96 17.04 3/29/96 18.88 4/30/96 15.83 5/31/96 16.07 6/28/96 13.68 7/31/96 19.46 8/30/96 17.01 9/30/96 16.95 10/31/96 18.11 11/29/96 17.14 12/31/96 20.92 1/31/97 20.82 2/28/97 21.1 3/31/97 22.14 4/30/97 20.06 5/30/97 19.19 6/30/97 21.53 7/31/97 21.48 8/29/97 24.76 9/30/97 22.91 10/31/97 35.09 11/28/97 27.43 12/31/97 24.01 1/30/98 21.47 2/27/98 18.55 3/31/98 24.22 4/30/98 21.18 5/29/98 21.32 6/30/98 19.71 7/31/98 24.8 8/31/98 44.28 9/30/98 40.95 10/30/98 28.05 11/30/98 26.01 12/31/98 24.42 1/29/99 26.25 2/26/99 27.88 3/31/99 23.26 4/30/99 25.07 5/31/99 25.39 6/30/99 21.09 7/30/99 24.64 8/31/99 24.45 9/30/99 25.41 10/29/99 22.2 11/30/99 24.18 12/31/99 24.64 1/31/2000 24.95 2/29/2000 23.37 3/31/2000 24.11 4/28/2000 26.2 5/31/2000 23.65 6/30/2000 19.54 7/31/2000 20.74 8/31/2000 16.84 9/29/2000 20.57 10/31/2000 23.63 11/30/2000 29.65 12/29/2000 26.85 1/31/2001 22.02 2/28/2001 28.35 3/30/2001 28.64 4/30/2001 25.48 5/31/2001 22.64 6/29/2001 19.06 7/31/2001 21.62 8/31/2001 24.92 9/28/2001 31.93 10/31/2001 33.56 11/30/2001 23.84 12/31/2001 23.8 1/31/2002 21.09 2/28/2002 21.59 3/29/2002 17.4 4/30/2002 21.91 5/31/2002 19.98 6/28/2002 25.4 7/31/2002 32.03 8/30/2002 32.64 9/30/2002 39.69 10/31/2002 31.14 11/29/2002 27.5 12/31/2002 28.62 1/31/2003 31.17 2/28/2003 29.63 3/31/2003 29.15 4/30/2003 21.21 5/30/2003 19.47 6/30/2003 19.52 7/31/2003 19.49 8/29/2003 18.63 9/30/2003 22.72 10/31/2003 16.1 11/28/2003 16.32 12/31/2003 18.31 1/30/2004 16.63 2/27/2004 14.55 3/31/2004 16.74 4/30/2004 17.19 5/31/2004 15.5 6/30/2004 14.34 7/30/2004 15.32 8/31/2004 15.29 9/30/2004 13.34 10/29/2004 16.27 11/30/2004 13.24 12/31/2004 13.29 1/31/2005 12.82 2/28/2005 12.08 3/31/2005 14.02 4/29/2005 15.31 5/31/2005 13.29 6/30/2005 12.04 7/29/2005 11.57 8/31/2005 12.6 9/30/2005 11.92 10/31/2005 15.32 11/30/2005 12.06 12/30/2005 12.07 1/31/2006 12.95 2/28/2006 12.34 3/31/2006 11.39 4/28/2006 11.59 5/31/2006 16.44 6/30/2006 13.08 7/31/2006 14.95 8/31/2006 12.31 9/29/2006 11.98 10/31/2006 11.1 11/30/2006 10.91 12/29/2006 11.56 Source: Bloomberg CDS SWELL, CREDIT SPREADS TIGHTEN Credit default swaps (CDS) continued to grow rapidly with notional par amounts exceeding $20 trillion (nearly 4 times the market value of the Lehman Brothers Credit Index) at the end of 2006 (see chart below left). Hedge funds, which have also been growing rapidly in size and number, account for roughly 30% of CDS activity and have been a key contributor to the expansion of the CDS market in recent years. While some are concerned that the additional liquidity this largely unregulated market brings to the bond market as a whole could be shallow, unreliable or, at some point, even detrimental, the growth of CDS clearly contributed to tighter credit spreads and lower spread volatility in 2006. The option-adjusted spread of the Lehman Brothers Investment Grade Credit Index tightened to 80 basis points at year end (from 83 bps in 2005) while the range of this spread during the entire year was just 11 basis points, the narrowest since 1996 (see chart below right). As in the equity markets, low volatility rewarded the assumption of additional risk in the bond market as well in 2006. CREDIT DEFAULT SWAPS Notional Principal ($ billions) 1996 $180.0 1998 $350.0 1999 $586.0 2000 $893.0 2001 $1,189.0 2002 $1,952.0 2003 $3,548.0 2004 $5,021.0 2006 $20,207.0 Source: British Banker Association & Lehman Brothers U.S. INVESTMENT GRADE CREDIT INDEX Option-Adjusted Spread Range 1991 95.18 153.79 107.20 1992 85.00 101.55 87.58 1993 72.91 85.54 72.91 1994 66.10 79.04 78.31 1995 61.25 76.13 64.91 1996 53.91 63.75 56.23 1997 51.14 71.17 67.22 1998 68.65 145.20 117.84 1999 101.65 125.11 110.84 2000 114.81 190.54 189.87 2001 143.02 190.61 164.03 2002 149.22 241.13 168.74 2003 88.66 166.11 88.80 2004 73.40 95.18 75.02 2005 69.99 98.75 83.39 2006 77.69 89.11 80.64 Source: Lehman Brothers SOLID RETURNS, TIPS FALTER Despite the modest increase in yields, all sectors of the bond market posted solid positive returns in 2006 (see following table). Low volatility and the compression of yield spreads combined to boost returns of spread sectors which easily surpassed the 3.08% return on Treasuries. Mortgage-backed securities (MBS), which by nature have high intrinsic optionality, thrived in the low- volatility environment and led all other investment grade sectors with a return of 5.22% for the year. Low volatility also helped asset-backed securities (ABS) generate a respectable 4.70% return in 2006. Government agencies (posting a return of 4.39%) and corporates (posting a return of 4.30%) benefited in 2006 from tighter spreads while moderate new supply and steady investor demand helped municipal bonds return 4.84% for the year. High yield bonds again correlated more closely with stocks and delivered a stunning 11.85% return for the year while modest CPI gains caused Treasury Inflation-Protected Securities (TIPS) to falter with a disappointing 2006 return of just 0.41%. TOTAL RETURNS OF SELECTED LEHMAN BROTHERS (LB) INDICES AND SUBSECTORS Index/Sector 2006 ------------ ---- LB Aggregate Index 4.33% LB Gov't/Credit Index 3.78% LB Int. Gov't/Credit Index 4.08% LB 1-3 yr. Gov't/Credit Index 4.25% US Treasury Sector 3.08% Government Agency Sector 4.39% Corporate Sector 4.30% Mortgage Backed Securities Sector 5.22% Asset Backed Securities Sector 4.70% High Yield Sector 11.85% Municipal Sector 4.84% US TIPS Sector 0.41% 2007 OUTLOOK We expect the moderate growth/modest inflation Goldilocks economy to persist in 2007 and would not be surprised if the Fed stays on the sidelines longer than many expect. Hence, the yield curve could remain flat longer than normal with interest rates near current levels. Tight spreads in corporates and agencies limit the added-value prospects for these sectors, and forecasts of manageable new supply suggest that spreads could remain tight. We believe some upward pressure on spreads could occur in the high yield market where LBO activity is creating more supply. Market volatility will likely increase somewhat from the lows of 2006, but we still see good relative value in certain MBS and ABS structures. BAIRD ADVISORS Mary Ellen Stanek, CFA Gary A. Elfe, CFA Charles B. Groeschell Warren D. Pierson, CFA Daniel A. Tranchita, CFA M. Sharon deGuzman BAIRD INTERMEDIATE BOND FUND DECEMBER 31, 2006 The Baird Intermediate Bond Fund seeks an annual total rate of return, before Fund expenses, greater than the annual rate of total return of the Lehman Brothers Intermediate Government/Credit Bond Index. The Lehman Brothers Intermediate Government/Credit Bond Index is an unmanaged, market value weighted index of investment grade, fixed-rate debt, including government and corporate securities, with maturities between one and ten years. The Fund delivered solid positive returns and outperformed its benchmark index in 2006. Helping the Fund's strong relative performance were the following factors: o The Fund's exposure to high-quality mortgage-backed and asset-backed securities which performed well relative to other sectors; o The Fund's overweighting of BBB-rated corporate bonds relative to the benchmark; and o Strong performance of specific individual corporate issues, particularly those in the auto and finance sectors. The Fund's exposure to a small number of issues which were negatively affected by leveraged buy-outs detracted slightly from relative performance in 2006. The Fund maintained its duration-neutral strategy, holding a broadly diversified portfolio of over 280 securities at year end. The Fund ended 2006 with a yield advantage versus its benchmark index. This yield advantage, combined with exposure to specific sectors which we believe have superior total return potential (mortgage-backed and asset-backed securities), enhance the Fund's prospects of continuing to add value over its benchmark in the coming year. PORTFOLIO CHARACTERISTICS QUALITY DISTRIBUTION* U.S. Treasury 9% U.S. Gov't \rAgency 23% AAA 20% AA 4% A 17% BBB 25% Below BBB 2% SECTOR WEIGHTINGS* Asset-Backed 8% Financials 20% Industrials 18% Utilities 8% Mortgage-Backed 16% International 2% Municipal 1% U.S. Gov't Agency 16% U.S. Treasuries 9% Cash 2% NET ASSETS: $328,042,613 SEC 30-DAY YIELD:** Institutional Class: 5.12% Investor Class: 4.88% AVERAGE EFFECTIVE DURATION: 3.60 years AVERAGE EFFECTIVE MATURITY: 4.89 years ANNUALIZED EXPENSE RATIO: Institutional Class: 0.30% Investor Class: 0.55%*** PORTFOLIO TURNOVER RATIO: 44.8% TOTAL NUMBER OF HOLDINGS: 283 * Percentages shown are based on the Fund's total net assets. ** SEC yields are based on SEC guidelines and are calculated for the 30 days ended December 31, 2006. *** Includes 0.25% 12b-1 fee. BAIRD INTERMEDIATE BOND FUND BAIRD INTERMEDIATE BOND FUND - INSTITUTIONAL CLASS VALUE OF A $250,000 INVESTMENT Baird Intermediate Lehman Brothers Intermediate Bond Fund - Government/Credit Institutional Class Shares Bond Index -------------------------- ---------------------------- 9/29/2000 $250,000 $250,000 12/31/2000 $266,589 $259,242 6/30/2001 $277,111 $269,827 12/31/2001 $284,379 $282,476 6/30/2002 $293,461 $291,870 12/31/2002 $307,199 $310,260 6/30/2003 $323,016 $323,504 12/31/2003 $325,290 $323,633 6/30/2004 $325,782 $323,274 12/31/2004 $338,193 $333,477 6/30/2005 $344,066 $338,777 12/31/2005 $344,187 $338,741 6/30/2006 $344,358 $341,944 12/31/2006 $360,344 $352,567 GROWTH OF A HYPOTHETICAL INVESTMENT OF $250,000 MADE ON THE FUND'S INCEPTION DATE (9/29/00), ASSUMING REINVESTMENT OF ALL DISTRIBUTIONS. BAIRD INTERMEDIATE BOND FUND - INVESTOR CLASS VALUE OF A $10,000 INVESTMENT Baird Intermediate Lehman Brothers Intermediate Bond Fund - Government/Credit Investor Class Shares Bond Index --------------------- ---------------------------- 9/29/2000 $10,000 $10,000 12/31/2000 $10,668 $10,370 6/30/2001 $11,075 $10,793 12/31/2001 $11,353 $11,299 6/30/2002 $11,711 $11,675 12/31/2002 $12,231 $12,410 6/30/2003 $12,845 $12,940 12/31/2003 $12,917 $12,945 6/30/2004 $12,921 $12,931 12/31/2004 $13,394 $13,339 6/30/2005 $13,615 $13,551 12/31/2005 $13,603 $13,550 6/30/2006 $13,592 $13,526 12/31/2006 $14,212 $14,103 GROWTH OF A HYPOTHETICAL INVESTMENT OF $10,000 MADE ON THE FUND'S INCEPTION DATE (9/29/00), ASSUMING REINVESTMENT OF ALL DISTRIBUTIONS. BAIRD INTERMEDIATE BOND FUND AVERAGE ANNUAL TOTAL RETURNS SINCE For the Periods Ended December 31, 2006 ONE YEAR FIVE YEARS INCEPTION(1) --------------------------------------- -------- ---------- ---------------- Baird Intermediate Bond Fund - Institutional Class Shares 4.70% 4.84% 6.02% Baird Intermediate Bond Fund - Investor Class Shares 4.47% 4.59% 5.78% Lehman Brothers Intermediate Government/Credit Bond Index(2) 4.08% 4.53% 5.65%
(1) For the period from September 29, 2000 (commencement of operations) through December 31, 2006. (2) The Lehman Brothers Intermediate Government/Credit Bond Index is an unmanaged, market value weighted index of investment grade, fixed-rate debt including government and corporate securities with maturities between one and 10 years. This index does not reflect any deduction for fees, expenses or taxes. A direct investment in an index is not possible. THE RETURNS SHOWN IN THE TABLE ABOVE REFLECT REINVESTMENT OF DIVIDENDS AND/OR CAPITAL GAINS DISTRIBUTIONS IN ADDITIONAL SHARES. THE RETURNS DO NOT REFLECT THE DEDUCTION OF TAXES THAT A SHAREHOLDER WOULD PAY ON FUND DISTRIBUTIONS OR THE REDEMPTION OF FUND SHARES. PAST PERFORMANCE DOES NOT GUARANTEE FUTURE RESULTS. INVESTMENT RETURN AND PRINCIPAL VALUE WILL FLUCTUATE SO THAT AN INVESTOR'S SHARES, WHEN REDEEMED, MAY BE WORTH MORE OR LESS THAN THEIR ORIGINAL COST. FOR INFORMATION ABOUT THE PERFORMANCE OF THE FUND AS OF THE MOST RECENT MONTH- END, PLEASE CALL 1-866-44BAIRD OR VISIT WWW.BAIRDFUNDS.COM. MUTUAL FUND PERFORMANCE CHANGES OVER TIME AND CURRENT PERFORMANCE MAY BE LOWER OR HIGHER THAN THAT STATED. BAIRD INTERMEDIATE BOND FUND SCHEDULE OF INVESTMENTS DECEMBER 31, 2006 Principal Amount Value --------- ----- LONG-TERM INVESTMENTS - 96.6% ASSET BACKED SECURITIES - 7.5% $ 3,000,000 American Express Credit Account Master Trust, Series 2004-5, Class A, 5.42%, 04/15/2012 $ 3,000,686 616,319 Amresco Residential Securities Mortgage Loan Trust, Series 1998-1, Class A6, 6.51%, 08/25/2027 618,379 1,150,000 Bayview Financial Acquisition Trust, Series 2005-B, Class 1A2, 4.70%, 04/28/2039 1,138,987 256,379 Chase Funding Mortgage Loan, Series 2004-1, Class 1A3, 2.98%, 04/25/2026 254,221 19,280 CitiFinancial Mortgage Securities, Inc., Series 2004-1, Class AF2, 2.65%, 04/25/2034 18,841 37,599 Contimortgage Home Equity Trust, Series 1999-1, Class A7, 6.47%, 12/25/2013 37,523 Countrywide Asset-Backed Certificates: 2,215,000 Series 2006-S3, Class A2, 6.09%, 06/25/2021 2,234,868 2,200,000 Series 2005-12, Class 1A2, 4.85%, 02/25/2036 2,181,148 375,000 Series 2006-13, Class 1AF3, 5.94%, 01/25/2037 377,337 75,000 Series 2006-9, Class 1AF3, 5.86%, 10/25/2046 75,351 1,500,000 Credit Based Asset Servicing and Securities, Series 2005-CB1, Class AF4, 4.62%, 01/25/2035 1,489,067 225,000 Daimler Chrysler Master Owner Trust, Series 2004-A, Class A, 5.38%, 01/15/2009 225,007 Delta Funding Home Equity Loan Trust: 308,216 Series 1997-2, Class A6, 7.04%, 06/25/2027 307,165 348,446 Series 1999-1, Class A6F, 6.34%, 12/15/2028 347,754 790,806 Series 1999-2, Class A7F, 7.03%, 08/15/2030 788,922 Discover Card Master Trust I: 150,000 Series 2003-4, Class A1, 5.46%, 05/15/2011 150,365 2,000,000 Series 2005-2, Class A, 5.38%, 04/17/2012 2,004,412 56,253 Equivantage Home Equity Loan Trust, Series 1996-3, Class A3, 7.70%, 09/25/2027 56,063 GMAC Mortgage Corporation Loan Trust: 1,757,323 Series 2004-GH1, Class A2, 4.39%, 12/25/2025 1,739,993 1,461,432 Series 2004-J4, Class A2, 5.50%, 09/25/2034 1,455,120 Green Tree Financial Corporation: 1,648,159 Series 1998-3, Class A5, 6.22%, 03/01/2030 1,660,654 597,653 Series 1998-4, Class A5, 6.18%, 04/01/2030 583,216 148,739 Series 1999-3, Class A5, 6.16%, 02/01/2031 148,798 184,780 IMC Home Equity Loan Trust, Series 1998-1, Class A6, 6.52%, 06/20/2029 185,668 244,735 IMPAC Secured Asset Corporation, Series 2004-2, Class A3, 5.00%, 08/25/2034 243,496 2,675,000 MBNA Credit Card Master Note Trust, Series 2003-A3, Class A3, 2.93%, 08/15/2010 2,679,599 233,282 New Century Home Equity Loan Trust, Series 2003-5, Class AI3, 3.56%, 11/25/2033 232,270 267,042 Oakwood Mortgage Investors, Inc., Series 1999-B, Class A3, 6.45%, 11/15/2017 251,217 24,795 Residential Asset Mortgage Products, Inc., Series 2003-RS7, Class AI6, 5.34%, 08/25/2033 24,589 1,458 Salomon Brothers Mortgage Securities VII, Series 1997-LB6, Class A6, 6.82%, 12/25/2027 1,456 ------------ 24,512,172 ------------ FINANCIAL - 19.8% Allfirst Financial, Inc. Subordinated Notes: 1,550,000 7.20%, 07/01/2007 1,560,796 725,000 6.88%, 06/01/2009 747,342 550,000 American General Finance Corporation Notes, 4.00%, 03/15/2011 522,172 589,000 American General Finance Corporation Senior Notes, 8.45%, 10/15/2009 635,143 25,000 American General Finance, 4.63%, 09/01/2010 24,397 630,000 AmSouth Bancorporation Subordinated Debentures, 6.75%, 11/01/2025 681,678 691,000 AmSouth Bank NA Subordinated Notes, 6.45%, 02/01/2008 697,572 500,000 AMVESCAP PLC Notes, 5.38%, 02/27/2013 F 494,819 50,000 AMVESCAP, Inc. Senior Notes, 5.90%, 01/15/2007 F 50,005 1,335,000 Anthem, Inc., 6.80%, 08/01/2012 1,416,001 725,000 Banco Santander Chile SA, 7.00%, 07/18/2007 F 727,182 310,000 Bank of America Corporation Subordinated Notes, 10.20%, 07/15/2015 404,208 400,000 Bank of Oklahoma Subordinated Notes, 7.13%, 08/15/2007 403,692 Bank One Corporation Subordinated Notes: 180,000 6.00%, 02/17/2009 182,248 1,043,000 10.00%, 08/15/2010 1,190,599 1,520,000 BankAmerica Institutional, 8.07%, 12/31/2026 (Acquired 01/04/2006, 06/01/2006 and 10/11/2006; Cost $500,456, $682,331 and $417,508 respectively)* 1,582,715 480,000 Bankers Trust Corporation Subordinated Notes, 7.38%, 05/01/2008 491,552 1,500,000 Banponce Trust I, Series A, 8.33%, 02/01/2027 1,564,341 1,000,000 BOI Capital Funding No. 2, 5.57%, 02/01/2049 (Acquired 01/20/2006; Cost $1,000,000)* F 976,615 2,035,000 Citigroup Capital II, 7.75%, 12/01/2036 2,104,231 300,000 CIT Group Company of Canada, 5.20%, 06/01/2015 F 290,575 25,000 CIT Group, Inc. Senior Notes, 7.75%, 04/02/2012 27,563 200,000 CIT Group, Inc. Bonds, 5.40%, 01/30/2016 196,504 1,336,000 Comerica Incorporated Subordinated Notes, 7.25%, 08/01/2007 1,350,625 850,000 Compass Bank Subordinated Notes, 8.10%, 08/15/2009 903,643 260,000 Corestates Capital Trust I, 8.00%, 12/15/2026 (Acquired 11/29/2005; Cost $276,398)* 270,748 650,000 Countrywide Financial Corporation Subordinated Notes, 6.25%, 05/15/2016 662,501 1,000,000 Countrywide Home Loans, Inc., 5.50%, 02/01/2007 1,000,045 885,000 Dime Capital Trust, 9.33%, 05/06/2027 935,774 462,728 First National Bank of Chicago Pass Thru Certificates, 8.08%, 01/05/2018 521,041 1,100,000 First National Bank of Omaha Subordinated Notes, 7.32%, 12/01/2010 1,106,117 1,900,000 First Union Capital, 7.94%, 01/15/2027 1,978,481 775,000 FMR Corporation Notes, 4.75%, 03/01/2013 (Acquired 02/26/2003; Cost $777,379)* 751,409 800,000 General Electric Capital Corporation Notes, 6.00%, 06/15/2012 828,137 1,000,000 Genworth Financial Inc. Notes, 5.75%, 06/15/2014 1,018,926 1,975,000 Glencore Funding LLC, 6.00%, 04/15/2014 (Acquired 03/31/2004, 02/02/2005, 04/26/2006 and 12/04/2006; 1,925,289 Cost $794,280, $146,738, $282,792 and $720,432 respectively)* 500,000 The Goldman Sachs Group, Inc. Bonds, 5.15%, 01/15/2014 492,552 25,000 The Goldman Sachs Group, Inc. Notes, 4.75%, 07/15/2013 24,132 1,000,000 Great West Life & Annuity Insurance, 7.15%, 05/16/2046 (Acquired 05/16/2006; Cost $1,000,000)* 1,059,686 1,195,000 Health Care Service Corporation Notes, 7.75%, 06/15/2011 (Acquired 06/20/2001, 01/26/2005 and 10/19/2006; Cost $497,765, $373,500 and $397,317 respectively)* 1,297,300 400,000 Highmark, Inc. Notes, 6.80%, 08/15/2013 (Acquired 08/14/2003; Cost $399,088)* 419,522 25,000 HSBC Finance Corporation Notes, 5.00%, 06/30/2015 24,309 1,050,000 Istar Financial Inc., 5.95%, 10/15/2013 (Acquired 09/13/2006; Cost $1,047,428)* 1,055,289 500,000 J.P. Morgan Chase & Company Subordinated Notes, 6.63%, 03/15/2012 527,395 1,600,000 Lehman Brothers Holdings Senior Notes, 8.80%, 03/01/2015 1,933,923 846,000 Lehman Brothers Holdings, Inc. Notes, 8.50%, 08/01/2015 1,009,521 600,000 Marsh & McLennan Companies, Inc., 5.38%, 07/15/2014 577,340 600,000 MBNA Corporation Notes, 6.13%, 03/01/2013 623,009 1,395,000 Mellon Capital II, Series B, 8.00%, 01/15/2027 1,452,273 750,000 Merrill Lynch & Co., Inc. Senior Unsubordinated Notes, 5.00%, 02/03/2014 733,974 125,000 Met Life Global Funding Senior Notes, 4.50%, 05/05/2010 (Acquired 08/04/2005; Cost $123,925)* 122,630 1,000,000 Morgan Stanley Dean Witter Debentures, 10.00%, 06/15/2008 1,064,388 25,000 Morgan Stanley Subordinated Notes, 4.75%, 04/01/2014 23,903 1,230,000 National Australia Bank Ltd. Subordinated Notes, Series A, 8.60%, 05/19/2010 F 1,356,312 534,000 National City Bank of Kentucky Subordinated Notes, 6.30%, 02/15/2011 553,112 500,000 Nationwide Life Global Fund Notes, 5.35%, 02/15/2007 (Acquired 02/08/2002; Cost $499,520)* 500,001 1,100,000 Navigators Group Inc. Senior Unsecured Notes, 7.00%, 05/01/2016 1,124,763 760,000 NB Capital Trust IV, 8.25%, 04/15/2027 793,246 1,000,000 North Fork Capital Trust II, 8.00%, 12/15/2027 1,055,818 800,000 Phoenix Companies, 6.68%, 02/16/2008 806,906 1,319,000 PNC Funding Corporation, 7.50%, 11/01/2009 1,392,914 1,000,000 Premium Asset Senior Notes, 4.13%, 03/12/2009 (Acquired 12/20/2006; Cost $935,000)* 940,000 25,000 Protective Life Corporation Senior Notes, 4.30%, 06/01/2013 23,465 500,000 Providian Capital I, 9.53%, 02/01/2027 (Acquired 06/30/2006; Cost $531,235)* 524,933 1,200,000 Rabobank Nederland Senior Notes, 2.70%, 03/15/2007 (Acquired 02/03/2004; Cost $1,199,760)* F 1,192,694 700,000 Residential Capital Corporation, 6.38%, 06/30/2010 708,147 805,000 SAFECO Corporation Notes, 6.88%, 07/15/2007 811,904 546,000 SAFECO Corporation Senior Notes, 7.25%, 09/01/2012 590,165 Santander Central Hispano Insurances: F 325,000 7.63%, 09/14/2010 351,120 550,000 6.38%, 02/15/2011 569,685 SLM Corporation Notes: 1,516,000 4.50%, 07/26/2010 1,475,615 25,000 5.38%, 05/15/2014 24,802 St. Paul Travelers, Inc., 1,000,000 6.25%, 06/20/2016 1,049,958 1,046,000 Toll Road Inv. Part II, 0.00%, 02/15/2011 (Acquired 09/28/2004; Cost $782,046)*^ 841,642 1,255,000 Transamerica Finance Corporation Debentures, 0.00%, 03/01/2010^ 1,047,344 925,000 UFJ Bank Ltd/New York, Subordinated Notes, 7.40%, 06/15/2011 999,336 350,000 UFJ Finance Aruba AEC, 6.75%, 07/15/2013 F 373,509 870,000 Union Planters Corporation Subordinated Notes, 6.50%, 03/15/2018 (Acquired 05/08/2002, 02/12/2003, 05/08/2003 and 09/22/2005; Cost $200,363, 881,431 $73,378, $400,227 and $234,877 respectively)* 500,000 Washington Mutual Bank Subordinated Notes, 6.88%, 06/15/2011 527,180 500,000 Washington Mutual Capital I, 8.38%, 06/01/2027 524,590 Westdeutsche Landesbank Subordinated Notes: F 25,000 6.05%, 01/15/2009 25,317 1,495,000 4.80%, 07/15/2015 1,433,895 ------------ 65,165,636 ------------ INDUSTRIAL - 18.1% 450,000 Alcan, Inc. Notes, 5.00%, 06/01/2015 F 428,010 1,008,000 Ameritech Capital Funding, 6.45%, 01/15/2018 1,011,168 225,000 Auburn Hills Trust Debentures, 12.38%, 05/01/2020 332,199 300,000 Bellsouth Corporation, 4.75%, 11/15/2012 289,506 650,000 British Telecom PLC Notes, 8.38%, 12/15/2010 F 725,406 Bunge Ltd. Finance Corporation Notes: 800,000 5.35%, 04/15/2014 768,887 1,085,000 5.10%, 07/15/2015 1,010,423 375,000 Caesars Entertainment Senior Notes, 7.50%, 09/01/2009 389,128 1,000,000 Clear Channel Communications Senior Unsubordinated Notes, 5.50%, 12/15/2016 809,469 125,000 Comcast Cable Communication Holdings, 8.38%, 03/15/2013 142,383 525,000 Comcast Corporation, 6.50%, 01/15/2017 547,849 50,000 Comcast Corporation Senior Subordinated Notes, 10.63%, 07/15/2012 60,381 50,000 Computer Sciences Corporation Notes, 6.25%, 03/15/2009 50,556 Continental Airlines, Inc. Pass Thru Certificates: 451 7.42%, 04/01/2007 430 46,541 6.54%, 03/15/2008 46,599 1,180,000 Cooper Cameron Corporation Senior Notes, 2.65%, 04/15/2007 1,170,409 960,000 Cooper Industries, Inc. Notes, 5.25%, 07/01/2007 957,055 1,281,000 COX Communications, Inc., 7.13%, 10/01/2012 1,365,632 1,000,000 D.R. Horton Inc. Unsubordinated Notes, 6.50%, 04/15/2016 1,006,097 1,125,000 Deutsche Telekom International Finance BV, 8.50%, 06/15/2010 F 1,218,187 300,000 Dollar General Corporation, 8.63%, 06/15/2010 318,750 2,050,000 Ensco International, Inc. Notes, 6.75%, 11/15/2007 2,074,676 500,000 Fiserv, Inc. Notes, 4.00%, 04/15/2008 490,258 623,000 Ford Capital BV Debentures, 9.50%, 06/01/2010 F 619,885 300,000 Ford Motor Company Debentures, 9.22%, 09/15/2021 263,250 500,000 General Electric Company Notes, 5.00%, 02/01/2013 494,450 General Motors Acceptance Corporation Notes: 1,025,000 7.75%, 01/19/2010 1,072,832 200,000 6.75%, 12/01/2014 205,427 550,000 General Motors Nova Scotia Finance Company, 6.85%, 10/15/2008 F 547,250 Halliburton Company Notes: 475,000 5.63%, 12/01/2008 476,345 675,000 5.50%, 10/15/2010 673,801 700,000 Hanson Australia Funding, 5.25%, 03/15/2013 F 682,695 650,000 Hanson PLC Notes, 6.13%, 08/15/2016 F 661,612 975,000 Hutchison Whampoa International Limited, 6.25%, 01/24/2014 (Acquired 11/19/2003 and 02/08/2005; Cost $749,228 and $244,602 respectively)* F 1,011,012 1,000,000 Ingersoll-Rand Company Debentures, 6.39%, 11/15/2027 F 1,069,692 530,000 International Paper Company Notes, 7.63%, 01/15/2007 530,228 1,100,000 Johnson Controls Inc. Senior Notes, 5.50%, 01/15/2016 1,078,541 675,000 Laboratory Corporation of America Holdings, 5.50%, 02/01/2013 650,623 550,000 Lafarge SA Notes, 6.50%, 07/15/2016 F 574,266 500,000 Limited Brands, Inc., 5.25%, 11/01/2014 475,060 1,210,000 Marathon Oil Corporation Debentures, 9.13%, 01/15/2013 1,439,046 500,000 Marathon Oil Corporation Notes, 5.38%, 06/01/2007 499,816 350,000 Marathon Oil Corporation, 6.00%, 07/01/2012 F 359,197 1,550,000 Masco Corporation, 6.13%, 10/03/2016 1,560,559 650,000 New York Telephone Company Debentures, 8.63%, 11/15/2010 709,026 1,650,000 Nextel Communications Senior Notes, 6.88%, 10/31/2013 1,667,044 700,000 PCCW Capital II Ltd., 6.00%, 07/15/2013 (Acquired 07/10/2003; Cost $696,731)* F 705,312 600,000 Pearson Dollar Finance PLC, 5.70%, 06/01/2014 (Acquired 09/28/2005; Cost $618,138)* F 594,332 1,545,000 Plum Creek Timberlands, 5.88%, 11/15/2015 1,518,228 1,500,000 Premcor Refining Group Inc. Senior Notes, 9.50%, 02/01/2013 1,620,116 Qwest Capital Funding, Inc.: 350,000 7.00%, 08/03/2009 356,125 100,000 7.25%, 02/15/2011 102,125 1,000,000 Reed Elsevier Capital Notes, 4.63%, 06/15/2012 955,112 500,000 SBC Communications, Inc. Notes, 5.63%, 06/15/2016 497,704 650,000 Sealed Air Corporation Senior Notes, 5.38%, 04/15/2008 (Acquired 04/09/2003; Cost $646,490)* 646,874 224,954 Southwest Airlines Company Pass Thru Certificates, Series 1996-A1, 7.67%, 01/02/2014 228,890 500,000 Sprint Nextel Corporation, 6.00%, 12/01/2016 487,314 1,100,000 Sunoco, Inc. Senior Notes, 5.75%, 01/15/2017 1,076,122 TCI Communications, Inc. Debentures: 325,000 7.88%, 08/01/2013 361,385 583,000 8.75%, 08/01/2015 689,564 Telecom Italia Capital: F 1,360,000 4.95%, 09/30/2014 1,259,961 25,000 5.25%, 10/01/2015 23,353 1,425,000 Telefonica Emisiones, S.A.U., 6.42%, 06/20/2016 F 1,470,056 681,000 Tele-Communications, Inc. Debentures, 9.80%, 02/01/2012 803,033 1,070,000 Telus Corporation Notes, 7.50%, 06/01/2007 F 1,077,919 1,075,000 Time Warner Companies Inc. Debentures, 9.13%, 01/15/2013 1,252,364 250,000 Time Warner Companies, Inc., 6.88%, 06/15/2018 265,824 1,470,000 Transocean, Inc., 6.63%, 04/15/2011 F 1,527,187 275,000 Tribune Company, 5.25%, 08/15/2015 233,004 Tyco International Group S.A.: F 1,425,000 6.38%, 10/15/2011 1,491,250 650,000 6.00%, 11/15/2013 672,538 1,000,000 Univision Communications, Inc., 3.50%, 10/15/2007 978,450 197,337 Union Pacific Corporation Pass Thru Certificates, Series 1994-A6, 8.66%, 07/02/2011 211,618 United AirLines, Inc. Pass Thru Certificates: 245,275 7.76%, 10/01/2005 (Acquired 12/08/2000; Cost $245,275)@^ 215,842 791,035 6.20%, 09/01/2008 (Acquired 08/10/2001, 10/31/2005 and 03/09/2006; Cost $325,423, $375,535 and $230,569 respectively) 795,979 287,902 10.02%, 03/22/2014 (Acquired 01/03/2001; Cost $322,008)@^ 146,830 1,500,000 Vale Overseas Limited, 6.25%, 01/23/2017 F 1,506,819 1,050,000 Viacom, Inc., 7.70%, 07/30/2010 1,121,538 Waste Management, Inc.: 1,175,000 6.88%, 05/15/2009 1,214,657 25,000 5.00%, 03/15/2014 24,031 160,000 Weyerhaeuser Company Notes, 5.95%, 11/01/2008 161,279 500,000 Willamette Industries, Inc. Notes, 6.60%, 06/05/2012 517,113 ------------ 59,344,963 ------------ UTILITIES - 7.7% 1,715,000 Cilcorp Inc. Senior Notes, 8.70%, 10/15/2009 1,836,985 50,000 Commonwealth Edison, 5.95%, 08/15/2016 50,550 1,000,000 Dominion Resources Inc., Series C, 5.15%, 07/15/2015 968,613 1,400,000 Duke Capital LLC Notes, 5.67%, 08/15/2014 1,396,212 600,000 Energy Transfer Partners, 5.65%, 08/01/2012 597,475 300,000 Exelon Corporation Senior Notes, 6.75%, 05/01/2011 313,355 2,500,000 Kinder Morgan Finance, 5.70%, 01/05/2016 F 2,293,798 416,757 Kiowa Power Partners LLC, 4.81%, 12/30/2013 (Acquired 11/19/2004; Cost $428,709)* 401,691 300,000 Korea Electric Power Corporation, 6.75%, 08/01/2027 F 334,157 MidAmerican Energy Holdings Company Senior Notes: 800,000 4.63%, 10/01/2007 794,799 1,500,000 7.52%, 09/15/2008 1,550,071 1,400,000 National Grid PLC Senior Unsecured Notes, 6.30%, 08/01/2016 F 1,449,959 25,000 National Rural Utilities, 4.38%, 10/01/2010 24,261 100,000 Nisource Finance Corporation, 7.88%, 11/15/2010 107,886 1,500,000 ONEOK, Inc. Senior Notes, 7.13%, 04/15/2011 1,583,210 400,000 Oneok Partners LP Notes, 5.90%, 04/01/2012 404,548 1,417,000 Panhandle Eastern Pipeline Senior Notes, 4.80%, 08/15/2008 1,395,970 1,475,000 PPL Energy Supply LLC Bonds, Series A, 5.70%, 10/15/2015 1,449,126 388,000 PPL Energy Supply, LLC Senior Notes, 6.40%, 11/01/2011 401,682 900,000 Progress Energy, Inc. Senior Notes, 6.85%, 04/15/2012 956,850 175,000 PSE&G Energy Holdings LLC Senior Notes, 8.50%, 06/15/2011 188,125 PSE&G Power LLC: 275,000 7.75%, 04/15/2011 297,137 425,000 5.00%, 04/01/2014 405,384 841,037 RGS (I&M) Funding Corporation Debentures, 9.82%, 12/07/2022 1,011,288 500,000 System Energy Resources 1st Mortgage, 4.88%, 10/01/2007 496,931 800,000 Transcontinental Gas Pipe Line Corporation Senior Notes, Series B, 8.88%, 07/15/2012 904,000 350,000 Tristate Gen & Trans Assn, 6.04%, 01/31/2018 (Acquired 10/14/2003; Cost $350,000)* 353,583 Vectren Utility Holdings: 900,000 6.63%, 12/01/2011 938,877 525,000 5.25%, 08/01/2013 509,159 900,000 Verizon Communications Debentures, 6.84%, 04/15/2018 956,797 25,000 Verizon Communications Senior Unsecured Notes, 5.55%, 02/15/2016 24,914 600,000 The Williams Companies, Inc. Notes, 8.13%, 03/15/2012 649,500 325,000 Yosemite Securities Trust I, 8.25%, 11/15/2004 (Acquired 04/26/2001; Cost $340,415)*@^ 261,625 ------------ 25,308,518 ------------ MORTGAGE BACKED SECURITIES - 16.0% Bank of America Alternative Loan Trust: 426,120 Series 2003-11, Class 4A1, 4.75%, 01/25/2019 412,004 1,744,558 Series 2004-2, Class 5A1, 5.50%, 03/25/2019 1,739,246 1,615,640 Series 2004-11, Class 4A1, 5.50%, 12/25/2019 1,607,561 1,173,469 Bank of America Funding Corporation, Series 2003-3, Class 1A41, 5.50%, 10/25/2033 1,149,308 Citicorp Mortgage Securities, Inc.: 1,548,815 Series 2004-5, Class 1A25, 5.50%, 10/25/2014 1,545,955 1,556,855 Series 2004-4, Class A5, 5.50%, 06/25/2034 1,531,198 Countrywide Alternative Loan Trust: 589,728 Series 2005-5R, Class A2, 4.75%, 12/25/2018 581,460 1,816,624 Series 2005-50CB, Class 4A1, 5.00%, 11/25/2020 1,794,920 73,944 Series 2004-18CB, 5.13%, 09/25/2034 73,498 50,000 Series 2005-10CB, Class 1A6, 5.50%, 05/25/2035 49,417 2,217,826 Countrywide Home Loans, Inc., Series 2003-18, Class A3, 5.25%, 07/25/2033 2,195,705 Federal Gold Loan Mortgage (FGLMC) Pass Thru Certificate: 2,160,624 6.00%, 06/01/2021 2,189,702 66,324 6.00%, 07/01/2028 67,127 Federal Home Loan Mortgage Corporation (FHLMC): 1,761,738 Series 3033, Class LU, 5.50%, 03/15/2013 1,769,620 1,350,000 Series 2592, Class PD, 5.00%, 07/15/2014 1,342,059 1,382,743 Series 2695, Class UA, 5.50%, 09/15/2014 1,386,192 701,466 Series R001, Class AE, 4.38%, 04/15/2015 684,005 2,156,913 Series R003, Class VA, 5.50%, 08/15/2016 2,160,795 1,994,162 Series 3122, Class VA, 6.00%, 01/15/2017 2,026,861 690,839 Series R009, Class AJ, 5.75%, 12/15/2018 691,390 60,668 Series 1395, Class G, 6.00%, 10/15/2022 60,551 724,412 Series 2970, Class DA, 5.50%, 01/15/2023 724,397 Federal National Mortgage Association (FNMA): 1,561,333 Series 2006-B2, Class AB, 5.50%, 05/25/2014 1,559,688 1,500,000 Series 2003-24, Class PC, 5.00%, 11/25/2015 1,484,853 50,000 Series 2003-35, Class TD, 5.00%, 12/25/2016 49,449 250,659 Series 1991-137, Class H, 7.00%, 10/25/2021 260,378 200,608 Series 1992-136, Class PK, 6.00%, 08/25/2022 203,304 106,049 Series 1993-32, Class H, 6.00%, 03/25/2023 106,142 560,056 Series 2002-95, Class MD, 5.00%, 07/25/2026 556,814 549,916 Series 2002-77, Class QP, 5.00%, 09/25/2026 546,667 19,341 Series 2003-25, Class PC, 4.50%, 02/25/2027 19,271 3,247,790 Series 2004-W6, Class 1A6, 5.50%, 07/25/2034 3,220,879 Government National Mortgage Association (GNMA): 553,013 Series 2003-12, Class ON, 4.00%, 02/16/2028 549,190 543,355 Series 1999-4, Class ZB, 6.00%, 02/20/2029 549,774 J.P. Morgan Alternative Loan Trust: 1,778,410 Series 2006-A1, Class 2A1, 5.80%, 03/25/2036 1,790,785 3,000,000 Series 2006-S2, Class A2, 5.81%, 05/25/2036 2,996,884 1,017,357 Lehman Mortgage Trust, Series 2006-4, Class 3A1, 5.00%, 08/25/2021 1,002,167 657,180 Master Alternative Loans Trust, Series 2004-3, Class 1A1, 5.00%, 03/25/2019 643,011 646,008 Salomon Brothers Mortgage Securities VII, Series 2003-UP2, Class A2, 4.00%, 06/25/2033 621,181 Washington Mutual: 3,820,092 Series 2004-CB3, Class 3A, 5.50%, 10/25/2019 3,809,785 868,599 Series 2004-CB4, Class 21A, 5.50%, 12/25/2019 866,223 Washington Mutual, Inc. Pass-Thru Certificates: 2,868,718 Series 2004-CB1, Class 5A, 5.00%, 06/25/2019 2,804,172 1,686,126 Series 2004-CB3, Class 4A, 6.00%, 10/25/2019 1,702,511 1,300,462 Series 2004-CB4, Class 22A, 6.00%, 12/25/2019 1,314,919 ------------ 52,441,018 ------------ INTERNATIONAL (U.S. $ DENOMINATED) - 1.6% 275,000 Corp Andina De Fomento Notes, 7.38%, 01/18/2011 F 294,002 1,000,000 Export Import Bank Korea, 5.13%, 02/14/2011 F 993,049 Korea Development Bank Notes: F 450,000 4.25%, 11/13/2007 445,136 350,000 4.63%, 09/16/2010 342,205 1,050,000 Korea Development Bank Notes, 3.88%, 03/02/2009 F 1,019,303 350,000 National Bank of Hungary Yankee Debentures, 8.88%, 11/01/2013 F 417,979 1,700,000 PEMEX Project Funding Master Trust, 9.13%, 10/13/2010 F 1,906,550 ------------ 5,418,224 ------------ TAXABLE MUNICIPAL BONDS - 0.5% Tobacco Settlement Financing Corporation: 275,000 Series 2001-A, Class A, 5.92%, 06/01/2012 274,114 1,262,188 Series 2001-A, Class A, 6.36%, 05/15/2025 1,263,362 ------------ 1,537,476 ------------ U.S. GOVERNMENT AGENCY ISSUES - 16.0% Federal National Mortgage Association (FNMA): 13,285,000 7.25%, 01/15/2010 14,133,832 36,775,000 6.00%, 05/15/2011 38,291,343 ------------ 52,425,175 ------------ U.S. TREASURY OBLIGATIONS - 9.4% U.S. Treasury Bonds, 22,350,000 9.13%, 05/15/2018 30,739,989 ------------ Total Long-Term Investments (Cost $317,510,070) 316,893,171 ------------ COLLATERAL POOL INVESTMENT FOR SECURITIES ON LOAN - 26.7% (Cost $87,414,866) (Please Refer to Note 6) 87,414,866 ------------ Shares ------ SHORT-TERM INVESTMENTS - 2.1% MONEY MARKET FUNDS - 2.1% 7,008,756 Short-Term Investment Company Liquid Assets Portfolio - AIM Fund 7,008,756 ------------ Total Short-Term Investments (Cost $7,008,756) 7,008,756 ------------ Total Investments (Cost $411,933,692) - 125.4% 411,316,793 ------------ Liabilities in Excess of Other Assets - (25.4)% (83,274,180) ------------ TOTAL NET ASSETS - 100.0% $328,042,613 ------------ ------------ @ Security in Default ^ Non Income Producing * Unregistered Security F Foreign Security The accompanying notes are an integral part of these financial statements. BAIRD AGGREGATE BOND FUND DECEMBER 31, 2006 The Baird Aggregate Bond Fund seeks an annual rate of total return, before Fund expenses, greater than the annual rate of total return of the Lehman Brothers Aggregate Bond Index. The Lehman Brothers Aggregate Bond Index is an unmanaged, market value weighted index of investment grade, fixed-rate debt issues, including government, corporate, asset-backed and mortgage-backed securities, with maturities of at least one year. The Fund delivered solid positive returns and outperformed its benchmark index in 2006. Helping the Fund's strong relative performance were the following factors: o The Fund's significant exposure to asset-backed securities; o The Fund's overweighting of BBB-rated corporate bonds relative to the benchmark; and o Strong performance of specific individual corporate issues, particularly those in the auto and finance sectors. The Fund's underweighting of mortgage pass-through securities relative to the benchmark and exposure to a small number of issues which were negatively affected by leveraged buy-outs detracted slightly from relative performance in 2006. The Fund maintained its duration-neutral strategy, holding a broadly diversified portfolio of over 300 securities at year end. The Fund ended 2006 with a yield advantage versus its benchmark index. This yield advantage, combined with exposure to specific sectors which we believe have superior total return potential (asset-backed securities and collateralized mortgage-backed obligations), enhance the Fund's prospects of continuing to add value over its benchmark in the coming year. PORTFOLIO CHARACTERISTICS QUALITY DISTRIBUTION* U.S. Treasury 10% U.S. Gov't Agency 28% AAA 27% AA 3% A 11% BBB 20% Below BBB 1% SECTOR WEIGHTINGS* Asset-Backed 9% Commercial Mortgage-Backed 3% Financials 14% Industrials 12% Utilities 6% Mortgage-Backed 36% International 1% Municipal 1% U.S. Gov't Agency 4% U.S. Treasuries 10% Cash 4% NET ASSETS: $336,756,477 SEC 30-DAY YIELD:** Institutional Class: 5.29% Investor Class: 5.04% AVERAGE EFFECTIVE DURATION: 4.46 years AVERAGE EFFECTIVE MATURITY: 7.21 years ANNUALIZED EXPENSE RATIO: Institutional Class: 0.30% Investor Class: 0.55%*** PORTFOLIO TURNOVER RATIO: 52.4% TOTAL NUMBER OF HOLDINGS: 304 * Percentages shown are based on the Fund's total net assets. ** SEC yields are based on SEC guidelines and are calculated for the 30 days ended December 31, 2006. *** Includes 0.25% 12b-1 fee. BAIRD AGGREGATE BOND FUND BAIRD AGGREGATE BOND FUND - INSTITUTIONAL CLASS VALUE OF A $250,000 INVESTMENT Baird Aggregate Bond Fund - Lehman Brothers Institutional Class Shares Aggregate Bond Index -------------------------- -------------------- 9/29/2000 $250,000 $250,000 12/31/2000 $264,448 $260,514 6/30/2001 $275,084 $269,936 12/31/2001 $286,461 $282,512 6/30/2002 $295,106 $293,222 12/31/2002 $310,239 $311,484 6/30/2003 $328,053 $323,719 12/31/2003 $332,520 $324,268 6/30/2004 $333,936 $324,755 12/31/2004 $350,368 $338,336 6/30/2005 $360,526 $346,843 12/31/2005 $360,351 $346,555 6/30/2006 $358,649 $344,050 12/31/2006 $377,922 $361,572 GROWTH OF A HYPOTHETICAL INVESTMENT OF $250,000 MADE ON THE FUND'S INCEPTION DATE (9/29/00), ASSUMING REINVESTMENT OF ALL DISTRIBUTIONS. BAIRD AGGREGATE BOND FUND - INVESTOR CLASS VALUE OF A $10,000 INVESTMENT Baird Aggregate Bond Fund - Lehman Brothers Investor Class Shares Aggregate Bond Index --------------------------- -------------------- 9/29/2000 $10,000 $10,000 12/31/2000 $10,577 $10,421 6/30/2001 $10,985 $10,797 12/31/2001 $11,420 $11,300 6/30/2002 $11,748 $11,729 12/31/2002 $12,343 $12,459 6/30/2003 $13,031 $12,949 12/31/2003 $13,200 $12,971 6/30/2004 $13,269 $12,990 12/31/2004 $13,894 $13,533 6/30/2005 $14,284 $13,874 12/31/2005 $14,247 $13,862 6/30/2006 $14,177 $13,762 12/31/2006 $14,904 $14,463 GROWTH OF A HYPOTHETICAL INVESTMENT OF $10,000 MADE ON THE FUND'S INCEPTION DATE (9/29/00), ASSUMING REINVESTMENT OF ALL DISTRIBUTIONS. BAIRD AGGREGATE BOND FUND AVERAGE ANNUAL TOTAL RETURNS SINCE For the Periods Ended December 31, 2006 ONE YEAR FIVE YEARS INCEPTION(1) --------------------------------------- -------- ---------- ----------------- Baird Aggregate Bond Fund - Institutional Class Shares 4.88% 5.69% 6.83% Baird Aggregate Bond Fund - Investor Class Shares 4.61% 5.46% 6.59% Lehman Brothers Aggregate Bond Index(2) 4.33% 5.06% 6.08%
