2nd Quarter, 2005

State Street Corporation

State Street reported second quarter earnings of 66¢ per share after accruing a charge of 5¢ per share to reflect fully the loss incurred on subleasing excess space it had contracted for at its new Boston headquarters. As a consequence, the quarter’s results were only 2% better than earnings for the same period a year ago. Excluding the one-time sub-lease expense to bring occupancy costs back in line with staffing requirements in Boston, State Street barely achieved its goal of keeping expense growth below revenue growth. During the quarter, the operating expense exceeded the amount spent in the first quarter by 3.7% while revenues advanced only 4%. The narrowness of this spread stalled the rise of State Street’s stock price. It is up almost 8% since mid-March, having risen above 51 right after the June 2nd investor meeting. During the quarter, State Street repurchased 2.2 million shares at an average price of $46.36 and plans to acquire more than twice that amount before year-end to
fully offset pending share dilution under expiring contracts tied to debt instruments issued in 2003 to finance over half the acquisition cost of Deutsche Bank’s Global Securities Services.

Chicago Mercantile Exchange

The Chicago Mercantile Exchange delivered another outstanding quarter. Revenues and earnings per share during the quarter were $239 million and $2.36 respectively, representing gains of 28% and 42%. Total expense rose 13%. Average daily volume at the CME was 4.4 million contracts, up 31%. Volume traded in the pit continued to decline, dropping 21% to 1.2 million contracts a day while electronically traded volume rose 82% to 3.1 million contracts. Electronic volume now represents 71% of the total. Trading volumes in interest rate futures and options contracts, the most actively traded contracts at the CME, rose 36% during the second quarter. Trading in stock index futures rose 20%, while foreign exchange contract volume jumped an astounding 89%.

CME shares have risen 46% since mid-March reflecting growth in trading volumes and the potential for an accretive combination with the Chicago Board of Trade. On June 28, the CBOT reported that it had received unsolicited, non-binding expressions of interest in a business combination, which is widely believed to be from its Chicago neighbor, CME. At the right price, and with CME management in control, a combination makes sense. The Chicago Merc already clears and settles all futures and options transactions for the CBOT through the Common Clearing Link, generating $55 million in revenues last year. In addition, the CME owns GLOBEX, its electronic trading platform while the CBOT licenses its platform from a European competitor. If a combination does not occur, CME’s stock price probably will decline.

Express Scripts, Inc.

Demand for Express Scripts’ tools to manage the cost of prescription drugs remains strong with mail prescriptions growing 5% during the quarter to a record 10.3 million. Revenues from the home delivery of specialty drugs grew 64% during the quarter by continuing to capture an increased share of the specialty drug prescriptions of Express Scripts’ clients. The acquisition of Priority Healthcare for $1.3 billion announced on July 21st will make CuraScript the largest specialty pharmacy in the U.S. with over $3 billion in annual revenues. Priority Healthcare’s oncology drug distribution business will strengthen CuraScript’s oncology franchise because many patients receive chemotherapy at a doctor’s office or outpatient clinic. The company’s second quarter earnings per share grew 30% to 60¢, not including non-recurring items in both quarters. Gross profit increased 24%, reflecting the increasing economies of scale in the retail and home delivery businesses. Express Scripts’ stock price has advanced 30.1% since mid-March.

First Data Corporation

First Data’s second quarter results were weaker than we anticipated. Operating earnings per share of 56¢ were 6% above the 53¢ reported a year ago. Overall revenue rose 3% to $2.6 billion. While the Western Union division, which accounts for one-half of company profit, reported solid results, the Merchant division profits were flat and Card issuing profits were down. Western Union money transfer growth accelerated to 20% during the quarter, while agent locations reached 233,000, up 19%. Total international money transfers rose 26% while the closely watched US to Mexico corridor had growth of 19%.

The company’s Merchant Services business reported a 3% revenue increase and no profit growth despite a 13% year over year gain in card transactions processed. The quarter was hurt by weak Telechek (check verification and guarantee) results and banks leaving the STAR ATM/debit network. These losses were known at the time FDC completed the acquisition of Concord. FDC is experiencing highly competitive pricing at its largest merchants who are accustomed to getting 20% annual price declines in fees paid per transaction. Pricing has been stable at smaller and mid size merchants, resulting in average price declines of 3 to 5% amongst all merchant customers. On August 9, FDC announced it had purchased Citigroup’s merchant processing business and formed an alliance with Citi to deliver merchant card processing services. This further solidifies FDC’s growing relationship with Citigroup. Citigroup is a member of the STAR network, is Western Union’s superagent in Mexico through its ownership of Banamex and utilizes FDC to process its retail cards. FDC’s stock price is up 3% since mid-March.

