EARNINGS LETTER

3rd Quarter, 2003

The coming Presidential election already has begun to influence our financial markets. We draw this conclusion from the effect exerted by releases of preliminary, but politically charged, U.S. Government statistics, such as the payroll employment figures. The U.S. economy is improving, but the preliminary estimate of 7.2% GDP growth during the third quarter probably will be revised downward.

All these initial numbers are subject to several revisions. For example, the initial employment number for September reporting an addition of 57,000 jobs has subsequently been revised upward to 125,000. The swing in the August number from an initially reported decline of 41,000 to a revised gain of 55,000 shows how preliminary “preliminary” is. Market strategists and portfolio managers undoubtedly know these numbers are flawed but react nonetheless because the Bush administration has shown a determination to use every available economic lever to beat opponents’ charges of economic ineptitude and insensitivity for presiding over a jobless recovery. Treasury secretary, John Snow, recently reinforced the political importance of payroll employment numbers by predicting that the success of the administration’s economic plan would produce 200,000 new jobs a month during 2004. That’s politics!

Our stock market, since the start of its rise from the mid-March low, has been dominated by a short-term trading mentality. Institutional portfolio managers willingly pay premiums to buy stocks whose prices are outperforming the market. Many rely on variants of simple trading tools, such as calculations of relative strength, which measures numerically how a stock moves relative to the market or to the stocks comprising its sector. This measurement is one of the basic tenets of technical analysis. A short-term focus increases reliance on chart patterns and other forms of analyzing past stock price movements, which impart to certain stock prices a determinative effect that impels those investors using these techniques to buy or sell. As market participants begin to trade on the macroeconomic implications of election year pronouncements by the administration or legislative initiatives by its adversaries, it is likely that stocks in many sectors will break through crucial price points on their charts. A few whose charts break down may be stocks we want to own. When this happens we are prepared to accept these gifts from Mr. Market.

State Street

State Street’s strong third quarter earnings growth propelled the stock back above $50 for the first time since 2002. It is up 30% since the beginning of the year. Reported earnings of 65¢ per share, 20% higher than last year’s quarter and 25% above the previous quarter’s earnings, appeared to dispel the doubts of those who questioned State Street’s ability to secure renewed sustainable earnings growth through its acquisition of Deutsche Bank’s worldwide custody business. On November 4, State Street confirmed that it had retained 88% of Deutsche Bank’s previous customer revenues. Assets under custody now exceed $8.7 trillion.

Revelations about mutual fund managers’ unethical and illegal trading practices have left State Street unscathed, although five of the fund groups cited are customers. The initial effect of the scandal has been an increase in State Street’s transition management business as public pension funds change advisors. Some of this business has moved into State Street’s index funds.

AIG

AIG’s third quarter earnings of 98¢ per share were 15% above the 85¢ earned a year ago. Property and casualty net premiums earned rose 34% above the amount earned a year ago. This resulted in a 47% increase in operating income after AIG added $2 billion to its net loss reserves. AIG has obtained a 25% average rate increase for covering casualty risks. Increases for directors and officers liability range from 55% to 88%! Operating profit at AIG’s foreign life insurance business rose 15% on a 14% increase in premiums earned. Life insurance premiums in China grew 38%.

We are puzzled by the sluggish performance of AIG’s stock price, which has risen less than 1% this year. During the first nine months of 2003, AIG’s retained earnings have increased $5.7 billion or 11% after it added $4.7 billion to its insurance reserves and paid $2.1 billion to acquire GE Edison Life in Japan. In our opinion, AIG remains the best avenue for investment in the revival of Japan and the emergence of a prosperous middle class in China.

First Data

First Data reported third quarter sales of $2.14 billion and earning per share of 49¢, gains of 10% and 9% respectively. Western Union revenue and profit rose 14%, as worldwide agent locations rose 25% to 169,000. Consumer-to-consumer money transfer transactions rose 18%, driven by 24% growth in international money transfers. Revenues and profits from the company’s merchant processing of electronic credit and debit card payment transactions rose 12% and 10% respectively. Total merchant transactions processed reached 3.275 billion during the quarter, up 26%, as consumer use of debit cards continues to surge. Profit from FDC’s credit card issuing business declined 25% due to higher costs and lower fees per card.

On October 23, the Justice Department sued to block FDC’s planned merger with Concord citing the dominance the combined companies would have in processing online debit card transactions. A trial date is set for December 15 with a ruling from the judge scheduled for early January. If the ruling is adverse, we expect First Data will seek to renegotiate the terms of the merger to compensate for the business consequences arising from divestitures required to complete the merger. The uncertainties occasioned by the merger have kept First Data’s stock price gain to only 4% this year.