(1) For the period from September 29, 2000 (commencement of operations) through December 31, 2006. (2) The Lehman Brothers Aggregate Bond Index is an unmanaged, market value weighted index of investment grade, fixed-rate debt issues, including government, corporate, asset-backed, and mortgage-backed securities, with maturities of at least one year. This index does not reflect any deduction for fees, expenses or taxes. A direct investment in an index is not possible. THE RETURNS SHOWN IN THE TABLE ABOVE REFLECT REINVESTMENT OF DIVIDENDS AND/OR CAPITAL GAINS DISTRIBUTIONS IN ADDITIONAL SHARES. THE RETURNS DO NOT REFLECT THE DEDUCTION OF TAXES THAT A SHAREHOLDER WOULD PAY ON FUND DISTRIBUTIONS OR THE REDEMPTION OF FUND SHARES. PAST PERFORMANCE DOES NOT GUARANTEE FUTURE RESULTS. INVESTMENT RETURN AND PRINCIPAL VALUE WILL FLUCTUATE SO THAT AN INVESTOR'S SHARES, WHEN REDEEMED, MAY BE WORTH MORE OR LESS THAN THEIR ORIGINAL COST. FOR INFORMATION ABOUT THE PERFORMANCE OF THE FUND AS OF THE MOST RECENT MONTH- END, PLEASE CALL 1-866-44BAIRD OR VISIT WWW.BAIRDFUNDS.COM. MUTUAL FUND PERFORMANCE CHANGES OVER TIME AND CURRENT PERFORMANCE MAY BE LOWER OR HIGHER THAN THAT STATED. BAIRD AGGREGATE BOND FUND SCHEDULE OF INVESTMENTS DECEMBER 31, 2006 Principal Amount Value -------- ----- LONG-TERM INVESTMENTS - 95.9% ASSET BACKED SECURITIES - 9.2% $ 2,700,000 American Express Credit Account Master Trust, Series 2005-5, Class A, 5.37%, 02/15/2013 $ 2,701,028 2,000,000 Bayview Financial Acquisition Trust, Series 2006-A, Class 1A2, 5.48%, 02/28/2041 1,991,497 50,839 Citifinancial Mortgage Securities, Inc., Series 2003-2, Class AF3, 3.04%, 05/25/2033 49,926 Contimortgage Home Equity Trust: 50,869 Series 1999-1, Class A7, 6.47%, 12/25/2013 50,766 6,937 Series 1997-2, Class A9, 7.09%, 04/15/2028 6,895 69,776 Series 1999-3, Class A8, 5.88%, 05/25/2029 69,916 Countrywide Asset-Backed Certificates: 2,000,000 Series 2005-17, Class 1AF2, 5.36%, 03/25/2030 1,991,595 834,393 Series 2004-12, Class AF3, 4.02%, 12/25/2030 828,450 1,500,000 Series 2004-15, Class AF6, 4.61%, 04/25/2035 1,446,654 1,300,000 Series 2005-1, Class AF6, 5.03%, 06/25/2035 1,283,238 1,500,000 Series 2005-10, Class AF2, 4.49%, 02/25/2036 1,485,916 3,000,000 Series 2005-10, Class AF6, 4.92%, 02/25/2036 2,922,735 Credit Based Asset Servicing and Securities: 1,000,000 Series 2005-CB1, Class AF4, 4.62%, 01/25/2035 992,712 2,000,000 Series 2005-CB8, Class AF2, 5.30%, 12/25/2035 1,989,727 875,000 Daimler Chrysler Master Owner Trust, Series 2004-A, Class A, 5.38%, 01/15/2009 875,029 407,006 Equivantage Home Equity Loan Trust, Series 1996-3, Class A3, 7.70%, 09/25/2027 405,632 GE Capital Mortgage Services, Inc.: 5,622 Series 1997-H3, Class A6, 6.72%, 10/25/2027 5,604 11,440 Series 1997-HE4, Class A7, 6.74%, 12/25/2027 11,401 107,645 Series 1999-HE1, Class A7, 6.27%, 04/25/2029 107,893 647,435 GMAC Mortgage Corporation Loan Trust, Series 2004-GH1, Class A2, 4.39%, 12/25/2025 641,050 Green Tree Financial Corporation: 248,905 Series 1993-3, Class A7, 6.40%, 10/15/2018 252,486 206,867 Series 1993-4, Class A5, 7.05%, 01/15/2019 210,067 4,289 Series 1995-4, Class A5, 6.95%, 06/15/2025 4,303 5,418 Series 1997-1, Class A5, 6.86%, 03/15/2028 5,589 212,532 Series 1997-6, Class A8, 7.07%, 01/15/2029 218,215 601,518 Series 1998-3, Class A5, 6.22%, 03/01/2030 606,078 986,127 Series 1998-4, Class A5, 6.18%, 04/01/2030 962,306 2,000,000 GSAA Home Equity Trust, Series 2005-1, Class AF2, 4.32%, 11/25/2034 1,961,163 255,483 Household Automobile Trust, Series 2003-1, 2.22%, 11/17/2009 252,964 600,113 IMC Home Equity Loan Trust, Series 1997-5, Class A10, 6.88%, 11/20/2028 598,500 120,867 Impac CMB Trust, Series 2004-4, Class 2A2, 5.25%, 09/25/2034 119,720 97,201 New Century Home Equity Loan Trust, Series 2003-5, Class AI3, 3.56%, 11/25/2033 96,779 133,521 Oakwood Mortgage Investors, Inc., Series 1999-B, Class A3, 6.45%, 11/15/2017 125,608 RAAC Series: 376,438 Series 2004-SP1, Class AI2, 4.38%, 01/25/2022 372,580 1,200,000 Series 2004-SP1, Class AI4, 5.29%, 08/25/2027 1,184,507 Residential Asset Mortgage Products, Inc.: 1,616,645 Series 2003-RS7, Class AI6, 5.34%, 08/25/2033 1,603,179 1,000,000 Series 2005-RS1, Class AI6, 4.71%, 11/25/2034 966,892 Residential Asset Securities Corporation: 151,409 Series 2004-KS2, Class AI3, 3.02%, 05/25/2029 150,563 232,113 Series 2003-KS5, Class AI6, 3.62%, 07/25/2033 221,599 300,000 Series 2004-KS2, Class AI6, 4.30%, 03/25/2034 286,883 2,157 Salomon Brothers Mortgage Securities VII, Series 1997-LB6, Class A6, 6.82%, 12/25/2027 2,153 Structured Asset Securities Corporation: 826,049 Series 2004-11XS, Class 1A3A, 4.76%, 06/25/2034 819,046 32,567 Series 2004-16XS, Class A2, 4.91%, 08/25/2034 32,412 ------------ 30,911,256 ------------ COMMERCIAL MORTGAGE-BACKED SECURITIES - 2.8% 2,400,000 First Union National Bank Commercial Mortgage Securities Inc., Series 2001-C4, Class A2, 6.22%, 12/12/2033 2,493,239 1,200,000 GE Capital Commercial Mortgage Corporation, Series 2002-3A, Class AR, 4.00%, 12/10/2037 1,187,698 3,500,000 GMAC Commercial Mortgage Securities, Inc., Series 2003-C1, Class A2, 4.08%, 05/10/2036 3,281,802 800,000 Government National Mortgage Association (GNMA): Series 2004-78, Class C, 4.66%, 04/16/2029 774,061 1,800,000 Wachovia Bank Commercial Mortgage Trust, Series 2003-C3, Class A2, 4.87%, 02/15/2035 1,763,049 ------------ 9,499,849 ------------ FINANCIAL - 13.9% 600,000 American General Finance Corporation Senior Notes, 8.45%, 10/15/2009 647,005 200,000 AmSouth Bancorporation Subordinated Debentures, 6.75%, 11/01/2025 216,406 275,000 AMVESCAP PLC Notes, 5.38%, 02/27/2013 F 272,150 300,000 BAC Capital Trust VI, 5.63%, 03/08/2035 283,987 1,015,000 Bank of America Corporation Subordinated Notes, 10.20%, 07/15/2015 1,323,456 1,000,000 BankBoston Capital Trust II, 7.75%, 12/15/2026 1,039,882 400,000 Bank of Oklahoma Subordinated Notes, 7.13%, 08/15/2007 403,692 909,000 Bank One Corporation Subordinated Notes, 10.00%, 08/15/2010 1,037,636 330,000 Bankers Trust Corporation Subordinated Notes, 7.25%, 10/15/2011 354,026 1,175,000 Banponce Trust I, 8.33%, 02/01/2027 1,225,401 325,000 CIT Group Company of Canada, 5.20%, 06/01/2015 F 314,789 300,000 CIT Group, Inc. Senior Notes, 7.75%, 04/02/2012 330,752 500,000 CIT Group, Inc. Bonds, 5.40%, 01/30/2016 491,259 1,581,000 Citigroup Capital II, 7.75%, 12/01/2036 1,634,786 1,181,000 Compass Bank Subordinated Notes, 8.10%, 08/15/2009 1,255,532 875,000 Countrywide Financial Corporation Subordinated Notes, 6.25%, 05/15/2016 891,828 1,070,000 Dime Capital Trust, 9.33%, 05/06/2027 1,131,388 800,000 Executive Risk Capital Trust, 8.68%, 02/01/2027 835,939 1,135,000 First Empire Capital Trust I, 8.23%, 02/01/2027 1,183,405 625,000 First Empire Capital Trust II, 8.28%, 06/01/2027 655,713 670,955 First National Bank of Chicago Pass Thru Certificates, 8.08%, 01/05/2018 755,509 1,800,000 First National Bank of Omaha Subordinated Notes, 7.32%, 12/01/2010 1,810,010 1,660,000 First Union Capital, 7.94%, 01/15/2027 1,728,568 250,000 FMR Corporation Notes, 4.75%, 03/01/2013 (Acquired 02/26/2003; Cost $250,768)* 242,390 1,575,000 Glencore Funding LLC, 6.00%, 04/15/2014 (Acquired 03/31/2004, 02/02/2005, 10/31/2005 and 12/04/2006; 1,535,357 Cost $496,425, $122,281, $231,168 and $695,590 respectively)* 850,000 Goldman Sachs Capital I, 6.35%, 02/15/2034 860,412 1,000,000 Great West Life & Annuity Insurance, 7.15%, 05/16/2046 (Acquired 05/16/2006; Cost $1,000,000)* 1,059,686 500,000 Health Care Service Corporation Notes, 7.75%, 06/15/2011 (Acquired 06/20/2001 and 01/26/2005; Cost $150,908 and $345,000 respectively)* 542,804 275,000 Highmark, Inc. Notes, 6.80%, 08/15/2013 (Acquired 08/14/2003; Cost $274,373)* 288,421 900,000 J.P. Morgan Chase & Company Notes, 5.88%, 03/15/2035 879,318 1,150,000 Jefferies Group Inc., 6.25%, 01/15/2036 1,115,559 565,000 Liberty Mutual Insurance Notes, 7.70%, 10/15/2097 (Acquired 03/26/2003; Cost $361,510)* 578,184 300,000 Marsh & McLennan Companies, Inc., 5.38%, 07/15/2014 288,670 475,000 Morgan Stanley Subordinated Notes, 4.75%, 04/01/2014 454,160 1,100,000 Navigators Group Inc. Senior Unsecured Notes, 7.00%, 05/01/2016 1,124,763 819,000 NB Capital Trust IV, 8.25%, 04/15/2027 854,827 1,500,000 North Fork Capital Trust II, 8.00%, 12/15/2027 1,583,727 600,000 Phoenix Companies, 6.68%, 02/16/2008 605,179 1,875,000 PNC Financial Services, Series C, 8.88%, 03/15/2027 1,968,448 1,000,000 Premium Asset Senior Notes, 4.13%, 03/12/2009 (Acquired 12/20/2006, Cost $935,000)* 940,000 700,000 Republic New York Corporation Debentures, 9.13%, 05/15/2021 903,657 1,775,000 Residential Capital Corporation, 6.88%, 06/30/2015 1,840,118 350,000 Santander Central Hispano Insurances, 7.63%, 09/14/2010 F 378,129 500,000 SLM Corporation Notes, 5.63%, 08/01/2033 479,203 500,000 State Street Institutional Cap B, 8.04%, 03/15/2027 (Acquired 09/06/2006; Cost $524,155)* 521,877 1,000,000 St. Paul Travelers, 6.75%, 06/20/2036 1,105,326 1,000,000 Symetra Financial Corporation Senior Notes, 6.13%, 04/01/2016 (Acquired 03/23/2006; Cost $995,570)* 1,011,484 435,000 UFJ Bank Ltd/New York, Subordinated Notes, 7.40%, 06/15/2011 469,958 225,000 UFJ Finance Aruba AEC, 6.75%, 07/15/2013 F 240,113 280,000 Washington Mutual Capital I, 8.38%, 06/01/2027 293,770 1,534,000 Westdeutsche Landesbank Subordinated Notes, 4.80%, 07/15/2015 F 1,471,301 750,000 Willis Group NA, 5.63%, 07/15/2015 717,917 2,420,000 Zurich Capital Trust I 8.38%, 06/01/2037 (Acquired 04/07/2006, 08/10/2006, 09/28/2006 10/04/2006 and 10/05/2006; Cost $1,065,910, $421,740, $527,660, $289,658 and $258,046 respectively)* 2,536,567 ------------ 46,714,444 ------------ INDUSTRIAL - 12.3% 500,000 Alcan, Inc., 5.75%, 06/01/2035 F 470,082 Ameritech Capital Funding Debentures: 933,437 9.10%, 06/01/2016 1,071,393 1,000,000 6.45%, 01/15/2018 1,003,143 1,000,000 Anadarko Petroleum Corporation, 6.45%, 09/15/2036 1,010,496 AOL Time Warner, Inc.: 1,100,000 7.63%, 04/15/2031 1,228,877 175,000 7.70%, 05/01/2032 197,451 875,000 AT&T Wireless Services, Inc. Senior Notes, 8.75%, 03/01/2031 1,137,119 441,000 Auburn Hills Trust Debentures, 12.38%, 05/01/2020 651,110 450,000 British Telecom PLC, 8.88%, 12/15/2030 F 615,543 600,000 Bunge Ltd. Finance Corporation Notes: 5.35%, 04/15/2014 576,665 275,000 Caesars Entertainment Senior Notes, 7.50%, 09/01/2009 285,361 800,000 Clear Channel Communications Senior Unsubordinated Notes, 5.50%, 12/15/2016 647,575 600,000 Comcast Corporation Senior Subordinated Notes, 10.63%, 07/15/2012 724,577 120,000 ConAgra Foods, Inc. Subordinated Notes, 9.75%, 03/01/2021 155,591 580,000 ConAgra Foods, Inc. Senior Unsecured Notes, 5.82%, 06/15/2017 (Acquired 12/21/2006; Cost $580,000)* 573,699 Continental Airlines, Inc. Pass Thru Certificates: 33,072 6.80%, 07/02/2007 32,907 36,360 6.54%, 03/15/2008 36,406 129,922 8.31%, 04/02/2011 130,571 443,065 6.90%, 01/02/2018 457,160 1,775,000 COX Communications Inc., 7.13%, 10/01/2012 1,892,269 1,000,000 D.R. Horton Inc. Unsubordinated Notes, 6.50%, 04/15/2016 1,006,097 250,000 Deutsche Telekom International Finance BV, 8.25%, 06/15/2030 F 307,335 152,128 FedEx Corporation Pass Thru Certificates, 6.85%, 07/15/2020 162,754 475,000 Ford Capital BV Debentures, 9.50%, 06/01/2010 F 472,625 403,000 Ford Motor Company Debentures, 9.22%, 09/15/2021 353,633 General Motors Acceptance Corporation Notes: 100,000 7.25%, 03/02/2011 103,993 150,000 6.75%, 12/01/2014 154,070 1,400,000 Greenpoint Capital Trust I, 9.10%, 06/01/2027 1,477,683 650,000 Health Management Association Senior Unsecured Notes, 6.13%, 04/15/2016 615,384 625,000 Hutchison Whampoa International Limited, 6.25%, 01/24/2014 (Acquired 06/02/2004 and 02/08/2005; Cost $333,834 and $298,958 respectively)* F 648,084 2,000,000 International Paper Company Notes, 6.65%, 12/15/2037 2,033,016 850,000 Johnson Controls Inc. Senior Notes, 6.00%, 01/15/2036 822,777 650,000 Knight-Ridder, Inc., 5.75%, 09/01/2017 603,894 400,000 Laboratory Corporation of America, 5.63%, 12/15/2015 393,239 900,000 Lafarge SA Notes, 7.13%, 07/15/2036 F 977,815 1,000,000 Masco Corporation, 6.13%, 10/03/2016 1,006,812 471,250 The May Department Stores Companies Debentures, 9.75%, 02/15/2021 503,389 320,000 Pactiv Corporation, 7.95%, 12/15/2025 356,509 400,000 PCCW Capital II Ltd., 6.00%, 07/15/2013 (Acquired 07/10/2003; Cost $398,132)* F 403,036 745,000 Plum Creek Timberlands, 5.88%, 11/15/2015 732,091 2,000,000 Premcor Refining Group, 7.50%, 06/15/2015 2,091,550 Qwest Capital Funding, Inc.: 300,000 7.00%, 08/03/2009 305,250 200,000 7.25%, 02/15/2011 204,250 250,000 Sealed Air Corporation Senior Notes, 5.38%, 04/15/2008 (Acquired 04/09/2003; Cost $248,650)* 248,798 358,000 Sprint Capital Corporation, 8.75%, 03/15/2032 430,893 1,063,616 System Energy Resources, 5.13%, 01/15/2014 (Acquired 06/27/2006; Cost $1,012,700)* 1,038,557 680,000 TCI Communications, Inc. Debentures, 7.88%, 08/01/2013 756,129 Telecom Italia Capital: F 1,000,000 4.95%, 09/30/2014 926,442 500,000 7.20%, 07/18/2036 522,359 1,000,000 Teva Pharmaceutical Finance LLC, 5.55%, 02/01/2016 977,825 Tyco International Group S.A.: F 875,000 6.38%, 10/15/2011 915,680 300,000 6.00%, 11/15/2013 310,402 United AirLines, Inc. Pass Thru Certificates: 269,803 7.76%, 12/31/2049 (Acquired 09/28/2004; Cost $22,658)@^ 237,427 870,138 6.20%, 09/01/2008 875,576 506,038 U.S. Airways Pass Thru Certificate, Series 1998-1, 6.85%, 07/30/2019 512,364 1,487,000 Univision Communications, Inc., 3.50%, 10/15/2007 1,454,955 Vale Overseas Limited: F 350,000 8.25%, 01/17/2034 414,590 1,400,000 6.88%, 11/21/2036 1,435,904 675,000 Viacom, Inc., 7.70%, 07/30/2010 720,989 1,000,000 Wal-Mart Stores, 5.25%, 09/01/2035 918,299 ------------ 41,330,470 ------------ UTILITIES - 5.7% 475,000 Beaver Valley Funding Corporation Debentures, 9.00%, 06/01/2017 533,420 1,000,000 Commonwealth Edison Notes, 7.63%, 01/15/2007 1,000,413 500,000 Dominion Resources Inc., 7.20%, 09/15/2014 548,655 1,000,000 Duke Capital LLC Notes, 5.67%, 08/15/2014 997,294 750,000 Energy Transfer Partners, 5.65%, 08/01/2012 746,844 300,000 Exelon Corporation Senior Notes, 6.75%, 05/01/2011 313,355 600,000 Kinder Morgan Energy Partners Senior Notes, 6.30%, 02/01/2009 607,964 900,000 Kinder Morgan Finance 5.70%, 01/05/2016 F 825,767 250,054 Kiowa Power Partners LLC, 4.81%, 12/30/2013 (Acquired 11/19/2004; Cost $257,225)* 241,015 750,000 MidAmerican Energy Holdings Company Senior Notes, 7.63%, 10/15/2007 761,769 1,325,000 National Grid PLC Notes, 6.30%, 08/01/2016 F 1,372,283 1,550,000 Nisource Finance Corporation, 7.88%, 11/15/2010 1,672,236 425,000 ONEOK, Inc. Senior Notes, 7.13%, 04/15/2011 448,576 850,000 Pacific Gas & Electric Company 1st Mortgage, 6.05%, 03/01/2034 857,289 1,000,000 Plains All American Pipeline Senior Notes, 5.63%, 12/15/2013 983,956 300,000 PPL Energy Supply, LLC Senior Notes, 6.40%, 11/01/2011 310,579 175,000 PSE&G Energy Holdings LLC Senior Notes, 8.50%, 06/15/2011 188,125 PSE&G Power LLC: 250,000 7.75%, 04/15/2011 270,125 350,000 5.00%, 04/01/2014 333,846 1,632,601 RGS (I&M) Funding Corporation Debentures, 9.82%, 12/07/2022 1,963,088 1,000,000 System Energy Resources 1st Mortgage, 4.88%, 10/01/2007 993,862 700,000 Transcontinental Gas Pipe Line Corporation Senior Notes, 8.88%, 07/15/2012 791,000 200,000 Tristate Gen & Trans Assn, Series 2003, 6.04%, 01/31/2018 (Acquired 10/14/2003; Cost $200,000)* 202,048 500,000 Vectren Utility Holdings, 6.63%, 12/01/2011 521,598 1,200,000 Verizon Communications Debentures, 6.84%, 04/15/2018 1,275,730 550,000 The Williams Companies, Inc. Notes, 8.13%, 03/15/2012 595,375 ------------ 19,356,212 ------------ MORTGAGE BACKED SECURITIES - 35.8% Bank of America Alternative Loan Trust: 706,443 Series 2003-4, Class 2A1, 5.00%, 06/25/2018 695,086 983,353 Series 2003-11, Class 4A1, 4.75%, 01/25/2019 950,779 738,935 Series 2004-6, Class 4A1, 5.00%, 07/25/2019 726,347 755,136 Series 2004-11, Class 4A1, 5.50%, 12/25/2019 751,360 1,257,684 Series 2005-2, Class 4A1, 5.50%, 03/25/2020 1,254,073 1,299,328 Series 2005-2, Class 1CB2, 5.50%, 03/25/2035 1,288,237 1,497,918 Series 2005-9, Class 1 CB3, 5.50%, 10/25/2035 1,493,183 896,406 Series 2005-11, Class 1CB4, 5.50%, 12/25/2035 894,724 2,847,750 Series 2006-5, Class CB7, 6.00%, 06/25/2036 2,850,579 1,175,291 Chase Mortgage Finance Corporation, Series 2003-S13, Class A11, 5.50%, 11/25/2033 1,173,618 811,370 Citicorp Mortgage Securities, Inc., Series 2004-3, Class A2, 5.25%, 05/25/2034 802,032 2,158,109 Citigroup Mortgage Loan Trust, Inc., Series 2005-9, Class 2A2, 5.50%, 10/25/2035 2,153,016 Countrywide Alternative Loan Trust: 3,000,000 Series 2006-43CB, Class 2A1, 6.000%, 01/15/2021 3,024,844 2,400,854 Series 2006-J5, Class 3A1, 6.12%, 07/25/2021 2,423,175 1,500,000 Series 2005-10CB, Class 1A6, 5.50%, 05/25/2035 1,482,512 1,001,253 Countrywide Home Loans, Inc., Series 2003-39, Class A5, 5.00%, 05/25/2012 991,073 1,651,650 CS First Boston Mortgage Securities Corp., Series 2004-4, Class 2A5, 5.50%, 06/25/2015 1,643,776 2,602,978 Deutsche Securities Inc. Mortgage, Series 2006- AR5, Class 21A, 6.00%, 10/25/2021 2,627,085 Federal Gold Loan Mortgage Corporation (FGLMC): 239,775 6.00%, 05/01/2017 243,233 2,217,366 6.00%, 06/01/2020 2,249,958 1,035,339 5.00%, 06/01/2023 1,008,171 2,232,064 6.50%, 06/01/2029 2,288,616 2,000,000 6.00%, 12/01/2036 2,014,792 Federal Home Loan Mortgage Corporation (FHLMC): 301,310 6.50%, 07/01/2014 308,229 926,709 5.50%, 11/01/2022 923,059 809,254 5.50%, 07/01/2023 805,851 886,990 Series 3124, Class VP, 6.00%, 06/15/2014 903,169 556,938 Series 2695, Class UA, 5.50%, 09/15/2014 558,327 795,322 Series 2857, Class VA, 5.00%, 09/15/2015 784,239 2,357,816 Series R007, Class AC, 5.88%, 05/15/2016 2,363,215 2,478,156 Series R003, Class VA, 5.50%, 08/15/2016 2,482,616 1,875,219 Series 3097, Class MC, 6.00%, 11/15/2016 1,907,650 88,284 Series 2533, Class PC, 5.00%, 10/15/2017 88,053 2,939,742 Series R009, Class AJ, 5.75%, 12/15/2018 2,942,084 278,645 Series 206, Class E, 0.00%, 07/15/2019^ 274,925 136,491 Series 141, Class D, 5.00%, 05/15/2021 135,563 114,298 Series 1074, Class I, 6.75%, 05/15/2021 114,081 701,124 Series 1081, Class K, 7.00%, 05/15/2021 699,996 119,805 Series 163, Class F, 7.83%, 07/15/2021 119,161 248,954 Series 188, Class H, 7.00%, 09/15/2021 247,600 114,342 Series 1286, Class A, 6.00%, 05/15/2022 114,123 70,989 Series 2141, Class N, 5.55%, 11/15/2027 70,848 1,075,000 Series 2664, Class LG, 5.50%, 07/15/2028 1,076,173 Federal National Mortgage Association (FNMA): 1,607,632 5.50%, 07/01/2015 1,612,413 568,132 5.50%, 12/01/2016 569,764 519,168 5.00%, 10/01/2017 511,999 580,754 5.00%, 11/01/2017 572,735 904,736 5.00%, 12/01/2017 892,243 2,708,108 5.00%, 02/01/2018 2,670,713 497,479 5.00%, 06/01/2018 490,509 648,220 5.00%, 10/01/2018 638,681 946,397 5.50%, 01/01/2023 942,070 2,867,744 5.50%, 07/01/2023 2,854,008 161,456 5.00%, 10/01/2023 157,299 2,781,477 6.00%, 03/01/2026 2,811,603 270,371 5.50%, 01/01/2032 267,934 775,462 6.00%, 03/01/2033 782,539 910,615 5.50%, 07/01/2033 901,332 585,535 5.00%, 11/01/2033 566,405 2,052,424 5.50%, 11/01/2033 2,031,502 1,080,165 6.00%, 11/01/2034 1,088,261 998,261 5.50%, 02/01/2035 987,559 1,336,462 5.50%, 02/01/2035 1,322,134 807,626 5.50%, 03/01/2035 798,401 2,355,401 5.00%, 11/01/2035 2,274,709 8,235,373 5.50%, 04/01/2036 8,141,313 2,927,499 Series 2006-B2, Class AB, 5.50%, 05/25/2014 2,924,414 1,000,000 Series 2003-27, Class OJ, 5.00%, 07/25/2015 990,549 1,150,000 Series 2002-94, Class MC, 5.00%, 08/25/2015 1,139,681 500,000 Series 2003-24, Class PC, 5.00%, 11/25/2015 494,951 2,200,000 Series 2002-74, Class TD, 5.00%, 12/25/2015 2,174,674 867,272 Series 2003-18, Class GB, 5.00%, 03/25/2016 860,242 116,280 Series 2002-56, Class MC, 5.50%, 09/25/2017 116,338 535,454 Series 1989-37, Class G, 8.00%, 07/25/2019 569,311 108,293 Series 1989-94, Class G, 7.50%, 12/25/2019 113,735 26,217 Series 1990-58, Class J, 7.00%, 05/25/2020 27,200 289,357 Series 1990-76, Class G, 7.00%, 07/25/2020 292,945 116,534 Series 1990-105, Class J, 6.50%, 09/25/2020 119,631 44,234 Series 1990-108, Class G, 7.00%, 09/25/2020 45,270 45,558 Series 1991-1, Class G, 7.00%, 01/25/2021 45,905 95,129 Series 1991-86, Class Z, 6.50%, 07/25/2021 96,420 379,257 Series 2003-28, Class KA, 4.25%, 03/25/2022 366,558 44,397 Series G92-30, Class Z, 7.00%, 06/25/2022 45,844 125,583 Series 1993-58, Class H, 5.50%, 04/25/2023 125,734 996,966 Series 2003-17, Class QR, 4.50%, 11/25/2025 988,597 911,470 Series 2003-31, Class KG, 4.50%, 12/25/2028 904,656 741,965 Series 1998-66, Class C, 6.00%, 12/25/2028 750,970 119,280 Series 2003-44, Class AB, 3.75%, 05/25/2033 112,503 3,106,582 Series 2004-W6, Class 1A6, 5.50%, 07/25/2034 3,080,841 2,500,000 Series 2004-W10, Class A24, 5.00%, 08/25/2034 2,470,043 First Horizon Alternative Mortgage Securities: 1,524,746 Series 2005-FA7, Class 2A1, 5.00%, 09/25/2020 1,506,209 2,385,598 Series 2006-FA6, Class 3A1, 5.75%, 11/25/2021 2,380,198 635,077 Government National Mortgage Association (GNMA), 6.00%, 11/20/2033 642,963 1,778,410 J.P. Morgan Alternative Loan Trust, Series 2006-A1, Class 2A1, 5.80%, 03/25/2036 1,790,785 1,104,750 Master Alternative Loans Trust, Series 2003-5, Class 6A1, 6.00%, 08/25/2033 1,092,891 941,680 Residential Accredit Loans, Inc., Series 2004-QS6, Class A1, 5.00%, 05/25/2019 925,403 800,000 Residential Funding Mortgage Security I, Series 2003-S11, Class A2, 4.00%, 06/25/2018 750,444 791,360 Salomon Brothers Mortgage Securities VII, Series 2003-UP2, Class A2, 4.00%, 06/25/2033 760,947 Washington Mutual, Inc. Pass-Thru Certificates: 2,919,047 Series 2004-CB1, Class 5A, 5.00%, 06/25/2019 2,853,368 2,073,935 Series 2004-CB3, Class 4A, 6.00%, 10/25/2019 2,094,088 1,259,469 Series 2004-CB4, Class 21A, 5.50%, 12/25/2019 1,256,023 ------------ 120,745,688 ------------ INTERNATIONAL (U.S. $ DENOMINATED) - 1.3% 50,000 Corp Andina De Fomento Notes, 7.38%, 01/18/2011 F 53,455 Korea Electric Power Corporation: F 100,000 7.75%, 04/01/2013 112,757 2,165,000 6.75%, 08/01/2027 2,411,498 510,000 National Bank of Hungary Yankee Debentures, 8.88%, 11/01/2013 F 609,056 675,000 PEMEX Project Funding Master Trust, F 9.13%, 10/13/2010 757,012 United Mexican States Notes: F 150,000 9.88%, 02/01/2010 169,725 400,000 7.50%, 04/08/2033 472,000 ------------ 4,585,503 ------------ TAXABLE MUNICIPAL BONDS - 0.9% 1,000,000 Cuyahoga County Ohio Industrial Development Revenue, 9.13%, 10/01/2023 1,199,780 1,000,000 Tobacco Settlement Authority Iowa, 6.50%, 06/01/2023 994,680 Tobacco Settlement Financing Corporation: 140,000 Series 2001-A, Class A, 5.92%, 06/01/2012 139,549 584,672 Series 2001-A, Class A, 6.36%, 05/15/2025 585,216 ------------ 2,919,225 ------------ U.S. GOVERNMENT AGENCY ISSUES - 4.0% Federal National Mortgage Association (FNMA): 10,625,000 6.00%, 05/15/2011 11,063,100 2,447,076 5.50%, 09/01/2034 2,420,842 ------------ 13,483,942 ------------ U.S. TREASURY OBLIGATIONS - 10.0% U.S. Treasury Bonds 2,300,000 9.13%, 05/15/2018 3,163,399 26,425,000 6.25%, 08/15/2023 30,415,598 ------------ 33,578,997 ------------ Total Long-Term Investments (Cost $323,072,961) 323,125,586 ------------ COLLATERAL POOL INVESTMENT FOR SECURITIES ON LOAN - 13.4% (Cost $45,053,190) (Please Refer to Note 6) 45,053,190 ------------ Shares ------ SHORT-TERM INVESTMENTS - 5.2% MONEY MARKET FUNDS - 5.2% 12,867,627 Short-Term Investment Company Liquid Assets Portfolio - AIM Fund 12,867,627 4,639,830 Short-Term Investment Trust Prime Portfolio - AIM Fund 4,639,830 ------------ Total Short-Term Investments (Cost $17,507,457) 17,507,457 ------------ Total Investments (Cost $385,633,608) - 114.5% 385,686,233 ------------ Liabilities in Excess of Other Assets - (14.5)% (48,929,756) ------------ TOTAL NET ASSETS - 100.0% $336,756,477 ------------ ------------ @ Security in Default ^ Non Income Producing * Unregistered Security F Foreign Security The accompanying notes are an integral part of these financial statements. BAIRD INTERMEDIATE MUNICIPAL BOND FUND DECEMBER 31, 2006 The Baird Intermediate Municipal Bond Fund seeks current income that is substantially exempt from federal income tax. A secondary objective is to provide total return with relatively low volatility of principal. The Fund strives to achieve an annual rate of return, before Fund expenses, greater than the annual rate of the total return of the Lehman Brothers 7-Year General Obligation Bond Index. The Lehman Brothers 7-Year General Obligation Bond Index is an unmanaged, market value weighted index consisting of investment grade state and local general obligation bonds that have been issued as part of an offering of at least $50 million; have a minimum amount outstanding of at least $5 million; have been issued within the last five years; and have a maturity of six to eight years. The Fund generated solid positive investment returns in 2006, but fell short of its benchmark index. The Fund's minimal exposure to shorter maturities helped the Fund's relative performance while its limited exposure to issues longer than ten years in maturity detracted from relative performance. The Fund's focus on high quality issues also detracted from performance somewhat as low quality issues outperformed high quality issues in 2006. With yield spreads on lower quality issues relatively tight by historical standards, we continue to emphasize high quality, intermediate holdings for the Fund. PORTFOLIO CHARACTERISTICS QUALITY DISTRIBUTION* AAA 97% AA 2% BBB 1% SECTOR WEIGHTINGS* Pre-refunded ETM 60% Insured 34% General Obligation 2% Cash 3% Revenue 1% NET ASSETS: $65,477,507 SEC 30-DAY YIELD:** Institutional Class: 3.77% Investor Class: 3.51% AVERAGE EFFECTIVE DURATION: 4.97 years AVERAGE EFFECTIVE MATURITY: 5.94 years ANNUALIZED EXPENSE RATIO: Institutional Class: 0.30% Investor Class: 0.55%*** PORTFOLIO TURNOVER RATIO: 25.1% TOTAL NUMBER OF HOLDINGS: 60 * Percentages shown are based on the Fund's total net assets. ** SEC yields are based on SEC guidelines and are calculated for the 30 days ended December 31, 2006. *** Includes 0.25% 12b-1 fee. BAIRD INTERMEDIATE MUNICIPAL BOND FUND BAIRD INTERMEDIATE MUNICIPAL BOND FUND - INSTITUTIONAL CLASS VALUE OF A $250,000 INVESTMENT Baird Intermediate Municipal Bond Fund - Lehman Brothers 7-Year Institutional Class Shares General Obligation Index -------------------------- ------------------------ 3/30/2001 $250,000 $250,000 6/30/2001 $255,511 $251,525 12/31/2001 $262,544 $255,876 6/30/2002 $275,570 $269,335 12/31/2002 $290,693 $281,429 6/30/2003 $302,139 $292,827 12/31/2003 $304,973 $297,131 6/30/2004 $300,175 $295,081 12/31/2004 $313,163 $309,923 6/30/2005 $317,383 $315,099 12/31/2005 $317,314 $315,540 6/30/2006 $316,841 $313,078 12/31/2006 $329,019 $325,411 GROWTH OF A HYPOTHETICAL INVESTMENT OF $250,000 MADE ON THE FUND'S INCEPTION DATE (3/30/01), ASSUMING REINVESTMENT OF ALL DISTRIBUTIONS. BAIRD INTERMEDIATE MUNICIPAL BOND FUND - INVESTOR CLASS VALUE OF A $10,000 INVESTMENT Baird Intermediate Municipal Bond Fund - Lehman Brothers 7-Year Investor Class Shares General Obligation Index --------------------- ------------------------ 3/30/2001 $10,000 $10,000 6/30/2001 $10,217 $10,061 12/31/2001 $10,474 $10,235 6/30/2002 $10,980 $10,773 12/31/2002 $11,569 $11,257 6/30/2003 $12,007 $11,713 12/31/2003 $12,111 $11,885 6/30/2004 $11,911 $11,803 12/31/2004 $12,402 $12,397 6/30/2005 $12,560 $12,604 12/31/2005 $12,542 $12,622 6/30/2006 $12,520 $12,523 12/31/2006 $12,974 $13,016 GROWTH OF A HYPOTHETICAL INVESTMENT OF $10,000 MADE ON THE FUND'S INCEPTION DATE (3/30/01), ASSUMING REINVESTMENT OF ALL DISTRIBUTIONS. BAIRD INTERMEDIATE MUNICIPAL BOND FUND AVERAGE ANNUAL TOTAL RETURNS SINCE For the Periods Ended December 31, 2006 ONE YEAR FIVE YEARS INCEPTION(1) --------------------------------------- -------- ---------- ----------------- Baird Intermediate Municipal Bond Fund - Institutional Class Shares 3.69% 4.62% 4.89% Baird Intermediate Municipal Bond Fund - Investor Class Shares 3.44% 4.38% 4.63% Lehman Brothers 7-Year General Obligation Bond Index(2) 4.06% 4.95% 4.71%
(1) For the period from March 30, 2001 (commencement of operations) through December 31, 2006. (2) The Lehman Brothers 7-Year General Obligation Bond Index is an unmanaged, market value weighted index comprised of investment grade state and local general obligation bonds that have been issued as part of an offering of at least $50 million, have a minimum amount outstanding of at least $5 million, have been issued within the last five years and have a maturity of six to eight years. This index does not reflect any deduction for fees, expenses or taxes. A direct investment in an index is not possible. THE RETURNS SHOWN IN THE TABLE ABOVE REFLECT REINVESTMENT OF DIVIDENDS AND/OR CAPITAL GAINS DISTRIBUTIONS IN ADDITIONAL SHARES. THE RETURNS DO NOT REFLECT THE DEDUCTION OF TAXES THAT A SHAREHOLDER WOULD PAY ON FUND DISTRIBUTIONS OR THE REDEMPTION OF FUND SHARES. PAST PERFORMANCE DOES NOT GUARANTEE FUTURE RESULTS. INVESTMENT RETURN AND PRINCIPAL VALUE WILL FLUCTUATE SO THAT AN INVESTOR'S SHARES, WHEN REDEEMED, MAY BE WORTH MORE OR LESS THAN THEIR ORIGINAL COST. FOR INFORMATION ABOUT THE PERFORMANCE OF THE FUND AS OF THE MOST RECENT MONTH- END, PLEASE CALL 1-866-44BAIRD OR VISIT WWW.BAIRDFUNDS.COM. MUTUAL FUND PERFORMANCE CHANGES OVER TIME AND CURRENT PERFORMANCE MAY BE LOWER OR HIGHER THAN THAT STATED. BAIRD INTERMEDIATE MUNICIPAL BOND FUND SCHEDULE OF INVESTMENTS DECEMBER 31, 2006 Principal Amount Value --------- ----- MUNICIPAL BONDS - 97.0% ALABAMA - 0.7% $ 460,000 Mobile Alabama, 6.20%, 02/15/2007 (ETM) $ 461,288 ----------- ARIZONA - 2.5% 1,415,000 Arizona Health Facilities Authority Hospital Revenue, 6.38%, 12/01/2037 (Pre-refunded to 12/01/2012) 1,622,326 ----------- ARKANSAS - 0.9% 595,000 Springdale Arkansas Sales & Use Tax Revenue, 4.00%, 07/01/2016 (Pre-refunded to 07/01/2010) 594,958 ----------- CALIFORNIA - 1.5% 500,000 Golden State Tobacco Securitization Corporation, 6.25%, 06/01/2033 558,800 350,000 Santa Rosa California Hospital Revenue, 10.30%, 03/01/2011 (ETM) 399,038 ----------- 957,838 ----------- COLORADO - 3.9% 2,000,000 Adams County Colorado Single Family Mortgage Revenue, 8.88%, 08/01/2012 (ETM) 2,495,280 90,000 Colorado Springs Colorado Utilities Revenue, 5.80%, 11/15/2010 (ETM) 93,591 ----------- 2,588,871 ----------- DELAWARE - 2.5% 1,500,000 Delaware State Economic Development Authority Revenue, 6.75%, 01/01/2013 (ETM) 1,662,885 ----------- FLORIDA - 2.8% 300,000 Jacksonville Florida Health Facility Authority Hospital Revenue, 11.50%, 10/01/2012 (ETM) 419,253 210,000 Orange County Florida Health Revenue, 8.75%, 10/01/2009 (ETM) 226,897 1,000,000 Orlando Florida Utilities Commission Water & Electric Revenue, 6.75%, 10/01/2017 (ETM) 1,195,200 ----------- 1,841,350 ----------- GEORGIA - 1.8% 1,020,000 Fulton County Georgia Hospital Authority Revenue, 7.88%, 10/01/2013 (ETM) 1,196,654 ----------- ILLINOIS - 8.7% 1,000,000 Chicago Illinois General Obligation Project and Refunding, 5.00%, 01/01/2017 (FSA Insured) 1,084,330 1,440,000 Chicago Illinois Metropolitan Water Reclamation District General Obligation, 7.00%, 12/01/2010 (ETM) 1,613,045 1,430,000 Cook County Illinois School District No. 100, 8.10%, 12/01/2016 (ETM) 1,926,639 1,000,000 Lake County Community High School District No. 128, 5.00%, 01/01/2013 1,066,520 ----------- 5,690,534 ----------- INDIANA - 0.6% 285,000 Indiana Toll Road Commission, 9.00%, 01/01/2015 (ETM) 363,868 ----------- IOWA - 2.5% 1,010,000 Des Moines Iowa Metropolitan Wastewater Reclamation Authority, 5.00%, 06/01/2015 (MBIA Insured) 1,093,012 530,000 Muscatine Iowa Electric Revenue, 6.70%, 01/01/2013 (ETM) 572,092 ----------- 1,665,104 ----------- LOUISIANA - 6.1% 745,000 Denham Springs-Livingston Housing and Mortgage Finance Authority, 7.20%, 08/01/2010 (ETM) 831,010 400,000 Houma-Terrebonne Public Trust Financing Authority, 7.30%, 04/01/2010 (ETM) 442,032 1,000,000 Houma-Terrebonne Public Trust Financing Authority Single Family Mortgage Revenue, 7.30%, 04/01/2011 (ETM) 1,134,580 1,450,000 Jefferson Parish Louisiana Home Mortgage Authority, 7.10%, 08/01/2010 (ETM) 1,617,736 ----------- 4,025,358 ----------- MINNESOTA - 1.1% 645,000 Western Minnesota Municipal Power Agency, 6.38%, 01/01/2016 (ETM) 710,197 ----------- MISSISSIPPI - 1.6% 600,000 Mississippi Housing Financial Corporation, 0.00%, 06/01/2015 (ETM)^ 430,764 600,000 Mississippi State, 6.20%, 02/01/2008 (ETM) 613,848 ----------- 1,044,612 ----------- NEVADA - 3.3% 1,965,000 Reno Nevada Capital Improvement Revenue, 5.50%, 06/01/2019 (Pre-refunded to 06/01/2012) 2,142,891 ----------- NEW JERSEY - 2.6% 1,000,000 New Jersey State Transportation Trust Fund Authority, 6.00%, 12/15/2017 (Pre-refunded 12/15/2011) 1,106,420 New Jersey State Turnpike Authority: (ETM) 422,000 6.75%, 01/01/2009 421,426 130,000 6.50%, 01/01/2016 151,649 ----------- 1,679,495 ----------- NEW YORK - 2.0% 1,000,000 New York, New York, 5.00%, 03/01/2016 (FGIC Insured) 1,080,540 235,000 TSASC Inc. New York, 4.75%, 06/01/2022 235,002 ----------- 1,315,542 ----------- NORTH CAROLINA - 0.4% 225,000 North Carolina Eastern Municipal Power Agency Power Systems Revenue, 6.40%, 01/01/2021 (ETM) 270,635 ----------- OHIO - 0.3% 150,000 Miamisburg Ohio Water Revenue, 7.00%, 11/15/2016 (ETM) 172,633 ----------- OKLAHOMA - 4.1% 2,360,000 Tulsa County Oklahoma Home Financing Authority Single Family Mortgage Revenue, 6.90%, 08/01/2011 (ETM) 2,682,518 ----------- PENNSYLVANIA - 5.0% 815,000 Philadelphia Pennsylvania Gas Works, 7.00%, 05/15/2020 (ETM) 971,007 1,285,000 Pittsburgh Pennsylvania Water & Sewer Authority, 7.25%, 09/01/2014 (ETM) 1,450,611 1,000,000 Wilson Pennsylvania Area School District, 0.00%, 05/15/2011 (AMBAC Insured)^ 844,890 ----------- 3,266,508 ----------- SOUTH CAROLINA - 0.5% 285,000 Greenville South Carolina Waterworks Revenue, 7.00%, 02/01/2010 (ETM) 312,785 ----------- SOUTH DAKOTA - 1.2% 715,000 Heartland Consumers Power District, 7.00%, 01/01/2016 (ETM) 807,321 ----------- TENNESSEE - 3.4% 430,000 Metropolitan Government Nashville & Davidson County Tennessee H&E, 6.10%, 07/01/2010 (ETM) 446,989 1,545,000 Metropolitan Government Nashville & Davidson County Tennessee Water & Sewer Revenue, 6.50%, 12/01/2014 (ETM) 1,796,959 ----------- 2,243,948 ----------- TEXAS - 34.3% 1,125,000 Barbers Hill Texas Independent School District General Obligation, 5.00%, 02/15/2017 (PSF Guaranteed) 1,210,320 1,000,000 Copperas Cove Texas Independent School District, 5.00%, 08/15/2016 (PSF Guaranteed) 1,083,590 1,500,000 Cypress-Fairbanks Texas Independent School District, 5.00%, 02/15/2017 (PSF Guaranteed) 1,625,475 1,625,000 Frisco Texas Independent School District, 6.00%, 08/15/2018 (PSF Guaranteed) 1,896,326 1,000,000 Georgetown Texas Independent School District, 5.00%, 02/15/2016 (PSF Guaranteed) 1,079,450 1,920,000 Houston Texas Sewer System Revenue, 9.38%, 10/01/2013 (ETM) 2,367,802 1,315,000 La Porte Texas Independent School District, 5.00%, 02/15/2018 (MBIA Insured) 1,405,288 1,735,000 Lufkin Texas Independent School District, 5.00%, 08/15/2015 (PSF Guaranteed) 1,870,278 1,265,000 Mission Consolidated Independent School District, 5.00%, 02/15/2019 (PSF Guaranteed) 1,352,766 1,295,000 Rockwall Texas Independent School District, 5.00%, 02/15/2015 (PSF Guaranteed) 1,402,576 775,000 Sam Rayburn Texas Municipal Power Agency, 6.00%, 09/01/2010 (ETM) 821,887 2,000,000 San Antonio Texas Independent School District, 5.00%, 08/15/2017 (PSF Guaranteed) 2,159,560 575,000 Socorro Texas Independent School District, 5.25%, 08/15/2012 (PSF Guaranteed) 619,781 345,000 Texas Public Building Authority Revenue, 7.13%, 08/01/2011 (ETM) 377,737 1,900,000 Trinity River Authority Texas Revenue, 5.50%, 02/01/2021 (MBIA Insured) 2,087,739 1,000,000 University of Houston Texas 5.25%, 02/15/2012 (FSA Insured) 1,070,130 ----------- 22,430,705 ----------- UTAH - 1.1% 605,000 Salt Lake City Utah Hospital Revenue, 8.13%, 05/15/2015 (ETM) 707,886 ----------- WASHINGTON - 1.6% 1,000,000 Washington State, 5.00%, 09/01/2013 (FGIC Insured) 1,061,050 ----------- Total Municipal Bonds (Cost $63,396,890) 63,519,760 ----------- Shares ------ SHORT-TERM INVESTMENTS - 1.2% MONEY MARKET FUNDS - 1.2% 782,330 Tax Free Investment Company Cash Reserve Portfolio - AIM Fund 782,330 ----------- Total Short-Term Investments (Cost $782,330) 782,330 ----------- Total Investments (Cost $64,179,220) - 98.2% 64,302,090 ----------- Other Assets in Excess of Liabilities - 1.8% 1,175,417 ----------- TOTAL NET ASSETS - 100.0% $65,477,507 ----------- ----------- ETM - Escrowed to Maturity ^ Non Income Producing The accompanying notes are an integral part of these financial statements. BAIRD CORE PLUS BOND FUND DECEMBER 31, 2006 The Baird Core Plus Bond Fund seeks an annual rate of total return, before Fund expenses, greater than the annual rate of total return of the Lehman Brothers U.S. Universal Bond Index. The Lehman Brothers U.S. Universal Bond Index is an unmanaged, market value weighted index of fixed income securities issued in U.S. dollars, including U.S. government and investment grade debt, non-investment grade debt, asset-backed and mortgage-backed securities, Eurobonds, 144A securities and emerging market debt, with maturities of at least one year. The Fund delivered solid positive returns and outperformed its benchmark index in 2006. Helping the Fund's strong relative performance were the following factors: o The Fund's significantly greater exposure to asset-backed securities than the benchmark; o The Fund's overweighting of BBB-rated corporate bonds relative to the benchmark; and o Strong performance of specific individual corporate issues, particularly those in the auto and airline sectors. The Fund's underweighting of below investment grade emerging market issuers detracted slightly from relative performance in 2006. The Fund maintained its duration-neutral strategy, holding a broadly diversified portfolio of over 140 securities at year end. The Fund ended 2006 with a yield advantage versus its benchmark index. This yield advantage, combined with exposure to specific sectors which we believe have superior total return potential (asset-backed securities and collateralized mortgage-backed obligations), enhance the Fund's prospects of adding value over its benchmark in the coming year. PORTFOLIO CHARACTERISTICS QUALITY DISTRIBUTION* U.S. Treasury 14% U.S. Gov't Agency 35% AAA 17% AA 2% A 5% BBB 21% Below Baa 6% SECTOR WEIGHTINGS* Asset-Backed 9% Financials 7% Industrials 17% Utilities 5% Mortgage-Backed 30% International 2% Municipal 1% U.S. Gov't Agency 11% U.S. Treasuries 14% Cash 4% NET ASSETS: $51,839,945 SEC 30-DAY YIELD:** Institutional Class: 5.21% Investor Class: 5.06% AVERAGE EFFECTIVE DURATION: 4.52 years AVERAGE EFFECTIVE MATURITY: 7.34 years ANNUALIZED EXPENSE RATIO: Institutional Class: 0.30% Investor Class: 0.55%*** PORTFOLIO TURNOVER RATIO: 62.0% TOTAL NUMBER OF HOLDINGS: 149 * Percentages shown are based on the Fund's total net assets. ** SEC yields are based on SEC guidelines and are calculated for the 30 days ended December 31, 2006. *** Includes 0.25% 12b-1 fee. BAIRD CORE PLUS BOND FUND BAIRD CORE PLUS BOND FUND - INSTITUTIONAL CLASS VALUE OF A $250,000 INVESTMENT Baird Core Plus Bond Fund - Lehman Brothers U.S. Institutional Class Shares Universal Bond Index -------------------------- -------------------- 9/29/2000 $250,000 $250,000 12/31/2000 $264,734 $259,261 6/30/2001 $273,977 $268,929 12/31/2001 $282,819 $280,238 6/30/2002 $287,185 $289,675 12/31/2002 $302,329 $307,801 6/30/2003 $321,649 $323,008 12/31/2003 $329,342 $325,717 6/30/2004 $331,030 $326,267 12/31/2004 $350,298 $341,904 6/30/2005 $360,122 $350,493 12/31/2005 $358,114 $351,187 6/30/2006 $359,096 $349,579 12/31/2006 $381,684 $368,652 GROWTH OF A HYPOTHETICAL INVESTMENT OF $250,000 MADE ON THE FUND'S INCEPTION DATE (9/29/00), ASSUMING REINVESTMENT OF ALL DISTRIBUTIONS. BAIRD CORE PLUS BOND FUND - INVESTOR CLASS VALUE OF A $10,000 INVESTMENT Baird Core Plus Bond Fund - Lehman Brothers U.S. Investor Class Shares Universal Bond Index --------------------------- -------------------- 9/29/2000 $10,000 $10,000 12/31/2000 $10,573 $10,370 6/30/2001 $10,932 $10,757 12/31/2001 $11,281 $11,210 6/30/2002 $11,443 $11,587 12/31/2002 $12,024 $12,312 6/30/2003 $12,787 $12,920 12/31/2003 $13,057 $13,029 6/30/2004 $13,119 $13,051 12/31/2004 $13,860 $13,676 6/30/2005 $14,221 $14,020 12/31/2005 $14,127 $14,047 6/30/2006 $14,160 $13,983 12/31/2006 $15,023 $14,746 GROWTH OF A HYPOTHETICAL INVESTMENT OF $10,000 MADE ON THE FUND'S INCEPTION DATE (9/29/00), ASSUMING REINVESTMENT OF ALL DISTRIBUTIONS. BAIRD CORE PLUS BOND FUND AVERAGE ANNUAL TOTAL RETURNS SINCE For the Periods Ended December 31, 2006 ONE YEAR FIVE YEARS INCEPTION(1) --------------------------------------- -------- ---------- ----------------- Baird Core Plus Bond Fund - Institutional Class Shares 6.58% 6.17% 7.00% Baird Core Plus Bond Fund - Investor Class Shares 6.34% 5.89% 6.72% Lehman Brothers U.S. Universal Bond Index(2) 4.97% 5.87% 6.77%