Automatic Data Processing

ADP’s fiscal fourth quarter and full year earnings per share gained 22% and 15% respectively. Revenues rose 10% during the quarter and for the year. These strong results were underpinned by the company’s payroll services unit which posted operating profit growth of 37% during the fourth quarter and 15% for the full year. ADP’s pays-per-control gained 2% for the full year, versus a 0.4% increase last year. The average tax filing float rose 11% to $13.4 billion, while the yield earned rose to 3.5%, up from 3.2%. During the fiscal year, the company acquired 14 million shares, representing 2% of its fully diluted shares outstanding, for $600 million. We expect ADP to deliver another year of double-digit growth in earnings per share in the year ahead. ADP’s stock price is up 1% since mid-March.

American International Group

AIG reported second quarter operating earnings of $1.27 per share compared to last year’s restated quarterly earnings of $1.10. This year’s quarterly results exclude an after tax realized gain of $825 million equal to 32¢ per share on derivative contracts that auditors, during the restatement of AIG’s past earnings, found ineligible for hedge accounting. Application of their interpretation earlier this year, resulted in AIG booking after-tax losses of $476 million on these contracts for the second quarters of 2004 and 2003. AIG’s combined ratio, which measures the profitability of its property and casualty insurance underwriting, was 92.04 during the quarter. Net premiums written increased 4% year over year. AIG experienced losses in excess of actuarial predicted trends for its underwriting years beginning 2001 through 2003. Favorable trends for 2004 more than offset the depletion of reserves, however, for the previous three years. An actuarial firm has been chosen to audit AIG’s loss reserves. It will issue its report early next year. A finding requiring a charge to bolster reserves would not be surprising.

In Japan, AIG’s annuity sales rose to $3.4 billion, an astounding 43% above restated second quarter sales for last year. Second quarter operating income for AIG’s unmatched foreign life insurance business advanced to $1.4 billion, 19% above the restated amount recorded for the year ago period. AIG’s stock price has rebounded 22% from the low it hit in mid-April when the NY State Attorney General was threatening to bring criminal charges against the company. The rise has brought the stock back to within 1% of its price in mid-March.

C.H. Robinson Worldwide Inc.

Revenues and earnings per share at CH Robinson continue to accelerate, rising 36% and 49% respectively. The 40% jump in net revenues in the core trucking business reflects higher volumes, higher transportation prices and expanded customer relationships. Freight forwarding related revenues gained 21%. The 50% gain in produce sourcing came entirely from the acquisition of FoodSource in the fourth quarter of last year. Robinson once again delivered impressive operating leverage as average profit per employee rose 13%. During the quarter the company hired 339 people into its 178 existing branch offices. Robinson’s shares have risen 10% since mid-March.

Donaldson Company, Inc.

On August 1, Donaldson increased its quarterly dividend 33% to 8¢ a share payable on September 9, 2005. In addition, the company will repatriate $80 million of foreign earnings and expects to take a $5.6 million, or 6¢ per share, charge in its fiscal fourth quarter for taxes payable on the repatriated earnings. Donaldson will announce fourth quarter results at the end of August. Donaldson’s stock price has declined less than 2% since mid-March.

Caterpillar Inc.

Strong demand across all of Caterpillar’s product lines resulted in record revenues and profit for the second quarter. Revenues rose 23% to $9.4 billion while net profit rose 34% to $1.08 per share as strong sales volumes and improved price realization offset increased steel and labor costs. Caterpillar expects strong demand for its products to continue throughout the year. Residential construction remains strong in all regions; governments of developing countries are investing in infrastructure to meet the strong demand for mining and oil and gas output; and U.S. trucking companies are using their profits to replace aging fleets with trucks that use Caterpillar’s new engines in advance of the 2007 EPA emissions regulations. Caterpillar’s stock price is up 15% since mid-March.

Varian Medical Systems, Inc.

