EARNINGS LETTER

2nd Quarter, 2004

The Market Negates Good Earnings

With few exceptions, your companies’ uniformly good second quarter earnings reports elicited selling. Not even the Chicago Mercantile Exchange, which produced a 61% quarterly earnings gain, saw its stock price rise after it reported. For Intel and State Street selling by portfolio and hedge fund managers was so aggressive that it immediately knocked 10% off their stock prices. Although the results for each company equaled the quarterly consensus earnings number, the composition of revenues and expenses along with cautious forecasts from management rattled already weakened investor confidence. The chart pattern for both stocks showed that upward price momentum had stopped many weeks before, leaving the stocks exposed to a sizeable drop if selling intensified.

Since the end of June the prices for our stocks have sagged almost 9%, while the spot price of oil has leapt 11% to a new all-time high. A correlation exists between a significant rise in oil prices and a decline in the S&P Index. Higher oil prices act like a tax deflating consumer demand, company hirings, and corporate profits. The possibilities for an interruption of the steady flow of oil to industrial countries dependent upon imports gain credence because terrorist acts in Iraq and threats in Saudi Arabia along with potentially transforming political struggles in Russia, Venezuela and Nigeria make the vulnerabilities more apparent. Soaring oil prices predictably have drawn in the usual financial buyers whose trading to reinforce a trend is augmented by many hedge fund buyers eagerly seeking short-term trading gains. Financial buyers’ positions represent over half the open interest in crude oil contracts traded on the New York Mercantile Exchange. Because hedge fund trading helps move commodity prices and the prices for our stocks, we enclose a note describing the trading practices of these funds.

State Street Corporation

State Street’s stock price fell 12% in the four trading days after it announced excellent second quarter results. The stock continues to languish at $43, 16% below its price at the beginning of the year. Second quarter earnings of $0.68 per share, however were 36% above the comparable year ago results. Importantly for us State Street doubled its forecast profit realization from the acquisition of Deutsche Bank GSS from $0.04 earlier to $0.08. With year to year second quarter fee income rising 19% while expenses grew 15%, State Street delivered the operating leverage whose absence was the focal point of analyst criticism of State Street’s strong first quarter results. An increase in incentive compensation accruals for a workforce with no headcount increase and an acceleration of contractual payments to David Spina who retired for health reasons as State Street’s CEO on June 30th, raised employee compensation expense 10% above the first quarter total, preventing State Street from realizing any sequential quarterly operating leverage. The comparative quarterly increase in revenue and expenses were 3% and 5% respectively.

The severity of the drop in State Street’s stock price was intensified by State Street’s new CEO Ron Logue’s prepared forecast, and his unprepared answers to “what if” questions posed by analysts. As State Street’s Chief Operating Officer, Ron is responsible for State Street’s ability to execute the many detailed tasks it performs for existing institutional customers such as CALPERS, which enables it to profitably secure outsourcing contracts from customers such as PIMCO and Deutsche Bank. He is a truly able manager, but is not versed in fielding analyst questions. In his initial statement Ron forecast that “market conditions in the second half may not be as favorable as they were in the first half of this year.” He then was asked about the effect of the Fed’s plan to raise short-term interest rates at a measured pace. His answers to several questions on this point left the impression that State Street was unable to manage its portfolio of short-term securities to lessen the decline in net interest income cited in simulated interest rate shock test data published annually in the 10K. In another answer he almost provided the rate of planned profit improvement State Street seeks when it negotiates with prospective outsourcing customers such as AXA Investment Managers, the largest asset manager in France. AXA is engaged in exclusive but prolonged negotiations with State Street. The questioning and the resultant vague answers made Ron appear inexperienced and indecisive. He is anything but.

American International Group

AIG reported second quarter earnings 19% above last year’s comparable results. Property and Casualty net premiums earned rose 22% during the quarter as did operating earnings which surpassed $1.5 billion after the company added $2 billion to its loss reserves. They now amount to $40.8 billion! Hank Greenberg, AIG’s exceptional CEO, confirmed that overall premium rate increases had slowed to 3% during the quarter and stated that AIG had declined to review risks amounting to a total of $325 million of potential premium income because it considered the rates inadequate. The steepest rate declines are occurring in directors and officers liability coverage.