(1) For the period from September 29, 2000 (commencement of operations) through December 31, 2006. (2) The Lehman Brothers U.S. Universal Bond Index is an unmanaged, market value weighted index of fixed income securities issued in U.S. dollars, including U.S. government and investment grade debt, non- investment grade debt, asset-backed and mortgage-backed securities, Eurobonds, 144A securities and emerging market debt, with maturities of at least one year. This index does not reflect any deduction for fees, expenses or taxes. A direct investment in an index is not possible. THE RETURNS SHOWN IN THE TABLE ABOVE REFLECT REINVESTMENT OF DIVIDENDS AND/OR CAPITAL GAINS DISTRIBUTIONS IN ADDITIONAL SHARES. THE RETURNS DO NOT REFLECT THE DEDUCTION OF TAXES THAT A SHAREHOLDER WOULD PAY ON FUND DISTRIBUTIONS OR THE REDEMPTION OF FUND SHARES. PAST PERFORMANCE DOES NOT GUARANTEE FUTURE RESULTS. INVESTMENT RETURN AND PRINCIPAL VALUE WILL FLUCTUATE SO THAT AN INVESTOR'S SHARES, WHEN REDEEMED, MAY BE WORTH MORE OR LESS THAN THEIR ORIGINAL COST. FOR INFORMATION ABOUT THE PERFORMANCE OF THE FUND AS OF THE MOST RECENT MONTH- END, PLEASE CALL 1-866-44BAIRD OR VISIT WWW.BAIRDFUNDS.COM. MUTUAL FUND PERFORMANCE CHANGES OVER TIME AND CURRENT PERFORMANCE MAY BE LOWER OR HIGHER THAN THAT STATED. BAIRD CORE PLUS BOND FUND SCHEDULE OF INVESTMENTS DECEMBER 31, 2006 Principal Amount Value --------- ----- LONG-TERM INVESTMENTS - 96.3% ASSET BACKED SECURITIES - 8.7% $ 300,000 American Express Credit Account Master Trust, Series 2005-5, Class A, 5.39%, 02/15/2013 $ 300,114 163,739 Contimortgage Home Equity Loan Trust, Series 1997-5, Class A6, 6.87%, 03/15/2024 162,677 Countrywide Asset-Backed Certificates: 600,000 Series 2005-10, Class AF6, 4.92%, 02/25/2036 584,547 400,000 Series 2006-S9, Class A3, 5.73%, 08/25/2036 397,550 300,000 Series 2006-10, Class 1AF3, 5.97%, 09/25/2046 303,939 325,000 Discover Card Master Trust I, Series 2005-2, Class A, 5.38%, 04/17/2012 325,717 GMAC Mortgage Corporation Loan Trust: 104,903 Series 2004-HE5, Class A3, 3.97%, 09/25/2034 103,922 500,000 Series 2005-HE3, Class A2, 5.50%, 02/25/2036 500,512 Green Tree Financial Corporation: 43,345 Series 1997-1, Class A5, 6.86%, 03/15/2028 44,713 395,945 Series 1998-4, Class A5, 6.18%, 04/01/2030 386,381 23,328 New Century Home Equity Loan Trust, Series 2003-5, Class AI3, 3.56%, 11/25/2033 23,227 76,298 Oakwood Mortgage Investors, Inc., Series 1999-B, Class A3, 6.45%, 11/15/2017 71,776 300,000 Renaissance Home Equity Loan Trust, Series 2006-2, Class AF3, 5.80%, 08/25/2036 301,501 300,000 Residential Asset Mortgage Products, Inc., Series 2003-RS10, Class AI7, 4.85%, 11/25/2033 295,407 417,804 Residential Asset Securities Corporation, Series 2003-KS5, Class AI6, 3.62%, 07/25/2033 398,878 300,000 Structured Asset Securities Corporation, Series 2005-7XS, Class 1A4B, 5.44%, 04/25/2035 295,835 ----------- 4,496,696 ----------- FINANCIAL - 7.6% 175,000 AMVESCAP, Inc. Senior Notes, 5.90%, 01/15/2007 F 175,016 300,000 Bank of America Corporation Subordinated Notes, 10.20%, 07/15/2015 391,169 30,000 BankBoston Capital Trust IV, 8.25%, 12/15/2026 31,287 200,000 Banponce Trust I, 8.33%, 02/01/2027 208,579 350,000 First National Bank of Omaha Subordinated Notes, 7.32%, 12/01/2010 351,946 250,000 First Union Capital, 7.94%, 01/15/2027 260,327 Glencore Funding LLC, 350,000 6.00%, 04/15/2014 (Acquired 03/31/2004 and 12/04/2006; Cost $148,928 and $198,740 respectively)* 341,191 30,000 Goldman Sachs Group LP, 33,540 8.00%, 03/01/2013 (Acquired 05/19/2006, Cost $33,031)* 100,000 Health Care Service Corporation Notes, 7.75%, 06/15/2011 (Acquired 01/26/2005; Cost $115,000)* 108,561 350,000 Lehman Brothers Holdings Senior Notes, 8.80%, 03/01/2015 423,046 375,000 Liberty Mutual Insurance Notes, 7.70%, 10/15/2097 (Acquired 03/26/2003; Cost $239,982)* 383,750 100,000 Marsh & McLennan Companies, Inc., 5.38%, 07/15/2014 96,223 50,000 Met Life Global Funding I Notes, 4.75%, 06/20/2007 (Acquired 09/15/2004; Cost $51,556)* 49,874 100,000 Principal Financial Group (AU) Senior Notes, 8.20%, 08/15/2009 (Acquired 09/16/2005; Cost $112,015)* F 107,041 Residential Capital Corporation: 100,000 6.38%, 06/30/2010 101,164 375,000 6.88%, 06/30/2015 388,757 457,000 Washington Mutual Capital I, 8.38%, 06/01/2027 479,475 ----------- 3,930,946 ----------- INDUSTRIAL - 17.4% 300,000 AOL Time Warner, Inc., 7.63%, 04/15/2031 335,148 100,000 AT&T Wireless Services, Inc. Senior Notes, 8.75%, 03/01/2031 129,956 503,423 Atlas Air, Inc. Pass Thru Certificates, 8.71%, 07/02/2021 529,853 Bunge Ltd. Finance Corporation Notes: 150,000 5.35%, 04/15/2014 144,166 100,000 5.10%, 07/15/2015 93,126 375,000 Clear Channel Communications, 4.50%, 01/15/2010 359,589 Continental Airlines, Inc. Pass Thru Certificates: 347 7.42%, 04/01/2007 330 50,711 6.80%, 07/02/2007 50,457 168,712 6.54%, 03/15/2008 168,923 222,723 8.31%, 04/02/2011 223,836 67,889 6.90%, 01/02/2018 70,049 100,000 COX Communications Inc. Notes, 7.88%, 08/15/2009 105,826 100,000 Deutsche Telekom International Finance BV, 8.25%, 06/15/2030 F 122,934 350,000 Dollar General Corporation, 8.63%, 06/15/2010 371,875 276,992 Federal Express Corporation Pass Thru Certificates, Series B2, 7.11%, 01/02/2014 292,290 400,000 Ford Motor Company Debentures, 9.22%, 09/15/2021 351,000 General Motors Acceptance Corporation Notes: 75,000 7.75%, 01/19/2010 78,500 150,000 6.75%, 12/01/2014 154,070 175,000 General Motors Nova Scotia Finance Company, 6.85%, 10/15/2008 F 174,125 350,000 Hanson PLC, 6.13%, 08/15/2016 F 356,252 350,000 Health Management Association, 6.13%, 04/15/2016 331,361 150,000 Hutchison Whampoa International Limited, 6.25%, 01/24/2014 (Acquired 06/23/2005; Cost $161,474)* F 155,540 322,000 Marathon Oil Corporation Debentures, 9.13%, 01/15/2013 382,953 253,750 The May Department Stores Companies Debentures, 9.75%, 02/15/2021 271,056 350,000 New York Telephone Company Debentures, 8.63%, 11/15/2010 381,784 200,000 PCCW Capital II Ltd., 6.00%, 07/15/2013 (Acquired 07/10/2003; Cost $199,066)* F 201,518 300,000 Plum Creek Timberlands, 5.88%, 11/15/2015 294,802 300,000 Sprint Capital Corporation, 8.75%, 03/15/2032 361,083 250,000 Sungard Data Systems Inc. Notes, 3.75%, 01/15/2009 236,250 175,000 TCI Communications, Inc. Debentures, 7.88%, 08/01/2013 194,592 350,000 Telecom Italia Capital, 7.20%, 07/18/2036 F 365,651 200,000 Telefonica Emisiones, S.A.U., 6.42%, 06/20/2016 F 206,324 92,000 Time Warner Companies, Inc., 6.88%, 06/15/2018 97,823 25,000 Time Warner Entertainment Senior Notes, 8.88%, 10/01/2012 28,738 50,000 Tyco International Group S.A., 6.00%, 11/15/2013 F 51,734 United AirLines, Inc. Pass Thru Certificates: 444,957 6.20%, 09/01/2008 447,738 73,583 7.76%, 12/31/2049 64,753 158,000 Univision Communication, Inc., 3.50%, 10/15/2007 154,595 Vale Overseas Limited: 100,000 8.25%, 01/17/2034 F 118,454 125,000 6.88%, 11/21/2036 F 128,206 150,000 Viacom, Inc., 7.70%, 07/30/2010 160,220 150,000 Viacom, Inc. Senior Notes, 6.25%, 04/30/2016 (Acquired 04/05/2006; Cost $149,342)* 148,961 100,000 Wharf International Finance Ltd, 7.63%, 03/13/2007 F 100,422 ----------- 8,996,863 ----------- UTILITIES - 4.7% 200,000 Commonwealth Edison, 5.40%, 12/15/2011 198,421 150,000 Energy Transfer Partners, 5.65%, 08/01/2012 149,369 350,000 Kinder Morgan Energy Partners Senior Notes, 5.35%, 08/15/2007 349,540 83,351 Kiowa Power Partners LLC, 4.81%, 12/30/2013 (Acquired 11/19/2004; Cost $85,742)* 80,338 400,000 ONEOK, Inc. Senior Notes, 7.13%, 04/15/2011 422,189 50,000 Pacific Gas & Electric Company 1st Mortgage, 6.05%, 03/01/2034 50,429 200,000 PPL Energy Supply LLC, 6.20%, 05/15/2016 205,583 200,000 PSE&G Energy Holdings LLC Senior Notes, 8.50%, 06/15/2011 215,000 50,000 PSI Energy, Inc. Debentures, 7.85%, 10/15/2007 50,848 296,837 RGS (I&M) Funding Corporation Debentures, 9.82%, 12/07/2022 356,925 100,000 Tristate Gen & Trans Assn, 6.04%, 01/31/2018 (Acquired 10/14/2003; Cost $100,000)* 101,024 Williams Cos. Inc. Notes: 50,000 7.13%, 09/01/2011 52,000 200,000 7.88%, 09/01/2021 214,500 ----------- 2,446,166 ----------- MORTGAGE BACKED SECURITIES - 30.3% Bank of America Alternative Loan Trust: 221,944 Series 2005-2, Class 4A1, 5.50%, 03/25/2020 221,307 473,226 Series 2006-2, Class 6A1, 5.50%, 03/25/2021 471,672 305,187 Citigroup Mortgage Loan Trust, Inc., Series 2005-9, Class 2A2, 5.50%, 11/25/2035 304,467 400,000 Countrywide Alternative Loan Trust, 6.00%, 01/15/2021 403,313 487,632 Deutsche Securities Inc. Mortgage, Series 2006-AR5, Class 21A, 6.00%, 10/25/2021 492,148 Federal Gold Loan Mortgage Corporation (FGLMC): 107,899 6.00%, 05/01/2017 109,455 741,959 5.50%, 11/01/2017 743,335 375,761 6.00%, 06/01/2021 380,818 267,709 5.00%, 12/01/2020 263,029 82,088 6.50%, 09/01/2028 84,218 135,546 6.50%, 12/01/2028 139,065 98,313 6.50%, 05/01/2029 100,804 98,529 6.50%, 06/01/2029 101,025 Federal Home Loan Mortgage Corporation (FHLMC): 379,840 Series 3122, Class VA, 6.00%, 01/15/2017 386,069 930,918 Series R009, Class AJ, 5.75%, 12/15/2018 931,660 23,091 Series 1053, Class G, 7.00%, 03/15/2021 23,053 50,535 Series 136, Class E, 6.00%, 04/15/2021 50,337 300,000 Series 2673, Class NC, 5.50%, 05/15/2021 299,514 270,160 Series 2804, Class VC, 5.00%, 07/15/2021 263,301 45,230 Series 1122, Class G, 7.00%, 08/15/2021 45,145 100,274 Series 1186, Class I, 7.00%, 12/15/2021 103,123 258,869 Series 3132, Class MA, 5.50%, 12/15/2023 258,273 241,259 Series 2598, Class QC, 4.50%, 06/15/2027 237,969 Federal National Mortgage Association (FNMA): 310,075 5.00%, 02/01/2018 305,793 216,073 5.00%, 10/01/2018 212,894 216,042 5.00%, 11/01/2018 212,863 167,668 5.50%, 03/01/2023 166,865 296,435 5.50%, 07/01/2023 295,015 370,864 6.00%, 03/01/2026 374,880 64,485 6.50%, 09/01/2028 66,188 112,889 6.50%, 02/01/2029 115,871 243,334 5.50%, 01/01/2032 241,141 502,716 5.50%, 02/01/2035 497,327 1,971,982 5.50%, 04/01/2036 1,949,459 20,825 Series 1989-94, Class G, 7.50%, 12/25/2019 21,872 90,875 Series 1990-15, Class J, 7.00%, 02/25/2020 94,142 16,136 Series 1991-21, Class J, 7.00%, 03/25/2021 16,686 318,208 Series 1991-43, Class J, 7.00%, 05/25/2021 330,268 391,407 Series 1991-65, Class Z, 6.50%, 06/25/2021 401,652 399,459 Series 1992-129, Class L, 6.00%, 07/25/2022 404,865 122,619 Series 1993-32, Class H, 6.00%, 03/25/2023 122,726 665,088 Series 1993-58, Class H, 5.50%, 04/25/2023 665,889 298,299 Series 2003-31, Class KG, 4.50%, 12/25/2028 296,069 57,233 Series 2003-44, Class AB, 3.75%, 05/25/2033 53,981 324,779 Series 2004-W6, Class 1A6, 5.50%, 07/25/2034 322,088 387,115 First Horizon Alternative Mortgage Securities, Series 2006-FA6, Class 3A1, 5.75%, 11/25/2021 386,239 600,000 First Union National Bank Commercial Mortgage Securities Inc., Series 2001-C4, Class A2, 6.22%, 12/12/2033 623,310 Government National Mortgage Association (GNMA): 179,549 6.00%, 12/20/2028 182,050 65,142 6.50%, 01/20/2029 66,755 169,354 6.00%, 11/20/2033 171,457 217,602 Master Alternative Loans Trust, Series 2003-5, Class 6A1, 6.00%, 08/25/2033 215,266 Washington Mutual, Inc. Pass-Thru Certificates: 234,866 Series 2004-CB1, Class 5A, 5.00%, 06/25/2019 229,581 269,780 Series 2004-CB3, Class 4A, 6.00%, 10/25/2019 272,402 ----------- 15,728,694 ----------- INTERNATIONAL (U.S. $ DENOMINATED) - 1.8% 500,000 Export-Import Bank Korea Notes, 4.63%, 03/16/2010 F 490,099 400,000 PEMEX Project Funding Master Trust, 9.13%, 10/13/2010 F 448,600 ----------- 938,699 ----------- TAXABLE MUNICIPAL BONDS - 0.6% 326,212 Tobacco Settlement Financing Corporation, 6.36%, 05/15/2025 326,515 ----------- U.S. GOVERNMENT AGENCY ISSUES - 11.0% 5,475,000 Federal National Mortgage Association (FNMA), 6.00%, 05/15/2011 5,700,751 ----------- U.S. TREASURY OBLIGATIONS - 14.2% U.S. Treasury Bonds: 1,650,000 9.13%, 05/15/2018 2,269,395 4,400,000 6.25%, 08/15/2023 5,064,470 ----------- 7,333,865 ----------- Total Long-Term Investments (Cost $49,761,614) 49,899,195 ----------- COLLATERAL POOL INVESTMENT FOR SECURITIES ON LOAN - 21.3% (Cost $11,037,325) (Please Refer to Note 6) 11,037,325 ----------- Shares ------ SHORT-TERM INVESTMENTS - 4.1% MONEY MARKET FUNDS - 4.1% 354,568 Short-Term Investment Company Liquid Assets Portfolio - AIM Fund 354,568 1,786,563 Short-Term Investment Company Trust Prime Portfolio - AIM Fund 1,786,563 ----------- Total Short-Term Investments (Cost $2,141,131) 2,141,131 ----------- Total Investments (Cost $62,940,070) - 121.7% 63,077,651 ----------- Liabilities in Excess of Other Assets - (21.7)% (11,237,706) ----------- TOTAL NET ASSETS - 100.0% $51,839,945 ----------- ----------- * Unregistered Security F Foreign Security The accompanying notes are an integral part of these financial statements. BAIRD SHORT-TERM BOND FUND DECEMBER 31, 2006 The Baird Short-Term Bond Fund seeks an annual rate of total return, before Fund expenses, greater than the annual rate of total return of the Lehman Brothers 1- 3 Year Government/Credit Bond Index. The Lehman Brothers 1-3 Year Government/Credit Bond Index is an unmanaged, market value weighted index of investment grade, fixed-rate debt issues, including government and corporate securities, with maturities between one and three years. The Fund delivered solid positive returns and outperformed its benchmark index in 2006. Helping the Fund's strong relative performance were the following factors: o The Fund's exposure to high-quality mortgage-backed and asset-backed securities which performed well relative to other sectors; o The Fund's overweighting of BBB-rated corporate bonds relative to the benchmark; and o Strong performance of specific individual corporate issues, particularly those in the auto and finance sectors. The Fund's exposure to a small number of issues which were negatively affected by leveraged buy-outs detracted slightly from relative performance in 2006. The Fund maintained its duration-neutral strategy, holding a broadly diversified portfolio of over 170 securities at year end. The Fund ended 2006 with a yield advantage versus its benchmark index. This yield advantage, combined with exposure to specific sectors which we believe have superior total return potential (mortgage-backed and asset-backed securities), enhance the Fund's prospects of continuing to add value over its benchmark in the coming year. PORTFOLIO CHARACTERISTICS QUALITY DISTRIBUTION* U.S. Treasury 11% U.S. Gov't Agency 24% AAA 19% AA 5% A 14% BBB 26% Below BBB 1% SECTOR WEIGHTINGS* Asset-Backed 9% Financials 20% Industrials 19% Utilities 6% Mortgage-Backed 13% International 1% Municipal 1% U.S. Gov't Agency 18% U.S. Treasuries 10% Cash 3% NET ASSETS: $148,604,711 SEC 30-DAY YIELD:** Institutional Class: 5.14% AVERAGE EFFECTIVE DURATION: 1.69 years AVERAGE EFFECTIVE MATURITY: 2.02 years ANNUALIZED EXPENSE RATIO: Institutional Class: 0.30% PORTFOLIO TURNOVER RATIO: 41.1% TOTAL NUMBER OF HOLDINGS: 172 * Percentages shown are based on the Fund's total net assets. ** SEC yields are based on SEC guidelines and are calculated for the 30 days ended December 31, 2006. BAIRD SHORT-TERM BOND FUND BAIRD SHORT-TERM BOND FUND - INSTITUTIONAL CLASS* VALUE OF A $250,000 INVESTMENT Baird Short-Term Bond Fund - Lehman 1-3 Year U.S. Institutional Class Shares Government/Credit Index ---------------------------- ----------------------- 8/31/2004 $250,000 $250,000 9/30/2004 $249,602 $249,862 12/31/2004 $250,238 $250,114 3/31/2005 $249,651 $249,411 6/30/2005 $252,823 $252,509 9/30/2005 $253,151 $252,834 12/31/2005 $254,859 $254,548 3/31/2006 $255,991 $255,650 6/30/2006 $258,202 $257,369 9/30/2006 $263,796 $262,691 12/31/2006 $266,708 $265,370 GROWTH OF A HYPOTHETICAL INVESTMENT OF $250,000 MADE ON THE FUND'S INCEPTION DATE (8/31/04), ASSUMING REINVESTMENT OF ALL DISTRIBUTIONS. * The Baird Short-Term Bond Fund is currently offering only the Institutional Class shares to investors. BAIRD SHORT-TERM BOND FUND AVERAGE ANNUAL TOTAL RETURNS For the Periods Ended December 31, 2006 ONE YEAR SINCE INCEPTION(1) --------------------------------------- -------- ----------------------- Baird Short-Term Bond Fund - Institutional Class 4.65% 2.81% Lehman Brothers 1-3 Year Government/Credit Bond Index(2) 4.25% 2.59%
(1) For the period from August 31, 2004 (commencement of operations) to December 31, 2006. (2) The Lehman Brothers 1-3 Year Government/Credit Bond Index is an unmanaged, market value weighted index of investment grade, fixed-rate debt including government and corporate securities with maturities between one and three years. This index does not reflect any deduction for fees, expenses or taxes. A direct investment in an index is not possible. THE RETURNS SHOWN IN THE TABLE ABOVE REFLECT REINVESTMENT OF DIVIDENDS AND/OR CAPITAL GAINS DISTRIBUTIONS IN ADDITIONAL SHARES. RETURNS DO NOT REFLECT THE DEDUCTION OF TAXES THAT A SHAREHOLDER WOULD PAY ON FUND DISTRIBUTIONS OR THE REDEMPTION OF FUND SHARES. PAST PERFORMANCE DOES NOT GUARANTEE FUTURE RESULTS. INVESTMENT RETURNS AND PRINCIPAL VALUE WILL FLUCTUATE SO THAT AN INVESTOR'S SHARES, WHEN REDEEMED, MAY BE WORTH MORE OR LESS THAN THEIR ORIGINAL COST. FOR INFORMATION ABOUT THE PERFORMANCE OF THE FUND AS OF THE MOST RECENT MONTH- END, PLEASE CALL 1-866-44BAIRD OR VISIT WWW.BAIRDFUNDS.COM. MUTUAL FUND PERFORMANCE CHANGES OVER TIME AND CURRENT PERFORMANCE MAY BE LOWER OR HIGHER THAN THAT STATED. BAIRD SHORT-TERM BOND FUND SCHEDULE OF INVESTMENTS DECEMBER 31, 2006 Principal Amount Value --------- ----- LONG-TERM INVESTMENTS - 97.3% ASSET BACKED SECURITIES - 9.0% $ 400,000 AESOP Funding II LLC, Series 2005-1A, Class A1, 3.95%, 04/20/2008 (Acquired 02/17/2005, Cost $399,964)* $ 393,513 700,000 Bayview Financial Acquisition Trust, Series 2005-B, Class 1A2, 4.70%, 04/28/2039 693,297 94,840 Chase Manhatten Auto Owner Trust, Series 2003-C, Class A4, 2.94%, 06/15/2010 93,541 771,193 CitiFinancial Mortgage Securities, Inc., Series 2004-1, Class AF2, 2.65%, 04/25/2034 753,651 375,310 CNH Equipment Trust, Series 2005-A, Class A3, 4.02%, 04/15/2009 372,816 Countrywide Asset-Backed Certificates: 1,000,000 Series 2006-13, Class 1AF3, 5.94%, 05/25/2033 1,006,232 1,500,000 Series 2006-S7, 5.57%, 11/25/2035 1,497,870 1,000,000 Series 2005-10, Class AF2, 4.49%, 02/25/2036 990,611 1,153,000 Series 2005-12, Class 1A2, 4.85%, 02/25/2036 1,143,120 725,000 Series 2005-13, Class AF2, 5.29%, 04/25/2036 721,671 1,500,000 Series 2006-9, Class 1AF3, 5.86%, 10/25/2046 1,507,027 500,000 Ford Credit Auto Owner Trust, Series 2005-B, Class A4, 4.38%, 01/15/2010 494,247 902,277 Green Tree Financial Corporation, Series 1998-3, Class A5, 6.22%, 03/01/2030 909,117 95,127 Household Automobile Trust, Series 2003-1, 2.22%, 11/17/2009 94,189 300,000 MBNA Credit Card Master Note Trust, Series 2003-A3, Class A3, 2.93%, 08/15/2010 300,516 805,138 Merrill Lynch Mortgage Investors Inc., Series 2005-A8, Class A1C1, 5.25%, 08/25/2036 796,914 58,320 New Century Home Equity Loan Trust, Series 2003-5, Class AI3, 3.56%, 11/25/2033 58,067 Residential Asset Mortgage Products, Inc.: 700,000 Series 2004-RS12, Class AI3, 3.98%, 04/25/2029 694,743 406,641 Series 2003-RS7, Class AI6, 5.34%, 08/25/2033 403,254 Residential Asset Securities Corporation: 11,505 Series 2003-KS9, Class AI3, 3.25%, 12/25/2028 11,463 121,127 Series 2004-KS2, Class AI3, 3.02%, 05/25/2029 120,450 74,585 Series 2004-KS4, Class AI3, 3.08%, 08/25/2029 73,569 193,990 Residential Funding Mortgage Securities, Series 2003-HS3, Class AI2, 3.15%, 07/25/2018 191,574 ------------ 13,321,452 ------------ FINANCIAL - 19.8% 880,000 ABN-AMRO Bank NV, 7.00%, 04/01/2008 F 895,088 1,405,000 Allfirst Financial, Inc. Subordinated Notes, 7.20%, 07/01/2007 1,414,786 140,000 American General Finance Corporation Notes, 4.50%, 11/15/2007 139,186 471,000 AMVESCAP, Inc. Senior Notes, 5.90%, 01/15/2007 F 471,044 594,000 Bank of Oklahoma Subordinated Notes, 7.13%, 08/15/2007 599,483 251,000 Bank United Notes, 8.00%, 03/15/2009 263,510 472,000 Bankers Trust Corporation Subordinated Notes, 7.38%, 05/01/2008 483,359 110,000 BB&T Corporation Subordinated Notes, 7.25%, 06/15/2007 110,896 623,000 Block Financial Corporation Notes, 8.50%, 04/15/2007 627,775 1,156,000 BNY Capital I Notes, Series B, 7.97%, 12/31/2026 1,203,389 500,000 Capital One Bank Notes, 4.88%, 05/15/2008 496,918 100,000 Chubb Corporation Senior Notes, 7.13%, 12/15/2007 101,381 210,000 CIT Group Inc. Senior Notes, 5.50%, 11/30/2007 210,463 848,000 Citicorp Capital II Notes, 8.02%, 02/15/2027 883,349 200,000 Citicorp Subordinated Notes, 7.00%, 07/01/2007 201,423 375,000 Citifinancial Debentures, 10.00%, 05/15/2009 415,174 675,000 Comerica Incorporated Subordinated Notes, 7.25%, 08/01/2007 682,389 550,000 Compass Bank Subordinated Notes, 8.10%, 08/15/2009 584,710 388,000 Corestates Capital Trust I, 8.00%, 12/15/2026 (Acquired 01/26/2006 & 06/05/2006; Cost $211,938 & $196,930 respectively)* 404,040 500,000 Countrywide Home Loans Notes, 4.13%, 09/15/2009 485,593 537,000 Credit Suisse First Boston USA Inc. Senior Notes, 6.50%, 06/01/2008 545,670 1,095,000 EOP Operating L.P. Notes, 7.75%, 11/15/2007 1,117,577 500,000 Executive Risk Capital Trust, 8.68%, 02/01/2027 522,462 800,000 First Union Capital, 7.94%, 01/15/2027 833,045 200,000 Franchise Finance Corporation Notes, 7.07%, 01/15/2008 202,917 273,000 The Goldman Sachs Group, Inc. Senior Unsubordinated Notes, 7.80%, 01/28/2010 292,788 400,000 HSBC Finance Corporation Notes, 6.88%, 03/01/2007 400,769 500,000 ING Security Life Institutional Funding Notes, 2.70%, 02/15/2007 (Acquired 05/26/2005; Cost $488,370)* 498,179 1,307,000 JPM Capital Trust II, 7.95%, 02/01/2027 1,360,101 575,000 Key Bank NA Subordinated Notes, 6.50%, 10/15/2027 585,125 400,000 Lehman Brothers Holdings, Inc. Notes, 3.50%, 08/07/2008 388,842 1,413,000 MBNA Capital Series A, 8.28%, 12/01/2026 1,472,928 500,000 MBNA Corporation Notes, 6.25%, 01/17/2007 500,142 250,000 Mellon Capital I Series A, 7.72%, 12/01/2026 260,290 180,000 Merrill Lynch & Co, Inc., 7.00%, 01/15/2007 180,020 200,000 Met Life Global Funding I Notes, 4.75%, 06/20/2007 (Acquired 02/11/2005; Cost $203,862)* 199,496 200,000 Morgan Stanley Group, Inc. Debentures, 8.33%, 01/15/2007 200,167 720,000 NB Capital Trust IV, 8.25%, 04/15/2027 751,496 625,000 New York Life Global Funding, 3.88%, 01/15/2009 (Acquired 01/23/2006; Cost $608,075)* 608,196 700,000 Phoenix Companies, 6.68%, 02/16/2008 706,042 633,000 PNC Financial Services Subordinated Notes, 9.65%, 06/15/2009 693,892 530,000 PNC Funding Corporation, 6.13%, 02/15/2009 538,867 Principal Life Global: 150,000 5.13%, 06/28/2007 (Acquired 12/28/2004; Cost $154,880)* 149,788 275,000 3.63%, 04/30/2008 (Acquired 08/17/2005; Cost $268,452)* 268,310 1,050,000 Providian Capital I, 9.53%, 02/01/2027 (Acquired 10/19/2005 and 10/20/2005; Cost $438,724 and $712,517 respectively)* 1,102,360 155,000 Republic New York Corporation Subordinated Notes, 9.70%, 02/01/2009 168,176 600,000 Residential Capital Corporation, 6.13%, 11/21/2008 602,972 487,000 SAFECO Corporation Notes, 6.88%, 07/15/2007 491,177 200,000 Transamerica Corporation Debentures, 9.38%, 03/01/2008 207,269 1,300,000 Unitrin, Inc. Senior Notes, 5.75%, 07/01/2007 1,300,972 313,000 Wells Fargo & Company Subordinated Notes, 6.25%, 04/15/2008 316,627 211,000 Westdeutsche Landesbank Subordinated Notes, 4.80%, 07/15/2015 F 202,376 1,000,000 Zurich Capital Trust I, 8.38%, 06/01/2037 (Acquired 04/06/2006; Cost $1,065,970)* 1,048,168 ------------ 29,391,162 ------------ INDUSTRIAL - 18.7% 306,000 Bell Telephone Co. Pennsylvania Debentures, 7.38%, 07/15/2007 308,851 150,000 BellSouth Telecommunication Debentures, 5.88%, 01/15/2009 151,365 1,000,000 Belo Corporation Senior Notes, 7.13%, 06/01/2007 1,003,844 125,000 British Telecom PLC Notes, 8.13%, 12/15/2010 F 139,501 1,000,000 Bunge Limited Finance Corporation, 4.38%, 12/15/2008 978,924 700,000 Cadbury Schweppes U.S. Finance Notes, 3.88%, 10/01/2008 (Acquired 08/30/2005; Cost $685,461)* 681,716 405,000 Centex Corporation Subordinated Debentures, 8.75%, 03/01/2007 406,723 165,000 Chevron Phillips Chemical Company Notes, 5.38%, 06/15/2007 164,848 1,300,000 Clear Channel Communication Senior Notes, 3.13%, 02/01/2007 1,297,603 200,000 Comcast Cable Communications, Inc. Notes, 6.20%, 11/15/2008 203,166 465,000 Computer Sciences Corporation Notes, 3.50%, 04/15/2008 451,941 1,336,000 Cooper Cameron Corporation Senior Notes, 2.65%, 04/15/2007 1,325,141 581,000 COX Communications Inc. Notes, 7.88%, 08/15/2009 614,850 579,000 Devon Energy Corporation Debentures, 10.13%, 11/15/2009 645,111 1,000,000 Donnelley (R.R.) & Sons Notes, 3.75%, 04/01/2009 962,595 1,000,000 FMC Corporation Notes, 7.00%, 05/15/2008 1,015,249 1,000,000 Fiserv Inc., 3.00%, 06/27/2008 963,889 300,000 Ford Motor Credit Company Senior Notes, 4.95%, 01/15/2008 294,932 250,000 General Motors Acceptance Corporation Notes, 6.13%, 08/28/2007 250,049 Halliburton Company Notes: 225,000 5.63%, 12/01/2008 225,637 425,000 5.50%, 10/15/2010 424,245 260,000 Harrahs Operating Company Inc., 7.13%, 06/01/2007 261,219 500,000 ICI Wilmington, 7.05%, 09/15/2007 504,646 International Paper Company Notes: 250,000 7.63%, 01/15/2007 250,107 885,000 6.50%, 11/15/2007 889,327 675,000 4.00%, 04/01/2010 647,870 1,000,000 John Deere Capital Corporation Senior Notes, 4.88%, 03/16/2009 991,089 700,000 Johnson Controls Inc. Notes, 6.30%, 02/01/2008 702,097 Marathon Oil Corporation Notes: 310,000 5.38%, 06/01/2007 309,886 563,000 6.85%, 03/01/2008 571,578 450,000 News America Holdings, 7.38%, 10/17/2008 464,379 800,000 Premcor Refining Group Inc. Senior Notes, 9.50%, 02/01/2013 864,062 1,000,000 Sealed Air Corporation Senior Notes, 5.38%, 04/15/2008 (Acquired 07/07/2006; Cost $989,890)* 995,191 402,000 Southwestern Bell Telephone Company Notes, 6.63%, 07/15/2007 404,158 500,000 Sprint Capital Corporation Notes, 6.38%, 05/01/2009 510,011 1,000,000 Telecom Italia Capital, 4.00%, 11/15/2008 F 973,854 1,028,000 Telus Corporation Notes, 7.50%, 06/01/2007 F 1,035,608 700,000 Thomson Corporation, 5.75%, 02/01/2008 F 702,097 255,000 Time Warner Companies, Inc., 8.18%, 08/15/2007 259,191 750,000 Time Warner Companies, Inc. Debentures, 7.48%, 01/15/2008 765,195 659,195 United AirLines, Inc. Pass Thru Certificates, Series 2001-1, 6.20%, 09/01/2008 663,315 1,050,000 Univision Communications, Inc., 3.50%, 10/15/2007 1,027,373 500,000 Viacom, Inc., 5.63%, 05/01/2007 500,258 1,000,000 Wharf International Finance Ltd., 7.63%, 03/13/2007 F 1,004,217 ------------ 27,806,908 ------------ UTILITIES - 6.4% 1,000,000 Baltimore Gas & Electric Company Notes, 5.78%, 10/01/2008 1,003,321 805,000 Cilcorp Inc. Senior Notes, 8.70%, 10/15/2009 862,258 Commonwealth Edison Notes: 1,000,000 7.63%, 01/15/2007 1,000,413 600,000 3.70%, 02/01/2008 588,130 Kinder Morgan Energy Partners Senior Notes: 150,000 5.35%, 08/15/2007 149,803 1,000,000 6.30%, 02/01/2009 1,013,273 MidAmerican Energy Holdings Company Senior Notes: 200,000 4.63%, 10/01/2007 198,700 575,000 7.63%, 10/15/2007 584,023 500,000 7.52%, 09/15/2008 516,690 1,000,000 Nisource Finance Corporation, 7.88%, 11/15/2010 1,078,862 1,032,000 Panhandle Eastern Pipeline Senior Notes, 4.80%, 08/15/2008 1,016,684 200,000 Public Service Electric & Gas Co. Notes, 6.25%, 01/01/2007 200,000 500,000 Sempra Energy Senior Notes, 4.62%, 05/17/2007 498,093 860,000 System Energy Resources 1st Mortgage, 4.88%, 10/01/2007 854,721 ------------ 9,564,971 ------------ MORTGAGE BACKED SECURITIES - 12.9% 1,083,213 Bank of America Alternative Loan Trust, Series 2003-4, Class 2A1, 5.00%, 06/25/2018 1,065,799 Citicorp Mortgage Securities, Inc.: 275,800 Series 2003-11, Class 2A8, 5.50%, 12/25/2033 274,322 811,370 Series 2004-3, Class A2, 5.25%, 05/25/2034 802,032 470,447 Series 2004-4, Class A2, 5.25%, 06/25/2034 456,980 1,651,477 Countrywide Alternative Loan Trust, Series 2005-50CB, Class 4A1, 5.00%, 11/25/2020 1,631,745 2,000,000 Deutsche Alternative Securities Inc. Mortgage, Series 2005-4, Class A2, 5.05%, 09/25/2035 1,981,557 Federal Home Loan Mortgage Corporation (FHLMC): 117,281 Series 2548, Class HA, 4.50%, 01/15/2010 115,886 208,710 Series 2835, Class VK, 5.50%, 11/15/2012 209,087 644,924 Series 3033, Class LU, 5.50%, 03/15/2013 647,810 1,113,376 Series 3124, Class VP, 6.00%, 06/15/2014 1,133,685 200,000 Series 2592, Class PD, 5.00%, 07/15/2014 198,823 325,507 Series 2789, Class VM, 5.50%, 04/15/2015 326,119 1,000,000 Series 2390, Class PW, 6.00%, 04/15/2015 1,007,912 285,070 Series 2541, Class JB, 5.00%, 02/15/2016 283,072 724,412 Series 2970, Class DA, 5.50%, 01/15/2023 724,397 Federal National Mortgage Association (FNMA): 762,264 5.50%, 07/01/2015 764,531 1,175,000 Series 2003-24, Class LC, 5.00%, 12/25/2015 1,163,620 211,506 Series 2002-77, Class QP, 5.00%, 09/25/2026 210,256 535,961 Series 2004-W6, Class 1A4, 5.50%, 07/25/2034 535,830 1,000,000 Series 2004-W10, Class A24, 5.00%, 08/25/2034 988,017 2,000,000 J.P. Morgan Alternative Loan Trust, Series 2006-S2, Class A2, 5.81%, 05/25/2036 1,997,923 1,200,000 Residential Accredit Loans Inc., Series 2003-QS17, Class CB3, 5.50%, 09/25/2033 1,193,344 Washington Mutual, Inc. Pass-Thru Certificates: 723,833 Series 2004-CB4, Class 21A, 5.50%, 12/25/2019 721,852 650,231 Series 2004-CB4, Class 22A, 6.00%, 12/25/2019 657,460 ------------ 19,092,059 ------------ INTERNATIONAL (U.S. $ DENOMINATED) - 0.6% 175,000 Export-Import Bank Korea Notes, 4.63%, 03/16/2010 F 171,535 600,000 Korea Development Bank Notes, 3.88%, 03/02/2009 F 582,459 200,000 PEMEX Project Funding Master Trust, 6.13%, 08/15/2008 F 201,600 ------------ 955,594 ------------ TAXABLE MUNICIPAL BONDS - 1.6% 210,362 Educational Enhancement Funding Corporation, 6.72%, 06/01/2025 210,776 70,000 Erie, Pennsylvania General Obligation, 5.60%, 11/15/2007 70,020 450,000 New Jersey Economic Development Authority, 0.00%, 02/15/2007^ ETM 447,282 500,000 Redding California Redevelopment Agency Tax Allocation, 6.00%, 09/01/2010 507,545 1,104,101 Tobacco Settlement Financing Corporation, Series 2001-A, Class A, 6.36%, 05/15/2025 1,105,128 ------------ 2,340,751 ------------ U.S. GOVERNMENT AGENCY ISSUES - 17.8% 1,000,000 Federal Home Loan Bank (FHLB), 4.70%, 10/07/2010 983,427 Federal National Mortgage Association (FNMA): 9,675,000 2.38%, 02/15/2007 9,642,937 15,200,000 6.00%, 05/15/2011 15,826,742 ------------ 26,453,106 ------------ U.S. TREASURY OBLIGATIONS - 10.5% U.S. Treasury Note: 3,000,000 5.50%, 02/15/2008 3,016,641 12,500,000 4.88%, 04/30/2011 12,581,050 ------------ 15,597,691 ------------ Total Long-Term Investments (Cost $145,010,435) 144,523,694 ------------ COLLATERAL POOL INVESTMENT FOR SECURITIES ON LOAN - 28.9% (Cost $42,992,134) (Please Refer to Note 6) 42,992,134 ------------ Shares ------ SHORT-TERM INVESTMENTS - 2.3% MONEY MARKET FUNDS - 2.3% 3,383,098 Short-Term Investment Company Liquid Assets Portfolio - AIM Fund 3,383,098 ------------ Total Short-Term Investments (Cost $3,383,098) 3,383,098 ------------ Total Investments (Cost $191,385,667) - 128.5% 190,898,926 ------------ Liabilities in Excess of Other Assets - (28.5)% (42,294,215) ------------ TOTAL NET ASSETS - 100.00% $148,604,711 ------------ ------------ ^ Non Income Producing * Unregistered Security F Foreign Security ETM - Escrowed to Maturity The accompanying notes are an integral part of these financial statements. BAIRD FUNDS, INC. ADDITIONAL INFORMATION ON FUND EXPENSES DECEMBER 31, 2006 (UNAUDITED) EXAMPLE As a shareholder of a mutual fund, you incur two types of costs: (1) transaction costs, which may include sales charges (loads) on purchase payments, reinvested dividends, or other distributions; redemption fees; and exchange fees; and (2) ongoing costs, such as management fees; distribution and/or service (12b-1) fees; and other fund expenses. Although the Funds do not charge any sales loads, redemption fees, or other transaction fees, you will be assessed fees for outgoing wire transfers, returned checks and stop payment orders at prevailing rates charged by U.S. Bancorp Fund Services, LLC, the Funds' transfer agent. If you request that a redemption be made by wire transfer, currently the Funds' transfer agent charges a $15.00 fee. This Example is intended to help you understand your ongoing costs (in dollars) of investing in each Fund and to compare these costs with the ongoing costs of investing in other mutual funds. The Example is based on an investment of $1,000 invested at the beginning of the period and held for the entire period (7/1/06 - 12/31/06). ACTUAL EXPENSES The third and fourth columns of the following table provide information about account values based on actual returns and actual expenses. You may use the information in these columns, together with the amount you invested, to estimate the expenses that you paid over the period. Simply divide your account value by $1,000 (for example, an $8,600 account value divided by $1,000 = 8.6), then multiply the result by the number in the fourth column entitled "Expenses Paid During Period" to estimate the expenses you paid on your account during this period. HYPOTHETICAL EXAMPLE FOR COMPARISON PURPOSES The fifth and sixth columns of the following table provide information about hypothetical account values and hypothetical expenses based on the Funds' actual expense ratios and an assumed rate of return of 5% per year before expenses, which is not the Funds' actual return. The hypothetical account values and expenses may not be used to estimate the actual ending account balance or expenses you paid for the period. You may use this information to compare the ongoing costs of investing in the Funds and other mutual funds. To do so, compare this 5% hypothetical example with the 5% hypothetical examples that appear in the shareholder reports of the other mutual funds. Please note that the expenses shown in the table are meant to highlight your ongoing costs only and do not reflect any transactional costs. Therefore, the sixth column of the table (entitled "Expenses Paid During Period") is useful in comparing ongoing costs only, and will not help you determine the relative total costs of owning different mutual funds. In addition, if these transactional costs were included, your costs could have been higher. ACTUAL VS. HYPOTHETICAL RETURNS For the Six Months Ended December 31, 2006 HYPOTHETICAL (5% RETURN ACTUAL BEFORE EXPENSES) ----------------------------- --------------------------- FUND'S BEGINNING ENDING EXPENSES ENDING EXPENSES ANNUALIZED ACCOUNT ACCOUNT PAID ACCOUNT PAID EXPENSE VALUE VALUE DURING VALUE DURING RATIO(1) 7/1/06 12/31/06 PERIOD(1) 7/1/06 PERIOD(1) ------------- --------- -------- -------------- ------- -------------- BAIRD INTERMEDIATE BOND FUND Institutional Class 0.30% $1,000.00 $1,046.40 $1.55 $1,023.69 $1.53 Investor Class 0.55% $1,000.00 $1,045.60 $2.84 $1,022.43 $2.80 BAIRD AGGREGATE BOND FUND Institutional Class 0.30% $1,000.00 $1,053.70 $1.55 $1,023.29 $1.53 Investor Class 0.55% $1,000.00 $1,051.30 $2.84 $1,022.43 $2.80 BAIRD INTERMEDIATE MUNICIPAL BOND FUND Institutional Class 0.30% $1,000.00 $1,038.40 $1.54 $1,023.69 $1.53 Investor Class 0.55% $1,000.00 $1,036.30 $2.82 $1,022.43 $2.80 BAIRD CORE PLUS BOND FUND Institutional Class 0.30% $1,000.00 $1,062.90 $1.56 $1,023.69 $1.53 Investor Class 0.55% $1,000.00 $1,061.00 $2.86 $1,022.43 $2.80 BAIRD SHORT-TERM BOND FUND Institutional Class 0.30% $1,000.00 $1,033.00 $1.54 $1,023.69 $1.53
(1) Expenses are equal to the Fund's annualized expense ratio multiplied by the average account value over the period, multiplied by 184 days and divided by 365 to reflect the one-half year period. BAIRD FUNDS, INC. STATEMENTS OF ASSETS AND LIABILITIES DECEMBER 31, 2006 BAIRD BAIRD BAIRD INTERMEDIATE BAIRD BAIRD INTERMEDIATE AGGREGATE MUNICIPAL CORE PLUS SHORT-TERM BOND FUND BOND FUND BOND FUND BOND FUND BOND FUND ------------ --------- ------------ --------- ---------- ASSETS: Investments, at value (cost $352,748,209, $355,129,704, $64,179,220, $55,467,092 and $162,277,229, respectively) $352,131,310 $355,182,329 $64,302,090 $55,604,673 $161,790,488 Repurchase agreements (cost $59,185,483, $30,503,904, $0, $7,472,978 and $29,108,438, respectively) 59,185,483 30,503,904 -- 7,472,978 29,108,438 Interest receivable 4,111,648 3,542,280 1,109,548 589,449 1,743,764 Receivable for investments sold 11,951 7,171 -- 2,390 -- Receivable for Fund shares sold 154,315 2,400,185 116,168 105,785 532,708 ------------ ------------ ----------- ----------- ------------ Total assets 415,594,707 391,635,869 65,527,806 63,775,275 193,175,398 ------------ ------------ ----------- ----------- ------------ LIABILITIES: Payable for collateral received for securities loaned (See Note 6) 87,414,866 45,053,190 -- 11,037,325 42,992,134 Payable for securities purchased -- 9,671,027 -- 812,863 1,522,713 Payable for Fund shares repurchased 52,525 64,800 30,000 37,952 18,438 Payable to Advisor and Distributor 83,746 81,880 20,299 12,148 37,402 Payable to the Custodian 957 -- -- -- -- Other liabilities -- 8,495 -- 35,042 -- ------------ ------------ ----------- ----------- ------------ Total liabilities 87,552,094 54,879,392 50,299 11,935,330 44,570,687 ------------ ------------ ----------- ----------- ------------ NET ASSETS $328,042,613 $336,756,477 $65,477,507 $51,839,945 $148,604,711 ------------ ------------ ----------- ----------- ------------ ------------ ------------ ----------- ----------- ------------ NET ASSETS CONSIST OF: Capital stock $331,731,393 $337,708,301 $65,687,283 $51,798,631 $149,369,914 Accumulated undistributed net investment income 207,297 177,153 9,471 33,503 78,385 Accumulated net realized loss on investments sold (3,279,178) (1,181,602) (342,117) (129,770) (356,847) Net unrealized appreciation (depreciation) on investments (616,899) 52,625 122,870 137,581 (486,741) ------------ ------------ ----------- ----------- ------------ NET ASSETS $328,042,613 $336,756,477 $65,477,507 $51,839,945 $148,604,711 ------------ ------------ ----------- ----------- ------------ ------------ ------------ ----------- ----------- ------------ INSTITUTIONAL CLASS SHARES Net Assets $326,835,399 $334,907,855 $64,932,629 $51,551,017 $148,604,711 Shares outstanding ($0.01 par value, unlimited shares authorized) 31,062,601 31,878,802 6,152,087 5,075,175 15,147,163 Net asset value, offering and redemption price per share $ 10.52 $ 10.51 $ 10.55 $ 10.16 $ 9.81 ------------ ------------ ----------- ----------- ------------ ------------ ------------ ----------- ----------- ------------ INVESTOR CLASS SHARES Net Assets $ 1,207,214 $ 1,848,622 $ 544,878 $ 288,928 Shares outstanding ($0.01 par value, unlimited shares authorized) 111,284 172,253 50,663 27,724 Net asset value, offering and redemption price per share $ 10.85 $ 10.73 $ 10.75 $ 10.42 ------------ ------------ ----------- ----------- ------------ ------------ ----------- -----------
The accompanying notes are an integral part of these financial statements. BAIRD FUNDS, INC. STATEMENTS OF OPERATIONS YEAR ENDED DECEMBER 31, 2006 BAIRD BAIRD BAIRD INTERMEDIATE BAIRD BAIRD INTERMEDIATE AGGREGATE MUNICIPAL CORE PLUS SHORT-TERM BOND FUND BOND FUND BOND FUND BOND FUND BOND FUND ------------ --------- ------------ --------- ---------- INVESTMENT INCOME: Interest income $14,353,462 $14,025,596 $2,771,283 $1,851,206 $6,016,088 Income from securities lending 40,526 25,570 -- 4,482 18,157 ----------- ----------- ---------- ---------- ---------- Total investment income 14,393,988 14,051,166 2,771,283 1,855,688 6,034,245 ----------- ----------- ---------- ---------- ---------- EXPENSES: Investment advisory fee 691,567 648,938 172,433 80,146 315,364 Administration fee 138,313 129,788 34,486 16,029 63,073 Distribution expense - Investor Class Shares 4,508 3,239 2,685 790 -- ----------- ----------- ---------- ---------- ---------- Total expenses 834,388 781,965 209,604 96,965 378,437 ----------- ----------- ---------- ---------- ---------- NET INVESTMENT INCOME 13,559,600 13,269,201 2,561,679 1,758,723 5,655,808 ----------- ----------- ---------- ---------- ---------- REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS: Net realized loss on investments (1,654,036) (888,625) (106,983) (55,454) (247,795) Change in unrealized appreciation/depreciation on investments 1,569,947 639,350 81,453 405,659 518,820 ----------- ----------- ---------- ---------- ---------- Net realized and unrealized gain (loss) on investments (84,089) (249,275) (25,530) 350,205 271,025 ----------- ----------- ---------- ---------- ---------- NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS $13,475,511 $13,019,926 $2,536,149 $2,108,928 $5,926,833 ----------- ----------- ---------- ---------- ---------- ----------- ----------- ---------- ---------- ----------
The accompanying notes are an integral part of these financial statements. BAIRD FUNDS, INC. STATEMENTS OF CHANGES IN NET ASSETS BAIRD INTERMEDIATE BOND FUND ------------------------------------- Year Ended Year Ended December 31, 2006 December 31, 2005 ----------------- ----------------- OPERATIONS: Net investment income $ 13,559,600 $ 9,443,219 Net realized loss on investments (1,654,036) (687,811) Change in unrealized appreciation/depreciation on investments 1,569,947 (4,795,310) ------------ ------------ Net increase in net assets resulting from operations 13,475,511 3,960,098 ------------ ------------ CAPITAL SHARE TRANSACTIONS: Proceeds from shares sold 111,704,742 71,651,001 Shares issued to holders in reinvestment of dividends 11,932,463 8,680,587 Cost of shares redeemed (30,115,437) (34,654,355) ------------ ------------ Net increase in net assets resulting from capital share transactions 93,521,768 45,677,233 ------------ ------------ DISTRIBUTIONS TO INSTITUTIONAL CLASS SHAREHOLDERS: From net investment income (13,507,486) (9,464,170) ------------ ------------ DISTRIBUTIONS TO INVESTOR CLASS SHAREHOLDERS: From net investment income (77,646) (118,722) ------------ ------------ TOTAL INCREASE IN NET ASSETS 93,412,147 40,054,439 NET ASSETS: Beginning of year 234,630,466 194,576,027 ------------ ------------ End of year (including undistributed net investment income of $207,297 and $154,379, respectively) $328,042,613 $234,630,466 ------------ ------------ ------------ ------------
The accompanying notes are an integral part of these financial statements. BAIRD FUNDS, INC. STATEMENTS OF CHANGES IN NET ASSETS BAIRD AGGREGATE BOND FUND ------------------------------------- Year Ended Year Ended December 31, 2006 December 31, 2005 ----------------- ----------------- OPERATIONS: Net investment income $ 13,269,201 $ 6,761,559 Net realized gain (loss) on investments (888,625) 294,456 Change in unrealized appreciation/depreciation on investments 639,350 (3,005,159) ------------ ------------ Net increase in net assets resulting from operations 13,019,926 4,050,856 ------------ ------------ CAPITAL SHARE TRANSACTIONS: Proceeds from shares sold 155,486,669 119,986,464 Shares issued to holders in reinvestment of dividends 11,939,014 6,520,179 Cost of shares redeemed (58,822,570) (11,028,752) ------------ ------------ Net increase in net assets resulting from capital share transactions 108,603,113 115,477,891 ------------ ------------ DISTRIBUTIONS TO INSTITUTIONAL CLASS SHAREHOLDERS: From net investment income (13,106,942) (7,004,294) From net realized gains (120,758) (149,762) ------------ ------------ Total Distributions (13,227,700) (7,154,056) ------------ ------------ DISTRIBUTIONS TO INVESTOR CLASS SHAREHOLDERS: From net investment income (60,662) (43,249) From net realized gains (525) (837) ------------ ------------ Total Distributions (61,187) (44,086) ------------ ------------ TOTAL INCREASE IN NET ASSETS 108,334,152 112,330,605 NET ASSETS: Beginning of year 228,422,325 116,091,720 ------------ ------------ End of year (including undistributed net investment income of $177,153 and $10,472, respectively) $336,756,477 $228,422,325 ------------ ------------ ------------ ------------
The accompanying notes are an integral part of these financial statements. BAIRD FUNDS, INC. STATEMENTS OF CHANGES IN NET ASSETS BAIRD INTERMEDIATE MUNICIPAL BOND FUND -------------------------------------- Year Ended Year Ended December 31, 2006 December 31, 2005 ----------------- ----------------- OPERATIONS: Net investment income $ 2,561,679 $ 1,726,837 Net realized loss on investments (106,983) (209,761) Change in unrealized appreciation/depreciation on investments 81,453 (847,084) ----------- ----------- Net increase in net assets resulting from operations 2,536,149 669,992 ----------- ----------- CAPITAL SHARE TRANSACTIONS: Proceeds from shares sold 36,672,168 29,861,346 Shares issued to holders in reinvestment of dividends 2,042,052 1,440,536 Cost of shares redeemed (28,525,030) (16,406,963) ----------- ----------- Net increase in net assets resulting from capital share transactions 10,189,190 14,894,919 ----------- ----------- DISTRIBUTIONS TO INSTITUTIONAL CLASS SHAREHOLDERS: From net investment income (2,536,465) (1,658,407) ----------- ----------- DISTRIBUTIONS TO INVESTOR CLASS SHAREHOLDERS: From net investment income (34,881) (83,967) ----------- ----------- TOTAL INCREASE IN NET ASSETS 10,153,993 13,822,537 NET ASSETS: Beginning of year 55,323,514 41,500,977 ----------- ----------- End of year (including undistributed net investment income of $9,471 and $19,139, respectively) $65,477,507 $55,323,514 ----------- ----------- ----------- -----------
