1st Quarter, 2008

Our calculations of the performance of your stocks over the past two and one half months begins on March 17th, the day when the Fed intervened to prevent Bear Stearns from imploding and the current stock market upturn began. We think the Fed’s actions averted a likely panic, and its subsequent injection of $500 billion of liquidity into the money market through innovative short-term lending facilities to member banks, government securities dealers and foreign central banks has lessened dangerous strains in the credit markets. The size of the Fed’s unprecedented lending and the horrendous losses reported recently by prominent financial institutions are evidence of the persistence of abnormal conditions in the financial markets where fears of real or imagined loss can cause sudden bouts of selling.

A common characteristic of the loss-making speculation that has imperiled our financial markets is the widespread use of leverage to heighten the possible return from buying complex financial instruments similar to those bought earlier by smart investors whose high returns were trumpeted widely. Eager equity investors and lenders financing funds investing in these arcane instruments were gulled by a belief still prevalent today that high returns came from investing in things incomprehensible to an average investor. The events of the past year confirm our conviction that increasing the complexity of a financial instrument or strategy diminishes its liquidity, thereby multiplying risk. Applying leverage to buy complex instruments or to pursue complex trading strategies invariably results in loss once copycats appear.

We think leveraged speculation has propelled the recent surge in commodity prices. Investments in commodity index funds from individuals, hedge funds, pension funds and endowments now exceed $200 billion. The seemingly unstoppable upward price momentum of nearly every tradable commodity continues to draw money into funds and is encouraging hedge funds and investment banks to offer hefty salaries and bonuses to anyone with commodity trading experience. Amazingly, Brian Hunter, who lost $6.6 billion in 2006 by leveraging wrong way bets on natural gas futures for Amaranth Advisors, is back in business advising a commodity trading fund! We point this out as evidence of the continuing appetite for leveraged speculation to reap profits by piling into the asset class delivering the highest recent returns. It is not meant as a comment on commodity price trends but instead a suggestion that perhaps a commodity bubble is inflating before the collapse of the credit bubble is complete.

State Street Corporation

State Street’s stock price is down 5% since March 17th and 7% below its price before the company reported on April 15th record first quarter earnings of $1.35 per share, 49% higher than earnings for the year ago quarter. Although the strong operating results demonstrate superb execution in servicing institutional investor needs amid tumultuous markets, these achievements are overshadowed by anxieties about possible adverse consequences from an increase of $1.7 billion in the unrealized mark-to-market losses at quarter end in State Street’s $73 billion investment securities portfolio. These unrealized losses which now total $3.1 billion loom more ominous when combined with management’s estimate of a $1.49 billion loss it must recognize if the conduit assets State Street manages for mutual fund customers were consolidated on its balance sheet. The possibility that State Street may be required to record these unrealized losses excites speculation that it may seek to raise additional capital to keep its regulatory capital ratios intact. At the end of March, the company raised $500 million through a preferred stock sale and is scheduled to receive $450 million before year-end from sale of its 50% interest in CitiStreet to ING. Capital worries will continue to weigh on State Street’s stock price until they are resolved.

The CME Group

CME’s first quarter revenues of $625 million rose 88% from a year ago before the merger with the Chicago Board of Trade. They rose 25% on a proforma basis. Earnings per share of $4.67 rose 27% from a year ago, or 38% on a proforma basis. These strong results were achieved because the volume of futures and options traded at the combined CME Group rose 32% during the first quarter. Stock and bond market volatility spurred volume growth of 66% and 24% respectively in stock index and interest rate futures and options contracts. Foreign exchange and commodities volumes also rose, increasing 15% and 20% respectively over the same period a year ago. The average rate per contract declined 1¢ from the year ago quarter to 63¢. The volume of contracts traded electronically during the quarter rose five percentage points from a year ago to 81%.

