EARNINGS LETTER

1st Quarter, 2004

Our Stalling Stock Market

Your companies’ strong first quarter earnings reports in many instances resulted in little appreciation in their stock prices and in few cases caused a decline. Believers in efficient market theory, which postulates that stock prices always reflect all the relevant information about companies’ prospects, would assert that the earnings gains were fully discounted before the reports were released. We think the reaction reflects a supposition among institutional portfolio managers and leveraged speculators that the greatest percentage earnings gains attainable this year for U.S. companies occurred in this quarter. This belief eliminates earnings momentum as an impetus for buying all but a few stocks.

Ever since the Fed announced, following its May 4 meeting, that it intended to raise short-term interest rates at a measured pace, financial markets worldwide have reacted to the prospect of higher rates. The Fed statement rightly is taken as an explicit warning to funds and financial institutions to unwind their leveraged carry trade positions which consist of holdings in longer dated fixed income securities financed with short-term borrowings. This unwinding has caused a fall in U.S. and European bond prices. It also has disrupted the market for junk bonds and emerging market debt. We think the measured interest rate tightening signaled by the Fed will affect the financial markets far more than the rest of the U.S. economy. Businesses borrow when they can make more money, not because interest rates are low. Interest rate futures currently indicate nearly a ¾ % increase in the Fed Funds rate by year-end. Not only bond prices but stock prices as well have adjusted to the changing interest rate outlook. Higher interest rates are subsumed in most computerized financial models used to evaluate stocks, which partially explains why most stocks have stopped going up. The S&P 500 is up only 1% so far this year.

The prospect of higher rates comes as the U.S. economy has added over 200,000 net new jobs for four successive months, amazingly validating Treasury Secretary John Snow’s forecast which we debunked. The U.S. economy’s capacity for non-inflationary growth at a 4.5% rate for the remainder of this year after a 5.5% expansion during the first quarter of 2004 depends upon the accuracy of the reported productivity figures often cited by Mr. Greenspan. He knows that the productivity numbers are high if employment has been undercounted. Both these figures, like most economic statistics, are guesstimates. Renewed inflation may be in the offing.

If the published economic statistics provide a reasonable approximation of what is happening now in the U.S. economy, the strength of the expansion underway will not be undermined by gradually rising interest rates, persistently high oil prices or the outcome of a contentiously close election. We think a focus on where we are, rather than preoccupations with forecasts, improves our chances of seeing what might happen next in these changing times. Although a lessening of the fiscal and monetary stimulus that helped fuel our expansion may be bungled by political considerations, we believe the operating efficiencies gained by your companies through the downturn and the arduous recovery assure good execution of sensible business plans for sustainable growth as economic conditions change. The recurrence of times such as these is the reason for owning well-managed companies.

State Street Corporation

State Street’s stock price declined 8% during the five trading days following the announcement of strong first quarter results. The stock has yet to rebound, leaving it 7% below $52, its price at the start of the year. With first quarter earnings per share of 67¢, 56% above earnings for the year ago quarter, the stock price decline makes one wonder what is going on. State Street fee revenue grew 31% during the quarter. Net interest revenues which contribute 18% of overall revenues were unchanged. Although an increase in interest rates may temporarily tighten State Street’s net interest margin, it cannot explain the stock’s weakness.

Disappointment with State Street’s apparently good results comes from their absence of any favorable operating leverage. Most analysts and portfolio managers have focused to the exclusion of all else on operating leverage in assessing most companies’ first quarter results. State Street’s first quarter operating expenses were 13% higher than its fourth quarter spending while revenues rose only 6%. Employee compensation and benefit expenses were up 6% and occupancy costs rose 15%. Although occupancy costs will fall as some existing leases expire, escalating costs create the impression that State Street is spending to prepare for business it may get in the future. This view makes State Street’s current exclusive negotiations with AXA Investment Managers to provide outsourced services for $330 billion of European assets seem more risky than it is. The successful acquisition of Deutsche Bank’s custody business, which is 70% converted and profitable, makes State Street the largest custodian of institutional assets in Europe with 17% of collective funds and 11% of the pension assets. Added business from AXA, the largest asset manager in France, will spread more transactions across State Street’s infrastructure in Europe which will help lower unit costs. State Street, like all information technology based processors, must lower its transaction costs 5-15% annually to maintain operating margins. The required cost savings falls when State Street sells more added services to its expanding customer base.