The accompanying notes are an integral part of these financial statements. BAIRD FUNDS, INC. STATEMENTS OF CHANGES IN NET ASSETS BAIRD CORE PLUS BOND FUND ------------------------------------- Year Ended Year Ended December 31, 2006 December 31, 2005 ----------------- ----------------- OPERATIONS: Net investment income $ 1,758,723 $ 1,595,244 Net realized gain (loss) on investments (55,454) 22,747 Change in unrealized appreciation/depreciation on investments 405,659 (938,103) ----------- ----------- Net increase in net assets resulting from operations 2,108,928 679,888 ----------- ----------- CAPITAL SHARE TRANSACTIONS: Proceeds from shares sold 35,731,850 4,215,390 Shares issued to holders in reinvestment of dividends 1,429,836 936,473 Cost of shares redeemed (18,311,499) (4,100,728) Other capital contributions 71 -- ----------- ----------- Net increase in net assets resulting from capital share transactions 18,850,258 1,051,135 ----------- ----------- DISTRIBUTIONS TO INSTITUTIONAL CLASS SHAREHOLDERS: From net investment income (1,727,098) (1,692,217) From net realized gains -- (21,380) ----------- ----------- Total Distributions (1,727,098) (1,713,597) ----------- ----------- DISTRIBUTIONS TO INVESTOR CLASS SHAREHOLDERS: From net investment income (15,311) (15,455) From net realized gains -- (291) ----------- ----------- Total Distributions (15,311) (15,746) ----------- ----------- TOTAL INCREASE IN NET ASSETS 19,216,777 1,680 NET ASSETS: Beginning of year 32,623,168 32,621,488 ----------- ----------- End of year (including undistributed net investment income of $33,503 and $0, respectively) $51,839,945 $32,623,168 ----------- ----------- ----------- -----------
The accompanying notes are an integral part of these financial statements. BAIRD FUNDS, INC. STATEMENTS OF CHANGES IN NET ASSETS BAIRD SHORT-TERM BOND FUND ------------------------------------- Year Ended Year Ended December 31, 2006 December 31, 2005 ----------------- ----------------- OPERATIONS: Net investment income $ 5,655,808 $ 2,344,937 Net realized loss on investments (247,795) (162,401) Change in unrealized appreciation/depreciation on investments 518,820 (797,479) ------------ ----------- Net increase in net assets resulting from operations 5,926,833 1,385,057 ------------ ----------- CAPITAL SHARE TRANSACTIONS: Proceeds from shares sold 79,434,155 81,066,185 Shares issued to holders in reinvestment of dividends 5,464,609 2,142,819 Cost of shares redeemed (33,715,361) (17,200,778) ------------ ----------- Net increase in net assets resulting from capital share transactions 51,183,403 66,008,226 ------------ ----------- DISTRIBUTIONS TO INSTITUTIONAL CLASS SHAREHOLDERS: From net investment income (5,563,493) (2,308,315) ------------ ----------- TOTAL INCREASE IN NET ASSETS 51,546,743 65,084,968 NET ASSETS: Beginning of period 97,057,968 31,973,000 ------------ ----------- End of period (including undistributed net investment income of $78,385 and $40,220, respectively) $148,604,711 $97,057,968 ------------ ----------- ------------ -----------
The accompanying notes are an integral part of these financial statements. BAIRD FUNDS, INC. FINANCIAL HIGHLIGHTS BAIRD INTERMEDIATE BOND FUND - INSTITUTIONAL CLASS -------------------------------------------------------------------------- Year Ended December 31, 2006 2005 2004 2003 2002 ------ ------ ------ ------ ------ Per Share Data: Net asset value, beginning of period $10.55 $10.83 $10.88 $10.86 $10.60 ------ ------ ------ ------ ------ Income from investment operations: Net investment income 0.51 0.46 0.47(1) 0.49 0.56 Net realized and unrealized gains (losses) on investments (0.03) (0.27) (0.05) 0.14 0.27 ------ ------ ------ ------ ------ Total from investment operations 0.48 0.19 0.42 0.63 0.83 ------ ------ ------ ------ ------ Less distributions: Dividends from net investment income (0.51) (0.47) (0.47) (0.49) (0.56) Distributions from net realized gains -- -- (0.00)(2) (0.12) (0.01) ------ ------ ------ ------ ------ Total distributions (0.51) (0.47) (0.47) (0.61) (0.57) ------ ------ ------ ------ ------ Net asset value, end of period $10.52 $10.55 $10.83 $10.88 $10.86 ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ Total return 4.70% 1.77% 3.91% 5.89% 8.02% Supplemental data and ratios: Net assets, end of period $326,835,399 $231,800,807 $191,563,699 $149,836,855 $146,236,339 Ratio of expenses to average net assets 0.30% 0.30% 0.30% 0.30% 0.30% Ratio of net investment income to average net assets 4.90% 4.34% 4.32% 4.39% 5.20% Portfolio turnover rate(3) 44.8% 42.1% 44.8% 64.4% 41.1%
(1) Calculated using average shares outstanding during the period. (2) Amount is less than $0.01. (3) Portfolio turnover is calculated on the basis of the Fund as a whole without distinguishing between the classes of shares issued. The accompanying notes are an integral part of these financial statements. BAIRD FUNDS, INC. FINANCIAL HIGHLIGHTS BAIRD INTERMEDIATE BOND FUND - INVESTOR CLASS -------------------------------------------------------------------------- Year Ended December 31, 2006 2005 2004 2003 2002 ------ ------ ------ ------ ------ Per Share Data: Net asset value, beginning of period $10.86 $11.13 $11.17 $11.13 $10.71 ------ ------ ------ ------ ------ Income from investment operations: Net investment income 0.50(1) 0.45 0.45(1) 0.48 0.54(1) Net realized and unrealized gains (losses) on investments (0.03) (0.28) (0.05) 0.14 0.27 ------ ------ ------ ------ ------ Total from investment operations 0.47 0.17 0.40 0.62 0.81 ------ ------ ------ ------ ------ Less distributions: Dividends from net investment income (0.48) (0.44) (0.44) (0.46) (0.38) Distributions from net realized gains -- -- (0.00)(2) (0.12) (0.01) ------ ------ ------ ------ ------ Total distributions (0.48) (0.44) (0.44) (0.58) (0.39) ------ ------ ------ ------ ------ Net asset value, end of period $10.85 $10.86 $11.13 $11.17 $11.13 ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ Total return 4.47% 1.56% 3.65% 5.61% 7.74% Supplemental data and ratios: Net assets, end of period $1,207,214 $2,829,659 $3,012,328 $1,321,648 $1,127,162 Ratio of expenses to average net assets 0.55% 0.55% 0.55% 0.55% 0.55% Ratio of net investment income to average net assets 4.65% 4.09% 4.07% 4.14% 4.95% Portfolio turnover rate(3) 44.8% 42.1% 44.8% 64.4% 41.1%
(1) Calculated using average shares outstanding during the period. (2) Amount is less than $0.01. (3) Portfolio turnover is calculated on the basis of the Fund as a whole without distinguishing between the classes of shares issued. The accompanying notes are an integral part of these financial statements. BAIRD FUNDS, INC. FINANCIAL HIGHLIGHTS BAIRD AGGREGATE BOND FUND - INSTITUTIONAL CLASS -------------------------------------------------------------------------- Year Ended December 31, 2006 2005 2004 2003 2002 ------ ------ ------ ------ ------ Per Share Data: Net asset value, beginning of period $10.54 $10.74 $10.71 $10.69 $10.51 ------ ------ ------ ------ ------ Income from investment operations: Net investment income 0.52 0.49(1) 0.49(1) 0.56 0.62 Net realized and unrealized gains (losses) on investments (0.03) (0.19) 0.07 0.20 0.23 ------ ------ ------ ------ ------ Total from investment operations 0.49 0.30 0.56 0.76 0.85 ------ ------ ------ ------ ------ Less distributions: Dividends from net investment income (0.52) (0.49) (0.50) (0.56) (0.62) Distributions from net realized gains (0.00)(2) (0.01) (0.03) (0.18) (0.05) ------ ------ ------ ------ ------ Total distributions (0.52) (0.50) (0.53) (0.74) (0.67) ------ ------ ------ ------ ------ Net asset value, end of period $10.51 $10.54 $10.74 $10.71 $10.69 ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ Total return 4.88% 2.85% 5.30% 7.19% 8.30% Supplemental data and ratios: Net assets, end of period $334,907,855 $227,132,399 $115,382,862 $91,550,534 $87,847,176 Ratio of expenses to average net assets 0.30% 0.30% 0.30% 0.30% 0.30% Ratio of net investment income to average net assets 5.11% 4.56% 4.58% 4.85% 5.75% Portfolio turnover rate(3) 52.4% 46.0% 72.6% 106.7% 51.2%
(1) Calculated using average shares outstanding throughout the period. (2) Amount is less than $0.01. (3) Portfolio turnover is calculated on the basis of the Fund as a whole without distinguishing between the classes of shares issued. The accompanying notes are an integral part of these financial statements. BAIRD FUNDS, INC. FINANCIAL HIGHLIGHTS BAIRD AGGREGATE BOND FUND - INVESTOR CLASS -------------------------------------------------------------------------- Year Ended December 31, 2006 2005 2004 2003 2002 ------ ------ ------ ------ ------ Per Share Data: Net asset value, beginning of period $10.75 $10.95 $10.88 $10.84 $10.57 ------ ------ ------ ------ ------ Income from investment operations: Net investment income 0.50 0.47(1) 0.48(1) 0.55 0.60(1) Net realized and unrealized gains (losses) on investments (0.02) (0.19) 0.07 0.19 0.23 ------ ------ ------ ------ ------ Total from investment operations 0.48 0.28 0.55 0.74 0.83 ------ ------ ------ ------ ------ Less distributions: Dividends from net investment income (0.50) (0.47) (0.45) (0.52) (0.51) Distributions from net realized gains (0.00)(2) (0.01) (0.03) (0.18) (0.05) ------ ------ ------ ------ ------ Total distributions (0.50) (0.48) (0.48) (0.70) (0.56) ------ ------ ------ ------ ------ Net asset value, end of period $10.73 $10.75 $10.95 $10.88 $10.84 ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ Total return 4.61% 2.54% 5.20% 6.95% 8.08% Supplemental data and ratios: Net assets, end of period $1,848,622 $1,289,926 $708,858 $719,844 $845,481 Ratio of expenses to average net assets 0.55% 0.55% 0.55% 0.55% 0.55% Ratio of net investment income to average net assets 4.86% 4.31% 4.33% 4.60% 5.50% Portfolio turnover rate(3) 52.4% 46.0% 72.6% 106.7% 51.2%
(1) Calculated using average shares outstanding during the period. (2) Amount is less than $0.01. (3) Portfolio turnover is calculated on the basis of the Fund as a whole without distinguishing between the classes of shares issued. The accompanying notes are an integral part of these financial statements. BAIRD FUNDS, INC. FINANCIAL HIGHLIGHTS BAIRD INTERMEDIATE MUNICIPAL BOND FUND - INSTITUTIONAL CLASS ----------------------------------------------------------------------- Year Ended December 31, 2006 2005 2004 2003 2002 ------ ------ ------ ------ ------ Per Share Data: Net asset value, beginning of period $10.56 $10.81 $10.91 $10.86 $10.25 ------ ------ ------ ------ ------ Income from investment operations: Net investment income(1) 0.39 0.39 0.40 0.42 0.43 Net realized and unrealized gains (losses) on investments (0.01) (0.25) (0.11) 0.10 0.64 ------ ------ ------ ------ ------ Total from investment operations 0.38 0.14 0.29 0.52 1.07 ------ ------ ------ ------ ------ Less distributions: Dividends from net investment income (0.39) (0.39) (0.39) (0.43) (0.46) Distributions from net realized gains -- -- -- (0.04) (0.00)(2) ------ ------ ------ ------ ------ Total distributions (0.39) (0.39) (0.39) (0.47) (0.46) ------ ------ ------ ------ ------ Net asset value, end of period $10.55 $10.56 $10.81 $10.91 $10.86 ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ Total return 3.69% 1.33% 2.69% 4.91% 10.72% Supplemental data and ratios: Net assets, end of period $ 64,932,629 $ 53,831,848 $ 36,889,211 $30,234,195 $31,221,508 Ratio of expenses to average net assets 0.30% 0.30% 0.30% 0.30% 0.30% Ratio of net investment income to average net assets 3.72% 3.64% 3.70% 3.88% 4.11% Portfolio turnover rate(3) 25.1% 13.7% 4.2% 17.7% 32.6%
(1) Calculated using average shares outstanding during the period. (2) Amount is less than $0.01. (3) Portfolio turnover is calculated on the basis of the Fund as a whole without distinguishing between the classes of shares issued. The accompanying notes are an integral part of these financial statements. BAIRD FUNDS, INC. FINANCIAL HIGHLIGHTS BAIRD INTERMEDIATE MUNICIPAL BOND FUND - INVESTOR CLASS ----------------------------------------------------------------------- Year Ended December 31, 2006 2005 2004 2003 2002 ------ ------ ------ ------ ------ Per Share Data: Net asset value, beginning of period $10.75 $10.99 $11.09 $11.02 $10.27 ------ ------ ------ ------ ------ Income from investment operations: Net investment income(1) 0.37 0.37 0.38 0.40 0.41 Net realized and unrealized gains (losses) on investments (0.01) (0.25) (0.12) 0.10 0.64 ------ ------ ------ ------ ------ Total from investment operations 0.36 0.12 0.26 0.50 1.05 ------ ------ ------ ------ ------ Less distributions: Dividends from net investment income (0.36) (0.36) (0.36) (0.39) (0.30) Distributions from net realized gains -- -- -- (0.04) (0.00)(2) ------ ------ ------ ------ ------ Total distributions (0.36) (0.36) (0.36) (0.43) (0.30) ------ ------ ------ ------ ------ Net asset value, end of period $10.75 $10.75 $10.99 $11.09 $11.02 ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ Total return 3.44% 1.13% 2.40% 4.69% 10.46% Supplemental data and ratios: Net assets, end of period $544,878 $1,491,666 $4,611,766 $756,792 $706,207 Ratio of expenses to average net assets 0.55% 0.55% 0.55% 0.55% 0.55% Ratio of net investment income to average net assets 3.47% 3.39% 3.45% 3.63% 3.86% Portfolio turnover rate(3) 25.1% 13.7% 4.2% 17.7% 32.6%
(1) Calculated using average shares outstanding during the period. (2) Amount is less than $0.01. (3) Portfolio turnover is calculated on the basis of the Fund as a whole without distinguishing between the classes of shares issued. The accompanying notes are an integral part of these financial statements. BAIRD FUNDS, INC. FINANCIAL HIGHLIGHTS BAIRD CORE PLUS BOND FUND - INSTITUTIONAL CLASS ----------------------------------------------------------------------- Year Ended December 31, 2006 2005 2004 2003 2002 ------ ------ ------ ------ ------ Per Share Data: Net asset value, beginning of period $10.06 $10.38 $10.45 $10.45 $10.42 ------ ------ ------ ------ ------ Income from investment operations: Net investment income 0.55(1) 0.51(1) 0.54 0.56 0.62 Net realized and unrealized gains (losses) on investments 0.09 (0.28) 0.10 0.36 0.07 ------ ------ ------ ------ ------ Total from investment operations 0.64 0.23 0.64 0.92 0.69 ------ ------ ------ ------ ------ Less distributions: Dividends from net investment income (0.54) (0.54) (0.53) (0.56) (0.62) Distributions from net realized gains -- (0.01) (0.18) (0.36) (0.04) ------ ------ ------ ------ ------ Total distributions (0.54) (0.55) (0.71) (0.92) (0.66) ------ ------ ------ ------ ------ Net asset value, end of period $10.16 $10.06 $10.38 $10.45 $10.45 ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ Total return 6.58% 2.23% 6.29% 8.94% 6.90% Supplemental data and ratios: Net assets, end of period $51,551,017 $32,173,459 $32,495,641 $42,709,634 $54,221,923 Ratio of expenses to average net assets 0.30% 0.30% 0.30% 0.30% 0.30% Ratio of net investment income to average net assets 5.49% 4.92% 4.85% 4.56% 6.03% Portfolio turnover rate(2) 62.0% 37.6% 52.5% 103.1% 66.8%
(1) Calculated using average shares outstanding during the period. (2) Portfolio turnover is calculated on the basis of the Fund as a whole without distinguishing between the classes of shares issued. The accompanying notes are an integral part of these financial statements. BAIRD FUNDS, INC. FINANCIAL HIGHLIGHTS BAIRD CORE PLUS BOND FUND - INVESTOR CLASS ----------------------------------------------------------------------- Year Ended December 31, 2006 2005 2004 2003 2002 ------ ------ ------ ------ ------ Per Share Data: Net asset value, beginning of period $10.30 $10.62 $10.67 $10.65 $10.49 ------ ------ ------ ------ ------ Income from investment operations: Net investment income 0.54(1) 0.49(1) 0.53 0.53(1) 0.60(1) Net realized and unrealized gains (losses) on investments 0.09 (0.29) 0.10 0.37 0.07 ------ ------ ------ ------ ------ Total from investment operations 0.63 0.20 0.63 0.90 0.67 ------ ------ ------ ------ ------ Less distributions: Dividends from net investment income (0.51) (0.51) (0.50) (0.52) (0.47) Distributions from net realized gains -- (0.01) (0.18) (0.36) (0.04) ------ ------ ------ ------ ------ Total distributions (0.51) (0.52) (0.68) (0.88) (0.51) ------ ------ ------ ------ ------ Net asset value, end of period $10.42 $10.30 $10.62 $10.67 $10.65 ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ Total return 6.34% 1.93% 6.09% 8.60% 6.58% Supplemental data and ratios: Net assets, end of period $288,928 $449,709 $125,847 $124,481 $296,026 Ratio of expenses to average net assets 0.55% 0.55% 0.55% 0.55% 0.55% Ratio of net investment income to average net assets 5.24% 4.67% 4.60% 4.31% 5.78% Portfolio turnover rate(2) 62.0% 37.6% 52.5% 103.1% 66.8%
(1) Calculated using average shares outstanding during the period. (2) Portfolio turnover is calculated on the basis of the Fund as a whole without distinguishing between the classes of shares issued. The accompanying notes are an integral part of these financial statements. BAIRD FUNDS, INC. FINANCIAL HIGHLIGHTS BAIRD SHORT-TERM BOND FUND - INSTITUTIONAL CLASS --------------------------------------------------------- August 31, 2004(1) Year Ended December 31, through 2006 2005 December 31, 2004 ------ ------ ----------------------- Per Share Data: Net asset value, beginning of period $9.79 $9.93 $10.00 ----- ----- ------ Income from investment operations: Net investment income 0.43 0.33 0.08 Net realized and unrealized losses on investments 0.02 (0.15) (0.07) ----- ----- ------ Total from investment operations 0.45 0.18 0.01 ----- ----- ------ Less distributions: Dividends from net investment income (0.43) (0.32) (0.08) ----- ----- ------ Net asset value, end of period $9.81 $9.79 $9.93 ----- ----- ------ ----- ----- ------ Total return 4.65% 1.85% 0.10%(2) Supplemental data and ratios: Net assets, end of period $148,604,711 $97,057,968 $31,973,000 Ratio of expenses to average net assets 0.30% 0.30% 0.30%(3) Ratio of net investment income to average net assets 4.48% 3.52% 2.60%(3) Portfolio turnover rate 41.1% 31.8% 16.7%(2)
(1) Commencement of operations. (2) Not annualized. (3) Annualized. The accompanying notes are an integral part of these financial statements. BAIRD FUNDS, INC. NOTES TO THE FINANCIAL STATEMENTS DECEMBER 31, 2006 1. ORGANIZATION Baird Funds, Inc. (the "Corporation") was incorporated on June 9, 2000 as a Wisconsin corporation and is registered as an open-end investment management company under the Investment Company Act of 1940, as amended (the "1940 Act"). The accompanying financial statements include the Baird Intermediate Bond Fund, Baird Aggregate Bond Fund, Baird Intermediate Municipal Bond Fund, Baird Core Plus Bond Fund and Baird Short-Term Bond Fund (each, a "Fund" and collectively, the "Funds"), five of the eight portfolios comprising the Corporation, each of which is diversified within the meaning of the 1940 Act. Robert W. Baird & Co. Incorporated ("Baird" or the "Advisor") serves as investment advisor to the Funds. The Baird Intermediate Bond Fund, Baird Aggregate Bond Fund and Baird Core Plus Bond Fund commenced operations with the sale of both Institutional and Investor class shares on September 29, 2000. The Baird Intermediate Municipal Bond Fund commenced operations with the sale of both Institutional and Investor class shares on March 30, 2001. The Baird Short-Term Bond Fund commenced operations with the sale of Institutional Class Shares on August 31, 2004. The Institutional Class Shares are not subject to a distribution and service (12b-1) fee, while the Investor Class Shares are subject to a distribution and service (12b-1) fee up to 0.25%. The investment objective of the Baird Intermediate Bond Fund is to provide an annual rate of total return, before Fund expenses, greater than the annual rate of total return of the Lehman Brothers Intermediate Government/Credit Bond Index. The Lehman Brothers Intermediate Government/Credit Bond Index is an unmanaged, market value weighted index of investment grade, fixed-rate debt, including government and corporate securities, with maturities between one and ten years. The investment objective of the Baird Aggregate Bond Fund is to provide an annual rate of total return, before Fund expenses, greater than the annual rate of total return of the Lehman Brothers Aggregate Bond Index. The Lehman Brothers Aggregate Bond Index is an unmanaged, market value weighted index of investment grade, fixed-rate debt issues, including government, corporate, asset-backed, and mortgage-backed securities, with maturities of at least one year. The primary investment objective of the Baird Intermediate Municipal Bond Fund is to provide current income that is substantially exempt from federal income tax. A secondary objective is to provide total return with relatively low volatility of principal. The investment objective of the Baird Core Plus Bond Fund is to provide an annual rate of total return, before Fund expenses, greater than the annual rate of total return of the Lehman Brothers U.S. Universal Bond Index. The Lehman Brothers U.S. Universal Bond Index is an unmanaged, market value weighted index of fixed income securities issued in U.S. dollars, including U.S. government and investment grade debt, non-investment grade debt, asset-backed and mortgage- backed securities, Eurobonds, 144A securities and emerging market debt, with maturities of at least one year. The investment objective of the Baird Short-Term Bond Fund is to provide an annual rate of total return, before Fund expenses, greater than the annual rate of total return of the Lehman Brothers 1-3 Year Government/Credit Bond Index. The Lehman Brothers 1-3 Year Government/Credit Bond Index is an unmanaged, market value weighted index of investment grade, fixed-rate debt including government and corporate securities with maturities between one and three years. 2. SIGNIFICANT ACCOUNTING POLICIES The following is a summary of significant accounting policies consistently followed by the Funds in the preparation of their financial statements. These policies are in conformity with accounting principles generally accepted in the United States of America. a) Investment Valuation - Because market quotations for most debt securities are not readily available, debt securities are stated at fair value as furnished by an independent pricing service, which uses valuation methods such as matrix pricing and other analytical pricing models, as well as on market transactions and dealer quotations. Debt securities purchased with a remaining maturity of 60 days or less are valued at acquisition cost, plus or minus any amortized discount or premium. Investments in mutual funds are valued at their stated net asset value. Common stocks that are listed on a securities exchange (other than NASDAQ) are valued at the last quoted sales price. Securities traded on NASDAQ are valued at the NASDAQ Official Closing Price. Price information on listed stocks is taken from the exchange where the security is primarily traded. Securities that were not traded on the valuation date, as well as stocks that are not listed on an exchange, including NASDAQ, are valued at the average of the current bid and asked price. Other assets and securities for which no quotations are readily available are valued at fair value as determined in good faith by the Advisor in accordance with procedures approved by the Corporation's Board of Directors. In accordance with such procedures, the Advisor may use broker quotes or, if the broker quotes are unavailable or deemed to be unreliable, fair value will be determined by a valuation committee of the Advisor. In determining fair value, the valuation committee takes into account all relevant factors and available information. Consequently, the price of the security used by a Fund to calculate its NAV may differ from quoted or published prices for the same security. Fair value pricing involves subjective judgments and there is no single standard for determining a security's fair value. As a result, different mutual funds could reasonably arrive at a different fair value for the same security. It is possible that the fair value determined for a security is materially different from the value that could be realized upon the sale of that security or from the values that other mutual funds may determine. In September 2006, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards ("SFAS") No. 157, "Fair Value Measurements". SFAS No. 157 defines fair value, establishes a framework for measuring fair value in accordance with GAAP, and expands disclosure about fair value measurements. SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007. Management is currently evaluating the impact of adoption of SFAS No. 157 on its financial statements. b) Unregistered Securities - Four of the Funds own certain investment securities which are unregistered and thus restricted with respect to resale. These securities are valued by the Advisor after giving due consideration to pertinent factors including recent private sales, market conditions and the issuer's financial performance. The value of such securities for the Baird Intermediate Bond, Baird Aggregate Bond, Baird Core Plus Bond and Baird Short-Term Bond Funds were $18,316,333 (5.58% of net assets), $12,038,318 (3.57% of net assets), $2,221,848 (4.29% of net assets) and $6,348,957 (4.27% of net assets), respectively, at December 31, 2006. Restricted securities may be deemed to be liquid as determined by the Advisor based on several factors. These securities consist of securities issued pursuant to Rule 144A under the Securities Act of 1933. c) Foreign Securities - The Funds may invest in U.S. dollar-denominated debt obligations of foreign companies and foreign governments. Investing in securities of foreign companies and foreign governments involves special risks and considerations not typically associated with investing in U.S. companies and the U.S. government. These risks include currency rate fluctuations, political and economic instability and differences in financial reporting standards and less strict regulation of securities markets. Moreover, securities of many foreign companies and foreign governments and their markets may be less liquid and their prices more volatile than those of securities of comparable U.S. companies and the U.S. government. Occasionally, events that affect these values and exchange rates may occur after the close of the exchange on which such securities are traded. If such events materially affect the value of a Fund's securities, these securities may be valued at their fair value pursuant to procedures adopted by the Board of Directors. d) Federal Income Taxes - The Funds intend to continue to qualify as regulated investment companies as provided in subchapter M of the Internal Revenue Code and to distribute substantially all of their taxable income to their shareholders in a manner which results in no tax cost to the Funds. Therefore, no federal income or excise tax provision is recorded. On July 13, 2006, the Financial Accounting Standards Board ("FASB") released FASB Interpretation No. 48 "Accounting for Uncertainty in Income Taxes" ("FIN 48"). FIN 48 provides guidance for how uncertain tax positions should be recognized, measured, presented and disclosed in the financial statements. FIN 48 requires the evaluation of tax positions taken or expected to be taken in the course of preparing the Funds' tax returns to determine whether the tax positions are "more likely than not" of being sustained by the applicable tax authority. A tax position that meets the more-likely-than-not threshold is measured to determine the amount of benefit or expense to recognize in the financial statements. Adoption of FIN 48 is required as of the date of the last NAV calculation in the first required financial statement reporting period for fiscal years beginning after December 15, 2006 and is to be applied to all open tax years as of the effective date. At this time, management is evaluating the implications of FIN 48 and whether it will have any impact on the Funds' financial statements. e) Allocation of Income and Expenses - Each Fund is charged for those expenses directly attributable to it. Expenses directly attributable to a class of shares, such as Rule 12b-1 distribution fees, are charged to that class of shares. Income, expenses and realized and unrealized gains and losses are allocated to the classes based on their respective net assets. Expenses that are not directly attributable to a Fund are allocated among the Funds in the series in proportion to their assets. f) Distributions to Shareholders - Dividends from net investment income are declared and paid monthly. Distributions of net realized capital gains, if any, are declared and paid at least annually. g) Use of Estimates - The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. h) Other - Investment and shareholder transactions are recorded on trade date. The Funds determine the gain or loss realized from investment transactions by comparing the original cost of the security lot sold with the net sales proceeds. Dividend income is recognized on the ex-dividend date and interest income is recognized on an accrual basis. Premiums and discounts on the purchase of securities are amortized/accreted using the effective interest method. Accounting principles generally accepted in the United States of America require that permanent financial reporting and tax differences be reclassified in the capital accounts. i) Guarantees and Indemnifications - In the normal course of business, the Funds enter into contracts with service providers that contain general indemnification clauses. The Funds' maximum exposure under these arrangements is unknown and would involve future claims against the Funds that have not yet occurred. Based on experience, the Funds would expect the risk of loss to be remote. 3. CAPITAL SHARE TRANSACTIONS The following table summarizes the capital share transactions of each Fund for the past two fiscal periods: BAIRD INTERMEDIATE BOND FUND Year Ended Year Ended December 31, 2006 December 31, 2006 -------------------------- ------------------------ INSTITUTIONAL CLASS SHARES Amount Shares INVESTOR CLASS SHARES Amount Shares -------- -------- -------- -------- Shares sold $111,623,242 10,666,486 Shares sold $ 81,500 7,531 Shares issued through Shares issued through reinvestment of dividends 11,873,363 1,136,626 reinvestment of dividends 59,100 5,495 Shares redeemed (28,370,722) (2,710,776) Shares redeemed (1,744,715) (162,273) ------------ ---------- ----------- -------- Net Increase $ 95,125,883 9,092,336 Net Decrease $(1,604,115) (149,247) ------------ ----------- ------------ ----------- Shares Outstanding: Shares Outstanding: Beginning of period 21,970,265 Beginning of period 260,531 ---------- -------- End of period 31,062,601 End of period 111,284 ---------- -------- ---------- --------
Year Ended Year Ended December 31, 2005 December 31, 2005 -------------------------- ------------------------ INSTITUTIONAL CLASS SHARES Amount Shares INVESTOR CLASS SHARES Amount Shares -------- -------- -------- -------- Shares sold $ 71,323,424 6,670,157 Shares sold $ 327,577 29,867 Shares issued through Shares issued through reinvestment of dividends 8,583,507 804,972 reinvestment of dividends 97,080 8,844 Shares redeemed (34,120,091) (3,198,827) Shares redeemed (534,264) (48,785) ------------ ---------- ----------- -------- Net Increase $ 45,786,840 4,276,302 Net Decrease $ (109,607) (10,074) ------------ ----------- ------------ ----------- Shares Outstanding: Shares Outstanding: Beginning of period 17,693,963 Beginning of period 270,605 ---------- -------- End of period 21,970,265 End of period 260,531 ---------- -------- ---------- --------
BAIRD AGGREGATE BOND FUND Year Ended Year Ended December 31, 2006 December 31, 2006 -------------------------- ------------------------ INSTITUTIONAL CLASS SHARES Amount Shares INVESTOR CLASS SHARES Amount Shares -------- -------- -------- -------- Shares sold $154,503,654 14,798,845 Shares sold $ 983,015 91,604 Shares issued through Shares issued through reinvestment of dividends 11,883,604 1,141,334 reinvestment of dividends 55,410 5,207 Shares redeemed (58,350,968) (5,615,794) Shares redeemed (471,602) (44,506) ------------ ---------- --------- ------- Net Increase $108,036,290 10,324,385 Net Increase $ 566,823 52,305 ------------ --------- ------------ --------- Shares Outstanding: Shares Outstanding: Beginning of period 21,554,417 Beginning of period 119,948 ---------- ------- End of period 31,878,802 End of period 172,253 ---------- ------- ---------- -------
Year Ended Year Ended December 31, 2005 December 31, 2005 -------------------------- ------------------------ INSTITUTIONAL CLASS SHARES Amount Shares INVESTOR CLASS SHARES Amount Shares -------- -------- -------- -------- Shares sold $119,199,176 11,216,865 Shares sold $ 787,288 72,544 Shares issued through Shares issued through reinvestment of dividends 6,483,075 609,270 reinvestment of dividends 37,104 3,418 Shares redeemed (10,800,456) (1,013,347) Shares redeemed (228,296) (20,735) ------------ ---------- --------- ------- Net Increase $114,881,795 10,812,788 Net Increase $ 596,096 55,227 ------------ --------- ------------ --------- Shares Outstanding: Shares Outstanding: Beginning of period 10,741,629 Beginning of period 64,721 ---------- ------- End of period 21,554,417 End of period 119,948 ---------- ------- ---------- -------
BAIRD INTERMEDIATE MUNICIPAL BOND FUND Year Ended Year Ended December 31, 2006 December 31, 2006 -------------------------- ------------------------ INSTITUTIONAL CLASS SHARES Amount Shares INVESTOR CLASS SHARES Amount Shares -------- -------- -------- -------- Shares sold $ 36,579,100 3,475,609 Shares sold $93,068 8,603 Shares issued through Shares issued through reinvestment of dividends 2,016,861 191,986 reinvestment of dividends 25,191 2,354 Shares redeemed (27,462,382) (2,611,483) Shares redeemed (1,062,648) (98,994) ------------ ---------- ---------- ------- Net Increase $ 11,133,579 1,056,112 Net Decrease $(944,389) (88,037) ------------ ---------- ------------ ---------- Shares Outstanding: Shares Outstanding: Beginning of period 5,095,975 Beginning of period 138,700 ---------- ------- End of period 6,152,087 End of period 50,663 ---------- ------- ---------- -------
Year Ended Year Ended December 31, 2005 December 31, 2005 -------------------------- ------------------------ INSTITUTIONAL CLASS SHARES Amount Shares INVESTOR CLASS SHARES Amount Shares -------- -------- -------- -------- Shares sold $ 28,720,646 2,699,678 Shares sold $ 1,140,700 104,296 Shares issued through Shares issued through reinvestment of dividends 1,391,125 130,582 reinvestment of dividends 49,411 4,548 Shares redeemed (12,175,572) (1,147,777) Shares redeemed (4,231,391) (389,626) ------------ ---------- ----------- -------- Net Increase $ 17,936,199 1,682,483 Net Decrease $(3,041,280) (280,782) ------------ ----------- ------------ ----------- Shares Outstanding: Shares Outstanding: Beginning of period 3,413,492 Beginning of period 419,482 ---------- -------- End of period 5,095,975 End of period 138,700 ---------- -------- ---------- --------
BAIRD CORE PLUS BOND FUND Year Ended Year Ended December 31, 2006 December 31, 2006 -------------------------- ------------------------ INSTITUTIONAL CLASS SHARES Amount Shares INVESTOR CLASS SHARES Amount Shares -------- -------- -------- -------- Shares sold $ 35,649,048 3,548,621 Shares sold $ 82,802 8,089 Shares issued through Shares issued through reinvestment of dividends 1,416,531 141,751 reinvestment of dividends 13,305 1,301 Shares redeemed (18,051,110) (1,814,933) Shares redeemed (260,389) (25,330) Other capital Other capital contributions(1) 71 -- contributions(1) 0(2) -- ------------ ---------- ---------- ------- Net Increase $ 19,014,540 1,875,439 Net Decrease $(164,282) (15,940) ------------ --------- ------------ --------- Shares Outstanding: Shares Outstanding: Beginning of period 3,199,736 Beginning of period 43,664 ---------- ------- End of period 5,075,175 End of period 27,724 ---------- ------- ---------- -------
Year Ended Year Ended December 31, 2005 December 31, 2005 -------------------------- ------------------------ INSTITUTIONAL CLASS SHARES Amount Shares INVESTOR CLASS SHARES Amount Shares -------- -------- -------- -------- Shares sold $ 3,826,490 370,555 Shares sold $ 388,900 36,683 Shares issued through Shares issued through reinvestment of dividends 923,131 90,264 reinvestment of dividends 13,342 1,281 Shares redeemed (4,036,994) (391,795) Shares redeemed (63,734) (6,148) ------------ ---------- --------- ------- Net Increase $ 712,627 69,024 Net Increase $ 338,508 31,816 ------------ --------- ------------ --------- Shares Outstanding: Shares Outstanding: Beginning of period 3,130,712 Beginning of period 11,848 ---------- ------- End of period 3,199,736 End of period 43,664 ---------- ------- ---------- -------
(1) Reimbursement for NAV Break. (2) Amount is less than $1. BAIRD SHORT-TERM BOND FUND Year Ended Year Ended December 31, 2006 December 31, 2005 -------------------------- ------------------------ INSTITUTIONAL CLASS SHARES Amount Shares INSTITUTIONAL CLASS SHARES Amount Shares -------- -------- -------- -------- Shares sold $ 79,434,155 8,124,186 Shares sold $81,066,185 8,221,158 Shares issued through Shares issued through reinvestment of dividends 5,464,609 559,203 reinvestment of dividends 2,142,819 217,900 Shares redeemed (33,715,361) (3,449,049) Shares redeemed (17,200,778) (1,746,644) ------------ ---------- ----------- ---------- Net Increase $ 51,183,403 5,234,340 Net Increase $66,008,226 6,692,414 ------------ ----------- ------------ ----------- Shares Outstanding: Shares Outstanding: Beginning of period 9,912,823 Beginning of period 3,220,409 ---------- ---------- End of period 15,147,163 End of period 9,912,823 ---------- ---------- ---------- ----------
4. INVESTMENT TRANSACTIONS AND INCOME TAX INFORMATION During the year ended December 31, 2006, purchases and sales of investment securities (excluding short-term investments) were as follows: Baird Baird Baird Intermediate Baird Baird Intermediate Aggregate Municipal Core Plus Short-Term Bond Fund Bond Fund Bond Fund Bond Fund Bond Fund ------------ --------- ------------ --------- ---------- Purchases: U.S. Government $ 87,000,294 $ 74,680,835 $ -- $15,625,591 $38,723,534 Other $116,557,214 $158,433,057 $27,938,064 $21,647,888 $54,242,291 Sales: U.S. Government $ 53,314,823 $ 86,202,753 $ -- $ 9,451,326 $27,452,764 Other $ 65,062,154 $ 44,046,798 $16,156,518 $ 9,859,979 $19,692,610
At December 31, 2006, gross unrealized appreciation and depreciation of investments and distributable ordinary income and long-term capital gains for federal tax purposes were as follows: INTERMEDIATE INTERMEDIATE AGGREGATE MUNICIPAL CORE PLUS SHORT-TERM BOND FUND BOND FUND BOND FUND BOND FUND BOND FUND ------------ --------- ------------ --------- ---------- Cost of Investments $352,890,822 $355,290,950 $64,184,619 $55,485,672 $162,277,229 ------------ ------------ ----------- ----------- ------------ ------------ ------------ ----------- ----------- ------------ Gross unrealized appreciation $ 2,414,197 $ 3,195,824 $ 612,696 $ 733,192 $ 282,887 Gross unrealized depreciation (3,173,709) (3,304,445) (495,225) (614,191) (769,628) ------------ ------------ ----------- ----------- ------------ Net unrealized appreciation/depreciation $ (759,512) $ (108,621) $ 117,471 $ 119,001 $ (486,741) ------------ ------------ ----------- ----------- ------------ ------------ ------------ ----------- ----------- ------------ Undistributed ordinary income $ 207,297 $ 177,153 $ 9,471 $ 33,503 $ 78,385 Undistributed long-term capital gain -- -- -- -- -- ------------ ------------ ----------- ----------- ------------ Total distributable earnings $ 207,297 $ 177,153 $ 9,471 $ 33,503 $ 78,385 ------------ ------------ ----------- ----------- ------------ ------------ ------------ ----------- ----------- ------------ Other accumulated gains (losses) $ (3,136,565) $ (1,020,356) $ (336,718) $ (111,190) $ (356,847) ------------ ------------ ----------- ----------- ------------ Total accumulated earnings (losses) $ (3,688,780) $ (951,824) $ (209,776) $ 41,314 $ (765,203) ------------ ------------ ----------- ----------- ------------ ------------ ------------ ----------- ----------- ------------
On the Statements of Asset and Liabilities, the following adjustments were made for permanent tax adjustments: UNDISTRIBUTED NET ACCUMULATED NET PAID IN INVESTMENT INCOME (LOSS) REALIZED GAIN (LOSS) CAPITAL ------------------------ -------------------- ------- Baird Intermediate Bond Fund $78,450 $(78,450) -- Baird Aggregate Bond Fund $65,084 $(65,084) -- Baird Intermediate Municipal Bond Fund -- $(38,217) $38,217 Baird Core Plus Bond Fund $17,189 $(17,189) -- Baird Short-Term Bond Fund $(54,150) $54,150 --
