EARNINGS LETTER

2nd Quarter, 2008

The good second quarter earnings of all your companies exerted little influence on their stock prices. As of this writing few are selling above their prices at the start of the year although most have declined considerably less than the stock market as measured by the S&P 500 which is down 16%. It appears as though our companies’ results were lost amid the anxieties aroused by the publicized plight of major financial institutions accustomed to using excessive leverage without possessing sufficient capital to reduce their borrowings without falling into insolvency. The worst fears were confirmed this week by the U.S. Treasury Department’s decision to appoint Fannie Mae’s and Freddie Mac’s regulator as the conservator for these mammoth government sponsored mortgage agencies. These two agencies have securitized over half the $10 trillion mortgages outstanding in the U.S. and must unwind almost $1.4 trillion of derivative contracts. The Treasury had no choice but to replace the implicit U.S. Government guarantee of the agencies’ debt securities with the explicit backing of the full faith and credit of the U.S. Government. This move constitutes a massive deleveraging of these agencies who had two cents of suspect capital for every dollar owed. Their dicey capital now is replaced with the equity of the full taxing power of the U.S. Government backing their debt. We, the citizenry, have taken on the debt.

Excessive leverage made the rescue necessary. These agencies are hardly the only culprits. The drumbeat of announced write downs of illiquid mortgage-backed securities and debt instruments containing these and other asset-backed securities as collateral serves as a reminder that the financial industry’s value-at-risk models are badly flawed. They are designed to measure the risk of price declines in a functioning market, not the risk of a security that cannot be sold while the underlying asset deteriorates.

This unprecedented government intervention in the market for mortgage-backed securities results directly from the best and brightest financial market participants’ fascination with complex securities and trading strategies which theoretically control risk. They do not. At best, they put a price on risk, which we ruefully find can prove “priceless.”

Roger Lowenstein, the thoughtful author of When Genius Failed: The Rise and Fall of Long-Term Capital Management, in an article in last Sunday’s New York Times succinctly points to the flaw in modern portfolio theory.

Modern finance is an antiseptic discipline; it eschews anecdotes and examples, which are messy and possibly misleading – but nonetheless real. It favors abstraction, which is perfect but theoretical. Rather than evaluate financial assets case by case, financial models rely on the notion of randomness, which has huge implications for diversification. It means two investments are safer than one, three safer than two…It is based on the idea that each new price is random, like a coin flip…Long-Term Capital’s partners were shocked that their trades, spanning multiple asset classes, crashed in unison. But markets aren’t so random. In times of stress, the correlations rise.

State Street Corporation

State Street’s stock price is down 14% since the start of the year, but up 22% from its low of $55 on July 14, the day before the company reported exceptionally strong second quarter earnings. At $1.40 per share they were 31% higher than the $1.07 earned in the year ago quarter. Revenues rose 39% to almost $2.7 billion. Securities lending revenues, propelled by customers’ short selling amid worldwide market tumult, increased 117% to $352 million, a level we believe is unsustainable. Net income during the quarter rose 50% to nearly $550 million. This percentage increase surpasses the rise reported in earnings per share because State Street increased its shares outstanding 15% a year ago to acquire Investors Financial and on June 3rd of this year it sold 41 million shares at $70 each to strengthen its equity base and its regulatory capital. The need for additional capital is a consequence of investors’ and regulators’ concerns about the mark-to-market losses State Street has incurred on mortgage and other asset- backed securities held in its $75 billion investment portfolio and in four funds invested in asset-backed commercial paper opened in 1992 for mutual fund customers. State Street administers and supports these funds with standby letters of credit. The mark-to-market writedown during the quarter on the investment portfolio was $72 million. The recorded unrealized loss in the commercial paper funds was $130 million. We expect State Street’s stock price will benefit from robust earnings growth, albeit at a rate lower than the percentage just reported. Meanwhile the ebb and flow of concern about financial institutions’ losses on structured debt instruments probably will continue to amplify fluctuations in its stock price.

The CME Group

CME Group’s second quarter revenues of $563 million rose 71%, operating income increased 79% to $343 million and net income of $201 million rose 60%. Earnings of $3.67 per share rose just 3% as shares outstanding increased 55% from a year ago, prior to CME’s acquisition of the Chicago Board of Trade. Proforma revenues rose 10% to $563 million and earnings rose 12% to $3.93 per share. Second quarter volume of 11.1 million contracts per day rose 75% overall or 7% on a proforma basis. The average rate per contract was 65¢, up 1¢ from a year ago. Stock index volume was up 33%, FX up 26%, commodities up 14% and interest rates down 3%. The decline in interest rate volumes has persisted since the end of the quarter. The company views this decline as a cyclical slowdown occasioned by problems in the global credit markets and the slowdown in mortgage and asset-backed security originations.