CME shares have declined 3% from mid-March. We think investors fear that deleveraging by investment banks will lead to lower volumes traded at CME. There is little evidence to support this conclusion. In fact, 80%
of trading volume is from by buy side firms not the proprietary trading desks of Wall Street banks. Many buy side firms, including algorithmic traders, do not employ capital intensive strategies. They trade rapidly, in and out of markets and end the day with little net exposure. Tighter provision of credit throughout the financial markets provides a further benefit to CME because of the ability of the CME Clearing House to provide portfolio based margining and credit mitigation reducing capital requirements and counter party risk.

Automatic Data Processing

Shares of ADP have rebounded 10% since their recent low in mid-March as fears about a sharp downturn in employment failed to materialize. During ADP’s fiscal third quarter, revenues of $2.4 billion rose 12% while earnings from continuing operations of 77¢ per share increased 18%. ADP’s PEO (Professional Employer Organization) continues to expand at a rapid pace, with revenues up 20% during the quarter and average work place employees increasing 17% to 181,000. Revenues from the company’s core payroll business increased 8% while add-on products and services rose 13%. The number of employees on existing clients’ payrolls slowed to 1.1%, from 1.6% the previous quarter, but remains positive. Interest earned on client funds was flat at nearly $200 million as a 6.2% increase in the average balance to $18.7 billion was offset by a reduction in interest yield to 4.2% from 4.5% a year ago. Client retention rose 90 basis points during the quarter, a large increase, while new business sales were up 4%. During the quarter, ADP acquired 5.8 million shares at an average price of $40 per share. Share buybacks have added 4¢ to earnings per share during the past three quarters.

EnCana Corp.

EnCana’s first quarter earnings rose 28% to $1.39 per share compared to a $1.09 earned during the comparable quarter last year. Results benefitted from share repurchases reducing fully diluted shares by 3.4% from a year ago. An average realized natural gas price of $8.02 per mcf, 11% higher than a year ago, on delivered volumes 9.8% higher lifted EnCana’s operating profits from gas production 28%. The company booked a $937 million mark-to-market loss equal to 98¢ per share on contracts it owns to hedge at $8.04 per mcf, 40% of its 2008 gas production. EnCana’s integrated oilsands-refining joint venture with Conoco generated operating profit 5% higher than a year ago as a realized price 50% higher than a year ago for slightly fewer barrels was largely offset by a 40% drop in refining margins.

EnCana’s stock price is up 20% since March 17 with one-third of the rise coming after May 11 when the company announced its plan to split itself in two. One company will own all of EnCana’s unconventional early life North American gas producing properties and prospects. The other will own the oilsands production and leases, conventional oil and gas producing fields in Alberta and Saskatchewan, and the company’s interest in the oilsands-refining joint venture with Conoco. This proposed tax-free transaction is scheduled to occur in early 2009. In the meantime EnCana intends to maintain its quarterly dividend at 40¢ per share but will cease stock repurchases and instead apply its free cash flow to reduce its net debt to capitalization ratio to 30% from 40% now.

C.H. Robinson Worldwide Inc.

Shares of CH Robinson have surged 23% since St. Patrick’s Day as the company reported strong results, boosting confidence in its ability to prosper in a difficult operating environment. Gross revenues of nearly $2.0 billion during the quarter rose 23% while earnings of 50¢ per share rose 19%. The company’s core trucking business secured 15% truckload volume growth and price increases of 8% including fuel. Since overall diesel fuel prices were up 10% year-over-year, underlying line haul rates actually declined 2% as a result of the weak freight environment. Overall volume growth of truckload services has been flat to down, but Robinson continues to gain share as a result of its long term customer relationships and its relentless focus on its customers’ needs. The company’s LTL (less than truckload) shipments increased 30%. Truckers have sought business through Robinson to take advantage of their unique ability to find truckload volume and their policy of paying quickly. Tighter credit market conditions have increased demand for Robinson’s fuel card and cash advance services, driving a 16% fee increase for these services during the quarter. Robinson’s other transportation businesses also executed well during the quarter. Freight forwarding increased 26% and fruit and vegetable sourcing for foodservice providers and retailers rose 13%.

Express Scripts, Inc.