American International Group

AIG’s first quarter earnings of $2.8 billion or $1.08 per share, 20% above last years quarterly results before an accounting charge evoked no positive response from investors. The muted reaction is attributable partly to AIG’s confirmation that the escalation in property and casualty insurance rates has ended. The other factor is fear that the pending upturns in interest rates will crimp financial companies’ earnings growth, including AIG’s. We consider this fear groundless given AIG’s proven skill in selecting and pricing risks even as the inflation of insurance claims continues unabated. AIG’s stock price is up 6% since the start of this year.

During the first quarter, AIG’s property and casualty earnings were $1.5 billion, 37% above the year ago results. These excellent earnings contributed 36% of AIG’s overall quarterly earnings and were achieved after a $2.1 billion addition to the company’s loss reserves. AIG’s combined ratio, a measure of underwriting profitability was 93.2%. The company’s life insurance operations, which produce 49% of total earnings, earned 24% more than the last year ‘s first quarter profit. A 40% increase in U.S. and international sales of fixed annuities along with a 48% increase in institutional sales of fixed annuities and a 48% increase in international sales of individual accident and health insurance helped propel growth. During the quarter life insurance sales in China and Japan rose 54% and 49% respectively.

Chicago Mercantile Exchange

Increased geopolitical uncertainty, anticipation of higher U.S. interest rates and a rise in equity market volatility combined to propel futures contract volume at the Chicago Mercantile Exchange. Average daily volume was 2.83 million contracts, up 19%, as interest rate, equity index and currency futures rose 26%, 12% and 48% respectively. Transactions executed electronically via Globex grew 29% and accounted for forty-eight percent of total volume, four percentage points higher than a year ago.

Total revenues rose 32% while total expenses increased only 8%. The operating margin expanded from 34.7% a year ago to 46.5% in the current quarter. This operating leverage inherent in CME’s business model, lifted earnings per share to $1.35, 75% higher than a year earlier. The company ended the first quarter with more than $13 per share in cash and marketable securities. The factors leading to CME’s strong first quarter remain in place. Futures contract volume in April and May was 21% above the first quarter level and 31% higher than the level achieved one year ago. CME’s stock price has leapt 78% since January 1.

On June 4, the final lock-up on CME’s member owner shares will expire, representing about one-half of the shares outstanding. These owners have previously sold 5 million shares, about one-fifth of their ownership. We expect additional shares to be sold, but do not foresee a stampede.

First Data Corporation

Following the completion of its acquisition of Concord EFS on February 26th, First Data reported increases in revenue and operating earnings per share of 14% and 16% respectively. Fifty-seven percent of the revenue gain was generated internally, while Concord’s results, from the date of acquisition, contributed 43%. Western Union consumer money transfer volume rose 20% overall, driven by international money transfer growth of 25%. The number of Western Union locations worldwide reached 188,000, up 18% from a year ago. During the quarter, FDC processed a record 3.8 billion merchant credit and debit transactions, up 45%. With the addition of Concord’s STAR debit network, the company is positioned to reap greater profits from the continued shift in consumer payments from cash and checks to PIN-based debit transactions.

FDC’s card issuing business reported improved profitability during the quarter as cards processed reached nearly 400 million. Concord’s 17 million PIN-based debit cards were added during the quarter. FDC converted 29 million retail cards onto its system and has an additional 41 million retail cards in the pipeline scheduled for conversion by year-end. BankOne’s plan to move its 50 million VISA bankcards by year-end could be delayed as a result of their agreement to merge with JP Morgan Chase. The combined company has 95 million credit and debit cards, all currently processed by First Data. A decision to process all of these cards in-house would diminish the profitability of FDC’s card processing business. Since First Data completed the acquisition of Concord on February 26, FDC shares have risen 6%.

Automatic Data Processing

ADP’s fiscal third quarter revenues rose 11%, the first time in three years that growth reached double-digits. Earnings per share of 50¢ were 7% below the level achieved a year ago. Despite a 28% increase in average client fund balances to $13.3 billion, interest income earned declined 3% as a result of lower short-term interest rates. An immediate one percent increase in interest rates would boost ADP’s annual pre-tax profit by $44 million, or about 5¢ per share. Brokerage services profits continued their recent rebound after several weak quarters as investor communications mailings and trading volumes processed rose 25% and 22% respectively. Reflecting investor anticipation of higher short-term interest rates and reports of more jobs in the U.S., ADP shares have risen 12% this year.

Merck & Company, Inc.