AIG’s life insurance premiums grew 21% during the quarter with foreign premiums rising 24%. In Japan AIG’s first year premium income rose 41% to $366 million, nearly ten times the first year premium income received on policies written in China. These premiums also rose more than 40% above the amount earned during the quarter a year ago. AIG’s success in becoming the largest seller of fixed annuities through Japanese banks produced a 150% increase in foreign retirement services income during the quarter. Operating income from these annuity sales equaled 30% of the quarterly profit earned by AIG’s VALIC subsidiary, the largest and most successful seller of fixed annuities in the US.

AIG’s stock price rose 5% during the five trading days immediately after its earnings announcement. It has since given back these meager gains and sells within a whisker of its price on January 2nd of this year.

Chicago Mercantile Exchange

Average daily volume traded at the Chicago Mercantile Exchange rose an impressive 25% to 3.3 million contracts with 52% of the volume traded electronically compared to 40% a year ago. Eurodollar interest rate contracts led the gain, rising 36% from a year ago, as expectations of the Fed’s initial rate hike fueled trading volumes. In the month of June, electronically traded Eurodollar volumes reached 50% of the total, up from only 3% a year ago. Equity index and foreign currency contracts rose 11% and 29% respectively during the quarter. Total revenues rose 31% while expenses increased only 9%, driving earnings per share 61% higher.

CME is expanding its foreign exchange futures product distribution through an agreement with Reuters to embed spot equivalent prices and access to the CME’s electronically traded futures on Reuters’ trading system used by 3,500 institutional FX customers. Unlike spot FX trades, CME futures contracts are guaranteed by their wholly-owned Clearing House. This reduces the regulatory capital requirements customers need to maintain for counter-party risk on derivatives transactions. Total contracts traded in July increased 29%. CME shares are up a remarkable 90% since the start of the year.

Express Scripts, Inc.

Express Scripts reported second quarter earnings per share of 93¢, an increase of 19% over the second quarter of 2003. This figure does not include a 10¢ per share charge associated with the early retirement of $205 million of high-cost debt. Express Scripts continues to implement its business plan by helping health plans manage the cost of their pharmacy benefit through the increased use of generic drugs, lower-cost branded drugs and mail pharmacy. Mail pharmacy prescription volumes reached 9.8 million this quarter, an increase of 20% over the same period last year. This increase includes the conversion of some retail network prescriptions to more profitable mail prescriptions. Mail pharmacy revenues jumped 38.7% with the contribution of higher cost specialty injectable drugs from CuraScript.

Express Scripts’ stock price has declined 7.7% since the beginning of the year and 23% from its all-time high of $80 on April 27. Investors were disappointed that the company narrowed the range of its 2004 earnings growth rate to 20-22.5% from 20-25%. They dumped their shares of the stock, however, after Elliott Spitzer, New York State’s Attorney General, announced his allegations for filing suit against Express Scripts. Spitzer has chosen the wrong company to advance his political agenda of exposing industry abuses in prescription drug pricing. Express Scripts publicly responded to his allegations by pointing out that the company had saved the State $2.0 billion in drug costs since 1998. Moreover, Express Scripts never ran any brand therapeutic interchange programs for the State, an issue in the suits that Medco Health Solutions eventually settled. Express Scripts has managed the pharmacy benefit for New York State since 1994. The State signed a new two year contract six months after Spitzer initiated his investigation of the company. Express Scripts plans to defend itself vigorously against these spurious charges.

Merck & Company, Inc.

Merck’s quarterly worldwide revenues grew 9% during the quarter, 6% in local currencies over the same period last year. Earnings per share were flat. The company has been actively in-licensing technologies and novel compounds. Merck and Bristol Myers Squibb will jointly develop and sell Bristol Myers Squibb’s diabetes drug currently in late Phase III trials. This drug has a similar mechanism of action and a better toxicological profile than the diabetes drug that Merck dropped in October 2003. On July 23, Merck and Schering Plough received FDA approval for Vytorin, the Zetia/Zocor combination. In addition, Merck’s investigational diabetes drug MK-431 entered Phase III trials as expected during the quarter. Merck’s stock price has declined 2.6% since the beginning of the year. We believe the bad news is behind Merck.

