EARNINGS LETTER

2nd Quarter, 2003

Our financial markets are awash with liquidity. The Federal Reserve has cut short-term interest rates and simultaneously expanded the nation’s monetary base to ward off the danger of a debilitating deflation. This excess liquidity is not yet deployed in commerce and industry through increased bank lending to businesses. Instead it remains in our financial markets, where it is readily available to leverage speculative trading positions taken by professional traders at Wall Street investment firms, banks, mutual funds, and especially hedge funds.

Increased focus upon quarterly performance by the selling organizations for hedge funds and mutual funds and the consultants advising the trustees of institutions compels most portfolio managers to shorten their investment time horizon. They have become traders, not investors. If the finish line is quarterly, portfolio managers with survival instincts will learn to become sprinters not long distance runners. Security analysts who wish to remain employed will concentrate on helping the sprinters compete.

Fundamental investment analysis of the financial, operating and competitive strengths and weaknesses of a business is a poor trading tool. Skilled traders invariably distinguish between a great company and a good stock. The worst thing that can befall a trader is to believe that a trading position, especially a losing one, is a good investment. Two years of sizeable losses have done little to change most portfolio managers’ buying and selling biases. They still cling to habits ingrained during the 90’s bull market. Foremost among these is use of a single number, such as consensus earnings per share or comparable same store sales, as trading triggers. A blinkered focus on what other traders deem important is a practical solution to the exponential expansion in the volume of data disseminated daily. This flood of data makes it difficult to differentiate meaningful information from noise. Under these circumstances, investment research has become an effort to quantify the chatter surrounding short-term stock price swings. The Elliot Spitzer imposed settlement reinforces the trading mindset by requiring that investment research reports include a price target, the one thing a competent research analyst cannot know.

Institutions’ concentration on short-term performance and an increased money flow into high fee hedge funds persuade us that heightened trading by these sizeable asset pools will amplify price fluctuations caused by traders giving undue weight to meaningless news. When this news moves markets it becomes significant and alarmingly repeated. This echo effect combined with excessive trading and constant hedging frequently cause prices within market sectors to overshoot. On occasion, this may give us irresistibly high bids for stocks that we own.

More often, the gyrations caused by over trading give us opportunities to buy companies we want to own at our price. For example, speculation about the likely effects of legislative proposals for a nationwide prescription drug benefit and a congressional vote in favor of authorizing the reimportation of prescription drugs sparked sell offs in the stocks of Express Scripts, Merck and Walgreens. These legislative initiatives, if enacted, impose burdens and create opportunities for these companies and all their competitors, but these companies’ resilience and proven ability to respond to change makes them good investments now.

State Street

State Street’s second quarter operating earnings were 52¢ per share, 7% below the year ago quarter but 13% higher than the first quarter. Fee revenue rose to $894 million, including $153 million contributed by Deutsche Bank Global Securities Services (GSS) customers. Fees from State Street’s core client base rose 2%. For the first time in over a year, 75% of the new business signed during the quarter came from existing clients. Continued compression of short-term interest rate spreads reduced State Street’s net interest margin to 1.1%, even though 21% of its deposits are non-interest bearing. A year ago the net interest margin was 1.45%.

A $292 million charge to fund voluntary early retirement for 3,100 State Street employees overwhelmed State Street’s good second quarter operating results. The early retirees comprise 16% of the company’s workforce, excluding those transferring from Deutsche Bank who are primarily client relationship officers. This one-time charge slightly exceeds 16% of State Street’s salary costs for the past four quarters. These retirements will cut State Street’s future salary costs 12 ½% if the company, as planned, hires as many as 1,000 new workers with the information technology skills that the retirees lacked.

Fortunately for us as shareholders, investors’ focus during this transition year is on operating earnings and State Street’s success in retaining the customer revenues of Deutsche Bank GSS, which it acquired on January 31. At the end of July, State Street reported that it is has nearly completed the conversion of 375 of GSS’s 1,320 customers. It expects to retain 90% of all the revenues of GSS’s former customers. The 100 largest customers generated 71% of the revenues paid to Deutsche Bank, whose asset management group alone paid 28% of the total revenues. Customers that produced 5% of revenues, including the Federal Home Loan Banks, have notified State Street of their intent to move to another custodian.