Merck’s first quarter earnings per share rose 7% over the first quarter of 2003 while revenues rose 1%. Sales outside the U.S. accounted for 42% of total revenues with international sales of Fosamax and Vioxx rising more than 30% above those of the first quarter of 2003. The company continues to fill its pipeline with late-stage in-licensed products. On April 28, Merck and Bristol Myers Squibb announced that they will jointly develop and co-promote a diabetes drug in Phase III trials with a similar mechanism of action to the diabetes drug that Merck stopped developing last October. Merck’s stock price has increased 2% since the beginning of the year.

Express Scripts, Inc.

Express Scripts’ first quarter earnings per share grew 20%, and revenues rose 13% over the same period last year. The company completed the integration of CuraScripts, a large specialty pharmacy services company, during the quarter. A combined sales team has already seen increased interest in Express Scripts’ specialty pharmacy services in client meetings. Express Scripts’ received a $1 million incentive payment from the Department of Defense for attaining a 97% beneficiary satisfaction rating for the TRICARE mail program. This is the third consecutive quarter that the company has earned an incentive payment under this contract. Express Scripts’ stock price has risen 18% since the beginning of the year. We believe that Express Scripts is fairly priced, but the stock price will remain volatile as traders react to news about the progress of the Medicare drug benefit and political rhetoric about prescription drug pricing.

Colgate-Palmolive, Company

Colgate’s sales growth during the quarter was 7% on 3% volume growth and favorable foreign exchange translations of 5%. The divesture of its European laundry detergent business and lower product prices reduced sales growth by 1%. Diluted earnings per share rose 5%. Free cash flow rose 11% as the company continued to reduce working capital as a percent of sales. Colgate’s after-tax return on capital was 36.2%, 0.9% above the level achieved one year ago. Colgate has accelerated its investment in product support, leading to a 14% spending increase to support its brands. Colgate’s U.S. toothpaste share reached 34.3% during the quarter according to ACNielsen, three points ahead of P&G’s Crest. Colgate shares are up 14% since the beginning of the year.

Pepsico

Worldwide volume increases of 7% for snacks and 8% for beverages resulted in revenue and earnings growth of 11% and 15% for PepsiCo during the first quarter of 2004. The company reported strong growth in both core brands such as Pepsi, Aquafina and Lays Classic potato chips and in innovative products including Rollitos (rolled tortilla chips) and Gatorade X-Factor. International operations achieved balanced growth across all regions and businesses with snack volumes up 10% and beverage volumes up 13%. PepsiCo’s stock price has risen 15% since the beginning of the year, reaching a five-year high of $54.95 on April 23. We will hold this stock as PepsiCo’s able senior management continues to invest strategically to grow both its core brands and new products throughout the world.

Harte-Hanks, Inc.

Harte-Hanks has been a good investment over the years. This year the stock is up 7%. Since the IPO in November 1993, Harte-Hanks shares have risen six-fold, compared to a 150% increase for the S&P 500. Harte-Hanks first quarter revenues, earnings per share and operating cash flow rose 9%, 17% and 8% respectively. Free cash flow generated during the quarter was flat with a year ago. The company’s shopper publications expanded revenues and cash flow by 12% and 16% respectively. Direct marketing revenues rose nearly 8%, the highest year over year gain in more than four years. Higher costs to secure new contracts from new and existing customers, however, brought the segment operating margin down again this quarter to 14.7%, a five year low.

After much thought and analysis about the causes for the continued margin deterioration in direct marketing, we conclude that two factors are impeding a resumption of growth. The first is the shift in the command of the use of information in direct marketing. The result is an empowered customer and a weakened provider. This irreversible change means that Harte-Hanks is obliged to price separately each step of their involvement in a customer’s marketing campaign. As a consequence their margins get whittled away unless their managers are numerically savvy about pricing and then repricing their proposals. Unfortunately this is where the second factor hits home with Larry Franklin’s decision to relinquish his job as CEO. Twice yearly he used to review rigorously the budget of every division in scheduled meetings with the operating managers. He then personally examined their monthly financial results with them. He inspired managers to understand the financial intricacies of their business. Harte-Hanks stock has become a substantial position in client portfolio’s over the years and it should be reduced.

Kronos, Inc.