Express Scripts’ stock price has risen 27% since Mid-March and is just 2% below its price at the beginning of the year. The company reported good first quarter results with earnings per share of 70¢, up 35% over the same period last year. Gross profit rose 14% to $468.7 million and cash flow from continuing operations jumped 56% to $248.3 million. Express Scripts’ generic fill rate continued its climb to new heights, reaching 65.1% for the quarter. Clients’ growing adoption of the company’s step-therapy programs, which require members to try a generic drug first, strongly contributes to this industry-leading rate. Express Scripts now offers formulary

management, prior authorization and therapy adherence programs for specialty drugs. Implementing these programs reduces the growth rate of specialty drug costs by one-third. Clients cite this unique offering as a key reason for choosing Express Scripts to manage their pharmacy benefit.

Stryker Corporation

Stryker’s first quarter sales of $1.6 billion grew 10.3% in local currencies. Earnings per share were 70¢, an increase of 20.7% over the first quarter of 2007. Revenues of the Orthopaedic Implants business grew 7.3% with a 1% decline in year-over-year hip implant sales offset by strong performances of Stryker’s other implant businesses. The Trauma, Spine and Craniomaxillofacial (head and jaw) businesses posted 16%, 18% and 21% revenue growth during the quarter. Revenues of the MedSurg businesses rose 15% during the quarter with double-digit growth in both U.S. and international markets. The decline in Stryker’s hip sales resulted from the voluntary recall of its popular Trident hip in January. The company has replaced the supply of the recalled product, but the sales force still has work to do to recapture lost sales. Stryker has received FDA warning letters for three implant manufacturing plants, two in the U.S. and one in Ireland. The company is investing $50 million this year to standardize the quality assurance systems of its decentralized manufacturing operations. Management has not changed its 2008 earnings forecast in spite of this significant investment in time and money to improve its quality systems. Stryker’s stock price is up 4% since mid-March.

Varian Medical Systems, Inc.

Varian Medical Systems has received more than 60 orders for its RapidArc technology for the faster delivery of image-guided radiotherapy (IGRT) since it became available for sale in January. This is the strongest demand for a new oncology product in the company’s history. Customers have added it to existing orders, to orders for new machines and have requested upgrades on systems that are already capable of performing IGRT. Oncology Systems’ net orders for the quarter rose 11% to $413 million over the same period last year with 15% growth in North America and 6% growth in international markets. Most of the RapidArc orders came from early adopters in the United States, the typical pattern for the uptake of new technologies. Varian’s fiscal second quarter earnings per share rose 22% to 56¢, while revenues rose 19% to $528 million. The stock price has risen 4% since mid-March. On April 11, it retreated from $50 when General Electric commented that tighter hospital capital budgets reduced their sales of imaging equipment during the quarter. Varian has not seen any change in the pace of purchasing decisions yet. Radiotherapy is a profit center for hospitals and free-standing clinics and will continue to have priority in capital budgets. The introduction of RapidArc makes Varian’s versatile treatment machines even more effective in delivering better patient outcomes more cost- effectively.


Genentech reported first quarter revenues of $3.0 billion and non-GAAP earnings per share of 84¢, increases of 8% and 12% over the same period last year respectively. U.S. sales of Avastin and Rituxan each grew 13% to $600 million and accounted for half of the company’s product sales during the quarter. Avastin use in newly-diagnosed metastatic lung cancer remains unchanged with 60% of patients undergoing treatment with the drug. During the quarter, 25% of newly-diagnosed metastatic breast cancer patients were treated with Avastin in combination with other drugs. Genentech expects the adoption rate in breast cancer patients to rise as the sales force educates oncologists outside of academic medical centers. Rituxan was used by13% of rheumatoid arthritis patients, up from 7% during the first quarter of 2007. January’s FDA approval of the claim that Rituxan slows the progression of the disease should increase its use in patients that cannot use other biologic treatments. Sales of Lucentis were down 6% over the same period last year. Concerns about reimbursement encourage the use of less expensive, but unapproved Avastin to treat age-related macular degeneration. Lucentis received a reimbursement code for Medicare patients in January, an event that should reduce the cost concerns of retinal specialists.