In June, State Street agreed to sell its New England based private asset management business to Charles Schwab for $365 million. This sale has no effect on the services State Street provides Capital Counsel clients. Since the mid-March low, State Street’s stock has risen 33%.

First Data

First Data reported second quarter sales of $2.1 billion and earnings per share of 47¢, gains of 12% and 15% respectively. Western Union profits surged 24%, driven by International transaction growth of 27%. Money transfers from the US to Mexico rose 25%, while total consumer transactions grew 20%. Western Union’s agent distribution network reached 165,000 locations worldwide, up 27% from a year ago. Merchant services sales and profits rose 12%. Merchant transactions processed increased 25% as pin-secured debit transactions continued to gain share of consumer payments. The company’s card issuer services reported a profit drop of 18%. This business faces price reductions from existing customers and higher costs from a multi-year system overhaul needed to secure its existing customer base and to win new customers. During the quarter the company repurchased 10.7 million shares of its stock for $454 million; an average cost of $42½ per share. First Data shares have risen 21% since the March low.

Successful completion of the Concord EFS acquisition will boost FDC’s stock price. The companies filed a preliminary joint S-4 proxy registration with the S.E.C. in late May. As expected, on June 12, First Data received a second request for information from the Department of Justice. CEO Charlie Fote has indicated that the Justice Department’s view of the debit market encompasses all debit transactions, both signature and PIN-based. The definition is important because a combination of Concord’s STAR ATM debit network with First Data’s majority owned NYCE network would process two thirds of the nation’s PIN-based debit transactions but only a quarter of all debit transactions. The addition of Concord’s 7% market share of the merchant processing business to First Data’s 42% should not pose an antitrust obstacle because First Data’s Alliance structure promotes competition among its seventeen jointly-owned bank alliances. FDC estimates $230 million in annualized cost savings from the combination. The acquisition should close by year-end.

AIG

AIG’s second quarter earnings of 96¢ per share were 14% above the 84¢ earned a year ago. Property and casualty net premiums earned rose 30% above the amount earned last year, producing a 26% increase in operating income. An addition of $1.5 billion raised loss reserves to over $33 billion!

AIG’s AAA credit rating enables it to profit from the financial troubles besetting European and Japanese property and casualty insurers and their weakened reinsurers. The quarterly profits of AIG’s unmatched foreign life insurance businesses rose 14%, with premium growth in China rising 28% despite the turmoil caused by the SARS epidemic. In June, AIG agreed to purchase for $2.1 billion GE Edison Life, a profitable life insurer in Japan, which will make AIG Japan’s sixth largest life insurer. Japan constitutes 25% of the worldwide life insurance market. AIG’s U.S. life insurance business, which consists predominately of businesses acquired through American General, grew its profit 8.5% in a difficult annuity market. Operating profits from the company’s financial services businesses were 15% higher than a year ago. After adjusting for year ago receipts from a legal settlement, ILFC, the company’s aircraft leasing business, achieved a modest profit increase. AIG’s decision to increase its quarterly dividend from a miserly 4.7¢ per share to a paltry 6.5¢ disappointed many institutional investors. The company’s stock price has advanced 40% since its low, which coincided with the stock market’s March 12 low.

ADP

ADP reported weak fiscal fourth quarter and full year results. Revenues improved 4% during the quarter, to $1.9 billion and earnings per share fell 22% to 36¢. As if reduced payrolls, lower trading volumes, and lower interest rates were not enough, a $60 million restructuring charge, which equates to 6¢ per share, was expensed during the quarter. For the year, ADP revenues rose 2% to $6.8 billion and earnings per share declined 4% to $1.68. Management forecast mid-single digit revenue growth and set an earnings per share range of $1.50 to $1.60 for fiscal 2004. ADP intends to hire 200 new salespeople this year to boost new sales as it rolls out several new products.