After Kronos announced its fiscal second quarter earnings of 30¢ per share, 25% higher than last year’s quarterly results, its stock price rose 14%. It now trades 10% above the highest price we paid for any of the shares bought this year. Although Kronos’ second quarter revenues were 12% above last year’s quarterly revenues and 8% higher than the previous quarter’s, the good news seen by analysts is the higher profit margins on the second quarter revenues. This improved profitability is interpreted as confirmation that Kronos’ new workforce management software, with its versatile employee scheduling and other human resource management capabilities, will generate persistently high revenue and profit growth. During the past quarter less than 15% of Kronos’ revenues came from system upgrades from existing customers while twelve new sales to hospital customers made healthcare for the first time Kronos’ largest customer category. Over 50% of the hospitals in the U.S. continue to use manual time record keeping and scheduling systems, which gives Kronos a huge opportunity.

C.H. Robinson Worldwide Inc.

CH Robinson’s first quarter net revenues and earnings per share rose 12% and 17% respectively. Robinson’s ability to find new trucking capacity in a tight freight market led existing customers to give the company additional business during the quarter. This increase in transactions more than offset slightly lower margins on each transaction. Robinson’s core trucking business expanded 12% while the smaller rail, ocean and air businesses rose a combined 25%. The company’s fresh fruit and vegetable sourcing business had flat revenues while T-Chek fuel card and information management business increased 9%. Robinson added 358 employees during the past year, an increase of 9%, in order to meet strong customer demand and to expand its geographic reach. CH Robinson’s shares have risen 10% through May.

Donaldson Company, Inc.

We recently purchased Donaldson shares after the stock price declined about 10% from its year-end level. Demand for Donaldson’s filtration systems continues to grow. In the company’s fiscal third quarter, reported on May 26, sales and earnings per share rose 22% and 18%, respectively. During the quarter, truck filter sales increased 36%, driven by rising North American truck build rates and U.S. Federal and State regulations spurring demand for Donaldson’s diesel truck emission control products. Sales growth for off-road products, such as construction and agriculture equipment, rose 24%, while aftermarket replacement sales increased 29%. Industrial product sales increased 14%. The gas turbine sales decline of 32% in North America was fully offset by a 29% improvement in sales to Europe and Asia. Disk drive filter sales rose 30%. Donaldson’s 90-day backlog, which reflects firm orders to be shipped during the current quarter, rose 28%, foretelling a good fiscal fourth quarter.

Varian Medical Systems, Inc.

During the second quarter of fiscal year 2004, Varian Medical Systems’ net orders increased 21%, sales increased 20% and earnings per share grew 28% over the second quarter of fiscal year 2003. On March 3, the company received FDA clearance for its new on-board imager, one of the key components of Image Guided Radiation Therapy, the next advance in radiation therapy for cancer patients. The imager is mounted on the treatment machine via robotically controlled arms and generates high resolution X-ray images. Varian’s software uses these images to make very precise adjustments to the patient’s position before each treatment. The company has already received thirty orders for the imager. Varian’s stock price has increased 20% since the beginning of the year, reaching an all-time high of $93 on April 23. We continue to hold this stock, in spite of our gains, because we believe that General Electric will strengthen its medical technologies business by acquiring Varian when Dick Levy, the current CEO, decides to retire.

Walgreen Company

Strong pharmacy sales at Walgreen’s led to second quarter revenue and earnings per share increases of 16% and 15% respectively over the second quarter of fiscal year 2003. The company continues to invest in new stores located on expensive, prime locations while maintaining strong earnings and cash flow growth. The company operates 1,250 24-hour stores, 247 more than they did a year ago and more than all their competitors combined. Customer traffic in established stores (stores at least two years old) increased about 5% during the quarter. Increased traffic substantiates Walgreen’s claim that adding more stores in a specific market increases customer visits to all stores. Walgreen’s stock has declined 4% since the beginning of the year. We will continue to hold Walgreen stock because we believe that investor apprehension about the impact of mail pharmacy on Walgreen’s long-term growth are exaggerated.

Patterson Dental Company

Patterson Dental reported fourth quarter and full year fiscal 2004 earnings per share growth of 28% and 19% over the comparable periods last year. Sales for the quarter and the year rose 20% and 19% respectively. Ability One, the leading distributor of rehabilitative products, has contributed 7% to the company’s 2004 earnings per share since its acquisition in September 2003. Patterson has strengthened each of its three divisions with strategic acquisitions in the last two months. ProVet, a regional supplier in the midwest and northwest, adds $50 to $60 million of revenues to Webster Veterinary Supply making it the second largest national distributor of companion animal vet supplies. Patterson also acquired Medco Supply Company, a leading national distributor of sports medicine supplies and CAESY Educational Systems, the leading provider of electronic patient educations services to dental practices in North America. Medco strengthens Ability One’s marketing initiatives to podiatrists, a new market, and CAESY’s products will further distinguish Patterson’s offerings to dentists. Patterson’s stock price has risen 18% since the beginning of the year. We believe that the company’s strong record of execution, demonstrated by the quality of its recent acquisitions, justifies its premium stock price.

