3rd Quarter, 2004

Weak Dollar

With the notable exceptions of Merck and State Street all your companies reported good, and in many instances, exceptionally strong earnings for the calendar quarter ending on September 30. The stock prices of all except Merck have advanced during the post-election stock market rally with some of your stocks recording most of their gain for the year during this upturn. Election euphoria usually fades as attention turns to mundane matters obscured by the rhetoric of the campaign. We think the current US economic expansion is sustainable unless an accelerating uncontainable decline in the dollar causes instability in the financial markets. A weaker dollar is inflationary. It means that the supply of dollars created exceeds the demand from buyers at the current price. When the dollar goes lower we become poorer. The current downward drift is bearable. A cascade brought on by intemperate policy disputes is not. We enclose our thoughts about the weaker dollar.

State Street Corporation

State Street’s disappointing third quarter earnings report immediately caused an 11% drop in the company’s stock price. It briefly sold below $40. Even after a rebound helped by an explicit commitment from Ron Logue, the new CEO, to keep expense growth within the rate of known revenue growth, State Street stock languishes 13% below its price at the beginning of the year. Earnings for the third quarter were 55¢ per share which compares unfavorably with 66¢ earned during the quarter a year ago and 68¢ earned in this year’s second quarter. Although State Street experienced a surprising $41 million sequential drop in quarterly foreign exchange revenues due to lessened volatility during the quarter, a decline in customer cross-border equity flows and an unwinding of customers’ speculative currency overlay trades, the poor earnings are attributable entirely to State Street allowing expenses to grow 14% while revenues rose less than 6%. Had foreign exchange revenues not plummeted, quarterly revenues would have grown no more than 10%. Rigorous expense control is the key to getting a higher multiple for higher earnings. Good execution will enable management to reach these goals.

American International Group

Catastrophic losses of $761 million resulting from hurricanes and three typhoons dragged down AIG’s third quarter earnings to 97¢ per share, 1% below the 98¢ earned in last year’s third quarter. Excluding the catastrophic losses, AIG’s earnings rose 16.5% during the quarter, after the company added $2.3 billion to its loss reserves. These reserves, amounting to $43.8 billion, almost equal one year’s net written premiums! AIG’s important foreign life insurance premiums increased 38% during the quarter. First year premium income received in Japan rose 31% while the pace of first year premium growth in China slowed to 23%. AIG, however, has secured a 15% share of the vibrant Shanghai life insurance market. In mid-October AIG’s stock price suddenly dropped 19%, when the NY State Attorney General revealed that two AIG employees had participated in an illegal bid rigging scheme with Marsh & McLennan. After recovering all but 6% of that drop, AIG’s stock remains 5% below its price at the start of the year.

Chicago Mercantile Exchange

The Chicago Mercantile Exchange’s revenues increased 42% while earnings per share rose 85% to $1.72. Average daily volume traded at the CME continued to expand, rising 29% to 3.2 million contracts a day. Growth was driven by an 87% rise in electronic trading on the company’s Globex platform which accounted for 61% of the exchange’s transactions compared to 42% a year ago. Total Eurodollar contract volume increased 47% from a year earlier to 1.9 million contracts per day while electronically-traded Eurodollar contracts have risen from one hundred thousand contracts per day in January to one million contracts per day in September. As trading volume shifts to Globex, CME’s average rate per trade rises because the company receives a Globex fee in addition to its regular transaction and clearing fees. Globex is now 68% of total volume compared to 44% a year ago. CME’s shares have risen 181% since the beginning of the year. We intend to trim positions in portfolios where appreciation has made CME too large a percentage of the overall assets.

Express Scripts, Inc.

Express Scripts reported third quarter earnings per share of $1.00, which does not include a charge of 20¢ per share to increase reserves for legal costs. Earnings per share grew 20% and gross profit increased 15% over the same period last year. Retail claims volume increased 13% to 101.8 million prescriptions with the inclusion of the first full quarter of the DoD TRICARE retail contract. Mail claims increased 22% to 10.0 million as clients encourage their members to use this cost-saving option. CuraScript’s specialty injectable prescription revenues have exceeded expectations with a run rate of over $750 million for 2004. The company’s current client base has doubled the number of patients using Curascript’s services because several new biotech drugs have been approved during the last 12 months. Despite its unnerving gyrations Express Script’s stock price has climbed 13% since the beginning of the year. It has risen 10% since the company reported strong earnings on November 4.