Merck

Merck reported third quarter earnings per share of 83¢ on revenues of $5.8 billion, 6% increases over the third quarter of 2002. With the successful spin-off of Medco Health Solutions completed, the core pharmaceutical business now accounts for all of Merck’s revenues. Sales of the company’s five key drugs grew 7% during the quarter, but Merck reduced its optimistic revenue forecasts for Fosamax and Singulair by $100 and $50 million respectively.

The company announced two initiatives that will reduce forecasted 2003 earnings per share from about $3.20-$3.27 to $2.90-$2.95. It has renegotiated its distribution program to eliminate speculative buying by distributors in advance of price increases. Merck will reap manufacturing efficiencies from the change as demand for its products will better reflect patient use. The new policy, which starts on December 1, will decrease revenues for the fourth quarter by $650 to $700 million as distributor inventory levels drop from a high of two months to two weeks. Merck also announced that it will lay-off 3,200 full-time and 1,200 temporary employees during the next six months to reduce ongoing operating costs by $250 to $300 million. Ray Gilmartin, Merck’s CEO, expects increased pressure on drug prices as competition to obtain preferred positions on managed care formularies increases and payors expect more value from new drugs. Merck’s core pharmaceuticals gross margin has held steady at 82% since the company began reporting it in 2002, so pricing pressure has not yet affected profits.

Merck’s stock price has declined 18% since the beginning of the year. The decision to lower its 2003 earnings guidance and restructure the organization in addition to concern about the impact of drug re-importation from Canada have reinforced the conventional wisdom that Merck’s earnings growth will remain lackluster for the next two years.

Express Scripts

Express Scripts reported third quarter earnings per share of 81¢, an increase of 21% over the third quarter of 2002. Gross profit, selling, general and administrative expenses declined because the company no longer accepts payments from pharmaceutical companies for drug switches. The decision to stop accepting drug manufacturer payments has helped Express renew all 10 of its top 50 clients whose contracts were up for renewal. Mail pharmacy claims rose a healthy 16% to 8.2 million during the quarter, but the gross margin was lowered by a decision to keep a second mail pharmacy in Tempe, AZ running to ensure excellent service to military personnel, their families and retirees covered by its new DOD contract. A 92% satisfaction level for plan participants helped Express win another DOD contract to provide retail pharmacy service for 2.5 million DOD beneficiaries. This $245 million 5 year contract was the largest contract open to competitive bids in 2003. The company’s stock price has increased 17.5% since the beginning of the year. The stock reached a high of $75 in July before analysts lowered their growth forecasts by extrapolating from two quarters of lower margins and factoring in concerns about the role for PBMs in a Medicare drug benefit. The company publicly stated that its earnings goal remains 20-25% growth during 2004.

ADP

ADP reported 4% revenue growth for its fiscal third quarter and an earnings per share of 32¢, a decline of 6%. The company’s Employer Services division, which produce 80% of the company’s profit, reported a 10% revenue gain. Client retention remained strong though new client sales were 4% lower than a year-ago. Client payrolls were down less than one half of one percent. Wage growth and the addition of client balances from acquisitions boosted the float from client funds to $9.2 billion, up 19.5% from $7.7 billion a year ago. ADP’s Brokerage Services revenues declined 13% due primarily to fewer trades processed and fewer mailings of investor communication by mutual funds. ADP Dealer Services revenue rose 8%. ADP shares have declined 2% since the start of the year. The shares will move higher as payroll jobs increase and expectations of rising interest rates build.

The Chicago Mercantile Exchange

The Chicago Mercantile Exchange reported third quarter net revenue growth of 8% to $135 million and earnings per share of 93¢. Average daily volume on the exchange increased 8% to 2.6 million contracts, while electronic trades rose 29% to 1.2 million contracts daily, representing 45% of total volume. Transaction fees in all major categories rose during the third quarter. Interest rate contracts, which account for 37% of transaction fees, rose 3%, while stock index products, which produce 46% of fees rose 2%. Foreign exchange contracts now generate 15% of fees, 50% more than a year ago.

On November 14, the Chicago Mercantile Exchange priced a secondary offering of 2.1 million shares of common stock at $67.00 per share. These shares constitute one-third of the shares eligible to be sold at this time by existing member shareholders. After the offering 28% of the Class A shares are publicly held.