Johnson & Johnson

Johnson & Johnson reported first quarter earnings per share growth of 20% over the same period last year. Revenues grew 18% over the first quarter of last year with a 5% contribution from foreign currency. The company achieved these results with strong performance from all of its divisions. Sales of the CYPHER drug eluting stent contributed to the 23% revenue growth (7% from foreign currency) of Medical Devices and Diagnostics. Boston Scientific launched a competing drug eluting stent at the beginning of March. Press and analysts’ reports about initial market share gains have built lofty and perhaps unrealistic expectations for this stent. Pharmaceutical sales grew 15% with a 4% contribution from foreign currency. Sales of Procrit, Johnson & Johnson’s largest drug, grew 2% over the fourth quarter of 2003, suggesting that the company has stabilized sales of this key product in spite of Amgen’s heavy discounting of its competing product. Consumer products revenue growth remained strong with sales of Johnson & Johnson’s skin care products growing 20% during the quarter. The company’s stock price has increased 8% since the beginning of the year. Analysts’ aggressive assumptions about the market share of Boston Scientific’s stent may give us opportunities to increase our position in this well-run company.

Beckman Coulter, Inc.

Beckman Coulter’s first quarter revenues and earnings per share increased 15% (11% in local currencies) and 20% respectively over the first quarter of 2003. Clinical diagnostics sales grew 17% as laboratories installed the company’s new high throughput immunoassay system, automated sample preparation systems and new hematology systems. Biotech and pharmaceutical companies increased their purchases of Beckman Coulter’s research equipment this quarter, especially their ProteomeLab systems. These systems automate and simplify the separation and characterization of proteins in tissue and cell samples. Beckman Coulter’s stock price has increased 19.5% since the beginning of the year and reached an all-time high of $61 per share on June 1. Beckman Coulter is at the beginning of a growth cycle based on its new platforms. We may purchase additional shares if institutional investors’ enthusiasm for medical instruments wanes.

Microsoft Corporation

Microsoft’s third quarter revenues grew 17% over the same period last year. Earnings per share increased 40% over the third quarter of fiscal year 2003 with six of the company’s seven businesses posting operating margin improvements. This quarter’s earnings figures do not include one-time charges of $2.5 billion to settle the litigation with Sun Microsystems and to reserve funds to pay the European Commission fine of $605 million. They are still contesting the Commission’s ruling. Microsoft’s cash flow from operations for the quarter was $5.0 billion. Purchases of Office 2003 and Windows Server 2003 remain very strong. Sales of these products are twice those of the previous versions for a comparable time period. Microsoft settled most of its on-going litigation this year. In spite of strong operating results and the decision to end its legal battles, the company’s stock price has declined 4% since the beginning of the year.

Amdocs

Amdocs reported revenue and earnings per share growth of 25% and 33% over the second quarter of fiscal year 2003. The company had nine key contract wins during the quarter from both wireless and wireline customers in a challenging market. Several existing customers extended Amdocs’ billing system to more businesses including Nextel, one of Amdocs largest customers. Nextel will use Enabler, Amdocs billing product, to support its broadband data trial. Amdocs’ stock price has risen 10% since the beginning of the year. We will continue to hold the stock because we believe that the company has a clearly-defined plan to expand its share of its existing customers’ billing and customer management systems. The stock price will fluctuate until senior managers convince investors that short-term revenue forecasts provide little insight into the long-term profitability of the business.

Intel Corporation

Intel’s first quarter revenues increased 20% above those of the first quarter of 2003 while earnings per share leapt 86%. The company successfully produced and shipped high volumes of the first Pentium 4 microprocessor for desktops made with its advanced 90 nanometer processes on 300 mm wafers. The initial yields of this microprocessor were higher than expected – a testament to Intel’s manufacturing prowess. The company also met its aggressive production schedule with the introduction of the first microprocessors for laptops made with the advanced processes on May 10. Intel’s stock price has declined 10% 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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2004 – 2nd Quarter EARNINGS LETTER 2003 – 4th Quarter EARNINGS LETTER