During the year, ADP’s average daily float from clients of $9.6 billion yielded 3.9%. The prospective yield on these funds, which provides a crucial part of ADP’s compensation, has declined to 3%, as maturing investments are re-invested at lower prevailing short-term interest rates. The acquisition of ProBusiness, which closed on June 30, adds $900 million to ADP’s average daily float.

ADP’s brokerage trade processing business reported a revenue decline of 8% and a profit decline of 29% for the quarter, a slight improvement from the 39% profit decline reported for the first nine months of this fiscal year. Current average daily volumes have risen somewhat and are close to the level ADP processed last year. ADP’s Auto Dealer Services segment reported 11% sales growth and a 17% increase in profit for the quarter. ADP shares are up 36% since its low on March 13. An improved economy and higher short-term interest rates are a prerequisite for a resumption of sustained earnings growth.

Express Scripts

Express Scripts reported earnings per share of 74¢, a 21% increase over the second quarter of 2002. This quarter’s earnings included a 4¢ per share charge for the early repayment of $60.4 million of debt. Mail prescriptions and Specialty Distribution claims grew to 8.1 and 1.0 million, increases of 16% and 27% respectively over the same period last year. Specialty Distribution continues its strong growth because client health plans recognize the savings they can achieve by including expensive injectable drugs in the pharmacy benefit. The company’s operating expenses grew 21% during the quarter as management focused on achieving high service levels for the Department of Defense TRICARE mail pharmacy contract. This decision caused the company to operate two mail pharmacies in Tempe, AZ. Gross profit per claim for the quarter was 4% lower than gross profit per claim of the same period a year ago. Express Scripts plans to reduce operating costs during the second half of the year as it shifts all of its mail service in Tempe to its new facility.

Institutional investors’ and analysts’ linear extrapolation of the company’s temporarily slowing growth caused by investment in the important DoD relationship made them ignore management’s forecast of 20 to 25% earnings growth for 2003 and 2004. Express Scripts stock price has increased 28% from the March 12 market low. The stock price reached an all-time high of 75 on July15.

Merck

Merck reported second quarter earnings per share of 83¢, an increase of 8% over the same period last year. Worldwide pharmaceutical sales grew 7% to $5.5 billion. On August 5, the company announced that it will distribute 0.1206 shares of Medco Health Solutions for every share of Merck common stock on August 19. This long-awaited spin out has weighed upon the stock. Merck also expects to file two new drug applications before the end of the year: one for Arcoxia, a second-generation COX-2 inhibitor, and one for Zocor/Zetia, a combination cholesterol-reducing drug. Merck’s stock price has increased 6% from the March 12 market low.

Walgreen

Walgreen’s reported third quarter earnings per share of 28¢ and revenues of $8.3 billion. Both increased 12% over the third quarter of fiscal year 2002. Comparable store sales were up 8.2%, while comparable pharmacy sales increased 11.5% for the quarter. Walgreen’s selling, general and administrative costs were higher than planned because prescription volume growth did not offset the increased staff levels required to run the company’s 24-hour pharmacies. Walgreen’s prescription volumes have recovered, growing above 8.0% for the first two months of the fourth quarter, primarily because the company is taking share from competitors. There should be less pressure on operating profits going forward. Walgreen’s stock price has risen 5% since the market low on March 12.

Patterson Dental

On May 22, Patterson Dental reported its fourth quarter and full year results for the fiscal year ending April 26, 2003. A 17% increase in revenues during the year yielded net earnings per share of $1.70, a 19.8% advance. Patterson’s management set an earnings goal for fiscal 2004 of $2.00 to $2.02 per share, a credible objective given their concentration upon good execution of attainable business plans.