First Data Corporation

Revenues and operating earnings per share rose 22% and 15% respectively during First Data’s second quarter. The company repurchased 15.5 million shares of stock for $683 million during the quarter at an average per share price of $44. Western Union consumer money transfer transactions rose 20%, driven by international transfer growth of 24%. Money transfers to Mexico, primarily through CitiGroup’s Banamex, which is Western Union’s Mexican super agent, rose 16%. Western Union’s global network of agent locations surpassed 195,000, up 18% from a year ago. The addition of Concord’s merchant transactions boosted total card transactions processed at merchant locations to 5.1 billion, 71% above last year’s second quarter.

Credit and debit card accounts on file reached 417 million, up nearly one-third from a year ago. During the quarter, FDC added 20 million retail card accounts from six different clients. The company will convert an additional 20 million GE retail accounts by year-end, but will lose 47 million accounts from the deconversion of BankOne’s cards. JP Morgan Chase announced in July that it also will move its 34 million credit and debit cards from First Data’s processing system within the next 18 months. The combined JP Morgan Chase/BankOne relationship generated 10.5% of Card Issuing processing revenues in the second quarter. The retail cards being converted will not make up for the loss of JP Morgan Chase because each retail card generates only about one-fifth the revenue of a bank-issued credit card. Charlie Fote, FDC’s CEO, stated that a failure to replace this business with new business could result in a reduction in earnings per share of up to 5¢, about 2% of 2006 earnings. Profits from FDC’s stagnant Card business represents about 20% of total company profit. FDC shares are up 2% this year to date.

Automatic Data Processing

The results for ADP’s fiscal year ended June 30, 2004 were in line with managements’ forecast given at the start of the year. Overall revenue grew 9% to $7.8 billion and earnings per share declined 7% to $1.56. During the year, ADP raised investment spending in its businesses by $170 million to bolster new products, sales and employee compensation. Interest earned on funds held for clients declined 4% despite a 24% increase in client funds. The company utilized about two thirds of its annual free cash flow to repurchase 16 million of its shares at an average price of $40.63 per share.

ADP’s largest and most profitable division, Employer Services, reported a 9% revenue gain during the quarter and a 10% gain for the year. New business sales surged 19% in the final fiscal quarter resulting in full year growth of 6%. The number of employees on each client’s payroll rose an average of 1.5% during the quarter and 0.4% for the year. Brokerage Services revenues rose 5% and 3% for the quarter and the year respectively. The investor communications segment delivered 15% more pieces, reflecting stock record growth and Sarbanes-Oxley regulatory mailings by mutual funds.

CEO Art Weinbach conservatively, as is his custom, forecast mid single-digit revenue growth and double-digit EPS growth for fiscal 2005. ADP’s shares, after rising 18% through mid-May, now remain unchanged since the start of the year. The stock will start going up again when more new jobs are reported and short-term interest rates rise.

C.H. Robinson Worldwide Inc.

CH Robinson’s gross revenues rose 15% to $1.1 billion while its net revenues after paying third parties for transportation costs rose 16% to $158 million. Earnings per share rose 15%. Robinson’s core trucking business gained momentum in the quarter with profit up 17% on strong growth in both truckload and less-than-truckload transactions. Although the company’s fruit and vegetable sourcing business reported a 4% decline in gross revenues, its net profit rose 14%. Robinson reports that 40% of Sourcing is now “high service” which includes just in time replenishment, quality control and category management which have better margins than just buying boxes of lettuce. Walmart is the largest user of these services. Robinson’s stock is up 13% this year.

Donaldson Company, Inc.

On August 1, 2004, Donaldson completed its planned leadership succession when Bill Cook assumed the role of President and Chief Executive Officer from Bill Van Dyke, who will remain Chairman of the Board for one more year. When asked at a recent investment conference what changes he planned to make once he became CEO, Bill Cook said he planned to build upon the strong track record delivered by Van Dyke’s team, where he was a leader. In Donaldson’s most recently reported quarter, sales and earnings per share rose 22% and 18% respectively. The company’s 90-day backlog, which reflects firm orders to be shipped during the current quarter rose 28%. Donaldson plans to announce its fiscal year end results on September 1. Donaldson’s shares are up 4% since mid-February.