First Data Corporation

During the third quarter First Data’s revenues and earnings per share gained 21% and 13% respectively. Western Union opened its 200,000th money transfer location during the quarter. Washington Mutual and Bank of America extended their relationships with the STAR online debit network. The company repurchased 28.4 million shares during the quarter for $1.2 billion, an average price of $42 per share. Western Union international money transfer growth of 23% boosted total money transfer growth to 18%. The US to Mexico corridor, which accounts for 10% of total transfers, rose 14%. China and India, which now account for 15% of all money transfer locations, experienced 90% volume growth but still account for only 3% of money transfers. Aided by the addition of Concord’s merchants credit and debit card transactions processed rose 65% to 5.2 billion. Credit card accounts processed reached 424 million, up 28%. FDC’s stock is up 4% year to date.

Automatic Data Processing

ADP’s operating results continue to gain momentum. Revenue rose 8% to $1.8 billion and earnings per share increased 9%. “Pays per control”, ADP’s metric for the number of people employed by each of the company’s 125,000 payroll customers, continued to accelerate, rising 1.8% during the quarter. Average client balances held by ADP on behalf of its payroll customers, increased 10% to $10.2 billion. Brokerage Services profitability nearly doubled from the low of a year ago as back-office trades processed per day increased 10%. The company began back-office trade processing for E*Trade during September. Investor communication mailings rose 22% on stock record growth and interim period Sarbanes-Oxley regulatory mailings. These solid results led ADP management to raise their revenue forecast for the full fiscal year ending June 2005 to a gain of 7 to 8% from mid-single digit growth. Double-digit EPS growth was affirmed. ADP’s stock is up 15% since January 1.

C.H. Robinson Worldwide Inc.

Once again, CH Robinson reported strong quarterly results. Gross revenues, which include the cost of third-party transportation, rose 22% to $1.1 billion, while net revenue grew 27% to $172 million. Earnings per share jumped 34%. Robinson is delivering scarce truck capacity to its customers during this difficult period of rising fuel prices and trucker shortages driving a 32% gain in their core truck business. Trucking companies are attracted to Robinson because of the company’s willingness to pay within 48 hours, in exchange for price discounts. Customers continue to shift more business to Robinson as demand strains supply because of the company’s proven ability to deliver capacity in tight markets. These are the best of times for the company. Shares of CH Robinson have risen 38% this year.

Donaldson Company, Inc.

Sales and earnings per share for Donaldson’s fiscal year ending July 31 rose 16% and 12% respectively. Reflecting continued strong end market demand, its 90-day backlog rose 14% to $209 million while total backlog gained 20% to $376 million. Donaldson’s engine products group, which accounts for nearly three-fifths of company sales, gained 20% in both the fourth quarter and in the full year. Increasing North American and European truck builds along with strong sales of new diesel emission filtration systems boosted the results. Industrial product filter sales, which generate two-fifths of company sales rose 11% in the fourth quarter and 9% for the full year. Donaldson repurchased 1.1 million shares during their fiscal year, 1.2% of the outstanding shares, for $30 million. Total net income for the year was $106 million. Donaldson’s stock is up 26% since mid-February.

Caterpillar Inc.

Caterpillar’s third quarter revenues of $7.6 billion rose 38% while profit surged 124% to $1.5 billion. Management is forecasting a revenue gain of 30% and an EPS gain of 80 to 85% in 2004, followed by a 10% increase in sales and earnings in 2005. Sales of Caterpillar machinery and engines rose 45% and 33% while profits increased 78% and 96% respectively. Caterpillar is benefiting from a broad recovery in mining and construction world-wide. As the leading supplier of diesel truck engines, Caterpillar’s results are boosted by the rapid increase in on-highway truck builds in North America. Higher steel, freight and expediting costs to meet customer delivery schedules held back the profit gain. CAT stock is up 17% since July 1.

Varian Medical Systems, Inc.

Physician interest in Varian Medical Systems’ newest products that improve the precision of radiation therapy pushed fourth quarter and fiscal year 2004 revenues up 14% and 19% respectively over the same periods last year. Earnings per share for the quarter and the fiscal year grew 19% and 28% respectively. The backlog, orders that will be filled in the next nine to twelve months, reached a record $970 million. Varian’s on-board imager and patient positioning software allow radiation oncologists to “see” the tumor before they treat it. These imaging products have increased oncologists’ confidence that they can safely deliver higher doses of radiation to the tumor while protecting more nearby healthy tissue. The company has received orders for 84 on-board imagers, 68 with new systems and 16 upgrades. This is the fastest uptake of a new technology that the company has seen. Varian’s stock price has risen 16.6% since the beginning of the year and has recovered 24.4% from its 12-month low on July 28.