Patterson is North America’s largest distributor of dental equipment. Its sales are twice the size of its nearest competitor. Equipment sales, which grew 22% during the year, were spurred by verifiable improvements in patient care and office productivity as well as tax benefits directed toward small businesses, such as dental practices. Patterson’s stock has advanced 23% since the market low with all the gain coming after the earnings report.

Harte-Hanks

Harte-Hanks reported second quarter revenues of $233 million, up 2%, and earnings per share of 26¢, up 4%. A substantial increase in capital spending reduced free cash flow 25% to $22 million. During the quarter the company repurchased 1.1 million shares for $19 million. Direct marketing operating profit fell 13% on flat revenues. Lower prices paid by customers continued to erode profits. Management’s continued focus on costs is expected to result in some margin improvement during the next two quarters. Retailers and financial service customers continued to spend less with the company while high-tech/telecom, pharmaceutical and automotive companies increased spending. Harte-Hanks Shoppers turned in another solid quarter with revenues and operating income growth of 6%. The company increased circulation by 85,000 households during the quarter. Management forecast earnings per share for 2003 above the 96¢ reported last year. Harte-Hanks stock has risen 10% since the March low.

Reed Elsevier

Reed Elsevier reported first half revenues of $3.775 billion, up 6%, and earnings per American Depository share of 62¢, up 15%. On an operating basis, at constant exchange rates, revenues were flat with a year ago and profits rose 3%. Revenue and profit gains in Science & Medical and Legal, which generate two-thirds of total profit, were offset by downturns in Business and Education.

Elsevier’s Science & Medical journal business reported revenues up 6% and profit up 5%. The operating margin remained strong, coming in at 33.9%. Subscription renewal rates remain at 96%. Reflecting growing online usage, total article downloads during the past 12 months have nearly doubled from the prior year. Lexis-Nexis reported a 17% profit gain as revenues rose 4%. Online sales growth of 7% helped boost the operating margin to 20.7%. Reductions in state education budgets and the loss of the state of California educational testing contract hurt Harcourt Education. Revenue declined 5% and profit fell by one-third. The majority of Harcourt’s revenue and profits, however, come in the second half when most schools purchase textbooks. Since the beginning of the year, Harcourt has won contracts from 7 of the 11 states which put their testing business out for rebid. Reed Business trade magazines and exhibitions reported revenue and profit declines of 6% and 12% respectively. While the rate of decline in Reed’s advertising markets has slowed, there is no sign of a broad recovery. Reed Elsevier management reported that the company is on track to achieve its full year target of double-digit operating profit growth, excluding the impact of changes in foreign currency exchange rates.

CH Robinson

CH Robinson reported strong second quarter results with gross profit rising 12% to $136 million and earnings per share rising 17% to 34¢. Robinson’s core trucking revenues increased 10%, while intermodal revenues, which utilize freight rail transportation, surged 42%. Rail transport has become a larger portion of Robinson’s customers’ shipments as rail service reliability has improved and relative costs have declined. Combined air and ocean revenue rose 22% boosted by growth in international forwarding after the company opened its first office in Hong Kong. Sourcing, the buying, transportation and sale of fruits and vegetables, improved 6%. The T-Chek transportation payment and information management system generated a 12% increase in revenues on a similar rate of transaction growth. Reported operating leverage during the quarter was reduced somewhat by an expense accrual for anticipated restricted stock grants of one million shares to vest over a five year period. Robinson’s stock price is up 20% since the low in March.

PepsiCo

Excellent volume and revenue growth of Pepsico’s Frito-Lay Snack and International businesses led to earnings per share of 58¢, a 19% increase over the same period last year. Division net revenues increased 7% to $6.5 billion. Volumes of better-for-you snacks such as granola bars, toaster pastries and fruit snacks increased 28% in the quarter. Pepsico’s International division’s revenues and operating profit grew 10% and 14% respectively with both snack and beverage volumes growing 6%. The company’s domestic beverage business delivered improved growth over the first quarter with volumes of non-carbonated drinks posting an 8% volume gain. Volumes of carbonated soft drinks grew 3% because weakness in trademark Pepsi sodas partially offset the strong volume gains of Sierra Mist and Diet Pepsi. Pepsico’s stock price has increased 20% from the March 12 market low and posted a 12-month high of 48 on July 16.

