EARNINGS LETTER

3rd Quarter, 2001

Most of your companies reported good third quarter earnings gains, although most saw their stock prices fall. Only DST Systems, Intel and Solectron suffered a quarterly decline greater than the S&P’s 15% drop. Since the end of September, most of your stocks have outpaced the 6.6% market rise. Intel’s up 42%!

Barring low inflation, none of the fundamental factors that propelled the stock market to new heights during the 1990’s bull market remains. Our economy is contracting, overall corporate earnings are down, equity mutual fund inflows are declining, merger activity is sparse and equity financing has slowed to a dribble. Business overdid its investment in information technology, which produced vital productivity gains throughout the past decade. Over-expansion has forced painful retrenchments on many companies causing widespread layoffs. Arrayed against this reversal of fortune, the investor has the bulwark of lower interest rates and rising financial liquidity. Investors also are promised an as yet undefined government spending increase in response to the economic and political effects of the awful events of September 11.

The present uncertainties should place a premium on the those financially strong companies that can still produce sustained revenue and profit growth. In reviewing your investments in this difficult time, we remind ourselves that during periods of economic duress, companies achieving growth through internal investment usually fare better than those buying it through acquisitions. The strength derived from internal growth is evident from a comparison of CH Robinson’s, State Street’s and Walgreen’s results with those of their competitors.

Intel

Although Intel’s earnings, before acquisition charges, were 17% below its previous quarter, revenues rose 3% sequentially. The improved revenue, along with a problem-free move into more efficient 0.13 micron manufacturing and a flawless introduction of the Pentium 4 lifted the stock. Intel is executing its plan like the Intel of old. Management forecast 18% growth in Intel’s server business next year after achieving sales growth following two successive down quarters.

State Street

DST

DST Systems reported a 25% gain in revenues and a 9% improvement in earnings per share. U.S. mutual fund accounts processed totaled 75.2 million, 15% higher than a year ago. During the quarter, the company secured two new mutual fund clients with 2.6 million shareowner accounts, which will be converted to the DST system during the next two quarters. DST’s stock fell 18% in the third quarter and has rebounded only 4% thereafter. We attribute the poor performance of DST’s stock to speculation that Stillwell’s expensive buyout of the Janus Fund’s founder will force it to resort to using its 34% ownership of DST to finance the purchase.

AIG

AIG reported a 13% gain in core income to $1.9 billion, which excludes $820 million in estimated losses from the September 11 terrorist attack. AIG’s premium growth was strong in property and casualty where prices are up significantly. Earnings of AIG’s overseas life insurance businesses, which are primarily in Asia, rose 22%. During the quarter, AIG closed its acquisition of American General, boosting its domestic life business and broadening distribution of fixed annuities through banks. AIG’s stock declined 9% in the third quarter and has stalled since then.

Harte-Hanks

Management’s painstaking cost control enabled Harte-Hanks to report 3.7% growth in operating cash flow despite an overall revenue decline of 8%. Aided by an ongoing share repurchase program, earnings per share rose 10%. Direct marketing revenues from retail, finance and technology customers suffered mid-teen revenue declines as existing clients cut costs and spent less. Pharmaceutical companies were the only customers spending more on direct to consumer marketing campaigns. The Shopper publications reported a 4% revenue growth and an 11% cash flow increase. Harte-Hanks stock, which declined 12% during the quarter, has recovered.

Disney

Disney’s awful results for its fiscal fourth quarter ending September 30 were accompanied by management forecasting a 50% year-to-year drop in operating earnings for the current quarter. This comes after Disney reported 13% operating earnings decreases at both of its theme parks and media networks divisions for the just completed quarter. Filmed entertainment recorded a loss. We think the recently consummated acquisition of the Family Channel for $5.2 billion destroys shareholder value and fear it may signal an inclination toward growth through deal making instead of creative productions. Disney’s stock is 33% below its price at the end of June. The rise of the stock from the low set by the Bass family sale is characteristic of the price movement of fallen investor favorites during a lengthy market bottoming process.

CH Robinsin

CH Robinson reported that revenue growth slowed to 5% as contractual freight volumes from existing customers weakened. This decline was offset by the company’s determined sales effort to gain new business from new and existing customers. By tightly managing selling, general and administrative expenses, the company reported a 19% earnings per share gain. Robinson, which derives 44% of its revenues from customers in the stable food and beverage industry, is well positioned to report good double-digit earnings gains in the coming quarters. Robinson’s stock rose 4% during the quarter and another 4% since the quarter’s end.

UPS

Unlike the non-asset based Robinson, UPS possesses a high fixed cost air and ground network, which makes earnings fluctuate more widely than revenues. Third quarter earnings fell 17% on a 3% decline in ground package volume and a 5% drop in next day air shipments. UPS’ stock declined 10% and recovered 6.6% precisely matching the post-September market gain.
First Data

First Data reported strong revenue and earnings per share growth, up 13% and 19% respectively. Growth in Visa and MasterCard point of sale transactions processed by the company stalled for ten days following September 11, but returned to double-digit growth in the final days of the quarter. The number of Western Union money transfers processed rose 20% as agent locations worldwide reached 117,000, one-quarter more than a year ago. The company produced $330 million in free cash flow during the quarter and spent nearly two times that amount repurchasing in 2.5% of its shares outstanding. First Data’s stock fell 9% during the third quarter, but since then it has leapt 25% to a new high.