Varian Medical Systems, Inc.

Varian Medical Systems’ earnings per share increased 30% over the third quarter of fiscal year 2003 as sales rose 14% over the same period. Operating margins reached a record 21.6% during the quarter. Oncology systems net orders’ for the quarter were up 14% over the same period last year, at the high end of Varian’s long-term expected growth rate of 10% to 15% for this business. Intensity Modulated Radiation Therapy (IMRT) has become the accepted standard for radiotherapy with over 700 clinics using IMRT at the end of the quarter.

Varian’s stock price has declined 5.7% since the beginning of the year and 31% from its five year high of $46 on April 22 because of investor fears that Varian is losing market share in the North American market. Varian believes that it has maintained or strengthened its dominant market share during the year as it continues to increase its technological lead over its competitors with new accessories and integrated software that increase doctors’ confidence that they can focus higher radiation doses on tumors while protecting healthy tissue. We believe the stock price is quite reasonable now.

Walgreen Company

Walgreen’s third quarter revenue and earnings per share grew 15% and 19% over the third quarter of fiscal year 2003. Operating expenses as a percent of sales remained constant in spite of additional costs associated with replacing analog photo labs with digital processing equipment. Pharmacy and front-end comparable store sales grew 13.4% and 5.6% respectively during the quarter. Walgreen’s continues to gain market share in the pharmacy and in 59 of the 60 categories that make up the bulk of its front-end sales. The company’s stock price has not changed since the beginning of the year despite its strong record of solid execution, earnings growth and cash generation.

Patterson Companies

On July 21st, Patterson Companies at its annual analyst meeting confirmed its goal of increasing earnings 24% during its fiscal year ending June 30, 2005 to $2.70 per share. It reported that it is the largest distributor in the North American dental supply market with a 30% market share, that 50% of its customers use Patterson’s electronic order entry system and that equipment sales constitute 30% of its revenues. Patterson is the exclusive distributor of Schick sensors used in the majority of digital x-ray systems which strengthens its position as the largest equipment distributor. Although only 15% of dental practices in the US now use digital x-rays, Patterson expects that with encouragement from its 1350 sales representatives and support from Patterson’s 990 field technicians, the vast majority of practices will replace their film based systems within the next five years. Installation of digital x-ray systems, which facilitate the migration to electronic patient records, is a major factor driving the conversion of dental practices to digitally-based offices. Conversion to a digitally-based practice improves productivity, patient retention and outcomes while broadening the services provided by Patterson sales reps and service technicians. Patterson is the only distributor offering one-stop shopping for the digital office. The company offers hardware, software, networking, training and technical services for dental offices. Patterson has expanded beyond dental supply distribution to become the second largest distributor of veterinary supplies in the US and the largest US distributor of rehabilitation supplies to physical and occupational therapists. These expansions have added to the company’s earnings. Patterson’s stock has advanced almost 21% since the beginning of the year.

Beckman Coulter, Inc.

Beckman Coulter reported second quarter revenue and earnings per share growth of 8.3% and 7.3% over the same period last year. Sales of its high throughput immunoassay system in the U.S. and Europe drove immunoassay sales up 19%, indicating that the company increased its market share during the quarter. The company’s automation products are driving sales growth in its clinical diagnostics business in the U.S. On August 10, Beckman Coulter announced a five-year, $25 million contract with the St. Joseph Health System, a group that includes 15 acute care hospitals in California and Texas. Beckman Coulter becomes the sole source provider of automation, immunoassay, data management and clinical chemistry, expanding on its existing hematology contract. The company’s stock price has increased 6.4% since the beginning of the year.