Genentech’s stock price continues its wild ride. It reached the low 80’s in March, only to plummet 15% to within 2% of its price at the beginning of the year. The April 28th report of the failure of the small clinical trial of Rituxan for systemic Lupus sent the stock price down 7%. The company is continuing a trial to determine if Rituxan helps treat Lupus nephritis, a separate disease from systemic lupus. Success would help those affected with this horrible disease. It would have scientific but no commercial significance. Genentech will present more than 400 papers and posters at the American Society of Clinical Oncologists at the end of May. One of the most anticipated is an update on the use of Avastin in the early stages of metastatic colon cancer. The recent six month report of the safety board overseeing the study did not see any significant safety issues and allowed the trial to continue.

Merck & Company, Inc.

Fund managers continue to sell Merck stock because of their fear of the imminent demise of Merck’s lipid-lowering drug business. Its stock price is down 8% since the middle of March. The stock price plummeted 15% on March 28 after a panel of cardiologists at the American College of Cardiology meeting suggested that Vytorin offers no clinical benefit to patients in their discussion the final results of the clinical study that caused the frenzied selling in January. In addition, the FDA did not approve Cordaptive, a combination of a novel anti-flushing drug and extended release niacin. High doses of niacin have been shown to increase HDL cholesterol levels and to reduce the risk of heart attacks and strokes. Patients, however, usually abandon this therapy because the therapeutic niacin dose causes severe flushing.

Merck’s first quarter results demonstrate the strength of the company’s business. First quarter revenues rose 1% to $5.8 billion, a loss of 3% excluding foreign currency. Earnings per share were 89¢, an increase of 6%. The realization of foreign tax credits decreased the company’s tax rate by 8%, adding 13¢ to earnings per share for the quarter. Sales of Zetia and Vytorin were lower than forecast and Fosamax, Merck’s leading anti-osteoporosis drug, lost its U.S. patent protection in early February. Sales growth in Singulair, the vaccines Gardasil, Rotateq and Zostavax, along with Merck’s other drugs offset most of this decline. Merck’s vaccine franchise is a unique asset that will remain profitable for many years to come. Unlike oral drugs, vaccines are difficult to make and have no generic competition. In addition, the company’s successful streamlining of its manufacturing facilities and its new marketing approach will allow the company to invest in research and development and to remain profitable as drug prices decline.


Amdocs reported fiscal second quarter revenues of $774 million, up 9.6% over the same period a year ago. Earnings per share rose 15% to 46¢. The general economic slow down has not yet caused their customers to rein in their spending. The company’s 12-month backlog rose $60 million to $2.36 billion, which includes increased AT&T managed services revenues and a deal to provide a customer relationship management system to a large European wireless carrier. Sprint’s conversion to the unified billing platform is in its final stages. Revenues from this mission critical managed services contract also contributes to the current backlog. Amdocs announced several wins from small European carriers for its Compact Convergence suite. This end-to-end platform is standardized for quick installation and can be scaled up as the carrier’s subscriber base and service offerings grow. On April 6, Amdocs announced the $45 million cash acquisition of Jacobs Rimell, a provider of fulfillment solutions to broadband cable operators. This acquisition enables Amdocs to offer a comprehensive solution to automate high volume processes for “right first time” fulfillment. It also deepens the company’s relationship with Comcast, a current Jacobs Rimell and Amdocs’ customer.

Amdocs’ stock price jumped 15% the day after the company reported its fiscal second quarter earnings. Its stock price has risen 10% since mid-March, having given back some of the gain as investors’ continue to worry about the financial strength of Sprint and Bell Canada. Amdocs has not seen slower payments from either company. Management expects Bell Canada to invest to upgrade its systems when its management turns its attention back to running the company.

Donaldson Company, Inc.