Concord EFS

Concord EFS’ earnings per share surged 33% on a 20% jump in revenues. During the quarter 1700 Wal-Mart stores were connected to Concord for PIN-secured debit card payments, and conversion began for Citizens Financial Group, which will add more than 100 million debit and ATM transactions annually. The integration of the STAR network is on track. An 11% rise in Concord’s stock price since September 30 has eclipsed its 6% decline during the quarter. The stock split two for one on September 28th.

Merck

Merck reported earnings growth of 8% higher than last year’s third quarter. While sales of the five key drugs grew 30% last quarter, the company’s worldwide pharmaceutical sales grew 8% to $5.5 billion. Foreign exchange and reduced revenues from drugs losing patent protection tempered the strong performance of the newer drugs. Merck demonstrated its superb clinical development capabilities with the filing of a new drug application for its second generation COX-2 inhibitor Arcoxia®. Clinical studies have shown this compound to be a more effective pain-killer than Vioxx with fewer side effects. Merck’s stock since September 30 has given back its 5% third quarter gain.

Express Scripts

Express Scripts’ third quarter earnings of 40¢ per share increased 33% over last year’s earnings. Mail pharmacy prescriptions increased 38% from the third quarter of 2000 to 5.4 million. This growth drove the increase in operating profit per prescription to $0.93 up 15% from $0.80 in the third quarter of last year. Express Scripts continues to provide workable health solutions for the uninsured through its contract with UnitedHealth to provide services to the AARP Pharmacy Services Discount Program and its participation in the launch of Glaxo SmithKline’s Orange Card. We believe the near panic selling of Express Scripts’ stock following an abrupt cancellation of its contract with Oxford Health occurred because this event unraveled many institutions expectation of an uninterrupted flow of new business. Suddenly, Express Scripts’ existing business appeared in jeopardy. A 29% drop in Express Scripts’ stock price over the past five weeks renders moot its third quarter rise to within 40¢ of a new high.

Mettler-Toledo

Express Scripts’ third quarter earnings of 40¢ per share increased 33% over last year’s earnings. Mail pharmacy prescriptions increased 38% from the third quarter of 2000 to 5.4 million. This growth drove the increase in operating profit per prescription to $0.93 up 15% from $0.80 in the third quarter of last year. Express Scripts continues to provide workable health solutions for the uninsured through its contract with UnitedHealth to provide services to the AARP Pharmacy Services Discount Program and its participation in the launch of Glaxo SmithKline’s Orange Card. We believe the near panic selling of Express Scripts’ stock following an abrupt cancellation of its contract with Oxford Health occurred because this event unraveled many institutions expectation of an uninterrupted flow of new business. Suddenly, Express Scripts’ existing business appeared in jeopardy. A 29% drop in Express Scripts’ stock price over the past five weeks renders moot its third quarter rise to within 40¢ of a new high.

Varian Medical Systems

Varian Medical Systems finished fiscal year 2001 with earnings per share of $2.08, up 34% from last year’s results. Revenues increased 14% to $774 million during the fiscal year, while the backlog reached a record $597 million. Orders for the equipment and software used to provide radiation therapy to cancer patients grew 30% in North America and 19% overall. Higher Medicare reimbursement rates for Intensity Modulated Radiation Therapy (IMRT) both in hospitals and in outpatient treatment centers will increase demand for Varian’s newest systems. Increased concerns about security offer Varian a new growth area. The company is the sole supplier of linear accelerators used in large scanners that check cars and containers for contraband as they enter the country. Varian’s stock has fully recouped the 10% decline registered during the third quarter.

Walgreen Co.

Walgreen’s reported fiscal year 2001 earnings per share of 85¢, 15% above last year’s results. Revenues were $24.6 billion, 16.1% higher than last year, while sales in stores open at least one year increased 10.5%. Prescription sales accounted for 57.5% of total sales and increased 21% over last year with sales in comparable stores rising 18%. The company’s total store count in the U.S. and Puerto Rico increased 355 to 3,520. Walgreen’s has maintained its sales momentum without interruption during the past two months. Operating difficulties and poor sales figures experienced by its principle competitor CVS has kept Walgreen’s stock price 5% below its close at the end of June.

Client portfolio holdings may change, and stocks of companies noted may or may not be held by one or more client portfolios from time to time. Investors should not consider references to individual securities as an endorsement or recommendation to purchase or sell such securities. Transactions in such securities may be made which seemingly contradict the references to them for a variety of reasons, including but not limited to, liquidity to meet redemptions or overall client portfolio rebalancing. Investing in the stock market involves gains and losses and may not be suitable for all investors. Investment return and principal value of an investment will fluctuate.

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2001 – 4th Quarter EARNINGS LETTER 2001 – 2nd Quarter EARNINGS LETTER