Intel

Strong sales in the Asia/Pacific region and of Centrino ™ mobil technology systems pushed Intel’s second quarter revenues up to $6.8 billion, an increase of 8% over the second quarter of 2002. Earnings per share were 14¢. For the first time, sales in the Asia/Pacific accounted for 40% of revenues, with microprocessors and chip sets being used for local consumption and for products designed for export. During the third quarter, the company expects to ship more than two million Pentium® M microprocessors in Centrino™ units for the back-to-school season. The company announced that gross margins for the third quarter and 2003 would increase from 51% to 54%. This forecast, based on projected revenue growth and increased capacity utilization, sent the stock price to a 12-month high of $25.50. Intel’s stock price has risen 55% since the March 12 market low.

Microsoft

Microsoft reported fourth quarter and fiscal year 2003 revenues of $8.1 billion and $32.2 billion, increases of 11% and 13% respectively. Earnings per share were 18¢ for the quarter and 92¢ for the fiscal year. Both numbers include a 5¢ per share charge associated with the legal settlement with AOL Time Warner. All seven business units reported double-digit revenue growth for the quarter. During the quarter Microsoft launched the Windows Server 2003 family of products, which are already seeing strong adoption. The company will not increase its cash distributions to shareholders until the company has more clarity about its outstanding legal issues. Microsoft’s stock price has risen 12% since the March 12 market low.

Amdocs

Amdocs, a leading supplier of billing and customer care systems to large global communications services providers, reported earnings per share of 21¢, compared with a net loss of 12¢ per share in the third quarter of fiscal year 2002. Revenues for the quarter were $377 million, an increase of 6% from the second quarter and 1% less than the same period a year ago.

Amdocs has reorganized both its organization and its product offering since it announced a steep decline in new contracts in April 2002. The company decreased its staff by 1,000 by September 30, 2002, resulting in annual savings of $30 million per year. In response to cost-containment strategies of all of its customers, Amdocs shifted its marketing strategy from providing customized billing solutions to offering component-based products with open architecture. Communication service providers may purchase the new Enabler® billing engine and Clarify® CRM software as stand-alone products that can be deployed in two to three weeks, or as a customized billing system. Customers can also outsource their billing system to Amdocs.

Two large wireless providers, Cégétel in France and Sprint PCS in the U.S., have chosen Amdocs’ convergent billing and CRM platform for their 13 and 18 million customers respectively. After successfully managing the migration of Bell Canada’s 150 separate billing systems to the Enabler-Clarify platform, Amdocs purchased Bell Canada’s share of its joint venture in July. Amdocs will provide one bill for wireline, wireless, data and satellite services in an outsourcing contract that will generate $250 million annually through 2010. With a research budget of $100 million per year, Amdocs is well positioned to meet its customers’ needs to support new services as telecommunications capital spending revives. Amdocs’ stock price has increased 63% since the March 12 market low. The stock price reached a 12-month high of $27 on July 15.

Varian Medical Systems

Strong performance in all business segments for Varian Medical Systems resulted in earnings per share, revenue and order growth of 41%, 23% and 14% respectively for the third quarter of fiscal year 2003. The earnings per share figure includes a 2¢ gain from a one-time tax refund. Nine North American medical facilities placed orders for two or more radiation systems during the quarter, including the M.D. Anderson Cancer Center’s $16.8 million order. With 364 sites using Varian’s advanced radiation systems, customer focus has shifted to Image-Guided Radiation Therapy (IGRT). These next-generation technologies will allow oncologists to target cancerous tissue more precisely and with higher doses of radiation while protecting healthy tissue nearby. Varian’s stock price has increased 24% since the March 12 market low.

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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2003 – 3rd Quarter EARNINGS LETTER 2003 – 1st Quarter EARNINGS LETTER