Global order growth for Varian Medical Systems’ oncology systems remained strong in the fiscal third quarter. Orders grew 15% with 7% growth in North America and 27% growth in international markets. The company reported earnings per share of 37¢, a 23% increase from the fiscal third quarter of 2004, while quarterly revenues grew 14% to $347 million. Eighty of Varian’s radiation therapy systems with on-board imaging are in operation or being installed around the world. These imaging units are the key accessory used to perform Image Guided Radiation Therapy. The uptake of this new technology is two to three times faster than the uptake of IMRT at this phase of the product cycle. Varian’s stock price has risen 19% from its low on April 28 and is up 8% since mid-March.

Walgreen Company

Walgreen reported fiscal third quarter earnings per share of 40¢, an increase of 19.5% over the same period last year. Revenues grew 13.1% to $10.8 billion for the quarter as the company extended its pharmacy market share in every state in which it operates. According to IMS Health, a company that measures prescription sales, Walgreen captured two-thirds of the retail prescription growth in Texas and Florida in the first three months of 2005, the states with the largest growth in retail prescriptions filled. A stronger and later flu season than last year’s contributed to the 8.8% gain in the number of prescriptions filled at comparable stores. Walgreen’s stock price has risen 25.7% since the beginning of the year and has reached levels not seen since October 2000 when the company’s earnings were only 60% of what it earns now. Nearly half of this year’s stock price appreciation has occurred since the middle of March.

Patterson Companies

Patterson Companies reported earnings per share of $1.32 for its fiscal year ending April 30, 2005. Revenue and earnings per share were 22% above the previous year’s results, although during the fiscal fourth quarter revenue growth decelerated to 16% and earnings per share growth during the quarter dropped to 10%. During the past fiscal year, Patterson’s dental equipment and consumables distribution business, which generates 76% of the company’s revenues and 78% of its profits, increased operating income 19% from the record results it achieved during the year ago fiscal year when income grew 20%. Patterson is the leading dental distributor in North America with a 32% market share. It is also the leading dental equipment provider and service organization with revenues twice that of its largest competitor. Equipment sales have risen to 40% of revenues as sales of its chair-side ceramic tooth restoration system and its digital x-ray systems increased 39% and 31% respectively last year.

The cause of the slowing of Patterson’s overall revenue and profit growth, evident in its fiscal fourth quarter results, is difficulties experienced in its veterinary and rehabilitation medical supply businesses acquired in 2001 and 2003 respectively. The veterinary distribution business, which is the nation’s second largest, has encountered price cutting from competitors who are merging to gain market share. Patterson is incurring cost to upgrade its product offering to include equipment so that sales reps can offer value-added services comparable to those that built the success of Patterson’s dental distribution business. The rehabilitation medical supply distribution business profit deterioration comes from high operating expenses, especially those associated with the distribution of 1.8 million 1,500 page catalogues to their 400,000 potential customers. Opening local branches that showcase rehabilitation equipment and installing Patterson’s well-received electronic ordering system for physical and occupational therapists will eventually reduce the number of catalogues mailed, but these changes take time to implement. We accordingly believe that this promising distribution business will act as a drag on Patterson’s otherwise solid growth throughout the coming year. Since mid-March, Patterson stock price has dropped 11% to $44 with substantially all the decline occurring on May 26 when the company announced its disappointing fourth quarter results.

Beckman Coulter, Inc.

Beckman Coulter’s second quarter revenues rose 3.6% to $618.8 million while earnings fell 9.1% to 80¢, not including retirement expenses for former CEO Jack Wareham and other non-recurring items. On August 9, the company raised the quarter’s earnings per share by 12¢ to 92¢ because the switch to operational leases significantly lowered the company’s tax rate. A lengthening of the sales cycle in automation lab systems and increased instrument placements with operating leases offset growth in U.S. clinical diagnostics, growth in international markets and overshadowed strong revenue growth in biomedical research, up 5.3% in local currencies.

The company announced a change in its instrument leasing policy and a reorganization. The new instrument leasing policy, a shift from sales leases to operating leases for clinical diagnostic instruments, reduces the company’s 2005 revenue forecast by $100 to $160 million and 2005 earnings per share by 35¢ to 50¢ based on the lower tax rates. The Clinical Diagnostics and Biomedical Research divisions will be reorganized into one operating unit with four product groups so that product and technical knowledge in the two divisions can be shared more effectively.