Harte-Hanks

Harte-Hanks reported third quarter revenues of $239 million, up 6% and earnings per share of 26¢, up 8%. Free cash flow of $21 million declined 14% from a year earlier primarily due to increased capital expenditures. The company’s direct marketing business reported the first year over year improvement in operating cash flow, after two years of quarterly declines. These third quarter results come one year after the company reported a 19% drop in cash flow at the direct marketing unit. Harte-Hanks reported gains in high-tech, telecom, healthcare and pharmaceutical client segments, offset by weakness from retail and financial services clients. The Shopper business reported a strong revenue gain of 7% but operating cash flow grew only 1%. The operating margin was hurt by higher worker compensation costs in California. Harte-Hanks shares have risen 11% this year.

CH Robinson

C.H. Robinson reported third quarter net revenue growth of 10% to $136 million. Earnings per share rose 13% to 34¢. Revenues from Robinson’s core truck business rose 9%, while revenues from intermodal and air freight rose 37%. Sourcing, the buying, transport and sale of fruits and vegetables, rose 7%. Strong volume gains from large retailers, such as Wal-Mart, and foodservice providers were offset by a continued decline from produce wholesale customers. Cash continues to build on Robinson’s balance sheet, rising to $178 million at September 30, from $133 million on December 31, 2002. The company has no debt. CH Robinson stock has risen 30% this year.

Varian Medical Systems

Strong demand for Varian Medical Systems new radiation therapy products led to another year of record earnings and revenues. Earnings per share for the fourth quarter and fiscal year 2003 were 61¢ and $1.84 respectively, increases of 27% and 38% over the same period last year. Annual revenues exceeded $1 billion for the first time, a 19% increase over fiscal year 2002. Quarterly sales of oncology systems increased 18% to $256.8 million. Sites equipped to perform IMRT reached 472 in 2003, more than twice the 188 sites operating in 2002. Proposed cuts in U.S. Medicare reimbursement rates for radiation therapy did not affect ordering activity in the fourth quarter. Varian is moving ahead with Dynamic Targeting™ image guided radiation therapy (IGRT), which adjusts for the movement of tumors, making it possible to target tumors more precisely. This technique also may make it possible to eradicate tumors that were previously untreatable with radiation. Varian’s stock price has increased 33% since the beginning of the year. It reached an all-time high of $67.88 on October 31.

Walgreen

Investors are beginning to see the results of Walgreen’s investment in twenty-four hour stores, improved inventory management systems and high levels of customer service. The addition of 1,112 twenty-four hour pharmacies and better in-stock levels increased customer traffic. Quarterly and annual revenues reached record highs while the company experienced lower prices for generic drugs and front-end merchandise. Revenues for the quarter and the year were $8.2 billion and $32.5 billion, up 14% and 13.3% respectively. Earnings per share for the quarter and fiscal year grew 12% and 14% to 27¢ and $1.12, respectively. Pharmacy sales for the year grew 17%, 13.7% on a comparable basis. With nationwide pharmacy sales up 11.3% for the year, Walgreen’s has taken share from its competitors. September and October pharmacy and front-end sales were twice those of CVS, its best competitor. Walgreen’s stock price has increased 24% since the beginning of the year.

Patterson Dental

Patterson Dental’s first quarter earnings increased 17% to 43¢ over the first quarter of fiscal year 2003. Revenues increased 12% to $433 million over the same period. North American dental supply sales rose 9% during the quarter to $281 million. Strong demand for digital radiography and in-office dental restoration systems increased equipment and software sales by 18% over the first quarter of last year. Patterson is addressing slow dental consumable sales growth of 5% for the quarter by adding new territory sales representatives and new sales and marketing programs to help experienced sales people increase sales with existing customers.

On September 15, Patterson completed its acquisition of AbilityOne Products, a leading distributor of non-wheelchair rehabilitative medical supplies and assistive products for $575 million. With expected 2003 sales of $220 million, AbilityOne is the primary source of rehabilitative supplies for physical and occupational therapists. This market is growing 6 to 8% per year as aging baby boomers seek help to remain active. The company offers its fragmented market 15,000 products from over 1,500 suppliers through a well-regarded catalogue and the largest direct sales force in the industry. Patterson’s stock price has increased 55% since the beginning of the year and reached a new high of $71.50 on November 13.