The permanent differences primarily relate to reclasses from paydown gains and losses from asset backed securities. The tax components of dividends paid during the periods ended December 31, 2006 and December 31, 2005 were: 2006 2005 --------------------------------- --------------------------------- ORDINARY LONG-TERM ORDINARY LONG-TERM INCOME CAPITAL GAINS INCOME CAPITAL GAINS DISTRIBUTIONS DISTRIBUTIONS DISTRIBUTIONS DISTRIBUTIONS ------------- ------------- ------------- ------------- Baird Intermediate Bond Fund $13,585,132 $ -- $9,582,892 $ -- Baird Aggregate Bond Fund $13,167,714 $ 121,173 $7,047,543 $ 150,599 Baird Intermediate Municipal Bond Fund $ -- $ -- $ -- $ -- Baird Core Plus Bond Fund $ 1,742,409 $ -- $1,707,672 $ 21,671 Baird Short-Term Bond Fund $ 5,563,493 $ -- $2,308,315 $ --
For the periods ended December 31, 2006 and December 31, 2005, distributions of $2,571,346 and $1,742,374, respectively, from the Baird Intermediate Municipal Bond Fund were tax-exempt. Under the current tax law, capital losses realized after October 31 may be deferred and treated as occurring on the first day of the following fiscal year. For the year ended December 31, 2006, the Baird Intermediate Bond, Baird Aggregate Bond Fund, Baird Intermediate Municipal Bond, Baird Core Plus Bond Fund and Baird Short-Term Bond Funds elected to defer capital losses occurring between November 1, 2006 and December 31, 2006 in the amount of $6,343, $73,662, $94,149, $72,252 and $40,321, respectively. At December 31, 2006, the Baird Intermediate Bond, Baird Aggregate Bond, Baird Intermediate Municipal Bond, Baird Core Plus Bond and Baird Short-Term Bond Funds had accumulated net realized capital loss carryovers of $3,130,445, $945,859, $242,569, $38,938 and $316,526, respectively. With respect to Baird Intermediate Bond Fund, $485,569 of the capital loss carryovers expire in 2012, $938,114 expire in 2013 and $1,706,762 expire in 2014. With respect to Baird Aggregate Bond Fund, $945,859 of the capital loss carryovers expire in 2014. With respect to Baird Intermediate Municipal Bond Fund, $6,626 of the capital loss carryovers expire in 2012, $184,660 expire in 2013 and $51,283 expire in 2014. With respect to Baird Core Plus Fund, $5,975 of the capital loss carryovers expire in 2013 and $32,963 expire in 2014. With respect to Baird Short-Term Bond Fund, $8,150 of the capital loss carryovers expire in 2012, $59,190 expire in 2013 and $249,186 expire in 2014. To the extent these Funds realize future net capital gains, those gains will be offset by any unused capital loss carryovers. 5. INVESTMENT ADVISORY AND OTHER AGREEMENTS The Funds have entered into an Investment Advisory Agreement with Baird for the provision of investment advisory services. Pursuant to the Investment Advisory Agreement, the Advisor is entitled to receive a fee, calculated daily and payable monthly, at the annual rate of 0.25% for the Baird Intermediate Bond Fund, Baird Aggregate Bond Fund, Baird Intermediate Municipal Bond Fund, Baird Core Plus Bond Fund and Baird Short-Term Bond Fund as applied to the respective Fund's average daily net assets. Certain officers of the Advisor are also officers of the Funds. The Funds have entered into an Administration Agreement with Baird. Under the Administration Agreement, the Advisor assumes and pays all expenses of the applicable Fund other than the investment advisory fees and fees under the 12b-1 plan. Pursuant to the Administration Agreement, the Advisor is entitled to receive a fee, calculated daily and payable monthly, at the annual rate of 0.05% for the Baird Intermediate Bond Fund, Baird Aggregate Bond Fund, Baird Intermediate Municipal Bond Fund, Baird Core Plus Bond Fund and Baird Short-Term Bond Fund as applied to the respective Fund's average daily net assets. U.S. Bancorp Fund Services, LLC serves as transfer agent, administrator, and accounting services agent for the Funds. U.S. Bank, N.A. serves as custodian for the Funds. Baird (the "Distributor") is the distributor of the Funds pursuant to a distribution agreement. 6. SECURITIES LENDING Each Fund may lend up to one-third of its total assets (including such loans) to borrowers under terms of participation in a securities lending program administered by U.S. Bancorp Asset Management, an affiliate of the Funds' custodian, transfer agent and administrator. The securities lending agreement requires that loans are collateralized at all times in an amount equal to at least 102% of the market value of any loaned securities at the time of the loan, plus accrued interest. The Funds receive compensation in the form of fees and earn interest on the cash collateral. The amount of fees depends on a number of factors including the type of security, length of the loan and credit standing of the borrower. Each Fund continues to receive interest payments or dividends on the securities loaned during the borrowing period. Each Fund has the right under the terms of the securities lending agreement to recover the securities from the borrower on demand. As of December 31, 2006, the Baird Intermediate Bond Fund, Baird Aggregate Bond Fund, Baird Core Plus Bond Fund and Baird Short-Term Bond Fund had loaned securities that were collateralized by cash equivalents. The cash collateral is invested by the custodian with the approval of the Advisor. Although the cash collateral is generally invested in readily marketable, high quality, short-term obligations, such investments are subject to risk of payment delays or default on the part of the issuer or counterparty or otherwise may not generate sufficient interest to support the costs associated with securities lending. A Fund could also experience delays in recovering its securities and possible loss of income or value if the borrower fails to return the borrowed securities, although this risk is mitigated by the collateral and by contract with the securities lending agent. As of December 31, 2006, the market value of the securities on loan and payable on collateral due to broker were as follows: MARKET VALUE OF PAYABLE ON COLLATERAL SECURITIES ON LOAN DUE TO BROKER ------------------ --------------------- Baird Intermediate Bond Fund $84,842,993 $87,414,866 Baird Aggregate Bond Fund 43,828,777 45,053,190 Baird Core Plus Bond Fund 10,746,184 11,037,325 Baird Short-Term Bond Fund 41,834,076 42,992,134 Individual reinvested cash collateral jointly pooled with collateral received by other Baird Funds as of December 31, 2006 is as follows: INTERMEDIATE AGGREGATE CORE PLUS SHORT-TERM OTHER BOND FUND BOND FUND BOND FUND BOND FUND BAIRD FUNDS TOTAL ------------ --------- --------- ---------- ----------- ----- Morgan Stanley Repurchase Agreement(1) $32,012,274 $16,498,967 $ 4,041,987 $15,744,187 $17,702,585 $ 86,000,000 Lehman Brothers Repurchase Agreement(2) 14,889,430 7,673,938 1,879,993 7,322,878 8,233,761 40,000,000 CS First Boston Repurchase Agreement(3) 4,466,829 2,302,181 563,999 2,196,863 2,470,128 12,000,000 Rams Funding LLC Discount Commercial Paper 4,466,829 2,302,181 563,999 2,196,863 2,470,128 12,000,000 CS First Boston Repurchase Agreement(4) 4,094,593 2,110,333 516,999 2,013,791 2,264,284 11,000,000 Thornburg Mortgage Capital Discount Commercial Paper 4,094,593 2,110,333 516,998 2,013,791 2,264,285 11,000,000 Antalis Fund 3,722,357 1,918,485 469,999 1,830,719 2,058,440 10,000,000 CS First Boston Repurchase Agreement(5) 3,722,357 1,918,485 470,000 1,830,719 2,058,439 10,000,000 Jupiter Sect. 3,722,357 1,918,485 470,000 1,830,718 2,058,440 10,000,000 Lakeside Funding LLC Interest Bearing Commercial Paper 3,722,357 1,918,485 469,999 1,830,719 2,058,440 10,000,000 Concord Minutemen Capital Company Interest Bearing Commercial Paper 2,605,650 1,342,939 328,998 1,281,504 1,440,909 7,000,000 Stratford 2,233,414 1,151,091 281,999 1,098,432 1,235,064 6,000,000 Leguna Interest Bearing Commercial Paper 1,861,179 959,242 234,999 915,360 1,029,220 5,000,000 Concord Minutemen Capital Company Interest Bearing Commercial Paper 1,488,943 767,394 187,999 732,288 823,376 4,000,000 Federated Prime Obligations Fund 311,694 160,646 39,356 153,297 172,366 837,359 Merrill Lynch Premier Institutional Fund 10 5 1 5 6 27 ----------- ----------- ----------- ----------- ----------- ------------ $87,414,866 $45,053,190 $11,037,325 $42,992,134 $48,339,871 $234,837,386 ----------- ----------- ----------- ----------- ----------- ------------ ----------- ----------- ----------- ----------- ----------- ------------
(1) (Dated 12/29/06), 5.40%, Due 01/02/07 (Repurchase Proceeds $86,038,700), (Collateralized by Mortgage Backed Securities) (2) (Dated 12/29/06), 5.3925%, Due 01/02/07 (Repurchase Proceeds $40,023,967), (Collateralized by Corporate Bonds) (3) (Dated 12/29/06), 5.325%, Due 01/02/07 (Repurchase Proceeds $12,007,093), (Collateralized by Mortgage Backed Securities) (4) (Dated 12/29/06), 5.32%, Due 01/02/07 (Repurchase Proceeds $11,006,502), (Collateralized by Agency Mortgage Backed Securities) (5) (Dated 12/29/06), 5.3625%, Due 01/02/07 (Repurchase Proceeds $10,005,958), (Collateralized by Mortgage Backed Securities) 7. LINE OF CREDIT On May 24, 2006, Baird Funds, Inc. entered into an uncommitted, senior secured line of credit ("LOC") with U.S. Bank, N.A. to provide the Funds a temporary liquidity source to meet unanticipated redemptions. Under the terms of the LOC, borrowings for each Fund are limited to one-third of the total assets (including the amount borrowed) of the respective Fund, or as otherwise indicated within the Funds' agreement with the Bank. The Bank charges interest at the Bank's Prime Rate less 1%. During the period May 24, 2006 through December 31, 2006, the Baird Bond Funds did not draw upon the line of credit. 8. DISTRIBUTION AND SHAREHOLDER SERVICE PLAN The Funds have adopted a distribution and shareholder service plan (the "Plan") pursuant to Rule 12b-1 under the 1940 Act. The Plan allows the Funds to compensate the Distributor for the costs incurred in distributing the Funds' Investor Class Shares, including amounts paid to brokers or dealers, at an annual rate not to exceed 0.25% of the average daily net assets of the Funds' Investor Class Shares. The Baird Intermediate Bond, Baird Aggregate Bond, Baird Intermediate Municipal Bond and Baird Core Plus Bond Funds incurred $4,508, $3,239, $2,685 and $790, respectively, in fees pursuant to the Plan during the year ending December 31, 2006. REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM The Board of Directors and Shareholders Baird Funds, Inc: We have audited the accompanying statements of assets and liabilities of Baird Intermediate Bond Fund, Baird Aggregate Bond Fund, Baird Intermediate Municipal Bond Fund, Baird Core Plus Bond Fund and Baird Short-Term Bond Fund (five of the portfolios constituting Baird Funds, Inc., hereafter referred to as the "Funds"), including the schedules of investments as of December 31, 2006, and the related statements of operations for the year then ended, the statements of changes in net assets, and the financial highlights for each of the two years in the period then ended. These financial statements and financial highlights are the responsibility of the Funds' management. Our responsibility is to express an opinion on these financial statements and financial highlights based on our audits. The financial highlights for each of the three years in the period ended December 31, 2004 were audited by other auditors. Those auditors expressed an unqualified opinion on those financial highlights in their report dated February 22, 2005. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Funds were not required to have, nor were we engaged to perform an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Funds' internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements and financial highlights. Our procedures included confirmation of securities owned as of December 31, 2006, by correspondence with the custodian and brokers or by other appropriate auditing procedures where replies from brokers were not received. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements and financial highlights referred to above present fairly, in all material respects, the financial position of each of the aforementioned funds of Baird Funds, Inc. as of December 31, 2006, the results of their operations for the year then ended, and the changes in their net assets, and the financial highlights for each of the two years in the period then ended, in conformity with accounting principles generally accepted in the United States of America. /s/ Grant Thornton LLP Chicago, Illinois February 19, 2007 BAIRD FUNDS, INC. DIRECTORS & OFFICERS AS OF DECEMBER 31, 2006 Number of Portfolios Other Position(s) Term of Office Principal in Complex Directorships Held with and Length of Occupation(s) Overseen Held Name, Address, and Age the Funds Time Served During Past 5 Years by Director by Director ----------------------- ----------- -------------- ------------------- ----------- ------------- G. Frederick Director Indefinite; Retired; Chairman, the Advisor (January 8 Director of Kasten, Jr. * And Since September 2000-December 2005); Chairman & CEO, the Regal-Beloit 777 East Chairman 2000 Advisor (January 1998-January 2000); Corporation, Wisconsin Avenue President, Chairman and CEO, the Advisor a manufacturing Milwaukee, WI 53202 (June 1983-January 1998); President, the company Age: 67 Advisor (January 1979-January 1983) John W. Feldt Independent Indefinite; Retired; Senior Vice President-Finance, 8 Director of University of Director Since September University of Wisconsin Foundation Thompson Wisconsin Foundation 2000 (1985-2006); Vice President-Finance, Plumb Funds, 1848 University Avenue University of Wisconsin Foundation Inc., a mutual Madison, WI 53705 (1980-1985); Associate Director, University fund complex Age: 64 of Wisconsin Foundation (1967-1980) of which Mr. Feldt oversees 2 portfolios; Director of Nakoma Mutual Funds, a mutual fund complex of which Mr. Feldt oversees 1 portfolio George C. Kaiser Independent Indefinite; CEO, George Kaiser & Co., a business 8 None 759 N. Milwaukee Street Director Since September consulting company, since 1999; Chairman Milwaukee, WI 53202 2000 and CEO, Hanger Tight Company, a Age: 73 manufacturing company (1988-1999); Chairman and CEO, Interstore Transfer Systems, Ltd., a manufacturing company (1992-1999); Chairman, International Retail Services Group, Ltd. (1995-1999); Executive Vice President, Arandell Schmidt Co., a catalog printer company (1984-1987); various positions Arthur Andersen & Co. (1957-1964, 1967-1984), most recently serving as Partner (1969-1984); Secretary of Administration, State of Wisconsin (1965-1967) Frederick P. Independent Indefinite; Retired; Chairman Emeritus, Briggs & 8 Director of Stratton, Jr. Director Since May Stratton Corporation, a manufacturing Midwest Air 10134 N. Port Washington 2004 company, since 2003; Chairman of the Board, Group, Inc., an Road, #2B Briggs & Stratton Corporation (2001-2002); airline company; Mequon, WI 53092 Chairman and CEO, Briggs & Stratton Weyco Group, Age: 67 Corporation (1986-2001) Inc., a men's footwear distributor; Wisconsin Energy Corporation and its subsidiaries Wisconsin Electric Power Company and Wisconsin Gas LLC
* Mr. Kasten is an "interested person" of the Corporation (as defined in the 1940 Act) because of his ownership of stock of the Advisor. Number of Portfolios Other Position(s) Term of Office Principal in Complex Directorships Held with and Length of Occupation(s) Overseen Held Name, Address, and Age the Funds Time Served During Past 5 Years by Director by Director ----------------------- ----------- -------------- ------------------- ----------- ------------- Mary Ellen Stanek President Re-elected by Managing Director, the Advisor, and Chief N/A N/A 777 East Board annually; Investment Officer, Baird Advisors, a Wisconsin Avenue Since September department of the Advisor, since March 2000; Milwaukee, WI 53202 2000 President and CEO, Firstar Investment Age: 50 Research & Management Company, LLC ("FIRMCO") (November 1998-February 2000); President, Firstar Funds, Inc. (December 1998-February 2000); President and Chief Operating Officer, FIRMCO (March 1994- November 1998) J. Bary Morgan Senior Vice Re-elected by Chief Investment Officer, Baird N/A N/A 777 East President Board annually; Investment Management, a department Wisconsin Avenue Since February of the Advisor, since January 2004; Managing Milwaukee, WI 53202 2003 Director, the Advisor, since January 2001; Age: 41 Director, Baird Investment Management (January 2001-January 2004); Senior Vice President, the Advisor (January 2000-January 2001); First Vice President, the Advisor (January 1996-January 2000) Todd S. Nichol Vice Re-elected by Chief Compliance Officer, the Advisor N/A N/A 777 East President and Board annually; since October 2004; Assistant Compliance Wisconsin Avenue Chief Since August Director, the Advisor since August 2002; Milwaukee, WI 53202 Compliance 2004 Senior Vice President, the Advisor since Age: 44 Officer January 2005; First Vice President, the Advisor (January 2004-January 2005): Vice President, the Advisor (August 2002-January 2004); Vice President-Risk Management, BNY Clearing Services, LLC, a division of The Bank of New York (August 1995-August 2002) Russell P. Schwei Vice Re-elected by Operations Director, the Advisor since N/A N/A 777 East President Board annually; July 1992; Managing Director, the Wisconsin Avenue Since September Advisor since January 1997; Chief Financial Milwaukee, WI 53202 2000 Officer and Managing Director, the Advisor Age: 47 (February 1999-December 1999). Leonard M. Rush Treasurer Re-elected by Chief Financial Officer, the Advisor N/A N/A 777 East Board annually; since January 2000 Wisconsin Avenue Since September Milwaukee, WI 53202 2000 Age: 60 Charles M. Weber Secretary Re-elected by Senior Vice President and Associate N/A N/A 777 East Board annually; General Counsel, the Advisor since Wisconsin Avenue Since August July 2005; Partner, Quarles & Brady Milwaukee, WI 53202 2005 LLP, a law firm (October 1998-June 2005) Age: 43 Robert A. Johnson AML Officer Re-elected by Compliance Officer, the Advisor since N/A N/A 777 East Board annually; 1998, and AML Compliance Officer, Wisconsin Avenue Since August the Advisor since January 2004 Milwaukee, WI 53202 2004 Age: 43 Bret T. Reese Assistant Re-elected by Vice President and Staff Attorney, the N/A N/A 777 East Secretary Board annually; Advisor since 2005; Senior Financial Wisconsin Avenue Since August Analyst, the Advisor (August 2001-June Milwaukee, WI 53202 2006 2004); Financial Analyst, Stark & Roth, Age: 37 Inc., a hedge fund (June 2001-August 2001)
Additional information about the Funds' directors is available in the Statement of Additional Information which may be obtained without charge, upon request, by calling 1-866-44BAIRD. BAIRD FUNDS, INC. DISCLOSURE REGARDING THE BOARD OF DIRECTORS APPROVAL OF THE INVESTMENT ADVISORY AGREEMENT FOR THE BAIRD BOND FUNDS The Board of Directors (the "Board") of Baird Funds, Inc. (the "Corporation") met on August 1, 2006 to consider the annual renewal of the Investment Advisory Agreement with Robert W. Baird & Co. Incorporated ("Baird" or the "Advisor") for the management of the Baird Intermediate Bond, Aggregate Bond, Intermediate Municipal Bond, Core Plus Bond and Short-Term Bond Funds (the "Funds"). The Board reviewed and discussed numerous documents that had been provided prior to the meeting, including the Investment Advisory Agreement, memoranda prepared by outside legal counsel and the Secretary of the Funds discussing in detail the Board's fiduciary obligations and the factors they should assess in considering the renewal of the Investment Advisory Agreement, information about the Advisor (including its Form ADV, Annual Report and statement of financial condition), comparative information about the Funds' performance for periods ended June 30, 2006, management fees and expense ratios, and other pertinent information. The Directors who are not "interested persons" of the Corporation or the Advisor ("Independent Directors"), within the meaning of the Investment Company Act of 1940 (the "1940 Act"), met separately in executive session with counsel to consider the Investment Advisory Agreement. The Board also received information periodically throughout the year that was relevant to the Investment Advisory Agreement renewal process, including performance, management fee and other expense information. Based on its evaluation of information provided by the Advisor, in conjunction with the Funds' other service providers, the Board, including a majority of the Independent Directors, approved the continuation of the Investment Advisory Agreement for an additional one-year period. In considering the Investment Advisory Agreement and reaching its conclusions, the Board reviewed and analyzed various factors that it determined were relevant, including the factors below. NATURE, EXTENT AND QUALITY OF SERVICES PROVIDED TO THE FUNDS ------------------------------------------------------------ The Board analyzed the nature, extent and quality of the services provided by the Advisor to the Funds. The Board reviewed and considered the Advisor's significant role in establishing the Funds and the construction of their investment objectives, principal strategies, investment limitations and fee structures. The Board noted the Advisor's overall reputation and positive name recognition, the depth of the Advisor's personnel, resources and commitment to the Funds, and the experience, credentials and continuity of the portfolio management teams employed to manage the Funds' investments. The Board considered the Advisor's disciplined investment decision-making process used for the Funds. The Board also considered other services that the Advisor provided for the Funds in its capacity as their investment advisor, such as providing some of its key personnel available to serve as officers of the Funds, selecting broker-dealers for execution of portfolio transactions, ensuring adherence to the Fund's investment policies and restrictions, providing support services to the Board and the Audit Committee of the Board and overseeing the Funds' other service providers. In addition, the Board considered that the Advisor provides administrative services to each Fund at an annual rate of 0.05% of the Fund's average daily net assets, and is responsible for paying each Fund's custody, transfer agency, accounting, pricing, auditing, legal and director fees and other ordinary expenses (except for advisory and 12b-1 fees), which has the effect of capping the Funds' expense ratios at 0.55% and 0.30% for Investor and Institutional Class shares, respectively. The Board further noted that the Advisor, in its capacity as a registered broker-dealer, also serves as distributor and principal underwriter of shares of the Funds and spends time and effort marketing the Funds. The Board also considered the strength of the Advisor's compliance department, including the Funds' chief compliance officer, and the fact that the Advisor has not experienced any significant legal, compliance or regulatory difficulties since the Funds were launched. The Board concluded that the nature, extent and quality of the services provided by the Advisor to the Funds were appropriate and that each Fund was likely to continue to benefit from services provided under the Investment Advisory Agreement. INVESTMENT PERFORMANCE OF THE ADVISOR AND THE FUNDS --------------------------------------------------- In considering the investment performance of each Fund, the Board reviewed information as of June 30, 2006 regarding the Fund's performance in comparison to its benchmark index and its peer groups as determined by Lipper. With respect to each Fund's performance relative to its benchmark index, the Board noted that the Baird Intermediate Bond Fund (both Institutional and Investor Class shares) had outperformed the Lehman Brothers Intermediate Government/Credit Index for the one-year, three-year and since inception periods ended June 30, 2006, but slightly trailed the benchmark for the five-year period ended June 30, 2006; the Baird Aggregate Bond Fund (both Institutional and Investor Class shares) had outperformed the Lehman Brothers Aggregate Bond Index for the one-year, three-year, five-year and since inception periods ended June 30, 2006; the Baird Core Plus Bond Fund (both Institutional and Investor Classes) had outperformed the Lehman Brothers U.S. Universal Bond Index for the three-year, five-year and since inception periods ending June 30, 2006, but slightly trailed the benchmark for the one-year period ended June 30, 2006; and the Short-Term Bond Fund had outperformed the Lehman Brothers 1-3 Year Government/Credit Bond Index for the one-year and since inception (8/31/04) periods ended June 30, 2006. The Board also noted that, while the performance of the Baird Intermediate Municipal Bond Fund was comparable but lower than the Lehman Brothers 7-Year General Obligation Bond Index for each of the one-year, three-year and five-year periods ended June 30, 2006, the Institutional Class of that Fund had outperformed the Index for the period from the inception of the Fund (3/31/01) through June 30, 2006. The Board recognized that the Advisor had recommended a change in the Index from the Lehman Brothers 10-Year General Obligation Bond Index at the end of the last fiscal year to better reflect the historical and intended duration to which the Fund was managed. The Board noted that the Fund had underperformed the 10-year Index for each of the periods ended June 30, 2006 as would be expected under the market conditions incurred during those periods. The Board recognized the Advisor's continued communication with respect to the investment strategy of the Fund and noted that the Fund was deliberately managed with measurably less interest rate and credit risk than the 10-year benchmark index and significantly less credit risk than the 7-year benchmark. The Board also reviewed information regarding the performance of each Fund relative to other mutual funds with a similar investment objective as determined by Lipper. The Board observed that the performance of the Institutional and Investor Class shares of the Baird Intermediate Bond Fund over the one-year, three-year and since inception periods ended June 30, 2006 and the performance of the Institutional Class for the five-year period ending June 30, 2006 were better than the Lipper Intermediate Investment Grade Debt Funds average; the performance of the Institutional and Investor Class shares of the Baird Aggregate Bond Fund over the one-year, three-year, five-year and since inception periods ended June 30, 2006 was better than the Lipper Intermediate Investment Grade Debt Funds average (in the top quartile for the three-year, five-year and since inception periods); the performance of the Institutional and Investor Class shares of the Baird Intermediate Municipal Bond Fund over the five-year and since inception periods ended June 30, 2006 was better than the Lipper Intermediate Municipal Debt Funds average (in the top quartile for the five-year and since inception periods); the performance of the Institutional and Investor Class shares of the Baird Core Plus Bond Fund over the one-year, three-year, five-year and since inception periods ended June 30, 2006 was better than the Lipper Intermediate Investment Grade Debt Funds average (in the top quartile for all periods); and the performance of the Baird Short Term Bond Fund for the one- year and since inception periods ended June 30, 2006 was better than the Lipper Short-Term Investment Grade Debt Funds average. The Board also considered the Advisor's quarterly portfolio commentaries and reviews explaining the Funds' performance, the Advisor's consistent and disciplined investment decision process and the investment strategies it employs for the Funds. After considering all of the information, the Board concluded that, although past performance is not a guarantee of future results, each Fund and its shareholders were likely to benefit from the Advisor's continued management. COSTS OF SERVICES PROVIDED AND PROFITS REALIZED BY THE ADVISOR -------------------------------------------------------------- The Board examined the fee and expense information for each of the Funds, including a comparison of such information to other similarly situated mutual funds as determined by Lipper. The Board noted that each Fund's investment management (or advisory) fee and total expense ratio (for both its Investor Class and Institutional Class shares) were significantly lower than the average and median advisory fees and expense ratios for all mutual funds in its Lipper category. The Board also reviewed and considered investment management fees charged by the Advisor to other investment advisory clients and found that the fee paid by the Funds (0.25%) was less than the fee that the Advisor charges on the first $25 million (0.30%) of a separately managed account and the same as the fee that the Advisor charges on the next $25 million. The Board noted and discussed the extent of the significant additional services provided to the Funds that the Advisor did not provide in the other advisory relationships. Those services included certain administrative services, oversight of the Fund's other service providers, director support, risk management, regulatory compliance and various other services. The Board considered the fees realized, and the costs incurred, by the Advisor in providing investment management services to the Funds and the profitability to the Advisor of having a relationship with the Funds. The Board noted the unique expense structure of the Funds whereby the Institutional Class shareholders were charged only a management fee and an administration fee and the Adviser incurred all of the other expenses on behalf of each Fund and that Investor Class shareholders incurred the same expenses as the Institutional Class shareholders plus a 0.25% 12b-1 fee. This structure means that the annual expense ratio for each Fund (as a percentage of average daily net assets) is 0.55% for Investor Class shares and 0.30% for Institutional Class shares. The Advisor informed the Board that the profits realized by the Advisor (as a percentage of revenue) from its relationship with the Funds were less than those realized by the Advisor on its investment advisory business as a whole, particularly since the 0.05% administration fee payable to the Advisor by each Fund was considerably less than the Fund's expenses that the Advisor is required to pay. The Board concluded that the profits realized by the Advisor from its relationship with the Funds were appropriate. The Board also reviewed and considered the general financial condition of the Advisor and determined it to be sound. In light of all of the information that it received and considered, the Board concluded that the management fee and total expense ratio of each Fund were reasonable with respect to the services provided and the performance of the Fund. OTHER BENEFITS TO THE ADVISOR ----------------------------- The Board noted that the Advisor does not have any soft dollar arrangements and does not realize any other tangible benefits in connection with its management of the Funds. The Board believed that the Funds generally benefit from their association with the Advisor and the use of the "Baird" name. The Board concluded that the other benefits realized by the Advisor from its relationship with the Funds were appropriate. ECONOMIES OF SCALE AND FEE LEVELS REFLECTING THOSE ECONOMIES ------------------------------------------------------------ The Board noted that the Funds' advisory fee structure does not contain any breakpoint reductions as the Funds grow in size. However, the Board recognized that the Advisor essentially bears all of the Funds' expenses other than management, 12b-1 and administration fees. The Board also recognized that the advisory fee rates paid by the Funds were designed to be lower than the fees otherwise charged by the Advisor to its separately managed account clients and to be comparable to the second or third breakpoint advisory fee levels paid by other comparable mutual funds. After consideration of the above factors as well as other factors, the Board, including a majority of the Independent Directors, approved the renewal of the Investment Advisory Agreement with their Funds as being in the best interest of each Fund and its shareholders. ADDITIONAL INFORMATION PROXY VOTING A description of the policies and procedures that the Funds use to determine how to vote proxies relating to portfolio securities is available without charge, upon request, by calling toll free, 1-866-44BAIRD, or by accessing the Funds' website at www.bairdfunds.com; and by accessing the SEC's website at www.sec.gov. Each Fund's proxy voting record for the most recent 12-month period ended June 30, if applicable, is available without charge, upon request, by calling toll free, 1-866-44BAIRD, or by accessing the Funds' website at www.bairdfunds.com; and by accessing the SEC's website at www.sec.gov. The Funds generally do not vote proxies because the securities held in their portfolios, consisting of bonds and other fixed-income securities, are not entitled to vote. PORTFOLIO HOLDINGS DISCLOSURE The Funds file a complete schedule of portfolio holdings with the SEC for the first and third quarters of each fiscal year on Form N-Q. The Funds' Forms N-Q are available on the SEC website at www.sec.gov and may be reviewed and copied at the SEC's Public Reference Room in Washington, D.C. Information on the operation of the Public Reference Room may be obtained by calling 1-800-732-0330. The Funds' Forms N-Q may also be obtained by calling toll-free 1-866-44BAIRD. BAIRD FUNDS, INC. c/o U.S. Bancorp Fund Services, LLC P.O. Box 701 Milwaukee, WI 53201-0701 1-866-44BAIRD BOARD OF DIRECTORS G. Frederick Kasten, Jr. (Chairman) John W. Feldt George C. Kaiser Frederick P. Stratton, Jr. INVESTMENT ADVISOR AND DISTRIBUTOR Robert W. Baird & Co. Incorporated 777 East Wisconsin Avenue Milwaukee, WI 53202 ADMINISTRATOR AND TRANSFER AGENT U.S. Bancorp Fund Services, LLC P.O. Box 701 615 East Michigan Street Milwaukee, WI 53202 CUSTODIAN U.S. Bank, N.A. 1555 N. RiverCenter Drive, Suite 302 Milwaukee, WI 53212 LEGAL COUNSEL Godfrey & Kahn, S.C. 780 North Water Street Milwaukee, WI 53202 INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM Grant Thornton LLP 175 West Jackson Boulevard, 13th Floor Chicago, IL 60604 (BAIRD LOGO) ANNUAL REPORT - BAIRD FUNDS December 31, 2006 Baird LargeCap Fund Baird MidCap Fund Baird SmallCap Fund TABLE OF CONTENTS PAGE ---- LETTER TO SHAREHOLDERS 1 2006 ECONOMIC AND STOCK MARKET COMMENTARY 2 BAIRD LARGECAP FUND 4 BAIRD MIDCAP FUND 11 BAIRD SMALLCAP FUND 18 ADDITIONAL INFORMATION ON FUND EXPENSES 25 STATEMENTS OF ASSETS AND LIABILITIES 27 STATEMENTS OF OPERATIONS 28 STATEMENTS OF CHANGES IN NET ASSETS 29 FINANCIAL HIGHLIGHTS 32 NOTES TO THE FINANCIAL STATEMENTS 38 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM 48 DIRECTORS AND OFFICERS 49 DISCLOSURE REGARDING THE BOARD OF DIRECTORS' APPROVAL OF THE INVESTMENT ADVISORY AGREEMENT FOR BAIRD EQUITY FUNDS 51 ADDITIONAL INFORMATION 54 This report has been prepared for shareholders and may be distributed to others only if preceded or accompanied by a current prospectus. CAUTIONARY NOTE ON ANALYSES, OPINIONS AND OUTLOOKS: In this report we offer --------------------------------------------------- analyses and opinions on the performance of individual securities, companies, industries, sectors, markets, interest rates and governmental policies, including predictions, forecasts and outlooks regarding possible future events. These can generally be identified as such because the context of the statements may include such words as "believe," "should," "will," "expects," "anticipates," "hopes" and words of similar effect. These statements reflect the portfolio managers' good faith beliefs and judgments and involve risks and uncertainties, including the risk that the portfolio managers' analyses, opinions and outlooks are or will prove to be inaccurate. It is inherently difficult to correctly assess and explain the performance of particular securities, sectors, markets, interest rate movements, governmental actions or general economic trends and conditions, and many unforeseen factors contribute to the performance of Baird Funds. Investors are, therefore, cautioned not to place undue reliance on subjective judgments contained in this report. (BAIRD LOGO) BAIRD FUNDS, INC. 1-866-442-2473 www.bairdfunds.com ------------------ February 27, 2007 Dear Shareholders, Thank you for investing in the Baird Funds. We are pleased to report that the Funds reached a new milestone in 2006 with their combined net assets exceeding $1 billion. We appreciate the opportunity to help our investors share in the growth presented by the financial markets in 2006. In this Annual Report we review the equities market in 2006 and the performance and composition of each of the Baird Equity Funds. We hope you find this report both informative and helpful in achieving your investment goals. We thank you for your support and look forward to helping you achieve your investment goals. Thank you again for choosing Baird Funds. Sincerely, /s/Mary Ellen Stanek Mary Ellen Stanek, CFA President Baird Funds 2006 ECONOMIC AND STOCK MARKET COMMENTARY The Dow Jones Industrial Average and the S&P 500 Index, the primary benchmarks used to assess the performance of the stock markets generally, posted strong total returns for 2006 of 19.05% and 15.79%, respectively. The S&P 500 reached a six-year high in November, though at year-end it remained roughly 100 points below its all-time record, set in early 2000. Much of the year's gain was realized in the second half, as oil prices fell from their mid-summer highs and the Federal Open Market Committee (Fed) declined to continue its regimen of interest rate increases. During the first two quarters of the year, solid earnings and muted inflation warred with high oil prices and rising interest rates, producing marked volatility in the second quarter, and leaving the major indices with only small gains. This trend continued through mid-July, amid concerns over a slowing economy and renewed inflationary pressures. The Israeli/Hezbollah eruption added a new dimension to existing uncertainty bred by the escalating insurgency in Iraq and the nuclear ambitions of Iran and North Korea. The resultant spike in oil prices to nearly $80/barrel acted as a drag on the domestic economy, which showed signs of slowing. However, in the third quarter, the pullback of oil prices, combined with signals that the Fed had completed its cycle of raising short-term interest rates and suggestions that the housing market had bottomed, produced a quick recovery in investor sentiment and rising equity markets off the mid-July low. By September, speculation had already begun as to the timing of an interest rate reduction. Strong fourth quarter gains followed, with nearly half of the S&P 500's annual return for the year accruing between October and December, on the bolstered belief in a "soft landing" for the economy, treading the gap between inflation and recession. One particular characteristic stood out in sharp relief against these changeable trends -- corporate earnings that exceeded expectations. Earnings were able to propel after-tax profits more than 24% higher from 4Q05 through 3Q06, producing a commensurate increase in corporate spending and hiring, and helping to fuel aggressive M&A activity, which exceeded that of the record-setting 2000. Despite this broad market strength, overall performance was driven by pockets of strong performers. Specifically, riskier securities such as junk bonds and emerging markets' equities provided stellar returns as risk was well rewarded during the year. 2006 was also not kind to active managers. Lipper reports that fewer than 25% of managers were able to outperform their designated benchmark, with no more than 10% of value managers' returns exceeding those of their particular index. In addition, 2006 marked the seventh consecutive year in which value stocks outperformed growth across all market capitalizations, a trend that may be flagging, if early signs are any indication. Following dramatic appreciation and outperformance during the 1990s, growth stocks began to underperform in 2000. Value stocks became quite attractive from a valuation perspective relative to growth issues, and powerful forces started to ignite value-oriented industries. The resurgence of global growth, particularly in India and China, and war in the Middle East drove commodity prices to new highs. While these cycles typically last only a few years, the current cycle's age has resulted in growth stock valuations that have become much more attractive relative to value stocks. This relationship may set the stage for growth to