Johnson & Johnson

Strong performances from operating companies in each segment of Johnson & Johnson’s business drove second quarter revenues and earnings per share growth of 9% in local currencies and 17% over the same period last year. Worldwide pharmaceutical sales grew 9.1% in local currencies with strong sales existing drugs offsetting weaker sales of Procrit, the company’s biggest drug. Medical Devices and Diagnostics’ revenues grew 8.3% in local currencies with strong sales of orthopedic joint reconstruction and spine products as well as international sales of Life Scan blood glucose monitoring products and the Cypher stent. Consumer products sales grew 7.5% in local currencies with the continued strength of the tabletop sweetener Splenda and Johnson & Johnson’s skin care products. The company’s stock price has increased 8.4% since the beginning of the year.

Colgate-Palmolive

Colgate reported sales growth, excluding divestments, of 5.5% and unit volume growth of 5.0%. Earnings per share rose 6.5%. Late in the quarter, Colgate completed the acquisition of GABA AG, a leading manufacturer and marketer of toothpaste in Europe. GABA accounted for 0.5% of the 7% increase in worldwide toothpaste unit volume growth during the quarter. The acquisition solidifies Colgate’s leading market position in Europe. Colgate’s U.S. market share, as reported by ACNielsen, remains 2.7 points ahead of P&G’s Crest at a 34.2% share. Colgate’s Asian and European operations, which generate 18% and 24% of company sales respectively, produced robust revenue growth of 13% and 11.5% respectively, excluding divestments. In China, Colgate is the market leader with a 31.9% share. The Hills Pet Nutrition business generated solid results as sales and operating profit each gained 9.0%. Colgate shares, after rising 15% through mid July, are up 4% for the year.

Pepsico

Strong volume growth and price realization from new products pushed PepsiCo’s second quarter sales and earnings per share up 8% and 12% from the second quarter of 2003. The strong performance of Pepsi Beverages North America offset the weak performance of some of the new Quaker snack products in the Frito Lay division. Beverage case sales of non-carbonated drinks rose 14% with double-digit volume growth for Gatorade and the successful launch of a new line of Tropicana juice drinks distributed through the bottling system. International snack and beverage volumes in all regions grew sharply with 11% and 13% volume growth respectively over the same period last year. India and China led the double-digit snack and beverage growth in the Asia Pacific region. PepsiCo’s stock price has increased 11% since the beginning of the year.

Kronos, Inc.

Positive customer response to the launch of Workforce Central 5 suite, Kronos’ newest version of its workforce management software, pushed the company’s third quarter product revenues up 21% over the same period in fiscal year 2003. Revenues for the quarter rose 17% while earnings per share increased 33% over the same period last year. Kronos has shipped well over one million licenses of Workforce Central 5 to new and existing customers since its launch in March. Unit sales of the new hardware that customers must also purchase to access all of the new features of the software increased 10% while the average selling price increased 18%. Kronos’ stock price has risen 2% since the beginning of the year, but jumped 14% the day after the earnings results were released.

Harte-Hanks, Inc.

Harte-Hanks second quarter revenues, earnings per share and operating cash flow rose 9%, 11.5% and 8.5% respectively. Free cash flow rose 19% during the quarter, boosted by a drop in capital expenditures of 24% from a year ago. The company’s Shopper publications turned in another solid quarter as revenues and operating cash flow rose above 9%. Harte-Hanks continues to expand Shoppers circulation, adding 293,500 households during the quarter, bringing the total added to 451,500 since the start of the year.

Direct marketing revenues and operating cash flow rose 8.8% and 9.7% respectively. The operating cash flow margin for the quarter came in at 18.1%, 0.1% above the level in last year’s second quarter, but 2.4% below the margin achieved two years ago. The company’s high tech/telecom, healthcare/pharma and automotive customers reported revenue gains in the double-digits. The retail customer segment rose only slightly. Shares of Harte-Hanks have risen 9% this year.

Amdocs

Amdocs reported third quarter revenues and earnings per share growth of 19% and 33% respectively over the third quarter of fiscal year 2003. During the quarter the company completed the implementation of the final and largest component of Bell Canada’s billing modernization project with the conversion of more than 4.7 million Bell Mobility subscribers and 4,000 system users to the Amdocs billing system. Amdocs now provides unified bills for all of Bell Canada’s residential and commercial customers. This outsourcing contract will generate annual revenues of $250 million through 2010. On July 14, Vodafone, one of Amdocs’ earliest and largest customers, selected Amdocs to be its global billing solution provider based on its proven global delivery capability and high-quality solutions.