Aggressive portfolio managers sold stock in reaction to the confusion created by the announcement of weak operating results and significant corporate changes. Beckman’s stock price dropped 15% on July 22 and is down 23% since mid-March. The new leasing policy should accelerate sales of Beckman Coulter’s industry leading instruments and automation systems. The 10% growth in consumables sales during quarter indicates that the company is placing more instruments and selling more tests to clinical laboratories. We will purchase stock for clients that do not currently own it or who own stock above $60 per share. We will recognize losses in taxable accounts before the end of the year.

Johnson & Johnson

Strong performance of Johnson & Johnson’s Medical Device and Consumer segments offset weak performance in Pharmaceuticals where generic competition for three drugs reduced sales by 5% during the quarter. The company reported second quarter revenues of $11.1 billion, an 11.1% increase over the second quarter of 2004. Earnings per share grew 13.4% to 93¢. The Medical Devices and Diagnostics segment grew 19.7% with currency contributing 2.3%. International sales of the CYPHER drug-eluting stent jumped 69% over the second quarter of 2004. CYPHER has 64% market share outside the U.S (including Japan) and 52% share where it competes with Boston Scientific’s TAXUS stent. CYPHER has 40% of the U.S. drug-eluting stent market. The Guidant acquisition remains on-track with the regulatory processes of the FTC and the European Authorities proceeding as expected. Johnson & Johnson’s stock price has declined 7.8% from its all-time of high of $70 reached on April 15 and is down 4.4% since mid-March.

Merck & Company, Inc.

Merck reported revenues of $5.5 billion and earnings per share of 62¢, not including a net tax charge associated with the company’s decision to repatriate $15 billion in foreign earnings in accordance with the American Jobs Creation Act. Revenues of Zetia and Vytorin, the two lipid-lowering drugs from the Merck Schering Plough joint venture exceeded $1 billion during the first half of the year and currently account for 12.5% of the new prescriptions written for this therapeutic class. The company’s stock price fluctuates with news from the first Vioxx product liability trial that is taking place in Texas. Merck’s stock price has declined 2.6% since mid-March.

Harte-Hanks, Inc.

Harte-Hanks second quarter revenues and earnings per share were up 12% and 17% respectively. EPS growth would have been 14% assuming a steady tax rate, but the company favorably resolved a State tax matter, lowering income tax expense. Free cash flow of $28.7 million rose 10% from the year ago period. Shopper revenue growth of 16% was boosted seven points by the April 20th acquisition of the Tampa Bay Flyer. Shoppers’ operating cash flow rose nearly 14%. Direct marketing revenues and operating cash flow rose 9% and 11% respectively. Financial services and automotive customer revenues gained 10% or more while retail, high-tech/telecom and pharma/healthcare customer revenues were up about 5%. Harte-Hanks’ stock price is down 1% since mid-March.


PepsiCo reported second quarter earnings per share of 70¢, an increase of 15% over the second quarter of 2004. Revenues for the quarter grew 9% to $7.7 billion. All of the divisions performed well with revenues from “better-for-you” snacks, such as chewy granola bars, low-fat salty snacks and rice cakes, international snacks and beverages and Quaker Oats all growing in double-digits this quarter. Revenues for PepsiCo Beverages North America rose 4% while volumes declined 0.5% as the division lapped a 7% volume gain in the second quarter of 2004. Strong performance of PepsiCo’s noncarbonated beverages with volume growth of 5% almost offset a 4% decline in carbonated soft drink volumes. PepsiCo’s stock price is up 4.2% since mid-March.

Kronos, Inc.

Kronos reported good fiscal third quarter results with both revenue and profits 13% higher than the quarter a year ago. Combined year-to-year growth of 20% in maintenance and professional service revenues, which attests to the strength of Kronos’ customers’ commitment, more than compensated for less than 5% growth in new product sales. Increased acceptance of remote implementation among Kronos’ larger enterprise customers increased the utilization of professional services and hence bookings. We attribute the modest increase in new product sales during the quarter to customers waiting before placing orders to evaluate Kronos’ June release of an upgraded version of its scheduling software which contains an absence management capability. Sales during the quarter, also, were hampered by the ongoing rebuild of the mid-market sales force.