outperform again. The cycle of value outperformance has also coincided closely with a run of small cap dominance over large cap, as measured by the Russell 1000(R) Index (large) and the Russell 2000(R) Index (small). Beginning in 1999, the Russell 2000(R) outperformed the Russell 1000(R) in seven of the last eight years. This recent small cap run has led to large company stocks being attractively valued versus their small company peers. Furthermore, lower quality speculative stocks have outperformed higher quality stocks from 2003 through the middle of 2006 with the help of an "easy money" environment created by the Fed's cutting of short-term interest rates to historically low levels leading up to the Iraq war. Previously, the market decline from 2000 through early 2003 had severely punished lower quality, speculative companies. At the market bottom, many of these companies had experienced declines of over 75% in their share prices and teetered on bankruptcy. The "easy money" environment spared many companies a bankrupt epitaph and allowed their share prices to experience large percentage increases from their lows (although still well below their peak). However, with the Fed having raised rates 17 times over a two-year period through June 2006, the "easy money" environment that led to increased speculative investment behavior has ended, and we believe the stage is set for quality outperformance. Finally, the domestic economy, despite the recent slowdown, is far healthier than many believe. After-tax corporate profits and cash flow have been expanding rapidly since 2002. Both of these measures of corporate profitability reached record levels as a percentage of gross domestic product recently at 8.5% and 15%, respectively, according to the Bureau of Economic Analysis. Although S&P earnings per share were up 18% in the four quarters ended September 30, 2006, after-tax corporate profits advanced 24% over the same period. This expansion in profitability is one of the key components underlying the healthy economy and stock market since 2002. OUTLOOK FOR 2007 Looking ahead at 2007, we believe U.S. economic growth will pace around 2.5% for most of the year. We do not expect the housing slowdown to cause a recession. We anticipate that corporate profits will continue to expand at a high, single- digit pace. Inflation seems to be moderating and absent a large exogenous shock we do not expect inflation to be a problem this year. Consequently, the Fed is likely to stay on the sidelines for some time before cutting rates. In fact, the minutes from recent Fed meetings indicate a higher level of concern regarding inflation than worries about the economy rolling over into recession. Given this backdrop, we anticipate the market will closely track earnings growth for 2007. The valuation level of the S&P 500 is quite reasonable at approximately 16 times trailing 12-month earnings. The current price/earnings multiple is the lowest since the mid 1990s. Profit margins and returns on invested capital have expanded along with record corporate profits. However, we do not believe that these positive developments are fully reflected in stock prices, which provides an opportunity for further increases in stock prices. In addition, the dramatic increase in leveraged buyouts and stock repurchases is actually reducing the supply of common stocks in the U.S. The number of announced buyouts greater than $20 billion each reached a record in 2006 at 20 deals. We believe merger and acquisition activity will continue at a high level. The cost of funding for purchases remains relatively cheap, private equity firms have tremendous liquidity, and buyers seem to be willing to pay higher prices in response to increasing competition for deals. BAIRD LARGECAP FUND DECEMBER 31, 2006 PORTFOLIO MANAGERS' COMMENTARY Stock market performance trends in 2006 extended tendencies in place since the market rebounded from the lows reached in late 2002. For the seventh consecutive year, value stocks outperformed growth in the overall market and particularly within the large cap universe. The large cap markets turned in their fourth year of positive returns. The Baird LargeCap Fund's equity performance trailed the broad market benchmarks in 2006. Specifically, the Fund's Institutional Class shares provided a 2.89% total return in 2006 (2.64% for Investor Class shares), lagging the 9.07% return on the Russell 1000(R) Growth Index. Last year's winning themes in the market were not consistent with the Fund's emphasis on high quality companies, i.e., companies that are leaders in their respective industries and that have strong balance sheets and an established record of consistent growth in sales, earnings, cash flows and dividends. Indeed, the growth stock component of the Russell 1000(R) Index posted a 9.07% gain in 2006 while the value stock component gained 22.25%. The most substantial contributors to performance within the large cap growth universe were found at the lower end of the market cap range: the smallest two quintiles of the Russell 1000(R) Growth Index provided the greatest boost to performance. Companies with market caps below $10 billion, the lowest market cap quintile, is the market capitalization segment where we define our mid cap universe. This strength of the smallest companies in the large cap growth benchmark presented a considerable obstacle to the LargeCap Fund's relative returns for the year. Portfolio construction guidelines for the Fund limit purchases of mid cap holdings to no more than 15% of assets. This disparity accounted for a significant difference in contribution to performance versus the benchmark. LargeCap Fund performance in the second market capitalization quintile (roughly $10 billion to $23 billion), however, experienced the greatest absolute positive performance contribution and outperformance relative to the benchmark. More significantly, this weighting reflects the continuation of our move down the large capitalization range while maintaining focus on investing in consistently profitable growth companies. We have lowered the weighted average market capitalization of the companies held by the Fund from nearly $90 billion as of the end of the first quarter of 2006 to $52 billion as of year end, with the greatest percentage of the Fund's assets (more than 35%) now in the second market cap quintile. We believe this strategy away from the largest of the large cap stocks will impart consistent benefits. Stock selection accounted for the bulk of the Fund's underperformance versus the Russell 1000(R) Growth Index during the year, with disappointing results from healthcare and technology holdings Teva Pharmaceutical, eBay, Corning and Maxim Integrated Products (-26%, -32%, -22% and -23%, respectively, for the year), though the weakness of individual IT stocks was offset somewhat by returns from the Fund's two best performing stocks: Cisco Systems and second quarter addition, Apple (+60% and +42%). Stock selections in the consumer groups were bright spots for the portfolio in 2006, contributing most strongly to performance on both an absolute and relative basis. Holdings Sysco Corp., Staples, Starbucks and second quarter addition Kohl's Corp. (+21%, +19%, +18% and +20%, respectively, in 2006) positively affected the Fund's relative performance. The financial services sector, in which we have maintained an overweight position in anticipation of the Federal Reserve's maintenance, and eventual reduction, of interest rates, provided a tepid contribution to performance. We believe the Fund's exposure to banks and other financial services companies should prove beneficial to performance when the Fed moves to cut rates, or when the yield curve becomes more upward-sloping. In keeping with our down-cap movement in 2006, several higher cap positions were eliminated from the portfolio, including Dell, Home Depot, General Electric, UPS, and Wal-Mart. Though Wal-Mart and GE contributed positively to the Fund's performance, by 3% and 4%, respectively, the other holdings specified contributed meaningfully to the Fund's disappointing relative performance. From the beginning of the year through the dates the positions were eliminated, Dell declined 15%, UPS dropped 8%, and Home Depot declined 6%. Several positions new to the Fund during the year were important contributors to performance. Electronic Arts was added to the Fund mid-year and gained roughly 19% before year-end. Western Union was purchased in October, and returned 14%, while Oshkosh Truck, which was added to the Fund in November, gained 6% through year- end. As 2007 begins, we believe that the Federal Reserve Board will remain conservative with monetary policy, avoiding the appearance of haste in making interest rate reductions. When, however, the Fed does ease interest rates, which we believe it will, the improving cost of borrowing should enhance corporate profit growth, creating an environment conducive to our fundamental investment style. The large cap growth asset class presents opportunities for visible earnings growth in an environment of low inflation and a reasonably healthy economy. We are optimistic about the likelihood of corporate profit growth and expanding multiples. As always, our goal is to be fully invested in high quality growth companies that typically demonstrate the ability to expand earnings, not only during economic upturns, but also when economic activity slows. Portfolio Managers: Douglas Guffy Kenneth Hemauer, CFA J. Bary Morgan, CFA BAIRD LARGECAP FUND A December 31, 2006 summary of the Fund's top 10 holdings and equity sector analysis compared to the Russell 1000(R) Growth Index is shown below. TOP 10 HOLDINGS* Sysco Corporation 3.1% Microsoft Corporation 3.1% Genentech, Inc. 3.0% Cisco Systems, Inc. 2.9% Staples, Inc. 2.8% Capital One Financial Corporation 2.8% Emerson Electric Company 2.7% Zimmer Holdings, Inc. 2.7% State Street Corporation 2.7% PepsiCo, Inc. 2.6% NET ASSETS: $28,530,277 PORTFOLIO TURNOVER RATIO: 63.9% NUMBER OF EQUITY HOLDINGS: 45 ANNUALIZED PORTFOLIO EXPENSE RATIO:*** INSTITUTIONAL CLASS: 0.75% INVESTOR CLASS: 1.00%**** EQUITY SECTOR ANALYSIS** LargeCap Fund Russell 1000(R) Growth Index ------------- ---------------------------- Consumer Discretionary (12.5%) 12.5% 14.2% Consumer Staples (10.9%) 10.9% 9.8% Energy (5.2%) 5.2% 4.0% Financials (11.5%) 11.5% 8.4% Health Care (16.2%) 16.2% 17.5% Industrials (15.7%) 15.7% 14.1% Information Technology (25.3%) 25.3% 26.9% Materials (2.6%) 2.6% 2.8% Telecommunication Services (0.0%) 0.0% 0.8% Utilities (0.0%) 0.0% 1.4% * The Fund's portfolio composition is subject to change and there is no assurance that the Fund will continue to hold any particular security. Percentages shown relate to the Fund's total net assets as of December 31, 2006. ** Percentages shown in parentheses relate to the Fund's total equity investments as of December 31, 2006, and may not add up to 100% due to rounding. *** The Advisor has contractually agreed to limit the Fund's total annual fund operating expenses to 0.75% of average daily net assets for the Institutional Class shares and 1.00% of average daily net assets for the Investor Class shares, at least through April 30, 2008. **** Includes 0.25% 12b-1 fee. BAIRD LARGECAP FUND BAIRD LARGECAP FUND - INSTITUTIONAL CLASS VALUE OF A $100,000 INVESTMENT Baird LargeCap Fund - Russell 1000(R) Institutional Class Shares Growth Index -------------------------- --------------- 9/29/2000 $100,000 $100,000 12/31/2000 $95,854 $78,655 6/30/2001 $86,949 $67,454 12/31/2001 $86,421 $62,591 6/30/2002 $70,799 $49,587 12/31/2002 $64,357 $45,138 6/30/2003 $70,181 $51,045 12/31/2003 $78,357 $58,566 6/30/2004 $79,364 $60,170 12/31/2004 $82,442 $62,256 6/30/2005 $81,530 $61,185 12/31/2005 $85,237 $65,533 6/30/2006 $82,781 $64,924 12/31/2006 $87,700 $71,479 GROWTH OF A HYPOTHETICAL INVESTMENT OF $100,000 MADE ON THE FUND'S INCEPTION DATE (9/29/00), ASSUMING REINVESTMENT OF ALL DISTRIBUTIONS. BAIRD LARGECAP FUND - INVESTOR CLASS VALUE OF A $10,000 INVESTMENT Baird LargeCap Fund - Russell 1000(R) Investor Class Shares Growth Index --------------------- --------------- 9/29/2000 $10,000 $10,000 12/31/2000 $9,572 $7,865 6/30/2001 $8,672 $6,745 12/31/2001 $8,612 $6,259 6/30/2002 $7,052 $4,959 12/31/2002 $6,403 $4,514 6/30/2003 $6,953 $5,105 12/31/2003 $7,760 $5,857 6/30/2004 $7,850 $6,017 12/31/2004 $8,148 $6,226 6/30/2005 $8,037 $6,118 12/31/2005 $8,404 $6,553 6/30/2006 $8,181 $6,492 12/31/2006 $8,626 $7,148 GROWTH OF A HYPOTHETICAL INVESTMENT OF $10,000 MADE ON THE FUND'S INCEPTION DATE (9/29/00), ASSUMING REINVESTMENT OF ALL DISTRIBUTIONS. BAIRD LARGECAP FUND AVERAGE ANNUAL TOTAL RETURNS For the Periods Ended December 31, 2006 ONE YEAR FIVE YEARS SINCE INCEPTION(1) --------------------------------------- -------- ---------- ----------------------- Baird LargeCap Fund - Institutional Class Shares 2.89% 0.29% -2.08% Baird LargeCap Fund - Investor Class Shares 2.64% 0.03% -2.34% Russell 1000(R) Growth Index(2) 9.07% 2.69% -5.23%
(1) For the period from September 29, 2000 (commencement of operations) through December 31, 2006. (2) The Russell 1000(R) Growth Index measures the performance of those Russell 1000(R) companies with higher price-to-book ratios and higher forecasted growth rates. The Russell 1000(R) Index consists of the 1,000 largest companies in the Russell 3000(R) Index, which represents approximately 92% of the total market capitalization of the Russell 3000(R) Index, which in turn is comprised of the 3,000 largest U.S. domiciled publicly traded common stocks by market capitalization. These indices do not reflect any deduction for fees, expenses or taxes. A direct investment in an index is not possible. THE RETURNS SHOWN IN THE TABLE ABOVE REFLECT REINVESTMENT OF DIVIDENDS AND/OR CAPITAL GAINS DISTRIBUTIONS IN ADDITIONAL SHARES. THE RETURNS DO NOT REFLECT THE DEDUCTION OF TAXES THAT A SHAREHOLDER WOULD PAY ON FUND DISTRIBUTIONS OR THE REDEMPTION OF FUND SHARES. PAST PERFORMANCE DOES NOT GUARANTEE FUTURE RESULTS. INVESTMENT RETURN AND PRINCIPAL VALUE WILL FLUCTUATE SO THAT AN INVESTOR'S SHARES, WHEN REDEEMED, MAY BE WORTH MORE OR LESS THAN THEIR ORIGINAL COST. FOR INFORMATION ABOUT THE PERFORMANCE OF THE FUND AS OF THE MOST RECENT MONTH- END, PLEASE CALL 1-866-44BAIRD OR VISIT WWW.BAIRDFUNDS.COM. MUTUAL FUND PERFORMANCE CHANGES OVER TIME AND CURRENT PERFORMANCE MAY BE LOWER OR HIGHER THAN THAT STATED. BAIRD LARGECAP FUND SCHEDULE OF INVESTMENTS DECEMBER 31, 2006 Shares Value ------ ----- COMMON STOCKS - 97.5% AUTO COMPONENTS - 1.1% 3,575 Johnson Controls, Inc. $ 307,164 ----------- BEVERAGES - 2.6% 12,040 PepsiCo, Inc. 753,102 ----------- BIOTECHNOLOGY - 3.0% 10,522 Genentech, Inc.* 853,650 ----------- CAPITAL MARKETS - 5.1% 7,278 Legg Mason, Inc. 691,774 11,320 State Street Corporation 763,421 ----------- 1,455,195 ----------- CHEMICALS - 2.6% 12,267 Praxair, Inc. 727,801 ----------- COMMERCIAL BANKS - 1.7% 10,000 Marshall & Ilsley Corp. 481,100 ----------- COMMUNICATIONS EQUIPMENT - 5.1% 29,905 Cisco Systems, Inc.* 817,303 34,704 Corning Incorporated* 649,312 ----------- 1,466,615 ----------- COMPUTERS & PERIPHERALS - 4.1% 6,890 Apple Computer, Inc.* 584,548 14,680 Network Appliance, Inc.* 576,630 ----------- 1,161,178 ----------- CONSUMER FINANCE - 2.8% 10,297 Capital One Financial Corporation 791,016 ----------- ELECTRICAL EQUIPMENT - 5.2% 17,689 Emerson Electric Company 779,908 11,618 Rockwell Automation, Inc. 709,627 ----------- 1,489,535 ----------- ELECTRONIC EQUIPMENT & INSTRUMENTS - 1.1% 9,300 Agilent Technologies, Inc.* 324,105 ----------- ENERGY EQUIPMENT & SERVICES - 4.1% 16,762 BJ Services Company 491,462 10,635 Schlumberger Limited 671,706 ----------- 1,163,168 ----------- FOOD & STAPLES RETAILING - 5.4% 24,281 Sysco Corporation 892,569 14,194 Walgreen Company 651,363 ----------- 1,543,932 ----------- HEALTH CARE EQUIPMENT & SUPPLIES - 4.6% 9,690 Medtronic, Inc. 518,512 9,949 Zimmer Holdings, Inc.* 779,803 ----------- 1,298,315 ----------- HEALTH CARE PROVIDERS & SERVICES - 1.5% 6,760 Cardinal Health, Inc. 435,547 ----------- HOTELS RESTAURANTS & LEISURE - 1.8% 14,563 Starbucks Corporation* 515,821 ----------- HOUSEHOLD PRODUCTS - 2.6% 11,380 Procter & Gamble Company 731,393 ----------- INSURANCE - 1.7% 10,435 AFLAC, Incorporated 480,010 ----------- INTERNET SOFTWARE & SERVICES - 2.2% 24,457 Yahoo!, Inc.* 624,632 ----------- IT SERVICES - 4.6% 15,870 Paychex, Inc. 627,500 31,160 Western Union Company 698,607 ----------- 1,326,107 ----------- MACHINERY - 8.0% 5,470 Danaher Corporation 396,247 13,285 Illinois Tool Works, Inc. 613,634 11,473 ITT Industries, Inc. 651,896 13,010 Oshkosh Truck Corporation 629,944 ----------- 2,291,721 ----------- MULTILINE RETAIL - 4.7% 8,614 Kohl's Corporation* 589,456 13,170 Target Corporation 751,349 ----------- 1,340,805 ----------- OIL & GAS - 1.0% 8,350 Southwestern Energy Company* 292,667 ----------- PHARMACEUTICALS - 6.7% 15,281 Abbott Laboratories 744,338 4,000 Allergan, Inc. 478,960 11,917 Novartis AG - ADR F 684,512 ----------- 1,907,810 ----------- SEMICONDUCTOR & SEMICONDUCTOR EQUIPMENT - 2.0% 20,025 Texas Instruments Incorporated* 576,720 ----------- SOFTWARE - 5.5% 9,740 Adobe Systems, Incorporated* 400,509 5,443 Electronic Arts Inc.* 274,109 29,581 Microsoft Corporation 883,289 ----------- 1,557,907 ----------- SPECIALTY RETAIL - 4.6% 10,589 Best Buy Co, Inc. 520,873 30,051 Staples, Inc. 802,362 ----------- 1,323,235 ----------- TRADING COMPANIES & DISTRIBUTORS - 2.1% 16,317 Fastenal Company 585,454 ----------- Total Common Stocks (Cost $24,502,228) 27,805,705 ----------- COLLATERAL POOL INVESTMENT FOR SECURITIES ON LOAN - 16.3% (Cost $4,643,026) (Please Refer to Note 6) 4,643,026 ----------- Principal Amount --------- SHORT-TERM INVESTMENTS - 2.6% MONEY MARKET FUNDS - 2.6% 748,314 Short-Term Investment Company Liquid Assets Portfolio - AIM Fund 748,314 ----------- Total Short-Term Investments (Cost $748,314) 748,314 ----------- Total Investments (Cost $29,893,568) - 116.4% 33,197,045 ----------- Liabilities in Excess of Other Assets - (16.4)% (4,666,768) ----------- TOTAL NET ASSETS - 100.0% $28,530,277 ----------- ----------- ADR - American Depository Receipt * Non Income Producing F Foreign Security The accompanying notes are an integral part of these financial statements. BAIRD MIDCAP FUND DECEMBER 31, 2006 PORTFOLIO MANAGERS' COMMENTARY Within the mid-cap universe, 2006 was marked by contradiction of historical trends and "conventional wisdom." Generally, the utilities and consumer staples sectors are weak in bullish environments; however, each posted respectable results for the year. Meanwhile, stocks in the technology and health care sectors, usually expected to lead the advance, were tepid. In the midst of these paradoxical results, mid-caps, as represented by the Russell MidCap(R) Index, narrowly missed posting their seventh consecutive year of outperformance against the S&P 500 Index. The cumulative five-year mid-cap performance remained an impressive 2-1/3 times that of the S&P 500's results. A similar record belongs to the mid-cap value asset class, which logged a sixth year out of the last seven of superior performance over mid cap growth. The Baird MidCap Fund's equity performance trailed the broad market benchmarks in 2006. Specifically, the Fund's Institutional Class shares provided a 3.93% total return in 2006 (3.73% for Investor Class shares), lagging the 10.66% return on the Russell MidCap(R) Growth Index. Last year's winning themes in the market were not consistent with the Fund's emphasis on high quality companies, i.e., companies that are leaders in their respective industries and that have strong balance sheets and an established record of consistent growth in sales, earnings, cash flows and dividends. Indeed, the growth stock component of the Russell MidCap(R) Index posted a 10.66% gain in 2006 while the value stock component gained 20.00%. The Fund spent all four quarters of 2006 averaging well above the Russell MidCap(R) Growth Index in the majority of our quality measures (historical return on equity, earnings growth and dividend growth), while maintaining average price/earnings ratios (trailing and forward) on a par with or below those of the benchmark. Such consistent fundamental characteristics validate the analysis behind the Fund's purchases, while indicating that the market has yet to fully appreciate their quality and growth metrics. Stock selection accounted for the bulk of the Fund's underperformance versus the Russell MidCap(R) Growth Index during the year with disappointing results from consumer discretionary and technology holdings P.F. Chang's China Bistro, Chico's FAS, Cheesecake Factory, and Cree, Inc. (-38%, -33%, -34% and -45%, respectively, for the year). The weakness of individual stocks in the technology and consumer discretionary sectors was offset somewhat by returns from two of the Fund's three best performing stocks: Alliance Data Systems and Dick's Sporting Goods (+75% and +47%). Stock selections in consumer staples and health care were bright spots for the portfolio in 2006, contributing strongly to performance on both an absolute and relative basis. The Fund's holdings of United Natural Foods, Resmed and third quarter addition Biomet (+36%, +28% and +32%, respectively, in 2006) positively affected relative performance. The financial services sector, in which we have maintained an overweight position in anticipation of the Federal Reserve's maintenance, and eventual reduction, of interest rates, provided respectable contribution to performance. Our exposure to banks and other financial services firms should prove beneficial to performance when the Federal Reserve Board moves to cut rates, or when the yield curve becomes more upward-sloping. Three stocks eliminated from the portfolio in 2006, Patterson UTI, Medicis and Cree, contributed meaningfully to the Fund's disappointing relative performance. From the beginning of the year through the dates the positions were eliminated, Patterson declined 31%, Medicis dropped 27% and Cree fell 45%. Two positions new to the Fund during the year were important contributors to performance. Biomet was added to the Fund mid-year and gained roughly 32% before being sold in December following an announcement that the company would be acquired by a private equity firm. Also, Cephalon, a biotechnology company, was added to the Fund in July and gained 12% through year-end. As 2007 begins, we believe that the Fed will remain conservative with monetary policy, avoiding the appearance of haste in making interest rate reductions. However, if and when the Fed does ease interest rates, the improving cost of borrowing should enhance corporate profit growth, creating an environment conducive to our fundamental investment style. The mid-cap growth asset class presents opportunities for visible earnings growth in an environment of low inflation and a reasonably healthy economy. We are optimistic about the likelihood of corporate profit growth and expanding multiples. As always, our goal is to be fully invested in high quality growth companies that typically demonstrate the ability to expand earnings, not only during economic upturns, but also when economic activity slows. Portfolio Managers: Greg Edwards, CFA J. Bary Morgan, CFA Chuck Severson, CFA BAIRD MIDCAP FUND A December 31, 2006 summary of the Fund's top 10 holdings and equity sector analysis compared to the Russell Midcap(R) Growth Index is shown below. TOP 10 HOLDINGS* Stericycle, Inc. 3.2% Alliance Data Systems Corporation 3.1% Investors Financial Services Corporation 3.1% Cytyc Corporation 3.1% Pharmaceutical Product Development, Inc. 2.9% Zions Bancorporation 2.7% Wintrust Financial Corporation 2.6% Cameron International Corporation 2.6% Roper Industries, Inc. 2.6% Tractor Supply Company 2.6% NET ASSETS: $37,080,835 PORTFOLIO TURNOVER RATIO: 78.6% NUMBER OF EQUITY HOLDINGS: 44 ANNUALIZED PORTFOLIO EXPENSE RATIO:*** INSTITUTIONAL CLASS: 0.85% INVESTOR CLASS: 1.10%**** EQUITY SECTOR ANALYSIS** MidCap Fund Russell Midcap(R) Growth Index ----------- ------------------------------ Consumer Discretionary (19.0%) 19.0% 22.2% Consumer Staples (3.5%) 3.5% 4.4% Energy (7.5%) 7.5% 7.7% Financials (13.2%) 13.2% 9.1% Health Care (19.0%) 19.0% 14.6% Industrials (17.1%) 17.1% 14.5% Information Technology (20.7%) 20.7% 19.5% Materials (0.0%) 0.0% 4.0% Telecommunication Services (0.0%) 0.0% 2.1% Utilities (0.0%) 0.0% 1.9% * The Fund's portfolio composition is subject to change and there is no assurance that the Fund will continue to hold any particular security. Percentages shown relate to the Fund's total net assets as of December 31, 2006. ** Percentages shown in parentheses relate to the Fund's total equity investments as of December 31, 2006, and may not add up to 100% due to rounding. *** The Advisor has contractually agreed to limit the Fund's total annual fund operating expenses to 0.85% of average daily net assets for the Institutional Class shares and 1.10% of average daily net assets for the Investor Class shares, at least through April 30, 2008. **** Includes 0.25% 12b-1 fee. BAIRD MIDCAP FUND BAIRD MIDCAP FUND - INSTITUTIONAL CLASS VALUE OF A $100,000 INVESTMENT Baird MidCap Fund - Russell Midcap(R) Institutional Class Shares Growth Index -------------------------- ----------------- 12/29/2000 $100,000 $100,000 6/30/2001 $93,807 $84,792 12/31/2001 $91,108 $77,788 6/30/2002 $85,310 $62,460 12/31/2002 $76,610 $56,466 6/30/2003 $83,400 $67,046 12/31/2003 $97,200 $80,586 6/30/2004 $103,800 $85,367 12/31/2004 $109,289 $93,057 6/30/2005 $106,688 $94,639 12/31/2005 $115,372 $104,311 6/30/2006 $119,523 $108,827 12/31/2006 $119,906 $115,436 GROWTH OF A HYPOTHETICAL INVESTMENT OF $100,000 MADE ON THE FUND'S INCEPTION DATE (12/29/00), ASSUMING REINVESTMENT OF ALL DISTRIBUTIONS. BAIRD MIDCAP FUND - INVESTOR CLASS VALUE OF A $10,000 INVESTMENT Baird MidCap Fund - Russell Midcap(R) Investor Class Shares Growth Index --------------------- ----------------- 12/29/2000 $10,000 $10,000 6/30/2001 $9,370 $8,479 12/31/2001 $9,091 $7,779 6/30/2002 $8,511 $6,246 12/31/2002 $7,631 $5,647 6/30/2003 $8,300 $6,705 12/31/2003 $9,650 $8,059 6/30/2004 $10,300 $8,537 12/31/2004 $10,839 $9,306 6/30/2005 $10,568 $9,464 12/31/2005 $11,406 $10,431 6/30/2006 $11,812 $10,983 12/31/2006 $11,832 $11,543 GROWTH OF A HYPOTHETICAL INVESTMENT OF $10,000 MADE ON THE FUND'S INCEPTION DATE (12/29/00), ASSUMING REINVESTMENT OF ALL DISTRIBUTIONS. BAIRD MIDCAP FUND AVERAGE ANNUAL TOTAL RETURNS For the Periods Ended December 31, 2006 ONE YEAR FIVE YEARS SINCE INCEPTION(1) --------------------------------------- -------- ---------- ----------------------- Baird MidCap Fund - Institutional Class Shares 3.93% 5.65% 3.07% Baird MidCap Fund - Investor Class Shares 3.73% 5.41% 2.84% Russell Midcap(R) Growth Index(2) 10.66% 8.21% 2.42%
(1) For the period from December 29, 2000 (commencement of operations) through December 31, 2006. (2) The Russell Midcap(R) Growth Index measures the performance of those Russell Midcap(R) Index companies with higher price-to-book ratios and higher forecasted growth rates. The Russell Midcap(R) Index consists of the 800 smallest companies in the Russell 1000(R) Index, which represent approximately 30% of the total market capitalization of the Russell 1000(R) Index. The Russell 1000(R) Index consists of the largest companies in the Russell 3000(R) Index, which in turn is comprised of the 3,000 largest U.S. domiciled publicly traded common stocks by market capitalization. These indices do not reflect any deduction for fees, expenses or taxes. A direct investment in an index is not possible. THE RETURNS SHOWN IN THE TABLE ABOVE REFLECT REINVESTMENT OF DIVIDENDS AND/OR CAPITAL GAINS DISTRIBUTIONS IN ADDITIONAL SHARES. THE RETURNS DO NOT REFLECT THE DEDUCTION OF TAXES THAT A SHAREHOLDER WOULD PAY ON FUND DISTRIBUTIONS OR THE REDEMPTION OF FUND SHARES. PAST PERFORMANCE DOES NOT GUARANTEE FUTURE RESULTS. INVESTMENT RETURN AND PRINCIPAL VALUE WILL FLUCTUATE SO THAT AN INVESTOR'S SHARES, WHEN REDEEMED, MAY BE WORTH MORE OR LESS THAN THEIR ORIGINAL COST. FOR INFORMATION ABOUT THE PERFORMANCE OF THE FUND AS OF THE MOST RECENT MONTH- END, PLEASE CALL 1-866-44BAIRD OR VISIT WWW.BAIRDFUNDS.COM. MUTUAL FUND PERFORMANCE CHANGES OVER TIME AND CURRENT PERFORMANCE MAY BE LOWER OR HIGHER THAN THAT STATED. BAIRD MIDCAP FUND SCHEDULE OF INVESTMENTS DECEMBER 31, 2006 Shares Value ------ ----- COMMON STOCKS - 97.1% AUTO COMPONENTS - 4.4% 13,467 Autoliv, Inc. $ 812,060 53,243 Gentex Corporation 828,461 ----------- 1,640,521 ----------- BIOTECHNOLOGY - 2.4% 12,606 Cephalon, Inc.* 887,589 ----------- CAPITAL MARKETS - 5.3% 24,647 Eaton Vance Corporation 813,597 27,189 Investors Financial Services Corporation 1,160,155 ----------- 1,973,752 ----------- COMMERCIAL BANKS - 7.6% 24,104 East West Bancorp, Inc. 853,764 19,818 Wintrust Financial Corporation 951,660 12,196 Zions Bancorporation 1,005,438 ----------- 2,810,862 ----------- COMMERCIAL SERVICES & SUPPLIES - 5.2% 19,623 Brady Corporation - Class A 731,546 15,772 Stericycle, Inc.* 1,190,786 ----------- 1,922,332 ----------- COMMUNICATIONS EQUIPMENT - 1.4% 50,240 Tellabs, Inc.* 515,462 ----------- COMPUTERS & PERIPHERALS - 2.0% 20,407 Avid Technology, Inc.* 760,365 ----------- ELECTRICAL EQUIPMENT - 4.5% 11,552 Rockwell Automation, Inc. 705,596 18,850 Roper Industries, Inc. 947,024 ----------- 1,652,620 ----------- ENERGY EQUIPMENT & SERVICES - 7.1% 28,981 BJ Services Company 849,723 17,866 Cameron International Corporation* 947,791 20,583 Smith International, Inc. 845,344 ----------- 2,642,858 ----------- FOOD & STAPLES RETAILING - 2.5% 25,390 United Natural Foods, Inc.* 912,009 ----------- HEALTH CARE EQUIPMENT & SUPPLIES - 10.4% 40,538 Cytyc Corporation* 1,147,225 13,844 Gen-Probe, Incorporated* 725,010 9,140 Hologic, Inc.* 432,139 18,881 ResMed, Inc.* 929,323 12,736 Varian Medical Systems, Inc.* 605,852 ----------- 3,839,549 ----------- HOTELS RESTAURANTS & LEISURE - 1.7% 25,849 The Cheesecake Factory Incorporated* 635,885 ----------- HOUSEHOLD DURABLES - 2.3% 8,705 Harman International Industries, Incorporated 869,717 ----------- IT SERVICES - 6.8% 18,605 Alliance Data Systems Corporation* 1,162,254 7,245 Cognizant Technology Solutions Corporation* 559,024 17,652 Global Payments, Inc. 817,288 ----------- 2,538,566 ----------- LIFE SCIENCES TOOLS & SERVICES - 4.6% 10,718 Covance Inc.* 631,397 33,723 Pharmaceutical Product Development, Inc. 1,086,555 ----------- 1,717,952 ----------- MACHINERY - 6.2% 8,971 Harsco Corporation 682,693 17,853 Joy Global Inc. 863,014 15,688 Oshkosh Truck Corporation 759,613 ----------- 2,305,320 ----------- OFFICE ELECTRONICS - 2.0% 21,347 Zebra Technologies Corporation - Class A* 742,662 ----------- OIL & GAS - 1.9% 19,901 Southwestern Energy Company* 697,530 ----------- SEMICONDUCTOR & SEMICONDUCTOR EQUIPMENT - 2.4% 27,579 Microchip Technology Incorporated 901,833 ----------- SOFTWARE - 4.3% 47,781 Activision, Inc.* 823,745 21,631 NAVTEQ* 756,436 ----------- 1,580,181 ----------- SPECIALTY RETAIL - 10.5% 21,095 Advance Auto Parts, Inc. 750,138 38,927 Chico's FAS, Inc.* 805,400 14,783 Dick's Sporting Goods, Inc.* 724,219 21,161 Tractor Supply Company* 946,109 20,896 Williams-Sonoma, Inc.* 656,970 ----------- 3,882,836 ----------- TRADING COMPANIES & DISTRIBUTORS - 1.6% 16,365 Fastenal Company 587,176 ----------- Total Common Stocks (Cost $28,689,463) 36,017,577 ----------- COLLATERAL POOL INVESTMENT FOR SECURITIES ON LOAN - 44.0% (Cost $16,309,878) (Please Refer to Note 6) 16,309,878 ----------- Total Investments (Cost $44,999,341) - 141.1% 52,327,455 ----------- Liabilities in Excess of Other Assets - (41.1)% (15,246,620) ----------- TOTAL NET ASSETS - 100.0% $37,080,835 ----------- ----------- * Non Income Producing The accompanying notes are an integral part of these financial statements. BAIRD SMALLCAP FUND DECEMBER 31, 2006 PORTFOLIO MANAGERS' COMMENTARY Within the small-cap universe, 2006 was marked by contradiction of historical trends and "conventional wisdom." Generally, the utilities and consumer staples sectors are weak in bullish environments; however, each performed strongly. Meanwhile, stocks in technology and health care, usually expected to lead the advance, lagged markedly. Despite these paradoxical results, small caps, as represented by the Russell 2000(R) Index, recorded their eighth consecutive year of outperformance against the S&P 500. A similar record belongs to the small- cap value asset class, which logged a sixth year out of the last seven of superior performance over small-cap growth. The Baird SmallCap Fund's equity performance trailed the broad market benchmarks in 2006. Specifically, the Fund's Institutional Class shares provided a 8.13% total return in 2006 (7.89% for Investor Class shares), lagging the 13.35% return on the Russell 2000(R) Growth Index. Last year's winning themes in the market were not consistent with the Fund's emphasis on high quality companies, i.e., companies that are leaders in their respective industries and that have strong balance sheets and an established record of consistent growth in sales, earnings, cash flows and dividends. Indeed, the growth stock component of the Russell 2000(R) Index posted a 13.35% gain in 2006 while the value stock component gained 23.48%. The portfolio spent all four quarters of 2006 averaging well above the index in the majority of our quality measures (historical return on equity, earnings growth and dividend growth), while maintaining price/earnings ratios (based on both trailing and forward 12-month earnings) appreciably below those of the benchmark. Such consistent fundamental characteristics validate the analysis behind the Fund's purchases, while indicating that the market has yet to fully appreciate their quality and growth metrics. Stock selection accounted for the bulk of the Fund's underperformance versus the Russell 2000(R) Growth Index during the year with disappointing results from consumer discretionary, industrial and health care holdings P.F. Chang's China Bistro, Red Robin Gourmet Burgers, Argon ST, Salix Pharmaceuticals and United Surgical Partners (-23%, -30%, -28%, -31% and -12%, respectively, for the year). The weakness of individual stocks in health care was offset somewhat by returns from the Fund's best performing stock: Allscripts Healthcare (+101%). Stock selections in information technology and energy were bright spots for the portfolio in 2006, contributing strongly to performance on both an absolute and relative basis. The Fund's holdings of Varian Semiconductor, Open Solutions, Plexus Corp., Oceaneering International, Gulfmark Offshore and first quarter addition RSA Security (+55%, +64%, +57%, +59%, +26%, and +70%, respectively, in 2006) positively affected the Fund's relative performance. The financial services sector, in which we have maintained an overweight position in anticipation of the Federal Reserve's maintenance, and eventual reduction, of interest rates, provided the weakest absolute contribution to portfolio performance. Our exposure to banks and other financial services firms should prove beneficial to performance when the Fed moves to cut rates. For the present, however, the continued inverted yield curve has left regional banks struggling with loan growth and pressure on net interest margins. Three stocks eliminated from the Fund's portfolio in 2006, Tekelec, Kronos and Grey Wolf, contributed meaningfully to disappointing relative performance. From the beginning of the year through the dates the positions were eliminated, Tekelec declined 26%, Kronos dropped 29% and Grey Wolf declined 19%. Two positions new to the Fund during the year were important contributors to performance. DTS, a digital audio products supplier, was added to the Fund in February and gained 43% during the year. Additionally, RSA Security, a software company, was added to the Fund in March and gained 70% before it was sold in September, following the announcement of its acquisition by EMC Corp. As 2007 begins, we believe that the Fed will remain conservative with monetary policy, avoiding the appearance of haste in making interest rate reductions. When, however, the Fed does ease interest rates, the improving cost of borrowing should enhance corporate profit growth, creating an environment conducive to our fundamental investment style. To focus more narrowly on the corporate climate and stock market, Bear Stearns' analysis suggests that the M&A cycle is not yet exhausted. With considerable private money available to invest in quality companies at reasonable valuations, it is possible that we will benefit from additional buyouts in its portfolios in the coming year. Portfolio Managers: Greg Edwards, CFA Chuck Severson, CFA BAIRD SMALLCAP FUND A December 31, 2006 summary of the Fund's top 10 holdings and equity sector analysis compared to the Russell 2000(R) Growth Index is shown below. TOP 10 HOLDINGS* Allscripts Healthcare Solutions, Inc. 3.1% Providence Service Corporation 3.1% United Community Banks, Inc. 2.9% Varian Semiconductor Equipment Associates, Inc. 2.7% LKQ Corporation 2.6% Hibbett Sporting Goods, Inc. 2.6% Boston Private Financial Holdings, Inc. 2.6% United Natural Foods, Inc. 2.6% Natus Medical Incorporated 2.6% Wintrust Financial Corporation 2.6% NET ASSETS: $71,712,174 PORTFOLIO TURNOVER RATIO: 52.8% NUMBER OF EQUITY HOLDINGS: 43 ANNUALIZED PORTFOLIO EXPENSE RATIO:*** INSTITUTIONAL CLASS: 0.95% INVESTOR CLASS: 1.20%**** EQUITY SECTOR ANALYSIS** SmallCap Fund Russell 2000(R) Growth Index ------------- ---------------------------- Consumer Discretionary (14.4%) 14.4% 16.3% Consumer Staples (5.6%) 5.6% 2.9% Energy (7.8%) 7.8% 5.6% Financials (12.7%) 12.7% 9.4% Health Care (19.9%) 19.9% 19.3% Industrials (16.9%) 16.9% 17.0% Information Technology (22.7%) 22.7% 24.6% Materials (0.0%) 0.0% 3.6% Telecommunication Services (0.0%) 0.0% 1.2% Utilities (0.0%) 0.0% 0.3% * The Fund's portfolio composition is subject to change and there is no assurance that the Fund will continue to hold any particular security. Percentages shown relate to the Fund's total net assets as of December 31, 2006. ** Percentages shown in parentheses relate to the Fund's total equity investments as of December 31, 2006, and may not add up to 100% due to rounding. *** The Advisor has contractually agreed to limit the Fund's total annual fund operating expenses to 0.95% of average daily net assets for the Institutional Class shares and 1.20% of average daily net assets for the Investor Class shares, at least through April 30, 2008. **** Includes 0.25% 12b-1 fee. BAIRD SMALLCAP FUND BAIRD SMALLCAP FUND - INSTITUTIONAL CLASS VALUE OF A $100,000 INVESTMENT Baird SmallCap Fund - Russell 2000(R) Institutional Class Shares Growth Index -------------------------- --------------- 6/30/2004 $100,000 $100,000 12/31/2004 $108,400 $108,163 6/30/2005 $108,100 $104,286 12/31/2005 $112,000 $112,655 6/30/2006 $116,300 $119,494 12/31/2006 $121,105 $127,689 GROWTH OF A HYPOTHETICAL INVESTMENT OF $100,000 MADE ON THE FUND'S INCEPTION DATE (6/30/04), ASSUMING REINVESTMENT OF ALL DISTRIBUTIONS. BAIRD SMALLCAP FUND - INVESTOR CLASS VALUE OF A $10,000 INVESTMENT Baird SmallCap Fund - Russell 2000(R) Investor Class Shares Growth Index --------------------- --------------- 6/30/2004 $10,000 $10,000 12/31/2004 $10,830 $10,816 6/30/2005 $10,780 $10,429 12/31/2005 $11,160 $11,266 6/30/2006 $11,570 $11,949 12/31/2006 $12,041 $12,769 GROWTH OF A HYPOTHETICAL INVESTMENT OF $10,000 MADE ON THE FUND'S INCEPTION DATE (6/30/04), ASSUMING REINVESTMENT OF ALL DISTRIBUTIONS. BAIRD SMALLCAP FUND AVERAGE ANNUAL TOTAL RETURNS For the Periods Ended December 31, 2006 ONE YEAR SINCE INCEPTION(1) --------------------------------------- -------- ----------------------- Baird SmallCap Fund - Institutional Class Shares 8.13% 7.95% Baird SmallCap Fund - Investor Class Shares 7.89% 7.70% Russell 2000(R) Growth Index(2) 13.35% 10.27%