Amdocs’ share price has declined 17% since the beginning of the year and is off 34% from its 12-month high of $29.4 on April 26. The company’s less optimistic short-term revenue growth estimates reinforced investor fears that large telecom companies will delay upgrading their billing and customer care systems, in spite of their need to send one bill for their panoply of voice and data services to keep existing customers and to compete for new ones. In addition, investors have extrapolated from their experience with IT systems outsourcers like EDS to assume that Amdocs’ large outsourcing contracts will prove less profitable than the company anticipates.

Intel Corporation

Intel reported second quarter sales of $8.05 billion and earnings per share of 27¢. Earnings per share were up 4% sequentially and up 93% from the second quarter of 2003. Strong sales of flash memory, chipsets and motherboards offset the seasonally slow sales of microprocessors during the quarter. Intels’s stock price has declined 31% since the beginning of the year. Its stock price dropped 10% on July 14 when the company lowered the midpoint of its 2004 gross margin estimate from 62% to 60%. Unexpectedly good yields of microprocessors manufactured with 90 nanometer geometries on 300 mm wafers reduced the number of units Intel needs to produce in the second half of the year, slightly lowering capacity utilization and thus increasing unit costs.

Microsoft Corporation

Fiscal year 2004 was a very successful year for Microsoft. Revenues increased 14% from fiscal year 2003 with healthy business demand driving 15% growth in fourth quarter revenues. Earnings per share for the year were 73¢, including 52¢ in after tax charges for stock-based compensation, the Sun Microsystems settlement and a fine imposed by the European Commission. All seven businesses showed double-digit revenue growth. The focus on cost management delivered higher operating margins as well. MSN posted its first-ever profitable year on strong advertising and premium services sales. MSN’s operating profit moved from a $570 million loss last year to a $120 million profit. This improvement exceeds Yahoo’s operating profit of $460 million over the same twelve month period! On July 20, Microsoft announced a plan to double the quarterly dividend to 8¢, buy back up to $30 billion shares of stock and pay a special dividend of $3.00 per share. This plan, once shareholders approve it, will distribute $75 billion of Microsoft’s cash to shareholders over the next four years. The company’s stock price has not changed since the beginning of the year in spite of the long-awaited announcement about the cash payout.

Reed Elsevier

Reed Elsevier reported first half revenues up 4%, excluding the impact of foreign exchange, and operating earnings per share up 11%. LexisNexis profit gained 11% and Reed Business publications and exhibitions profit jumped 17%. The exhibitions business was boosted by the contribution from several events, which take place every other year. This positive comparison will reverse in the second half. The Harcourt education unit reported a slight profit improvement, but has forecast a decline for the year due to a weak state adoption calendar and reductions in textbook funding. Elsevier’s Science and Medical business experienced a 3% improvement in revenue, but a profit decline of 3%. The Science & Medical business generates over 40% of company profits. Elsevier indicated there remains considerable pressure on institutional budgets, which impedes their ability to raise journal prices. The profit decline is worrisome because more profitable electronic-only subscriptions now account for 30% of journal subscriptions by value, and usage of Science Direct online continues to expand. This was supposed to boost operating margins. That is not happening.

As internally generated growth becomes more difficult, Elsevier has placed greater emphasis on acquisitions in adjacent markets to fuel growth in revenue and operating earnings. As a result Elsevier’s debt continues to rise, reaching nearly $5 billion as of June 30. In addition, the company is not yet earning its cost of capital on many of its acquisitions including its largest deal in recent years, Harcourt Education. The attempt to buy growth continued with the expensive July acquisition of Seisint, a U.S. provider of public records information for $745 million. Seisint generated revenues of $81 million last year and EBITDA of $28 million. Management does not expect this deal will cover its weighted average cost of capital during the next three years. This is too long to wait. We are selling the stock. Elseviers American Depository shares are up 2% this 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 – 3rd Quarter EARNINGS LETTER 2004 – 1st Quarter EARNINGS LETTER