Walgreen Company

Walgreen’s reported its 30th consecutive year of record sales and profits. Fourth quarter and fiscal year 2004 earnings per share rose 18.1% and 16.7% respectively over the same periods last year. Revenues grew 14.3% and 15.4% for the quarter and the year respectively. Walgreen’s filled 443 million prescriptions in 2004, an increase of 10.8% from last year and more than any other pharmacy retailer. Gross margins also increased as consumers used more generic drugs and processed more digital photos at Walgreen’s kiosks. The company opened 436 new stores across the country for a net gain of 355 stores after closings and relocations. Walgreen’s stock price has increased 6.7% since the beginning of the year.

Patterson Companies

Patterson Companies’ fiscal second quarter earnings for the period ending October 31 are scheduled for release on November 24. Based upon information provided in conjunction with the company’s September dental branch managers meeting, Patterson should report a 25% year to year earnings increase. Sales of dental consumables are running 7% above a year ago while equipment sales are growing 12%. The company continues to benefit from dental customers installation of digital x-ray systems along with adoption of the company’s Eaglesoft software which permits seamless integration of a dental practice’s administrative and clinical information. With strength in its divisions distributing products to veterinarians and physical therapists complementing its dental business, Patterson is positioned to once again deliver annual earnings growth of 24% for its shareholders. During October, Patterson’s veterinary distribution business acquired Milburn Distributors. With annual sales of $50 million, it is the largest distributor specializing in the US equine veterinary supply market. On October 22nd the company split its stock 2 for 1. It has risen 24% since the beginning of the year.

Beckman Coulter, Inc.

Strong sales of immunoassay systems drove Beckman Coulter’s third quarter earnings and revenues up 40% and 9% respectively over the same period last year. The company believes that it is winning a significant share of high volume immunoassay placements which were up 23% in the quarter. Immunoassay product sales increased 34% over the third quarter of 2003. Sales of Beckman’s thyroid assay grew 27%, an indication that hospitals are using their platform to run routine assays. In addition, new customers accounted for more than 60% of worldwide sales. Quarterly sales of Beckman’s genetic and protein analyzers grew 4.8% in local currencies as more molecular biology labs use the company’s automated protein characterization and DNA sequencing systems. Beckman Coulter’s stock price has risen 25% since the beginning of the year and reached an all-time high of $63.73 on November 18.

Johnson & Johnson

Johnson & Johnson’s third quarter earning per share grew 13% over the third quarter of 2003, while revenues grew 7.7% in local currencies. The pharmaceuticals division turned in a strong performance with revenues up 11% in local currencies. U.S. pharmaceutical division revenues grew 12.5% in spite of another quarter of declining PROCRIT/EPREX sales. Medical Devices and Diagnostics’ revenues grew 3.6% in local currencies, including a 26% decline in year-over-year U.S. sales of the CYPHER stent. This quarter is the second full quarter since the launch of Boston Scientific’s TAXUS stent in the U.S. International CYPHER sales grew 42% with the launch in Japan on March 31. CYPHER’s U.S. market share has continued to recover since the TAXUS launch, with a 38% share of the drug-eluting stent markets at the end of the quarter. A new skin care line from Neutrogena contributed to the 17% quarterly revenue growth of the skin care products in the Consumer Products division where revenues grew 7.4% in local currencies. Johnson & Johnson’s stock has increased 18% since the beginning of the year as investors move money out of Eli Lilly, Merck and Pfizer shares.

Merck & Company, Inc.

Merck reported third quarter earnings per share of 60¢, which includes a charge of 25¢ per share for costs to withdraw Vioxx. Revenues for the quarter were $5.5 billion, including a $491.6 million decrease from Vioxx returns from distributors. Vytorin, the Merck/Schering Plough cholesterol-lowering drug launched in the U.S. at the end of July, had revenues of $52 million. It has captured 2% of the new prescriptions in the U.S. cholesterol lowering market. On November 1, Merck Scientists announced that Phase II clinical trial results demonstrated that their HPV vaccine remained 100% effective for four years in preventing the development of the precancerous lesions that precede cervical cancer. In addition, Merck will co-promote and help develop the clinical and marketing strategy for Muraglitazar, a drug developed by Bristol Myers. The results of several Phase III clinical trials have demonstrated its safety and efficacy. Muraglitazar is the first drug that controls both blood sugar and lipid levels in patients with Type 2 diabetes. Bristol Myers plans to file the application for approval in December. Merck’s share price has dropped 41% since the beginning of the year and has remained at this depressed level as everyone attempts to quantify the magnitude of Merck’s legal liabilities from its Vioxx withdrawal. We will take losses in Merck before year-end to offset realized gains in taxable accounts.