(1) For the period from June 30, 2004 (commencement of operations) through December 31, 2006. (2) The Russell 2000(R) Growth Index measures the performance of those Russell 2000(R) Index companies with higher price-to-book and higher forecasted growth rates. The Russell 2000(R) Index consists of the 2,000 smallest U.S. domiciled publicly-traded common stocks that are included in the Russell 3000(R) Index. These common stocks represent approximately 8% of the U.S. equity market. These indices do not reflect any deduction for fees, expenses or taxes. A direct investment in an index is not possible. THE RETURNS SHOWN IN THE TABLE ABOVE REFLECT REINVESTMENT OF DIVIDENDS AND/OR CAPITAL GAINS DISTRIBUTIONS IN ADDITIONAL SHARES. THE RETURNS DO NOT REFLECT THE DEDUCTION OF TAXES THAT A SHAREHOLDER WOULD PAY ON FUND DISTRIBUTIONS OR THE REDEMPTION OF FUND SHARES. PAST PERFORMANCE DOES NOT GUARANTEE FUTURE RESULTS. INVESTMENT RETURN AND PRINCIPAL VALUE WILL FLUCTUATE SO THAT AN INVESTOR'S SHARES, WHEN REDEEMED, MAY BE WORTH MORE OR LESS THAN THEIR ORIGINAL COST. FOR INFORMATION ABOUT THE PERFORMANCE OF THE FUND AS OF THE MOST RECENT MONTH- END, PLEASE CALL 1-866-44BAIRD OR VISIT WWW.BAIRDFUNDS.COM. MUTUAL FUND PERFORMANCE CHANGES OVER TIME AND CURRENT PERFORMANCE MAY BE LOWER OR HIGHER THAN THAT STATED. BAIRD SMALLCAP FUND SCHEDULE OF INVESTMENTS DECEMBER 31, 2006 Shares Value ------ ----- COMMON STOCKS - 93.6% AIRLINES - 1.8% 49,901 SkyWest, Inc. $ 1,272,974 ----------- AUTO COMPONENTS - 2.6% 82,513 LKQ Corporation* 1,896,974 ----------- COMMERCIAL BANKS - 9.8% 66,188 Boston Private Financial Holdings, Inc. 1,867,164 37,161 Pinnacle Financial Partners, Inc.* 1,233,002 65,173 United Community Banks, Inc. 2,106,391 38,194 Wintrust Financial Corporation 1,834,076 ----------- 7,040,633 ----------- COMMERCIAL SERVICES & SUPPLIES - 5.0% 47,858 Brady Corporation - Class A 1,784,146 74,335 Marlin Business Services Corporation* 1,786,270 ----------- 3,570,416 ----------- COMPUTERS & PERIPHERALS - 4.1% 40,232 Avid Technology, Inc.* 1,499,044 47,244 Rackable Systems, Inc.* 1,463,147 ----------- 2,962,191 ----------- DIVERSIFIED FINANCIAL SERVICES - 2.0% 49,663 Heartland Payment Systems, Inc.* 1,402,980 ----------- ELECTRONIC EQUIPMENT & INSTRUMENTS - 8.3% 64,140 Argon ST, Inc.* 1,381,576 69,265 DTS, Inc.* 1,675,520 60,702 Plexus Corp.* 1,449,564 47,850 ScanSource, Inc.* 1,454,640 ----------- 5,961,300 ----------- ENERGY EQUIPMENT & SERVICES - 5.8% 35,141 Dawson Geophysical Company* 1,280,187 29,524 GulfMark Offshore, Inc.* 1,104,493 44,309 Oceaneering International, Inc.* 1,759,067 ----------- 4,143,747 ----------- FOOD & STAPLES RETAILING - 2.6% 51,937 United Natural Foods, Inc.* 1,865,577 ----------- HEALTH CARE EQUIPMENT & SUPPLIES - 4.7% 36,665 Kyphon Inc.* 1,481,266 111,965 Natus Medical Incorporated* 1,859,739 ----------- 3,341,005 ----------- HEALTH CARE PROVIDERS & SERVICES - 13.0% 82,490 Allscripts Healthcare Solutions, Inc.* 2,226,405 45,324 Computer Programs & Systems, Inc. 1,540,563 34,109 Healthways, Inc.* 1,627,340 87,580 Providence Service Corporation* 2,200,886 61,354 United Surgical Partners International, Inc.* 1,739,386 ----------- 9,334,580 ----------- HOTELS RESTAURANTS & LEISURE - 3.1% 29,539 PF Chang's China Bistro, Inc.* 1,133,707 31,063 Red Robin Gourmet Burgers Inc.* 1,113,608 ----------- 2,247,315 ----------- HOUSEHOLD PRODUCTS - 1.4% 20,370 Central Garden & Pet Company* 986,315 ----------- IT SERVICES - 4.6% 56,511 Forrester Research, Inc.* 1,532,013 66,703 SRA International, Inc. - Class A* 1,783,638 ----------- 3,315,651 ----------- LEISURE EQUIPMENT & PRODUCTS - 2.2% 36,653 RC2 Corporation* 1,612,732 ----------- MACHINERY - 4.5% 34,107 Bucyrus International, Inc. - Class A 1,765,378 32,081 ESCO Technologies, Inc.* 1,457,761 ----------- 3,223,139 ----------- PHARMACEUTICALS - 1.8% 108,435 Salix Pharmaceuticals, Ltd.* 1,319,654 ----------- SEMICONDUCTOR & SEMICONDUCTOR EQUIPMENT - 2.7% 41,748 Varian Semiconductor Equipment Associates, Inc.* 1,900,369 ----------- SOFTWARE - 2.7% 21,356 Open Solutions Inc.* 803,840 35,631 THQ Inc.* 1,158,720 ----------- 1,962,560 ----------- SPECIALTY RETAIL - 5.2% 61,610 Hibbett Sporting Goods, Inc.* 1,880,953 40,734 Tractor Supply Company* 1,821,217 ----------- 3,702,170 ----------- TRADING COMPANIES & DISTRIBUTORS - 5.7% 47,852 Applied Industrial Technologies, Inc. 1,258,986 94,690 Beacon Roofing Supply, Inc.* 1,782,066 22,406 Watsco, Inc. 1,056,667 ----------- 4,097,719 ----------- Total Common Stocks (Cost $60,370,975) 67,160,001 ----------- COLLATERAL POOL INVESTMENT FOR SECURITIES ON LOAN - 38.2% (Cost $27,386,967) (Please Refer to Note 6) 27,386,967 ----------- Principal Amount --------- SHORT-TERM INVESTMENTS - 6.2% MONEY MARKET FUNDS - 6.2% 2,893,950 Short-Term Investment Company Liquid Assets Portfolio - AIM Fund 2,893,950 1,525,987 Short-Term Investment Trust Prime Portfolio - AIM Fund 1,525,987 ----------- Total Short-Term Investments (Cost $4,419,937) 4,419,937 ----------- Total Investments (Cost $92,177,879) - 138.0% 98,966,905 ----------- Liabilities in Excess of Other Assets - (38.0)% (27,254,731) ----------- TOTAL NET ASSETS - 100.0% $71,712,174 ----------- ----------- * Non Income Producing The accompanying notes are an integral part of these financial statements. BAIRD FUNDS, INC. ADDITIONAL INFORMATION ON FUND EXPENSES DECEMBER 31, 2006 (UNAUDITED) EXAMPLE As a shareholder of a mutual fund, you incur two types of costs: (1) transaction costs, which may include sales charges (loads) on purchase payments, reinvested dividends, or other distributions; redemption fees; and exchange fees; and (2) ongoing costs, such as management fees; distribution and/or service (12b-1) fees; and other fund expenses. Although the Funds do not charge any sales loads, redemption fees, or other transaction fees, you will be assessed fees for outgoing wire transfers, returned checks and stop payment orders at prevailing rates charged by U.S. Bancorp Fund Services, LLC, the Fund's transfer agent. If you request that a redemption be made by wire transfer, currently the Fund's transfer agent charges a $15.00 fee. This Example is intended to help you understand your ongoing costs (in dollars) of investing in each Fund and to compare these costs with the ongoing costs of investing in other mutual funds. The Example is based on an investment of $1,000 invested at the beginning of the period and held for the entire period (7/1/06 - 12/31/06). ACTUAL EXPENSES The third and fourth columns of the following table provide information about account values based on actual returns and actual expenses. You may use the information in these columns, together with the amount you invested, to estimate the expenses that you paid over the period. Simply divide your account value by $1,000 (for example, an $8,600 account value divided by $1,000 = 8.6), then multiply the result by the number in the fourth column entitled "Expenses Paid During Period'' to estimate the expenses you paid on your account during this period. HYPOTHETICAL EXAMPLE FOR COMPARISON PURPOSES The fifth and sixth columns of the following table provide information about hypothetical account values and hypothetical expenses based on the Funds' actual expense ratios and an assumed rate of return of 5% per year before expenses, which is not the Funds' actual return. The hypothetical account values and expenses may not be used to estimate the actual ending account balance or expenses you paid for the period. You may use this information to compare the ongoing costs of investing in the Funds and other mutual funds. To do so, compare this 5% hypothetical example with the 5% hypothetical examples that appear in the shareholder reports of the other mutual funds. Please note that the expenses shown in the table are meant to highlight your ongoing costs only and do not reflect any transactional costs. Therefore, the sixth column of the table (entitled "Expenses Paid During Period") is useful in comparing ongoing costs only, and will not help you determine the relative total costs of owning different mutual funds. In addition, if these transactional costs were included, your costs could have been higher. ACTUAL VS. HYPOTHETICAL RETURNS For the Six Months Ended December 31, 2006 HYPOTHETICAL (5% RETURN ACTUAL BEFORE EXPENSES) --------------------------- --------------------------- FUND'S BEGINNING ENDING EXPENSES ENDING EXPENSES ANNUALIZED ACCOUNT ACCOUNT PAID ACCOUNT PAID EXPENSE VALUE VALUE DURING VALUE DURING RATIO(1) 7/1/06 12/31/06 PERIOD(1) 12/31/06 PERIOD(1) ------------- --------- -------- -------------- -------- -------------- BAIRD LARGECAP FUND Institutional Class 0.75% $1,000.00 $1,059.40 $3.89 $1,021.42 $3.82 Investor Class 1.00% $1,000.00 $1,058.30 $5.19 $1,020.16 $5.09 BAIRD MIDCAP FUND Institutional Class 0.85% $1,000.00 $1,002.40 $4.29 $1,020.92 $4.33 Investor Class 1.10% $1,000.00 $1,001.70 $5.55 $1,019.66 $5.60 BAIRD SMALLCAP FUND Institutional Class 0.95% $1,000.00 $1,041.30 $4.89 $1,020.42 $4.84 Investor Class 1.20% $1,000.00 $1,040.70 $6.17 $1,019.16 $6.11
(1) Expenses are equal to the Fund's annualized expense ratio multiplied by the average account value over the period, multiplied by 184 days and divided by 365 to reflect the one-half year period. BAIRD FUNDS, INC. STATEMENTS OF ASSETS AND LIABILITIES DECEMBER 31, 2006 BAIRD LARGECAP BAIRD MIDCAP BAIRD SMALLCAP FUND FUND FUND -------------- ------------ -------------- ASSETS: Investments, at value (cost $26,749,941; $33,956,506 and $73,635,144 respectively) $30,053,418 $41,284,620 $80,424,170 Repurchase agreements (cost $3,143,627; $11,042,835 and $18,542,735 respectively) 3,143,627 11,042,835 18,542,735 Dividends receivable 14,512 3,015 6,711 Interest receivable 1,902 4,826 14,588 Receivable for investments sold -- 1,189,065 -- Receivable for fund shares sold 5,794 4,745 223,061 Other assets 6,032 5,838 4,691 ----------- ----------- ----------- Total assets 33,225,285 53,534,944 99,215,956 ----------- ----------- ----------- LIABILITIES: Payable for collateral received for securities loaned (See Note 6) 4,643,026 16,309,878 27,386,967 Payable to Advisor and Distributor 6,260 20,922 41,491 Payable for fund shares repurchased 3,831 2,332 8,508 Accrued expenses and other liabilities 41,891 120,977 66,816 ----------- ----------- ----------- Total liabilities 4,695,008 16,454,109 27,503,782 ----------- ----------- ----------- NET ASSETS $28,530,277 $37,080,835 $71,712,174 ----------- ----------- ----------- ----------- ----------- ----------- NET ASSETS CONSIST OF: Capital stock $27,988,668 $30,447,881 $64,831,661 Accumulated undistributed net investment income 203 -- -- Accumulated net realized gain (loss) on investments sold (2,762,071) (695,160) 91,487 Net unrealized appreciation on investments 3,303,477 7,328,114 6,789,026 ----------- ----------- ----------- NET ASSETS $28,530,277 $37,080,835 $71,712,174 ----------- ----------- ----------- ----------- ----------- ----------- INSTITUTIONAL CLASS SHARES Net Assets $27,442,329 $32,057,214 $64,008,514 Shares outstanding ($0.01 par value, unlimited shares authorized) 3,217,096 3,436,591 5,319,537 Net asset value, offering and redemption price per share $ 8.53 $ 9.33 $ 12.03 ----------- ----------- ----------- ----------- ----------- ----------- INVESTOR CLASS SHARES Net Assets $ 1,087,948 $ 5,023,621 $ 7,703,660 Shares outstanding ($0.01 par value, unlimited shares authorized) 128,018 548,110 644,338 Net asset value, offering and redemption price per share $ 8.50 $ 9.17 $ 11.96 ----------- ----------- ----------- ----------- ----------- -----------
The accompanying notes are an integral part of these financial statements. BAIRD FUNDS, INC. STATEMENTS OF OPERATIONS YEAR ENDED DECEMBER 31, 2006 BAIRD LARGECAP BAIRD MIDCAP BAIRD SMALLCAP FUND FUND FUND -------------- ------------ -------------- INVESTMENT INCOME: Dividends $ 287,210 $ 381,998 $ 170,585 Interest 25,259 102,625 109,624 Income from securities lending 3,420 16,381 18,431 ----------- ----------- ---------- Total investment income 315,889 501,004 298,640 ----------- ----------- ---------- EXPENSES: Investment advisory fees 172,798 549,742 518,853 Administration fees 11,864 35,147 27,537 Shareholder servicing fees 17,456 22,340 82,313 Fund accounting fees 25,554 35,185 33,333 Professional fees 24,593 24,653 25,143 Federal and state registration 26,294 29,172 26,760 Directors fees 8,030 7,990 8,270 Custody fees 6,441 20,954 9,110 Reports to shareholders 3,026 8,976 13,601 Distribution fees - Investor Class Shares (See Note 8) 4,265 12,185 12,573 Miscellaneous expenses 2,120 6,095 3,335 ----------- ----------- ---------- Total expenses 302,441 752,439 760,828 Expense reimbursement by Advisor (98,794) (117,213) (168,361) ----------- ----------- ---------- Total expenses 203,647 635,226 592,467 ----------- ----------- ---------- NET INVESTMENT INCOME (LOSS) 112,242 (134,222) (293,827) ----------- ----------- ---------- REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS: Net realized gain on investments 3,822,130 5,175,206 1,686,398 Change in unrealized appreciation/depreciation on investments (3,222,372) (5,482,914) 2,986,275 ----------- ----------- ---------- Net realized and unrealized gain (loss) on investments 599,758 (307,708) 4,672,673 ----------- ----------- ---------- NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM OPERATIONS $ 712,000 $ (441,930) $4,378,846 ----------- ----------- ---------- ----------- ----------- ----------
The accompanying notes are an integral part of these financial statements. BAIRD FUNDS, INC. STATEMENTS OF CHANGES IN NET ASSETS BAIRD LARGECAP FUND ------------------------------------- Year Ended Year Ended December 31, 2006 December 31, 2005 ----------------- ----------------- OPERATIONS: Net investment income $ 112,242 $ 273,336 Net realized gain on investments 3,822,130 2,075,582 Change in unrealized appreciation/depreciation on investments (3,222,372) (360,051) ----------- ----------- Net increase in net assets resulting from operations 712,000 1,988,867 ----------- ----------- CAPITAL SHARE TRANSACTIONS: Proceeds from shares sold 8,900,784 4,077,942 Shares issued to holders in reinvestment of dividends 112,014 269,481 Cost of shares redeemed (10,858,598) (42,940,244) ----------- ----------- Net decrease in net assets resulting from capital share transactions (1,845,800) (38,592,821) ----------- ----------- DISTRIBUTIONS TO INSTITUTIONAL CLASS SHAREHOLDERS: From net investment income (110,900) (258,497) ----------- ----------- DISTRIBUTIONS TO INVESTOR CLASS SHAREHOLDERS: From net investment income (1,174) (15,591) ----------- ----------- TOTAL DECREASE IN NET ASSETS (1,245,874) (36,878,042) NET ASSETS: Beginning of year 29,776,151 66,654,193 ----------- ----------- End of year (including undistributed net investment income of $203 and $35, respectively) $28,530,277 $29,776,151 ----------- ----------- ----------- -----------
The accompanying notes are an integral part of these financial statements. BAIRD FUNDS, INC. STATEMENTS OF CHANGES IN NET ASSETS BAIRD MIDCAP FUND ------------------------------------- Year Ended Year Ended December 31, 2006 December 31, 2005 ----------------- ----------------- OPERATIONS: Net investment loss $ (134,222) $ (214,719) Net realized gain on investments 5,175,206 4,534,559 Change in unrealized appreciation/depreciation on investments (5,482,914) 1,330,768 ----------- ----------- Net increase (decrease) in net assets resulting from operations (441,930) 5,650,608 ----------- ----------- CAPITAL SHARE TRANSACTIONS: Proceeds from shares sold 27,770,122 22,919,718 Shares issued to holders in reinvestment of dividends 6,860,350 2,763,152 Cost of shares redeemed (80,341,536) (28,445,712) ----------- ----------- Net decrease in net assets resulting from capital share transactions (45,711,064) (2,762,842) ----------- ----------- DISTRIBUTIONS TO INSTITUTIONAL CLASS SHAREHOLDERS: From net realized gains (5,953,538) (2,976,399) ----------- ----------- DISTRIBUTIONS TO INVESTOR CLASS SHAREHOLDERS: From net realized gains (990,249) (155,477) ----------- ----------- TOTAL DECREASE IN NET ASSETS (53,096,781) (244,110) NET ASSETS: Beginning of year 90,177,616 90,421,726 ----------- ----------- End of year $37,080,835 $90,177,616 ----------- ----------- ----------- -----------
The accompanying notes are an integral part of these financial statements. BAIRD FUNDS, INC. STATEMENTS OF CHANGES IN NET ASSETS BAIRD SMALLCAP FUND ------------------------------------- Year Ended Year Ended December 31, 2006 December 31, 2005 ----------------- ----------------- OPERATIONS: Net investment loss $ (293,827) $ (169,732) Net realized gain (loss) on investments 1,686,398 (622,142) Change in unrealized appreciation/depreciation on investments 2,986,275 2,209,185 ----------- ----------- Net increase in net assets resulting from operations 4,378,846 1,417,311 ----------- ----------- CAPITAL SHARE TRANSACTIONS: Proceeds from shares sold 36,379,202 33,342,662 Shares issued to holders in reinvestment of dividends 420,515 -- Cost of shares redeemed (16,364,194) (4,785,759) ----------- ----------- Net increase in net assets resulting from capital share transactions 20,435,523 28,556,903 ----------- ----------- DISTRIBUTIONS TO INSTITUTIONAL CLASS SHAREHOLDERS: From net realized gains (425,164) -- ----------- ----------- DISTRIBUTIONS TO INVESTOR CLASS SHAREHOLDERS: From net realized gains (50,691) -- ----------- ----------- TOTAL INCREASE IN NET ASSETS 24,338,514 29,974,214 NET ASSETS: Beginning of period 47,373,660 17,399,446 ----------- ----------- End of period $71,712,174 $47,373,660 ----------- ----------- ----------- -----------
The accompanying notes are an integral part of these financial statements. BAIRD FUNDS, INC. FINANCIAL HIGHLIGHTS BAIRD LARGECAP FUND - INSTITUTIONAL CLASS ----------------------------------------------------------------------- Year Ended December 31, 2006 2005 2004 2003 2002 ------ ------ ------ ------ ------ Per Share Data: Net asset value, beginning of period $8.33 $8.13 $7.78 $6.41 $8.63 ----- ----- ----- ----- ----- Income from investment operations: Net investment income 0.04 0.04(1) 0.06(1) 0.02 0.02 Net realized and unrealized gains (losses) on investments 0.20 0.24 0.35 1.37 (2.22) ----- ----- ----- ----- ----- Total from investment operations 0.24 0.28 0.41 1.39 (2.20) ----- ----- ----- ----- ----- Less distributions: Dividends from net investment income (0.04) (0.08) (0.06) (0.02) (0.02) ----- ----- ----- ----- ----- Net asset value, end of period $8.53 $8.33 $8.13 $7.78 $6.41 ----- ----- ----- ----- ----- ----- ----- ----- ----- ----- Total return 2.89% 3.39% 5.21% 21.75% (25.53)% Supplemental data and ratios: Net assets, end of period $27,442,329 $27,375,626 $64,754,140 $59,743,783 $48,900,767 Ratio of expenses to average net assets 0.75% 0.75% 0.75% 0.75% 0.75% Ratio of expenses to average net assets (before waivers) 1.12% 0.93% 0.93% 0.95% 0.95% Ratio of net investment income to average net assets 0.44% 0.46% 0.72% 0.34% 0.23% Ratio of net investment income to average net assets (before waivers) 0.07% 0.28% 0.54% 0.14% 0.03% Portfolio turnover rate(2) 63.9% 28.6% 23.2% 24.8% 16.2%
(1) Calculated using average shares outstanding during the period. (2) Portfolio turnover is calculated on the basis of the Fund as a whole without distinguishing between the classes of shares issued. The accompanying notes are an integral part of these financial statements. BAIRD FUNDS, INC. FINANCIAL HIGHLIGHTS BAIRD LARGECAP FUND - INVESTOR CLASS ----------------------------------------------------------------------- Year Ended December 31, 2006 2005 2004 2003 2002 ------ ------ ------ ------ ------ Per Share Data: Net asset value, beginning of period $8.29 $8.09 $7.75 $6.40 $8.61 ----- ----- ----- ----- ----- Income from investment operations: Net investment income (loss) 0.01 0.02(1) 0.04(1) 0.01 (0.00)(2) Net realized and unrealized gains (losses) on investments 0.21 0.23 0.35 1.35 (2.21) ----- ----- ----- ----- ----- Total from investment operations 0.22 0.25 0.39 1.36 (2.21) ----- ----- ----- ----- ----- Less distributions: Dividends from net investment income (0.01) (0.05) (0.05) (0.01) (0.00)(2) ----- ----- ----- ----- ----- Net asset value, end of period $8.50 $8.29 $8.09 $7.75 $6.40 ----- ----- ----- ----- ----- ----- ----- ----- ----- ----- Total return 2.64% 3.15% 5.00% 21.20% (25.65)% Supplemental data and ratios: Net assets, end of period $1,087,948 $2,400,525 $1,900,053 $634,160 $647,018 Ratio of expenses to average net assets 1.00% 1.00% 1.00% 1.00% 1.00% Ratio of expenses to average net assets (before waivers) 1.37% 1.18% 1.18% 1.20% 1.20% Ratio of net investment income (loss) to average net assets 0.19% 0.21% 0.47% 0.09% (0.02)% Ratio of net investment income (loss) to average net assets (before waivers) (0.18)% 0.03% 0.29% (0.11)% (0.22)% Portfolio turnover rate(3) 63.9% 28.6% 23.2% 24.8% 16.2%
(1) Calculated using average shares outstanding during the period. (2) Amount is less than $0.01. (3) Portfolio turnover is calculated on the basis of the Fund as a whole without distinguishing between the classes of shares issued. The accompanying notes are an integral part of these financial statements. BAIRD FUNDS, INC. FINANCIAL HIGHLIGHTS BAIRD MIDCAP FUND - INSTITUTIONAL CLASS ----------------------------------------------------------------------- Year Ended December 31, 2006 2005 2004 2003 2002 ------ ------ ------ ------ ------ Per Share Data: Net asset value, beginning of period $11.12 $10.91 $9.72 $7.66 $9.11 ------ ------ ----- ----- ----- Income from investment operations: Net investment loss (0.02)(1) (0.02)(1) (0.04)(1) (0.07) (0.07)(1) Net realized and unrealized gains (losses) on investments 0.46 0.63 1.25 2.13 (1.38) ------ ------ ----- ----- ----- Total from investment operations 0.44 0.61 1.21 2.06 (1.45) ------ ------ ----- ----- ----- Less distributions: Distributions from net realized gains (2.23) (0.40) (0.02) -- -- ------ ------ ----- ----- ----- Net asset value, end of period $9.33 $11.12 $10.91 $9.72 $7.66 ------ ------ ----- ----- ----- ------ ------ ----- ----- ----- Total return 3.93% 5.56% 12.44% 26.89% (15.92)% Supplemental data and ratios: Net assets, end of period $32,057,214 $85,670,669 $86,476,869 $28,629,656 $20,864,264 Ratio of expenses to average net assets 0.85% 0.85% 0.85% 1.20% 1.25% Ratio of expenses to average net assets (before waivers) 1.01% 0.98% 1.05% 1.20% 1.39% Ratio of net investment loss to average net assets (0.17)% (0.21)% (0.43)% (0.81)% (0.84)% Ratio of net investment loss to average net assets (before waivers) (0.33)% (0.34)% (0.63)% (0.81)% (0.98)% Portfolio turnover rate(2) 78.6% 77.4% 77.9% 81.8% 55.4%
(1) Calculated using average shares outstanding during the period. (2) Portfolio turnover is calculated on the basis of the Fund as a whole without distinguishing between the classes of shares issued. The accompanying notes are an integral part of these financial statements. BAIRD FUNDS, INC. FINANCIAL HIGHLIGHTS BAIRD MIDCAP FUND - INVESTOR CLASS ----------------------------------------------------------------------- Year Ended December 31, 2006 2005 2004 2003 2002 ------ ------ ------ ------ ------ Per Share Data: Net asset value, beginning of period $10.99 $10.82 $9.65 $7.63 $9.09 ------ ------ ----- ----- ----- Income from investment operations: Net investment loss (0.04) (0.05)(1) (0.07)(1) (0.09) (0.09)(1) Net realized and unrealized gains (losses) on investments 0.45 0.62 1.26 2.11 (1.37) ------ ------ ----- ----- ----- Total from investment operations 0.41 0.57 1.19 2.02 (1.46) ------ ------ ----- ----- ----- Less distributions: Distributions from net realized gains (2.23) (0.40) (0.02) -- -- ------ ------ ----- ----- ----- Net asset value, end of period $9.17 $10.99 $10.82 $9.65 $7.63 ------ ------ ----- ----- ----- ------ ------ ----- ----- ----- Total return 3.73% 5.24% 12.32% 26.47% (16.06)% Supplemental data and ratios: Net assets, end of period $5,023,621 $4,506,947 $3,944,857 $959,209 $801,703 Ratio of expenses to average net assets 1.10% 1.10% 1.10% 1.45% 1.50% Ratio of expenses to average net assets (before waivers) 1.26% 1.23% 1.30% 1.45% 1.64% Ratio of net investment loss to average net assets (0.42)% (0.46)% (0.68)% (1.06)% (1.09)% Ratio of net investment loss to average net assets (before waivers) (0.58)% (0.59)% (0.88)% (1.06)% (1.23)% Portfolio turnover rate(2) 78.6% 77.4% 77.9% 81.8% 55.4%
(1) Calculated using average shares outstanding during the period. (2) Portfolio turnover is calculated on the basis of the Fund as a whole without distinguishing between the classes of shares issued. The accompanying notes are an integral part of these financial statements. BAIRD FUNDS, INC. FINANCIAL HIGHLIGHTS BAIRD SMALLCAP FUND - INSTITUTIONAL CLASS -------------------------------------------------------- Year Ended Year Ended June 30, 2004(1) December 31, December 31, through 2006 2005 December 31, 2004 ------------ ------------ ----------------- Per Share Data: Net asset value, beginning of period $11.20 $10.84 $10.00 ------ ------ ------ Income from investment operations: Net investment loss(2) (0.05) (0.06) (0.03) Net realized and unrealized gains on investments 0.96 0.42 0.87 ------ ------ ------ Total from investment operations 0.91 0.36 0.84 ------ ------ ------ Less distributions: Distributions from net realized gains (0.08) -- -- ------ ------ ------ Net asset value, end of period $12.03 $11.20 $10.84 ------ ------ ------ ------ ------ ------ Total return 8.13% 3.32% 8.40%(3) Supplemental data and ratios: Net assets, end of period $64,008,514 $45,010,093 $17,331,262 Ratio of expenses to average net assets 0.95% 0.95% 0.95%(4) Ratio of expenses to average net assets (before waivers) 1.23% 1.31% 1.89%(4) Ratio of net investment loss to average net assets (0.46)% (0.57)% (0.65)%(4) Ratio of net investment loss to average net assets (before waivers) (0.74)% (0.93)% (1.59)%(4) Portfolio turnover rate(5) 52.8% 56.4% 34.7%(3)
(1) Commencement of operations. (2) Calculated using average shares outstanding during the period. (3) Not annualized. (4) Annualized. (5) Portfolio turnover is calculated on the basis of the Fund as a whole without distinguishing between the classes of shares issued. The accompanying notes are an integral part of these financial statements. BAIRD FUNDS, INC. FINANCIAL HIGHLIGHTS BAIRD SMALLCAP FUND - INVESTOR CLASS -------------------------------------------------------- Year Ended Year Ended June 30, 2004(1) December 31, December 31, through 2006 2005 December 31, 2004 ------------ ------------ ----------------- Per Share Data: Net asset value, beginning of period $11.16 $10.83 $10.00 ------ ------ ------ Income from investment operations: Net investment loss(2) (0.08) (0.09) (0.05) Net realized and unrealized gains on investments 0.96 0.42 0.88 ------ ------ ------ Total from investment operations 0.88 0.33 0.83 ------ ------ ------ Less distributions: Distributions from net realized gains (0.08) -- -- ------ ------ ------ Net asset value, end of period $11.96 $11.16 $10.83 ------ ------ ------ ------ ------ ------ Total return 7.89% 3.05% 8.30%(3) Supplemental data and ratios: Net assets, end of period $7,703,660 $2,363,567 $68,184 Ratio of expenses to average net assets 1.20% 1.20% 1.20%(4) Ratio of expenses to average net assets (before waivers) 1.48% 1.56% 2.14%(4) Ratio of net investment loss to average net assets (0.71)% (0.82)% (0.90)%(4) Ratio of net investment loss to average net assets (before waivers) (0.99)% (1.18)% (1.84)%(4) Portfolio turnover rate(5) 52.8% 56.4% 34.7%(3)
(1) Commencement of operations. (2) Calculated using average shares outstanding during the period. (3) Not annualized. (4) Annualized. (5) Portfolio turnover is calculated on the basis of the Fund as a whole without distinguishing between the classes of shares issued. The accompanying notes are an integral part of these financial statements. BAIRD FUNDS, INC. NOTES TO THE FINANCIAL STATEMENTS DECEMBER 31, 2006 1. ORGANIZATION Baird Funds, Inc. (the "Corporation") was incorporated on June 9, 2000 as a Wisconsin corporation and is registered as an open-end management investment company under the Investment Company Act of 1940, as amended (the "1940 Act"). The accompanying financial statements include the Baird LargeCap Fund, the Baird MidCap Fund and the Baird SmallCap Fund (each a "Fund" and collectively the "Funds"), three of the eight portfolios comprising the Corporation. Pursuant to the 1940 Act, the Funds are "diversified" series of the Corporation. The investment advisor to the Funds is Robert W. Baird & Co. Incorporated ("Baird" or the "Advisor"). The Baird LargeCap Fund commenced operations with the sale of both Institutional and Investor Class Shares on September 29, 2000. The Baird MidCap Fund commenced operations with the sale of both Institutional and Investor Class Shares on December 29, 2000. The Baird SmallCap Fund commenced operations with the sale of both Institutional and Investor Class Shares on June 30, 2004. The Institutional Class Shares are not subject to a distribution and service (12b-1) fee, while the Investor Class Shares are subject to a distribution and service (12b-1) fee up to 0.25%. The Baird LargeCap Fund seeks long-term growth of capital through investments in equity securities of large-capitalization companies. Dividend income is a secondary consideration. The Baird MidCap Fund seeks long-term growth of capital through investments in equity securities of mid-capitalization companies. The Baird SmallCap Fund seeks long-term growth of capital through investments in equity securities of small-capitalization companies. On December 31, 2006, one shareholder related to the Advisor held approximately 58% of the Baird LargeCap Fund. 2. SIGNIFICANT ACCOUNTING POLICIES The following is a summary of significant accounting policies consistently followed by the Funds in the preparation of their financial statements. These policies are in conformity with accounting principles generally accepted in the United States of America. a) Investment Valuation - Common stocks that are listed on a securities exchange (other than NASDAQ) are valued at the last quoted sales price. Securities traded on NASDAQ are valued at the NASDAQ Official Closing Price. Price information on listed stocks is taken from the exchange where the security is primarily traded. Securities that were not traded on the valuation date, as well as stocks that are not listed on an exchange, including NASDAQ, are valued at the average of the current bid and asked price. Because market quotations for most debt securities are not readily available, debt securities are stated at fair value as furnished by an independent pricing service, which uses valuation methods such as matrix pricing and other analytical pricing models, as well as market transactions and dealer quotations. Debt securities purchased with a remaining maturity of 60 days or less are valued at acquisition cost plus or minus any amortized discount or premium. Investments in mutual funds are valued at their stated net asset value. Other assets and securities for which no quotations are readily available are valued at fair value as determined in good faith by the Advisor in accordance with procedures approved by the Corporation's Board of Directors. In accordance with such procedures, the Advisor may use broker quotes or, if the broker quotes are unavailable or deemed to be unreliable, fair value will be determined by a valuation committee of the Advisor. In determining fair value, the valuation committee takes into account all relevant factors and available information. Consequently, the price of the security used by a Fund to calculate its NAV may differ from quoted or published prices for the same security. Fair value pricing involves subjective judgments and there is no single standard for determining a security's fair value. As a result, different mutual funds could reasonably arrive at a different fair value for the same security. It is possible that the fair value determined for a security is materially different from the value that could be realized upon the sale of that security or from the values that other mutual funds may determine. In September 2006, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards ("SFAS") No. 157, "Fair Value Measurements". SFAS No. 157 defines fair value, establishes a framework for measuring fair value in accordance with GAAP, and expands disclosure about fair value measurements. SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007. Management is currently evaluating the impact of adoption of SFAS No. 157 on its financial statements. b) Foreign Securities - Investing in securities of foreign companies and foreign governments involves special risks and considerations not typically associated with investing in U.S. companies and the U.S. government. These risks include revaluation of currencies and future adverse political and economic developments. Moreover, securities of many foreign companies and foreign governments and their markets may be less liquid and their prices more volatile than those of securities of comparable U.S. companies and the U.S. government. Occasionally, events that affect those values and exchange rates may occur after the close of the exchange on which such securities are traded. If such events materially affect the value of a Fund's securities, these securities may be valued at their fair value pursuant to procedures adopted by the Board of Directors. c) Federal Income Taxes - The Funds intend to continue to qualify as regulated investment companies as provided in subchapter M of the Internal Revenue Code and to distribute substantially all of their taxable income to their shareholders in a manner which results in no tax cost to the Funds. Therefore, no federal income or excise tax provision is recorded. On July 13, 2006, the Financial Accounting Standards Board ("FASB") released FASB Interpretation No. 48 "Accounting for Uncertainty in Income Taxes" ("FIN 48"). FIN 48 provides guidance for how uncertain tax positions should be recognized, measured, presented and disclosed in the financial statements. FIN 48 requires the evaluation of tax positions taken or expected to be taken in the course of preparing the Funds' tax returns to determine whether the tax positions are "more likely than not" of being sustained by the applicable tax authority. A tax position that meets the more-likely-than-not threshold is measured to determine the amount of benefit or expense to recognize in the financial statements. Adoption of FIN 48 is required as of the date of the last NAV calculation in the first required financial statement reporting period for fiscal years beginning after December 15, 2006 and is to be applied to all open tax years as of the effective date. At this time, management is evaluating the implications of FIN 48 and whether it will have any impact on the Funds' financial statements. d) Distributions to Shareholders - Dividends from net investment income are declared and paid annually. Distributions of net realized gains, if any, are declared and paid at least annually. e) Allocation of Income and Expenses - Each Fund is charged for those expenses directly attributable to it. Expenses directly attributable to a class of shares, such as Rule 12b-1 distribution fees, are charged to that class of shares. Income, expenses, and realized and unrealized gains and losses are allocated to the classes based on their respective net assets. Expenses that are not directly attributable to a Fund are allocated among the Funds in the series in proportion to their assets. f) Use of Estimates - The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. g) Other - Investment and shareholder transactions are recorded on trade date. The Funds determine the gain or loss realized from investment transactions by comparing the original cost of the security lot sold with the net sales proceeds. Dividend income is recognized on the ex-dividend date and interest income is recognized on an accrual basis. Accounting principles generally accepted in the United States require that permanent financial reporting and tax differences be reclassified in the capital accounts. h) Guarantees and Indemnifications - In the normal course of business, the Funds enter into contracts with service providers that contain general indemnification clauses. The Funds' maximum exposure under these arrangements is unknown and this would involve future claims against the Funds that have not yet occurred. Based on experience, the Funds would expect the risk of loss to be remote. 3. CAPITAL SHARE TRANSACTIONS The following table summarizes the capital share transactions of each Fund for the past two fiscal periods: BAIRD LARGECAP FUND Year Ended Year Ended December 31, 2006 December 31, 2006 ------------------------ ----------------------- INSTITUTIONAL CLASS SHARES Amount Shares INVESTOR CLASS SHARES Amount Shares -------- -------- -------- -------- Shares sold $ 8,494,502 1,011,084 Shares sold $ 406,282 48,746 Shares issued through Shares issued through reinvestment of dividends 110,843 12,995 reinvestment of dividends 1,171 138 Shares redeemed (9,118,187) (1,094,378) Shares redeemed (1,740,411) (210,595) ----------- ---------- ----------- -------- Net Decrease $ (512,842) (70,299) Net Decrease $(1,332,958) (161,711) ----------- ----------- ----------- ----------- Shares Outstanding: Shares Outstanding: Beginning of period 3,287,395 Beginning of period 289,729 ---------- -------- End of period 3,217,096 End of period 128,018 ---------- -------- ---------- --------
Year Ended Year Ended December 31, 2005 December 31, 2005 ------------------------ ----------------------- INSTITUTIONAL CLASS SHARES Amount Shares INVESTOR CLASS SHARES Amount Shares -------- -------- -------- -------- Shares sold $ 3,287,419 410,040 Shares sold $ 790,523 98,881 Shares issued through Shares issued through reinvestment of dividends 253,910 30,227 reinvestment of dividends 15,571 1,863 Shares redeemed (42,566,187) (5,113,671) Shares redeemed (374,057) (45,879) ------------ ---------- --------- ------- Net Decrease $(39,024,858) (4,673,404) Net Increase $ 432,037 54,865 ------------ --------- ------------ --------- Shares Outstanding: Shares Outstanding: Beginning of period 7,960,799 Beginning of period 234,864 ---------- ------- End of period 3,287,395 End of period 289,729 ---------- ------- ---------- -------
BAIRD MIDCAP FUND Year Ended Year Ended December 31, 2006 December 31, 2006 ------------------------ ----------------------- INSTITUTIONAL CLASS SHARES Amount Shares INVESTOR CLASS SHARES Amount Shares -------- -------- -------- -------- Shares sold $ 24,906,207 2,109,560 Shares sold $2,863,915 250,734 Shares issued through Shares issued through reinvestment of dividends 5,870,101 625,975 reinvestment of dividends 990,249 107,988 Shares redeemed (77,918,215) (7,000,989) Shares redeemed (2,423,321) (220,539) ------------ ---------- ---------- -------- Net Decrease $(47,141,907) (4,265,454) Net Increase $1,430,843 138,183 ------------ ---------- ------------ ---------- Shares Outstanding: Shares Outstanding: Beginning of period 7,702,045 Beginning of period 409,927 ---------- -------- End of period 3,436,591 End of period 548,110 ---------- -------- ---------- --------
Year Ended Year Ended December 31, 2005 December 31, 2005 ------------------------ ----------------------- INSTITUTIONAL CLASS SHARES Amount Shares INVESTOR CLASS SHARES Amount Shares -------- -------- -------- -------- Shares sold $21,848,259 2,032,237 Shares sold $1,071,459 99,399 Shares issued through Shares issued through reinvestment of dividends 2,612,352 234,082 reinvestment of dividends 150,800 13,672 Shares redeemed (27,724,642) (2,488,411) Shares redeemed (721,070) (67,838) ----------- ---------- ---------- ------- Net Decrease $(3,264,031) (222,092) Net Increase $ 501,189 45,233 ----------- ---------- ----------- ---------- Shares Outstanding: Shares Outstanding: Beginning of period 7,924,137 Beginning of period 364,694 ---------- ------- End of period 7,702,045 End of period 409,927 ---------- ------- ---------- -------
BAIRD SMALLCAP FUND Year Ended Year Ended December 31, 2006 December 31, 2006 ------------------------ ----------------------- INSTITUTIONAL CLASS SHARES Amount Shares INVESTOR CLASS SHARES Amount Shares -------- -------- -------- -------- Shares sold $30,531,287 2,601,055 Shares sold $5,847,915 501,916 Shares issued through Shares issued through reinvestment of dividends 369,831 30,717 reinvestment of dividends 50,684 4,238 Shares redeemed (15,510,501) (1,330,621) Shares redeemed (853,693) (73,644) ----------- ---------- ---------- ------- Net Increase $15,390,617 1,301,151 Net Increase $5,044,906 432,510 ----------- ---------- ----------- ---------- Shares Outstanding: Shares Outstanding: Beginning of period 4,018,386 Beginning of period 211,828 ---------- ------- End of period 5,319,537 End of period 644,338 ---------- ------- ---------- -------
Year Ended Year Ended December 31, 2005 December 31, 2005 ------------------------ ----------------------- INSTITUTIONAL CLASS SHARES Amount Shares INVESTOR CLASS SHARES Amount Shares -------- -------- -------- -------- Shares sold $30,846,152 2,842,497 Shares sold $2,496,510 225,110 Shares redeemed (4,571,120) (422,581) Shares redeemed (214,639) (19,578) ----------- --------- ---------- ------- Net Increase $26,275,032 2,419,916 Net Increase $2,281,871 205,532 ----------- ---------- ----------- ---------- Shares Outstanding: Shares Outstanding: Beginning of period 1,598,470 Beginning of period 6,296 --------- ------- End of period 4,018,386 End of period 211,828 --------- ------- --------- -------
4. INVESTMENT TRANSACTIONS AND INCOME TAX INFORMATION During the year ended December 31, 2006, purchases and sales of investment securities (excluding short-term investments) were as follows: Baird Baird Baird LargeCap Fund MidCap Fund SmallCap Fund ------------- ----------- ------------- Purchases: $16,853,812 $ 55,290,297 $47,721,521 Sales: $23,445,807 $108,457,760 $31,261,039 At December 31, 2006, accumulated earnings/losses on a tax basis were as follows: LARGECAP MIDCAP SMALLCAP FUND FUND FUND -------- ------ -------- Cost of Investments $26,810,528 $34,871,277 $73,693,370 ----------- ----------- ----------- ----------- ----------- ----------- Gross unrealized appreciation $ 3,834,888 $ 8,153,894 $ 9,953,396 Gross unrealized depreciation (591,998) (1,740,551) (3,222,596) ----------- ----------- ----------- Net unrealized appreciation $ 3,242,890 $ 6,413,343 $ 6,730,800 ----------- ----------- ----------- ----------- ----------- ----------- Undistributed ordinary income $ 203 $ -- $ 221,455 Undistributed long-term capital gain -- 219,611 12 ----------- ----------- ----------- Total distributable earnings $ 203 $ 219,611 $ 221,467 ----------- ----------- ----------- ----------- ----------- ----------- Other accumulated losses $(2,701,484) $ -- $ (71,754) ----------- ----------- ----------- Total accumulated earnings $ 541,609 $ 6,632,954 $ 6,880,513 ----------- ----------- ----------- ----------- ----------- -----------