Donaldson shares rose 6% to $50 after reporting a 21% increase in its fiscal third quarter sales to $588 million and a 16% increase in earnings to 57¢ per share. The impact of foreign currency translation increased sales by 7.6%. The company’s sales growth was strong worldwide with an increase of 15% or more in NAFTA and Asia and more than 25% in Europe. Sales of Engine Products rose 17%, propelled by off-road filter sales growth of 30%. Replacement filter sales accelerated to 17% growth from 14% last quarter. Agricultural, mining and military applications led the engine filter sales gains. The Industrial Products segment generated 27% sales growth. Strong demand for power generation by oil and gas producers drove a 43% increase in Donaldson’s gas turbine filter sales. The company repurchased 500,000 shares of stock during the quarter at $41 per share. Donaldson’s stock price has risen 25% since mid-March.

PepsiCo, Inc.

PepsiCo delivered good first quarter results with management successfully addressing higher than expected inflation in key commodities. First quarter revenues rose 13% to $8.3 billion and earnings per share grew 7% to 70¢ over the same period last year. The company’s snack businesses will offset the 9 – 10% worldwide price increases in energy, grains and cooking oil with price increases and cost savings from productivity improvements. John Compton, the CEO of Pepsi Americas Foods, reported that price increases to Frito Lay products have not reduced consumer appetite for them. Pepsi’s U.S. businesses have been less affected than their competitors by the shift of purchases from single servings in restaurants and convenience stores to larger sizes purchased in grocery stores and mass merchandisers for home meals. PepsiCo International continued its robust growth in the first quarter with 10% snack and beverage volume growth, 12% revenue growth and 14% operating profit growth excluding acquisitions and the positive effect of foreign currency. Opportunities to expand this business take several forms including adapting core brands for local markets. Barbeque-flavored Doritos were a big hit in Saudi Arabia and Lay’s lychee and mango flavored chips sold well in China during the New Year celebrations. The company continues the successful launch of core beverage brands such as Pepsi Max in China and India. Pepsi’s stock price is down 2% since mid-March.

Intuit Inc.

Intuit delivered excellent results during its important fiscal third quarter. Revenues of $1.3 billion rose 15% from a year ago while non-GAAP earnings of $1.39 per share rose 23%. GAAP earnings of $1.33 per share increased 28% from the same period last year. Revenues from Consumer Tax increased 16% from the year ago quarter and generated one-half of total quarterly sales. Intuit sold 7.0 million Turbo Tax online units, up 33% and 3.3 million desktop units, flat with a year ago, for total Turbo Tax unit growth of 20%. The number of Federal Tax returns filed on April 14 and 15 by Intuit more than doubled from a year ago. Attesting to the company’s improved data processing capability, there were no filing glitches. Professional Tax sales of $166 million rose 20% from a year ago as more annual revenue was recorded in this year’s fiscal third quarter than in its fiscal second quarter. Total Small Business revenue rose 9% to $307 million during the quarter. This increase is comprised of growth in QuickBooks and Payroll & Payments which rose 5% and 14% respectively. Digital Insight, the company’s online banking and bill payment product for small banks reported 10% revenue growth. The number of internet banking customers increased 9% to 8.5 million, while the number of bill payment customers rose 17% to 2.4 million. Intuit plans to roll out an enhanced version of this product named Finance Works for consumers and small business later this year. Intuit shares have risen 13% since mid-March.

Intel Corp.

Intel reported first quarter revenues of $9.7 billion, an increase of 9% over the first quarter of 2007. Earnings per share were 25¢. The company reported strong sales of both its high-end and quad-core Xeon server microprocessors in North America. Xeon microprocessors are now manufactured in high volume with the 45

nanometer process. This successful crossover extends Intel’s technological lead in this important segment of the microprocessor business and contributed to the 17% increase in gross profit. The company completed the sale its
flash memory business to Numonyx during the quarter and took a 4¢ per share charge for restructuring costs and impaired assets. Intel began selling Atom processors, its new line of lower cost, low power processors designed for mobile internet devices. These computers are smaller than a notebook and are designed for web-browsing and other simple tasks. Twenty-five designers have already selected Atom processors for 35 new products. Intel’s successful transition of its manufacturing process to 45 nanometers and analyst’s improved forecasts of 2008 personal computer demand have lifted Intel’s stock price is up 13% since mid-March. Its stock price is up 26% from its recent low on January 22.