During the quarter, Kronos signed license agreements with the Cleveland Clinic and Westchester Medical Center to deploy Kronos’ latest workforce management solutions. The availability of Kronos’ absence management solution helped seal the Cleveland Clinic sale while Westchester medical purchased the entire Kronos Workforce Central suite: from payroll to biometric terminals which includes all the scheduling, time and management solutions. Since mid-March, Kronos’ stock price has fallen nearly 12% in response to anxieties caused by the falloff in sales to mid-market customers. We believe this problem is being addressed realistically and will be fixed.

Dolby Laboratories

Dolby’s fiscal third quarter revenues rose 5%, while revenues for the fiscal year to date rose 13%. Licensing fees, which generate three quarters of company revenue, gained 10%, while product sales declined 12%. Last year AMC Theaters replaced its cinema processors (made by Sony) with Dolby systems, lifting product sales 30%. These revenues are absent this year. Dolby’s licensing revenue growth was curtailed by slowing growth in DVD player shipments and a shift to lower priced products manufactured in China. The low-end DVD players pay Dolby a lower licensing fee because they have fewer digital audio channels. Consolidation amongst Chinese electronics manufacturers also means more units receive volume-based discounts. During the quarter, Dolby licensing revenue benefited from growth in the PC, broadcasting and gaming markets. Microsoft and Sony have confirmed their use of Dolby surround sound technology in their new game consoles which will ship in Dolby’s fiscal 2006. Dolby management reiterated fiscal 2005 earning guidance of 55¢ to 62¢ on a pro-forma basis and 67¢ to 74¢, excluding stock based compensation expense. Dolby’s stock is close to its February 17 IPO price of $18 per share.


On July 1, Amdocs announced its long-anticipated entrance into the broadband billing and customer care market with the acquisition of a subsidiary of DST Systems that serves Tier 1 satellite and cable systems companies including DIRECTV, Comcast and Cablevision. The company also entered the Chinese market with a contract to provide an integrated billing solution to Beijing Mobile Communication Corporation, a subsidiary of China Mobile Corporation. Amdocs acquired privately-held Longshine Information Technology Corporation to expand its presence in China. Longshine currently serves three of the four largest communication service providers in China and offers services in 15 provinces across the country. Amdocs reported fiscal third quarter revenue and earnings growth of 13% and 33.3% respectively over the same period last year. The stock price has returned to $30, rising 8% since mid-March.

Intel Corporation

Strong demand for notebook platforms sent revenues from microprocessors for mobile computing up 68% during the second quarter and contributed to Intel’s second quarter revenue of $9.2 billion, a 15% increase over the second quarter of 2004. Earnings per share for the quarter grew 20% to 31¢, not including the impact of tax benefits in both years. Intel’s technology plans are on track. The company expects to move the 65 nanometer manufacturing process into production this year and is shipping samples of dual core processors for desktops, notebooks and servers. Intel’s stock price has risen 12.3% since mid-March.

Microsoft Corporation

Microsoft’s fourth quarter and full year revenue growth of 9% and 8% respectively over the same periods last year surpassed the company’s forecast. Earnings per share for the quarter and the year were 30¢ and $1.16, increases of 33% and 28.9% respectively. It is worth noting that these figures include stock compensation expense, unlike the earnings results of most tech companies. At the annual analyst meeting on July 28, Steve Ballmer stated that the company has its strongest new product pipeline in three years with XBOX 360 and its associated games, new server software, Windows Vista (formerly Longhorn) and Office 12 coming to the market over the next 18 months. Microsoft has received positive feedback on the beta version of Windows Vista launched on July 27 and expects the product to launch on schedule in the second half of calendar year 2006. The company is upbeat about its prospects for fiscal year 2006, forecasting revenues and earnings per share growth of 10-12% and 12% respectively. Microsoft expects strong license renewals from its enterprise customers in the second half of its fiscal year to ensure prompt receipt of Windows Vista and Office 12 as soon as they become available.

Microsoft’s stock price has risen 9.5% since mid-March to $27, back to its price after distributing the $3 per share dividend on December 2, 2004. Microsoft repurchased $8 billion of stock during the year, but has not increased its quarterly dividend, disappointing many investors. Meanwhile, aggressive portfolio managers shun Microsoft because its large capitalization makes it a poor trading stock, especially compared to the stocks of smaller software companies such as Kronos. This lack of enthusiasm allows the stock to remain fairly priced.

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.