Undistributed income or net realized gains for financial statement purposes may differ from amounts recognized for federal income tax purposes due to differences in the recognition and characterization of income, expense and capital gain items. Under the current tax law, capital losses realized after October 31 may be deferred and treated as occurring on the first day of the following fiscal year. For the year ended December 31, 2006, the Baird SmallCap Fund elected to defer capital losses occurring between November 1, 2006 and December 31, 2006 in the amount of $71,754. At December 31, 2006, the Baird LargeCap Fund had accumulated net realized capital loss carryovers of $1,167,011 that expire in 2012 and $1,534,473 that expire in 2011. To the extent the Funds realize future net capital gains, taxable distributions to shareholders will be offset by any unused capital loss carryovers. During the year ended December 31, 2006, the Baird LargeCap Fund utilized $3,842,197 in capital loss carryovers from previous years. During the year ended December 31, 2006 the Baird SmallCap Fund utilized $545,967 in capital loss carryovers from previous years. During the year ended December 31, 2006, the Funds paid the following dividends: ORDINARY INCOME DIVIDENDS NET LONG-TERM CAPITAL GAINS ------------------------- --------------------------- Baird LargeCap Fund $112,074 -- Baird MidCap Fund 355,507 $6,588,280 Baird SmallCap Fund -- 475,855 During the year ended December 31, 2005, the Funds paid the following dividends: ORDINARY INCOME DIVIDENDS NET LONG-TERM CAPITAL GAINS ------------------------- --------------------------- Baird LargeCap Fund $274,088 -- Baird MidCap Fund 674,962 $2,456,914 Baird SmallCap Fund -- -- 5. INVESTMENT ADVISORY AND OTHER AGREEMENTS The Funds have entered into an Investment Advisory Agreement with Baird for the provision of investment advisory services. Pursuant to the Investment Advisory Agreement, the Advisor is entitled to receive a fee, calculated daily and payable monthly, at the annual rate of 0.65% for the Baird LargeCap Fund, 0.75% for the Baird MidCap Fund and 0.85% for the Baird SmallCap Fund as applied to the respective Fund's average daily net assets. Certain officers of the Advisor are also officers of the Funds. For the year ended December 31, 2006 and through April 30, 2007, and again for the year ended December 31, 2007 and through April 30, 2008 the Advisor has contractually agreed to waive its investment advisory fee and/or reimburse the Funds' operating expenses (exclusive of brokerage, interest, taxes, and extraordinary expenses) to the extent necessary to ensure that each Fund's operating expenses do not exceed the following percentages of average daily net assets: INSTITUTIONAL CLASS SHARES INVESTOR CLASS SHARES -------------------------- --------------------- Baird LargeCap Fund 0.75% 1.00% Baird MidCap Fund 0.85% 1.10% Baird SmallCap Fund 0.95% 1.20% To the extent that the Advisor reimburses or absorbs fees and expenses, it may seek payment of such amounts for three years after the year in which expenses were reimbursed or absorbed. A Fund will make no such payment, however, if its total annual operating expenses exceed the expense limits in effect at the time the expenses were reimbursed or at the time these payments are proposed. Fiscal Period Ended December 31, -------------------------------- 2006 2005 2004 ---- ---- ---- REIMBURSED / ABSORBED EXPENSES SUBJECT TO RECOVERY BY ADVISOR UNTIL: 2009 2008 2007 BAIRD LARGECAP FUND $ 98,794 $109,024 $114,127 BAIRD MIDCAP FUND $117,213 $129,774 $116,179 BAIRD SMALLCAP FUND $168,361 $104,335 $ 72,320 U.S. Bancorp Fund Services, LLC serves as transfer agent, administrator, and accounting services agent for the Funds. U.S. Bank, N.A. serves as custodian for the Funds. Robert W. Baird & Co. Incorporated (the "Distributor") is the sole distributor of the Funds pursuant to a distribution agreement. No commissions were earned by the Distributor for services rendered as a registered broker-dealer in securities transactions for the Baird LargeCap Fund, Baird MidCap Fund and Baird SmallCap Fund for the year ended December 31, 2006. 6. SECURITIES LENDING Each Fund may lend up to one-third of its total assets (including such loans) to borrowers under terms of participation in a securities lending program administered by U.S. Bancorp Asset Management, an affiliate of the Funds' custodian, transfer agent and administrator. The securities lending agreement requires that loans are collateralized at all times in an amount equal to at least 102% of the market value of any loaned securities at the time of the loan, plus accrued interest. The Funds receive compensation in the form of fees and earn interest on the cash collateral. The amount of fees depends on a number of factors including the type of security, length of the loan and credit standing of the borrower. Each Fund continues to receive interest payments or dividends on the securities loaned during the borrowing period. Each Fund has the right under the terms of the securities lending agreement to recover the securities from the borrower on demand. As of December 31, 2006, the Baird LargeCap, Baird MidCap and Baird SmallCap Funds had loaned securities that were collateralized by cash equivalents. The cash collateral is invested by the custodian with the approval of the Advisor. Although the cash collateral is generally invested in readily marketable, high quality, short-term obligations, such investments are subject to risk of payment delays or default on the part of the issuer or counterparty or otherwise may not generate sufficient interest to support the costs associated with securities lending. A Fund could also experience delays in recovering its securities and possible loss of income or value if the borrower fails to return the borrowed securities, although this risk is mitigated by the collateral and by contract with the securities lending agent. As of December 31, 2006, the market value of the securities on loan and payable on collateral due to broker were as follows: MARKET VALUE OF PAYABLE ON COLLATERAL SECURITIES ON LOAN DUE TO BROKER ------------------ --------------------- Baird LargeCap Fund $ 4,471,398 $ 4,643,026 Baird MidCap Fund 15,683,569 16,309,878 Baird SmallCap Fund 26,104,491 27,386,967 Individual reinvested cash collateral jointly pooled with collateral received by other Baird Funds as of December 31, 2006 is as follows: LARGECAP MIDCAP SMALLCAP OTHER FUND FUND FUND BAIRD FUNDS TOTAL -------- ------ -------- ----------- ----- Morgan Stanley Repurchase Agreement(1) $1,700,327 $ 5,972,854 $10,029,404 $ 68,297,415 $ 86,000,000 Lehman Brothers Repurchase Agreement(2) 790,850 2,778,072 4,664,839 31,766,239 40,000,000 CS First Boston Repurchase Agreement(3) 237,255 833,421 1,399,452 9,529,872 12,000,000 Rams Funding LLC Discount Commercial Paper 237,255 833,421 1,399,452 9,529,872 12,000,000 CS First Boston Repurchase Agreement(4) 217,483 763,970 1,282,831 8,735,716 11,000,000 Thornburg Mortgage Capital Discount Commercial Paper 217,484 763,970 1,282,831 8,735,715 11,000,000 Antalis Fund 197,712 694,518 1,166,210 7,941,560 10,000,000 CS First Boston Repurchase Agreement(5) 197,712 694,518 1,166,209 7,941,561 10,000,000 Jupiter Sect. 197,712 694,518 1,166,210 7,941,560 10,000,000 Lakeside Funding LLC Interest Bearing Commercial Paper 197,712 694,518 1,166,210 7,941,560 10,000,000 Concord Minutemen Capital Company Interest Bearing Commercial Paper 138,399 486,163 816,347 5,559,091 7,000,000 Stratford 118,627 416,711 699,726 4,764,936 6,000,000 Leguna Interest Bearing Commercial Paper 98,856 347,259 583,105 3,970,780 5,000,000 Concord Minutemen Capital Company Interest Bearing Commercial Paper 79,085 277,807 466,484 3,176,624 4,000,000 Federated Prime Obligations Fund 16,556 58,156 97,654 664,993 837,359 Merrill Lynch Premier Institutional Fund 1 2 3 21 27 ---------- ----------- ----------- ------------ ------------ $4,643,026 $16,309,878 $27,386,967 $186,497,515 $234,837,386 ---------- ----------- ----------- ------------ ------------ ---------- ----------- ----------- ------------ ------------
(1) (Dated 12/29/06), 5.40%, Due 01/02/07 (Repurchase Proceeds $86,038,700), (Collateralized by Mortgage Backed Securities) (2) (Dated 12/29/06), 5.3925%, Due 01/02/07 (Repurchase Proceeds $40,023,967), (Collateralized by Corporate Bonds) (3) (Dated 12/29/06), 5.325%, Due 01/02/07 (Repurchase Proceeds $12,007,093), (Collateralized by Mortgage Backed Securities) (4) (Dated 12/29/06), 5.32%, Due 01/02/07 (Repurchase Proceeds $11,006,502), (Collateralized by Agency Mortgage Backed Securities) (5) (Dated 12/29/06), 5.3625%, Due 01/02/07 (Repurchase Proceeds $10,005,958), (Collateralized by Mortgage Backed Securities) 7. LINE OF CREDIT During the course of operations, certain Funds' custody accounts with U.S. Bank, N.A. (the "Bank") were overdrawn at times during the year due to shareholder redemptions within those Funds. In May 2006, Baird Funds, Inc. entered into an uncommitted, senior secured line of credit ("LOC") with U.S. Bank, N.A. to provide the Funds a temporary liquidity source to meet unanticipated redemptions. Under the terms of the LOC, borrowings for each Fund are limited to one-third of the total assets (including the amount borrowed) of the respective Fund, or as otherwise indicated within the Funds' agreement with the Bank. The Bank charges interest at the Bank's Prime Rate less 1% (weighted average rate of 7.20% during 2006). For the year ended December 31, 2006, the Baird LargeCap Fund and Baird MidCap Fund incurred $533 and $1,595 in interest charges respectively, which are included in the Funds' custody fees, on average daily loan balances of $11,975 and $35,828. The Baird SmallCap Fund did not draw upon the LOC during 2006. 8. DISTRIBUTION AND SHAREHOLDER SERVICE PLAN The Funds have adopted a distribution and shareholder service plan (the "Plan") pursuant to Rule 12b-1 under the 1940 Act. The Plan allows the Funds to compensate the Distributor for the costs incurred in distributing the Funds' Investor Class Shares, including amounts paid to brokers or dealers, at an annual rate not to exceed 0.25% of the average daily net assets of the Funds' Investor Class Shares. The Baird LargeCap Fund, Baird MidCap Fund and Baird SmallCap Fund incurred $4,265, $12,185 and $12,573, respectively, in fees pursuant to the Plan during the year ended December 31, 2006. REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM The Board of Directors and Shareholders Baird Funds, Inc: We have audited the accompanying statements of assets and liabilities of Baird LargeCap Fund, Baird MidCap Fund and Baird SmallCap Fund (three of the portfolios constituting Baird Funds, Inc., hereafter referred to as the "Funds"), including the schedules of investments as of December 31, 2006, and the related statements of operations for the year then ended, the statements of changes in net assets, and the financial highlights for each of the two years in the period then ended. These financial statements and financial highlights are the responsibility of the Funds' management. Our responsibility is to express an opinion on these financial statements and financial highlights based on our audits. The financial highlights for each of the three years in the period ended December 31, 2004 were audited by other auditors. Those auditors expressed an unqualified opinion on those financial highlights in their report dated February 22, 2005. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Funds were not required to have, nor were we engaged to perform an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Funds' internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements and financial highlights. Our procedures included confirmation of securities owned as of December 31, 2006, by correspondence with the custodian and brokers. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements and financial highlights referred to above present fairly, in all material respects, the financial position of each of the aforementioned funds of Baird Funds, Inc. as of December 31, 2006, the results of their operations for the year then ended, and the changes in their net assets, and the financial highlights for each of the two years in the period then ended, in conformity with accounting principles generally accepted in the United States of America. /s/Grant Thornton LLP Chicago, Illinois February 19, 2007 BAIRD FUNDS, INC. DIRECTORS & OFFICERS AS OF DECEMBER 31, 2006 Number of Portfolios Other Position(s) Term of Office Principal in Complex Directorships Held with and Length of Occupation(s) Overseen Held Name, Address, and Age the Funds Time Served During Past 5 Years by Director by Director ----------------------- ----------- -------------- ------------------- ----------- ------------- G. Frederick Director Indefinite; Retired; Chairman, the Advisor (January 8 Director of Kasten, Jr. * And Since September 2000-December 2005); Chairman & CEO, Regal-Beloit 777 East Chairman 2000 the Advisor (January 1998-January 2000); Corporation, Wisconsin Avenue President, Chairman and CEO, the Advisor a manufacturing Milwaukee, WI 53202 (June 1983-January 1998); President, the company Age: 67 Advisor (January 1979-January 1983) John W. Feldt Independent Indefinite; Retired; Senior Vice President-Finance, 8 Director of University of Director Since September University of Wisconsin Foundation Thompson Wisconsin Foundation (1985-2006); Vice President-Finance, Plumb Funds, 1848 University Avenue 2000 University of Wisconsin Foundation Inc., a mutual Madison, WI 53705 (1980-1985); Associate Director, fund complex Age: 64 University of Wisconsin Foundation of which Mr. (1967-1980) Feldt oversees 2 portfolios; Director of Nakoma Mutual Funds, a mutual fund complex of which Mr. Feldt oversees 1 portfolio George C. Kaiser Independent Indefinite; CEO, George Kaiser & Co., a business 8 None 759 N. Milwaukee Street Director Since September consulting company, since 1999; Chairman Milwaukee, WI 53202 2000 and CEO, Hanger Tight Company, a Age: 73 manufacturing company (1988-1999); Chairman and CEO, Interstore Transfer Systems, Ltd., a manufacturing company (1992-1999); Chairman, International Retail Services Group, Ltd. (1995-1999); Executive Vice President, Arandell Schmidt Co., a catalog printer company (1984-1987); various positions Arthur Andersen & Co. (1957-1964, 1967-1984), most recently serving as Partner (1969-1984); Secretary of Administration, State of Wisconsin (1965-1967) Frederick P. Independent Indefinite; Retired; Chairman Emeritus, Briggs & 8 Director of Stratton, Jr. Director Since May Stratton Corporation, a manufacturing Midwest Air 10134 N. Port Washington 2004 company, since 2003; Chairman of the Group, Inc., an Road, #2B Board, Briggs & Stratton Corporation airline company; Mequon, WI 53092 (2001-2002); Chairman and CEO, Briggs Weyco Group, Age: 67 & Stratton Corporation (1986-2001) Inc., a men's footwear distributor; Wisconsin Energy Corporation and its subsidiaries Wisconsin Electric Power Company and Wisconsin Gas LLC
* Mr. Kasten is an "interested person" of the Corporation (as defined in the 1940 Act) because of his ownership of stock of the Advisor. Number of Portfolios Other Position(s) Term of Office Principal in Complex Directorships Held with and Length of Occupation(s) Overseen Held Name, Address, and Age the Funds Time Served During Past 5 Years by Director by Director ----------------------- ----------- -------------- ------------------- ----------- ------------- Mary Ellen Stanek President Re-elected by Managing Director, the Advisor, and N/A N/A 777 East Board annually; Chief Investment Officer, Baird Wisconsin Avenue Since September Advisors, a department of the Advisor, Milwaukee, WI 53202 2000 since March 2000; President and CEO, Age: 50 Firstar Investment Research & Management Company, LLC ("FIRMCO") (November 1998-February 2000); President, Firstar Funds, Inc. (December 1998-February 2000); President and Chief Operating Officer, FIRMCO (March 1994-November 1998) J. Bary Morgan Senior Vice Re-elected by Chief Investment Officer, Baird N/A N/A 777 East President Board annually; Investment Management, a department Wisconsin Avenue Since February of the Advisor, since January 2004; Milwaukee, WI 53202 2003 Managing Director, the Advisor since Age: 41 January 2001; Director, Baird Investment Management (January 2001-January 2004); Senior Vice President, the Advisor (January 2000-January 2001); First Vice President, the Advisor (January 1996-January 2000) Todd S. Nichol Vice Re-elected by Chief Compliance Officer, the Advisor N/A N/A 777 East President and Board annually; since October 2004; Assistant Compliance Wisconsin Avenue Chief Since August Director, the Advisor since August 2002; Milwaukee, WI 53202 Compliance 2004 Senior Vice President, the Advisor since Age: 44 Officer January 2005; First Vice President, the Advisor (January 2004-January 2005): Vice President, the Advisor (August 2002-January 2004); Vice President-Risk Management, BNY Clearing Services, LLC, a division of The Bank of New York (August 1995-August 2002) Russell P. Schwei Vice Re-elected by Operations Director, the Advisor since N/A N/A 777 East President Board annually; July 1992; Managing Director, the Wisconsin Avenue Since September Advisor since January 1997; Chief Milwaukee, WI 53202 2000 Financial Officer and Managing Director, Age: 47 the Advisor (February 1999- December 1999) Leonard M. Rush Treasurer Re-elected by Chief Financial Officer, the Advisor N/A N/A 777 East Board annually; since January 2000 Wisconsin Avenue Since September Milwaukee, WI 53202 2000 Age: 60 Charles M. Weber Secretary Re-elected by Senior Vice President and Associate N/A N/A 777 East Board annually; General Counsel, the Advisor since Wisconsin Avenue Since August July 2005; Partner, Quarles & Brady Milwaukee, WI 53202 2005 LLP, a law firm (October 1998-June 2005) Age: 43 Robert A. Johnson AML Officer Re-elected by Compliance Officer, the Advisor since N/A N/A 777 East Board annually; 1998, and AMLCompliance Officer, Wisconsin Avenue Since August the Advisor since January 2004 Milwaukee, WI 53202 2004 Age: 43 Bret T. Reese Assistant Re-elected by Vice President and Staff Attorney, N/A N/A 777 East Secretary Board annually; the Advisor since 2005; Senior Wisconsin Avenue Since August Financial Analyst, the Advisor Milwaukee, WI 53202 2006 (August 2001-June 2004); Financial Age: 37 Analyst, Stark & Roth, Inc., a hedge fund (June 2001-August 2001)
Additional information about the Funds' directors is available in the Statement of Additional Information which may be obtained without charge, upon request, by calling 1-866-44BAIRD. BAIRD FUNDS, INC. DISCLOSURE REGARDING THE BOARD OF DIRECTORS' APPROVAL OF THE INVESTMENT ADVISORY AGREEMENT FOR BAIRD EQUITY FUNDS The Board of Directors (the "Board") of Baird Funds, Inc. (the "Corporation") met on August 1, 2006 to consider the annual renewal of the Investment Advisory Agreement with Robert W. Baird & Co. Incorporated ("Baird" or the "Advisor") for the management of the Baird LargeCap, MidCap and SmallCap Funds (the "Funds"). The Board reviewed and discussed numerous documents that had been provided prior to the meeting, including the Investment Advisory Agreement, memoranda prepared by outside legal counsel and the Secretary of the Funds discussing in detail the Board's fiduciary obligations and the factors they should assess in considering the renewal of the Investment Advisory Agreement, information about the Advisor (including its Form ADV, Annual Report and statement of financial condition), comparative information about the Funds' performance for periods ended June 30, 2006, management fees and expense ratios, and other pertinent information. The Directors who are not "interested persons" of the Corporation or the Advisor ("Independent Directors"), within the meaning of the Investment Company Act of 1940 (the "1940 Act"), met separately in executive session with counsel to consider the Investment Advisory Agreement. The Board also received information periodically throughout the year that was relevant to the Investment Advisory Agreement renewal process, including performance, management fee and other expense information. Based on its evaluation of information provided by the Advisor, in conjunction with the Funds' other service providers, the Board, including a majority of the Independent Directors, approved the continuation of the Investment Advisory Agreement for an additional one-year period. In considering the Investment Advisory Agreement and reaching its conclusions, the Board reviewed and analyzed various factors that it determined were relevant, including the factors below. NATURE, EXTENT AND QUALITY OF SERVICES PROVIDED TO THE FUNDS ------------------------------------------------------------ The Board analyzed the nature, extent and quality of the services provided by the Advisor to the Funds. The Board reviewed and considered the Advisor's significant role in establishing the Funds and the construction of their investment objectives, principal strategies, investment limitations and fee structures. The Board noted the Advisor's overall reputation and positive name recognition, the depth of the Advisor's personnel, resources and commitment to the Funds, and the experience, credentials and continuity of the portfolio management teams employed to manage the Funds' investments, while acknowledging the recent departures of portfolio managers and research analysts within the Baird Investment Management department of the Advisor. The Board considered the Advisor's disciplined investment decision-making process used for the Funds. The Board also considered other services that the Advisor provided for the Funds in its capacity as their investment advisor, such as providing some of its key personnel available to serve as officers of the Funds, selecting broker-dealers for execution of portfolio transactions, ensuring adherence to the Fund's investment policies and restrictions, providing support services to the Board and the Audit Committee of the Board and overseeing the Funds' other service providers. The Board further noted that the Advisor, in its capacity as a registered broker-dealer, also serves as distributor and principal underwriter of shares of the Funds and spends time and effort marketing the Funds. The Board also considered the strength of the Advisor's compliance department, including the Funds' chief compliance officer, and the fact that the Advisor has not experienced any significant legal, compliance or regulatory difficulties since the Funds were launched. The Board concluded that the nature, extent and quality of the services provided by the Advisor to the Funds were appropriate and that each Fund was likely to continue to benefit from services provided under its agreement with the Advisor. INVESTMENT PERFORMANCE OF THE ADVISOR AND THE FUNDS --------------------------------------------------- In considering the investment performance of each Fund, the Board reviewed information as of June 30, 2006 regarding the Fund's performance in comparison to various benchmark indices and their peer groups as determined by Lipper. With respect to the Baird LargeCap Fund (both Institutional and Investor Class shares), the Board observed that the Fund had outperformed its primary benchmark, the Russell 1000(R) Growth Index, for the period from inception (9/29/00) through June 30, 2006, but lagged the index for the one-year and five- year periods then ended. The Board further noted that, for the period from the Fund's inception through June 30, 2006, the Fund (Institutional Class shares) had performed in the top quartile of the Lipper universe of Large Cap Growth Funds, and that for the five-year period then ended the Fund had performed above the Lipper Large Cap Growth Funds average. The Board recognized that the investment strategy of the LargeCap Fund focused on producing long-term risk adjusted return. The Board noted that the Baird MidCap Fund (both Institutional and Investor Class shares) had outperformed the Russell MidCap(R) Growth Index, its primary benchmark, for the period from the Fund's inception through June 30, 2006 and that its Institutional Class outperformed the benchmark for the five-year period then ended, while acknowledging that the Fund had underperformed that benchmark for the one-year and three-year periods ending June 30, 2006. The Board further noted that, for the period from the Fund's inception through June 30, 2006, the Fund had performed in the top quartile of the Lipper universe of Mid Cap Growth Funds, and that for the one- and three-year periods then ended the Fund had performed below the Lipper Mid Cap Growth Funds average. For the five-year period ending June 30, 2006, the Fund had performed above the Lipper Mid Cap Growth Funds average. With respect to the Baird SmallCap Fund, the Board observed that the Fund had underperformed its benchmark index, the Russell 2000(R) Growth Index, for the year-to-date, one-year, and since inception periods ended June 30, 2006. They also noted that the Fund had performed in the bottom quartile of funds in the Lipper Small Cap Core Funds category for each of the periods. The Board recognized that the Fund had been in operation for a short period of time and also referred to commentary by the Advisor with respect to the Advisor's focus on low-risk, high quality growth stocks as opposed to investments that could be considered more speculative. The Board also considered the Advisor's quarterly portfolio commentaries and reviews explaining the Funds' performance, the Advisor's consistent and disciplined investment decision process and the investment strategies it employs for the Funds. After considering all of the information, the Board concluded that, although past performance is not a guarantee of future results, each Fund and its shareholders were likely to benefit from the Advisor's continued management. COSTS OF SERVICES PROVIDED AND PROFITS REALIZED BY THE ADVISOR -------------------------------------------------------------- The Board examined the fee and expense information for each of the Funds, including a comparison of such information to other similarly situated mutual funds as determined by Lipper. The Board noted that each Fund's investment management (or advisory) fee was either below or slightly above the average and median for the universe of all mutual funds in its Lipper category. The Board also reviewed and considered management fees charged by the Advisor to other investment advisory clients and found that the investment management fee paid by the Funds was 10 basis points (or 0.10%) less than what the Advisor charges on the first $5 million of a separately managed account. The Board recognized the extent of the significant additional services provided to each Fund that the Advisor did not provide to its other clients, such as certain administrative services, oversight of the Fund's other service providers, director support, risk management, regulatory compliance and various other services. The Board also examined the total expense ratio of each Fund relative to all other mutual funds in its Lipper category. The Board noted that each Fund's total expense ratio (both for its Institutional and Investor Class shares), after fee waivers and expense reimbursements by the Advisor, was not only lower than the average and median expense ratios for all funds in its Lipper category, but in the lowest quartile (other than Investor Class shares of the SmallCap Fund, which was in the second lowest quartile) and compared favorably to the average and median expense ratios for institutional class shares of other similarly sized funds in its Lipper category. Each Fund's total expense ratio was also significantly below its Morningstar category average. The Board considered the fees realized, and the costs incurred, by the Advisor in providing investment management services to the Funds and the profitability to the Advisor of having a relationship with the Funds. The Board noted that the Adviser had waived significant fees and/or reimbursed expenses for the Funds since their respective inception dates and that this was likely to continue in the future in order to maintain the competitiveness of the Funds' expense ratios. The Advisor informed the Board that the profits realized by the Advisor (as a percentage of revenue) from its relationship with the Fund have generally been less than those realized by the Advisor on its investment advisory business as a whole. The Board concluded that the profits realized by the Advisor from its relationship with the Funds were appropriate. The Board also reviewed and considered the general financial condition of the Advisor and determined it to be sound. In light of all of the information that it received and considered, the Board concluded that the management fee and total expense ratio of each Fund were reasonable with respect to the services provided and the performance of the Fund. BENEFITS DERIVED FROM THE RELATIONSHIP WITH THE FUNDS ----------------------------------------------------- The Board noted that the Advisor derives ancillary benefits from its association with the Funds in the form of research products and services received from unaffiliated broker-dealers who execute portfolio trades for the Funds. However, the Board determined such products and services have been used for legitimate purposes relating to the Funds by providing assistance in the Advisor's investment decision-making process. The Board believed that the Funds generally benefit from their association with the Advisor and the use of the "Baird" name. The Board concluded that the other benefits realized by the Advisor from its relationship with the Funds were appropriate. ECONOMIES OF SCALE AND FEE LEVELS REFLECTING THOSE ECONOMIES ------------------------------------------------------------ The Board noted that the Funds' advisory fee structures do not contain any breakpoint reductions as the Funds grow in size. However, the Board recognized that the Advisor has been waiving fees and/or reimbursing expenses for the Funds since their inception and anticipates that the Advisor will continue to do so for the foreseeable future. The Board also recognized that the advisory fee rates paid by the Funds were designed to be lower than the fees otherwise charged by the Advisor to its separately managed account clients and to be comparable to the second or third breakpoint advisory fee levels paid by other comparable mutual funds. After consideration of the above factors, the Board, including a majority of the Independent Directors, approved the renewal of the Investment Advisory Agreement with the Funds as being in the best interests of each Fund and its shareholders. ADDITIONAL INFORMATION PROXY VOTING A description of the policies and procedures that the Funds use to determine how to vote proxies relating to portfolio securities is available without charge, upon request, by calling toll free, 1-866-44BAIRD, or by accessing the Funds' website at www.bairdfunds.com; and by accessing the SEC's website at www.sec.gov. Information regarding how each Fund voted proxies relating to portfolio securities during the most recent 12-month period ended June 30 is available without charge, upon request, by calling toll free, 1-866-44BAIRD, or by accessing the Funds' website at www.bairdfunds.com; and by accessing the SEC's website at www.sec.gov. PORTFOLIO HOLDINGS DISCLOSURE The Funds file a complete schedule of portfolio holdings with the SEC for the first and third quarters of each fiscal year on Form N-Q. The Funds' Forms N-Q are available on the SEC website at www.sec.gov and may be reviewed and copied at the SEC's Public Reference Room in Washington, D.C. Information on the operation of the Public Reference Room may be obtained by calling 1-800-732-0330. The Funds' Forms N-Q may also be obtained by calling toll-free 1-866-44BAIRD. ADDITIONAL TAX INFORMATION The Baird LargeCap Fund designates 100% of dividends declared in 2006 from net investment income as qualified dividend income under the Jobs Growth and Tax Relief Reconciliation Act of 2003. The Baird MidCap Fund designates 53.3% as qualified dividend income. Additionally, 100% and 53.4% of the dividends paid by the Baird LargeCap Fund and Baird MidCap Fund in 2006 qualify for the dividend received deduction. The SmallCap Fund did not pay any dividends in 2006. BAIRD FUNDS, INC. c/o U.S. Bancorp Fund Services, LLC P.O. Box 701 Milwaukee, WI 53201-0701 1-866-44BAIRD BOARD OF DIRECTORS G. Frederick Kasten, Jr. (Chairman) John W. Feldt George C. Kaiser Frederick P. Stratton, Jr. INVESTMENT ADVISOR AND DISTRIBUTOR Robert W. Baird & Co. Incorporated 777 East Wisconsin Avenue Milwaukee, WI 53202 ADMINISTRATOR AND TRANSFER AGENT U.S. Bancorp Fund Services, LLC P.O. Box 701 615 East Michigan Street Milwaukee, WI 53202 CUSTODIAN U.S. Bank, N.A. 1555 N. RiverCenter Drive, Suite 302 Milwaukee, WI 53212 LEGAL COUNSEL Godfrey & Kahn, S.C. 780 North Water Street Milwaukee, WI 53202 INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM Grant Thornton LLP 175 West Jackson Boulevard, 13th Floor Chicago, IL 60604 ITEM 2. CODE OF ETHICS. ----------------------- As of the end of the period covered by this report, the Registrant has adopted a code of ethics that applies to the Registrant's principal executive officer and principal financial officer. The Registrant has not made any amendments to its code of ethics during the period covered by this report. The Registrant has not granted any waivers from any provisions of the code of ethics during the period covered by this report. ITEM 3. AUDIT COMMITTEE FINANCIAL EXPERT. ---------------------------------------- The Registrant's board of directors has determined that John W. Feldt and Frederick P. Stratton, Jr., members of the audit committee, each qualify as an "audit committee financial expert" as such term is defined in paragraph (b) of Item 3 of Form N-CSR. Mr. Feldt and Mr. Stratton are each "independent" as such term is defined in paragraph (a)(2) of Item 3 of Form N-CSR. ITEM 4. PRINCIPAL ACCOUNTANT FEES AND SERVICES. ----------------------------------------------- Fees Billed by Grant Thornton LLP. The aggregate fees billed for professional services by Grant Thornton LLP ("GT") during the last two fiscal years were as follows: FYE 12/31/2006 FYE 12/31/2005 --------------- --------------- Audit Fees $105,000 $100,000 Audit-Related Fees - - Tax Fees $25,200 $24,000 All Other Fees - - In the above table, "audit fees" are fees billed for professional services for the audit of the Registrant's annual financial statements or for services that are normally provided by the accountant in connection with statutory and regulatory filings or engagements. "Tax fees" are fees billed for professional services rendered for tax compliance, tax advice and tax planning. The audit committee has adopted pre-approval policies and procedures that require the audit committee to pre-approve all audit and non-audit services rendered to the Registrant, as well as all non-audit services provided to the Registrant's investment adviser and any entity affiliated with the Registrant's investment adviser with respect to any engagement that relates directly to the operations and financial reporting of the Registrant. In accordance with its policies and procedures, the audit committee pre-approved all audit and tax services provided by GT during fiscal 2006. During the past two fiscal years, the Registrant did not receive any non-audit services from GT pursuant to any waivers of the pre-approval requirement under paragraph (c)(7)(i)(C ) of Rule 2- 01 of Regulation S-X. All of GT's hours spent on auditing the Registrant's financial statements were attributed to work performed by full-time permanent employees of GT. During the last two fiscal years, GT has served as the auditor to Robert W. Baird & Co. Incorporated ("RWB"), the Registrant's investment adviser, and has rendered non-audit services to RWB and an affiliate of RWB. The non-audit services consisted of tax services provided to investment partnerships affiliated with RWB, which partnerships do not provide ongoing services to the Registrant; verification and related analytical services provided to RWB in connection with its various GIPS composite performance presentations; and a 2006 tax analysis regarding RWB's ownership and sale of certain securities. GT charged the following amounts for such non-audit services to RWB and its affiliates: $165,600 in 2006 and $142,350 in 2005. The Audit Committee has concluded that the provision of these audit services to RWB and non-audit services to RWB-affiliated partnerships is compatible with GT's independence. ITEM 5. AUDIT COMMITTEE OF LISTED REGISTRANTS. ---------------------------------------------- Not applicable because the Registrant is not a "listed issuer" within the meaning of Rule 10A-3 under the Securities Exchange Act of 1934. ITEM 6. SCHEDULE OF INVESTMENTS. -------------------------------- The Schedules of Investments are included as part of the reports to shareholders filed under Item 1 of this Form N-CSR. ITEM 7. DISCLOSURE OF PROXY VOTING POLICIES AND PROCEDURES FOR CLOSED-END ------------------------------------------------------------------------- MANAGEMENT INVESTMENT COMPANIES. -------------------------------- Not applicable because the Registrant is not a closed-end management investment company. ITEM 8. PORTFOLIO MANAGERS OF CLOSED-END MANAGEMENT INVESTMENT COMPANIES. ------------------------------------------------------------------------- Not applicable because the Registrant is not a closed-end management investment company. ITEM 9. PURCHASES OF EQUITY SECURITIES BY CLOSED-END MANAGEMENT INVESTMENT --------------------------------------------------------------------------- COMPANY AND AFFILIATED PURCHASERS. ---------------------------------- Not applicable because the Registrant is not a closed-end management investment company. ITEM 10. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. ------------------------------------------------------------ There have been no material changes to the procedures by which shareholders may recommend nominees to the Registrant's board of directors. ITEM 11. CONTROLS AND PROCEDURES. --------------------------------- (a) The Registrant's management, with the participation of its principal executive and principal financial officers, has evaluated the effectiveness of the Registrant's disclosure controls and procedures (as defined in Rule 30a-3(c) under the Investment Company Act of 1940 (the "Act")), as of a date within 90 days prior to the filing date of this Form N-CSR. Based on such evaluation, the Registrant's principal executive and principal financial officers have concluded that the design and operation of the Registrant's disclosure controls and procedures are effective in providing reasonable assurance that the information required to be disclosed on Form N-CSR is recorded, processed, summarized and reported within the applicable time periods. (b) There were no changes in the Registrant's internal control over financial reporting (as defined in Rule 30a-3(d) under the Act) that occurred during the second fiscal quarter of the period covered by this report that has materially affected, or is reasonably likely to materially affect, the Registrant's internal control over financial reporting. ITEM 12. EXHIBITS. ----------------- (a) (1) Code of ethics. Incorporated by reference to the Registrant's Form N-CSR filed on March 9, 2004. (2) Certifications pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. Filed herewith. (3) Any written solicitation to purchase securities under Rule 23c-1 under the Act sent or given during the period covered by the report by or on behalf of the registrant to 10 or more persons. Not applicable because the Registrant is not a closed-end management investment company. (b) Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. Furnished herewith. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934 and the Investment Company Act of 1940, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. BAIRD FUNDS, INC. By: /s/ Mary Ellen Stanek ---------------------------- Mary Ellen Stanek, President Date: March 6, 2007 ---------------------------- Pursuant to the requirements of the Securities Exchange Act of 1934 and the Investment Company Act of 1940, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. By: /s/ Mary Ellen Stanek ---------------------------- Mary Ellen Stanek, President Date: March 6, 2007 ---------------------------- By: /s/ Leonard M. Rush ---------------------------- Leonard M. Rush, Treasurer Date: March 6, 2007 ----------------------------