PepsiCo reported third quarter revenue and earnings per share growth of 6% and 14% respectively over the same period last year. Led by strong volume growth and price realization in both snacks and beverages, PepsiCo International’s revenues grew 11% in local currencies and operating profits increased 29%. On September 1 Irene Rosenfeld, the former president of Kraft Foods’s North American businesses, joined the company as the head of Frito-Lay. CEO Reinemund chose her to lead the division into the broader “convenience foods” market. The company has created a “Smart Spot” program to make it easier for consumers to find its better-for-you and good-for-you products. All snack and beverage products with this label had high-single digit to double digit sales growth during the quarter. PepsiCo’s stock price has risen 11.4% since the beginning of the year.

Harte-Hanks, Inc.

Harte-Hanks reported improved results in its third quarter as revenues, earnings per share and operating cash flow rose 10% or more. The company’s capital expenditures fell by one-third from the year earlier period, boosting free cash flow 26%. The Direct Marketing unit’s revenues gained 10% and operating income was 19% higher than a year ago. The company improved this businesses’ year-over-year operating cash flow margin by 60 basis points after two years of decline. High-tech/telecom, healthcare/pharma and automotive customers once again led the sales gain. Retail and financial services customers also spent more with Harte-Hanks during the quarter. The Shopper Pennysaver business sales rose nearly 10% and operating income was up 11%. During the quarter the company expanded circulation to an additional 148,500 households, bringing the total expansion this year to 600,000. Harte-Hanks continues to buy in stock, purchasing one million shares during the quarter and 3.1 million year to date, representing 3.5% of the shares outstanding. Harte-Hanks shares are up 21% this year.

Kronos, Inc.

Customer interest remains strong for Kronos’ Workforce Central 5, its new suite of workforce management software. Software sales rose a strong 17% over the fourth quarter of last year. Revenues for the fourth quarter and fiscal year 2004 rose 14% and 13% respectively while earnings per share jumped 47% and 28.6% in the quarter and year. The new scheduling feature and the centralized, web-based software are generating sales from new customers and upgrades from existing customers. Over 100 distinct organizations have purchased the scheduling product. Exel Logistics, a global leader in supply chain management, selected Workforce Central 5 over its competitors because it offers a centralized, reliable solution that ensures the consistent use of work rules for its 15,000 employees in 450 locations. Kronos’ stock price has increased 23.4% since the beginning of the year, reaching a new high of $50.58 on October 21.


Amdocs reported fourth quarter and fiscal year 2004 earnings per share growth of 50% and 43% respectively over the same periods in 2003. Revenues rose 9.9% during the quarter and 19.6% during the fiscal year. On October 26, Cingular Wireless completed its acquisition of AT&T Wireless and announced that it would move AT&T’s 22 million subscribers to its in-house billing platforms, one of which runs Amdocs’ software. Amdocs will work with Cingular to facilitiate this transition over the next 18 months. The company also announced two major deals with North American wireline carriers. The opportunity to replace the legacy wireline billing systems is growing as these large carriers invest billions of dollars to upgrade their networks to offer broadband services such as video on demand. They will need flexible billing systems that present one bill for bundled wireline, wireless and data services. Amdocs has designed its Integrated Customer Management platform, which uses one database to access all customer data, to meet their needs. Amdocs’ stock price has risen 17% since the beginning of the year and has leapt 46% from its 12-month low of $18.30 on August 13.

Intel Corporation

Intel’s third quarter revenues and earnings per share grew 8% and 20% respectively over the third quarter of 2003. Record server and mobile microprocessor shipments were offset by weaker demand for desktop microprocessors. While Intel’s desktop market share remained constant during the first three quarters of the year, PC manufacturers held larger inventories of desktop microprocessors than Intel initially had forecast. On November 10, Intel’s board announced that the company would double its annual dividend to 32¢ per share and authorized the company to repurchase 500 million more shares. Intel’s stock price has declined 26% since the beginning of the year. It reached a 12-month low of $19.72 a few days after the company gave its mid-quarter update. Investor optimism about improving PC demand has lifted Intel’s stock price 19% since then.

Microsoft Corporation

Microsoft’s first quarter earnings per share rose 12.5% over the first quarter of fiscal 2004. Sales for the quarter increased 12% with 19% growth in the Server and Tools group. The consumer-focused businesses also had a good quarter with MSN’s revenues growing 10% over the first quarter of last year on continued strength of its advertising business. Microsoft released Halo 2, its much-awaited video game, on November 9. First day sales were $100 million, almost one-third more than that of the popular animated film The Incredibles which had opened the previous weekend. Microsoft shares went ex-dividend on Monday, November 15. Microsoft’s stock price is up 9.9% since the beginning of the year. The company will distribute a special dividend of $3 per share on December 2.

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.