Johnson & Johnson

Johnson & Johnson reported third quarter earnings per share of 69¢, an increase of 15%. Revenues for the quarter were $10.5 billion, an increase of 15.2% over the same period last year with currency contributing 3.5% of the growth. The Medical Devices and Diagnostics segment achieved sales of $3.8 billion for the quarter, an increase of 20.3% with 4.0% coming from currency. In its first full quarter of sales, the CYPHER™ drug-eluting stent achieved sales of $429 million and was used in 45% of all coronary angioplasty procedures performed in the U.S. Worldwide pharmaceutical sales increased 13% to $4.8 billion with growth in sales of Topamax, an anti-convulsant, Remicade, a treatment for rheumatoid arthritis and Crohn’s disease, and Duragesic, ALZA’s patch for chronic pain. Procrit sales declined because of increased competition from Aranesp, Amgen’s second generation erythropoetin. Industry data, however, suggests that Procrit’s sales have stabilized in the U.S. with Procrit accounting for about 70% of injectable erythropoetin sales for the dialysis, pre-dialysis and oncology markets. Strong sales of SPLENDA, a sweetener, and AVEENO skin care products drove sales of the Consumer Products division up 10.8% to $1.8 billion with currency contributing 3.4% to the growth.

Johnson & Johnson’s stock price has declined 9.1% since the beginning of the year. The stock hit a 52-week low on October 29 when investors rushed to sell because of an FDA advisory about reported adverse events for the CYPHER stent. In fact, the adverse event rates for this stent are well within the established guidelines for bare metal stents while offering significant reduction in re-blockage of cardiac arteries.

Microsoft

Stronger than expected consumer sales for Microsoft Windows XP resulted in first quarter fiscal year 2004 earnings per share of 30¢, an increase of 20% over the same period last year. These figures do not include equity compensation costs of 6¢ per share in the first quarters of both 2003 and 2004. Revenues for the quarter grew 6% to $8.2 billion. Sales of Microsoft’s server software products grew more than 10% during the quarter. Since the April launch twice as many copies have been purchased compared with Windows Server 2000. MSN advertising revenues increased 51% over the first quarter of 2003 and the company expects to see operating profits from this division during the current fiscal year. Microsoft launched the new version of Office on October 21 with good reviews from evaluators who have generally recommended against installing earlier upgrades of Office. Unearned revenues decreased $768 million from June 2003 because multi-year contract billings declined. The company overestimated the number of contracts that would be signed during the quarter, and the Blaster virus focused the attention of Enterprise customers and sales representatives on security issues rather than on new business. Microsoft has not yet participated in the tech stock rally. Its stock price has risen 1% since the beginning of the year.

Amdocs

Amdocs reported fourth quarter and fiscal year earnings per share of 21¢ and 82¢. Revenues for the quarter of $412 million increased 9.2% from the previous quarter and 15.8% over the fourth quarter of fiscal year 2002. Revenues for the year were $1.5 billion, down 8.1% from last year. Amdocs increased its presence in Asia with new contracts in Taiwan and Japan. FarEasTone, a wireless service provider in Taiwan with 4.3 million subscribers, chose the Enabler billing software to replace five billing systems from five different vendors. One of Japan’s major wireline companies selected Amdocs’ order management system to reduce time-to-market for advanced data services. Amdocs teamed with IBM to win this contract. The company successfully integrated the operations of its two newest outsourcing customers, Bell Canada and SBC’s online directories, and met service levels and profitability targets. Amdocs’ stock price has risen 11% since mid-July.

Intel

Intel’s third quarter revenues were $7.8 billion, up 20% year-over-year. Earnings per share of 25¢ jumped 150% from the third quarter of 2002. Record shipments of microprocessors and chipsets and lower operating costs drove the quarter’s gross margin to a startling 58%. The Asian markets for microprocessors and chipsets remained strong with revenues above $3 billion for the quarter, a 31% increase year-over-year. Strong notebook sales in Europe also contributed to revenue growth. Intel’s stock price has increased 118% since the beginning of the year. It reached a 12-month high of $34.51 on November 7.

PepsiCo

Strong performance in all three of PepsiCo’s divisions contributed to third quarter earnings of 62¢, an increase of 14% over the third quarter of 2002. Revenues grew 9% to $6.8 billion. Frito Lay’s net revenue and volume grew 7% and 4%, respectively with strong performance from line expansions in core brands Cheetos, Lays and Doritos. Volume growth of Better-for-You snacks’ sales volume grew 25% during the quarter. PepsiCo beverages posted 6% net revenue growth and 4% volume growth supported by strong growth in diet sodas and the introduction Pepsi Vanilla and Diet Pepsi Vanilla. PepsiCo International delivered 10% revenue growth with international snack and beverage volumes up 10% and 17%, respectively over the third quarter of 2002. PepsiCo’s share price has increased 12.5% since the beginning of the year.

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 – 4th Quarter EARNINGS LETTER 2003 – 2nd Quarter EARNINGS LETTER