Western Union

Western Union shares have rebounded 14% since mid-March as good first quarter results and continued growth in consumer money transfers boosted investor confidence that the company will thrive as it continues to expand globally. Revenue of $1.3 billion rose 12% while earnings of 27¢ per share which includes 2¢ of restructuring expenses increased 8%. Excluding the charge earnings were up 16%. Consumer to consumer money transfers and revenues each rose 14%. International transfer volumes increased 29% generating revenue 28% ahead of a year ago. This compares to 25% growth last quarter. This important part of Western Union’s business now generates one-half of company revenue and is its fastest growing segment. The US to Mexico corridor was relatively flat, posting 1% revenue and 2% transaction growth. Revenue from India and China, however, rose 52% and 35% respectively and are about the size of the US to Mexico corridor on a combined basis. The company continues to expand its agent network, ending the quarter with 345,000 agent locations, up 15% from a year ago, and an increase of 10,000 agents during the quarter. Western Union is utilizing its abundant free cash flow to buy back stock. It purchased 14 million shares for $21.41 per share on average during the quarter.


Exxon Mobil’s first quarter earnings of $2.03 per share rose 25% above its year ago results aided in part by stock repurchases at an average price of $86 which reduced fully diluted shares outstanding by 6%. Higher oil and gas prices realized on worldwide production 6% below last year’s volumes provided all the improved operating profit. Production sharing contracts primarily on increased Angolan offshore production curtailed realized volumes by 1.5%. Venezuela’s expropriation of Exxon’s producing properties cut production 3%. During the comparable quarter a year ago, chemical and refining and marketing operations generated 35% of Exxon’s operating profits. This year they produced 20%. Exxon nonetheless remains the world’s most profitable refiner and petrochemical producer. These businesses, which are technological leaders, derive 30% of their profits from their U.S. facilities where regulation restricts expansion. Predictably, they concentrate their investments outside the United States. Exxon’s stock price has risen 5% since March 17.

Johnson & Johnson

Johnson & Johnson reported fully diluted first quarter earnings of $1.26 per share, 8.6% above the amount earned on a comparable basis a year ago. Quarterly sales were 7.7% higher than sales for last year’s quarter. Absent a 5.1% foreign currency gain, sales grew 2.6%. J&J’s pharmaceutical division, its largest, reported worldwide sales growth of only 3.3% to $6.4 billion which, without currency gains, became a .6% decline. These weak results are largely caused by declining sales for J&J’s second and third largest selling pharmaceuticals, Procrit – its treatment for anemia, and Risperdal – its antipsychotic medication. Procrit’s U.S. sales continue to plummet, falling 37% year-to-year during the quarter due to the FDA’s recommended constraint on usage. Risperdal’s international sales fell 26% amid competition from generics. J&J’s U.S. patent for Risperdal expires in June. These sales declines are partially offset by a 27% increase in sales of J&J’s best selling pharmaceutical, Remicade, a biologic for treatment of rheumatoid arthritis and other autoimmune diseases. This acceleration of Remicade sales results from inventory purchases for a multi-market international sales launch by J&J’s distributor. The company’s Medical Devices and Diagnostic businesses, comprising its second largest division, with worldwide sales of $5.7 billion during the quarter also are experiencing sales declines or slowdowns in key products. First quarter sales, excluding currency, rose only 1.4%. A prolonged drop in sales of drug eluting stents may finally have bottomed, albeit at a level 15% below a year ago. Meanwhile, sales growth at DePuy, J&J’s orthopedic implant business slowed to 4%, with 2% growth in worldwide knee sales and none for spine.

J&J’s consumer business provided a marked contrast to its two larger divisions. Bolstered by the successful integration of the product lines acquired from Pfizer, the consumer division produced resoundingly strong first
quarter results. U.S. sales rose almost 12% and international sales, excluding currency, increased more than 8%. All long-term J&J shareholders should thank Bill Weldon, J&J’s CEO, for refusing to pay too much to buy Guidant, a manufacturer of defective implantable heart defibrillators. The company instead used available cash to buy Pfizer’s consumer products business. J&J’s stock price has advanced only 1% since St. Patrick’s Day.

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.