CME shares, which rose 35% last year, have declined 52% since the start of the year. On August 22, the CME Group completed its acquisition of NYMEX adding its energy and metals businesses. Unlike the CBOT transaction which became dilutive because of the emergence of another bidder which forced CME to raise its offer, the NYMEX acquisition is accretive to earnings in the first year. CME declared a special dividend of $5 per share payable October 10 to shareholders of record on September 25, 2008.

Automatic Data Processing

ADP’s fiscal fourth quarter revenue and earnings per share growth of 10% and 20% respectively brought full fiscal year revenues to $8.8 billion, up 12.5%, and earnings to $2.18 per share, 21% higher than the comparable year ago figure. ADP’s base U.S. payroll business rose 4% during the quarter and 7% for the full year, while add-on products and services rose 12% in the quarter and 16% for the year. Employee growth per payroll slowed to 0.8% in the fourth quarter, bringing the full-year increase to 1.3%. Client retention improved 20 basis points, reaching a new record. Interest earned on client funds balances declined 4.7% during the fourth quarter to $170 million as growth in fund balances of 4.2% to $16.1 billion was offset by a decline in yield to 4.2% from 4.6% the previous quarter. For the year interest earned on client funds rose 4.7% to $685 million as the average balance of $15.7 billion was 6.6% higher than the previous year. The yield was 4.4% for the full year, a decline of only 10 basis points. During the year ADP returned more than $2 billion to shareholders: $1.5 billion through the repurchase of 32.9 million shares or 6% of its outstanding shares, and dividend payments of $549 million providing shareholders with a dividend yield of 2.6%. ADP shares are unchanged since the start of the year.

EnCana Corp.

EnCana reported good second quarter earnings of $1.96 per share, 9% higher than the $1.79 it earned during last year’s comparable quarter. Natural gas production rose 10% during the quarter to 3.8 billion cubic feet per day. The higher volumes came largely from the Deep Bossier, a sand formation in East Texas where EnCana acquired the remaining 50% interest it did not own for $2.55 billion on October 1, 2007. EnCana operated there for almost three years before making the acquisition. Its experience enables it to obtain initial production 50% higher from wells drilled now than it got from those drilled two years ago. Power outages during scheduled maintenance cut oil bitumen production from EnCana’s 50% owned oil sands 22% below the first quarter rate and crimped profits of EnCana’s 50% owned integrated oil sand-refining business despite the realization of over $90 a barrel for the heavy oil produced. Production volumes are now 10% above that of the first quarter. The price however has declined by a third so the chance to briefly reap maximum profit at the oil price peak was missed. Refining margins in the second quarter collapsed to less than half that realized during the first quarter. Despite these adverse developments, the joint-venture management delivered operating cash flow equal to 95% of the amount produced in the first quarter, which bodes well for the valuation these properties will be accorded by investors when they are spun-out in early 2009 as a separate publicly traded company. EnCana’s stock price decline has tracked the drop natural gas spot prices which peaked on July 2. Since then, gas prices are down 45% and EnCana’s stock price is 28% lower, leaving it 5% below its’ price at the start of the year.

C.H. Robinson Worldwide Inc.

CH Robinson’s second quarter net revenue of $341 million and earnings of 52¢ per share each rose 10% from the year ago period. Total gross revenues of $2.3 billion rose 23.5%. Gross revenues in Robinson’s core transportation business, which generated 83% of total gross revenues, rose 27.5%, though its cost of hire rose at a faster 31% annual rate, resulting in net transportation revenue growth of 10% during the quarter. For the first time during the current shipping cycle, Robinson was unable to fully pass through higher shipping costs to its customers. This is the result of flat to down industry shipping volumes combined with year-over-year increases in diesel fuel of more than 50%. In this difficult environment, Robinson’s truckload volume growth of 11% during the quarter is impressive, a result of its unwavering focus on execution. Robinson’s fruit and vegetable sourcing business rose 7% while information services increased 17%. Robinson’s stock price now stands 2% below where it began the year after rising 21% through mid-May.

Ritchie Bros. Auctioneers

Ritchie Bros. Auctioneers, the world largest auctioneer of industrial equipment, reported second quarter gross auction proceeds of $1.2 billion, up 23% from a year ago. Its net auction revenues of $116 million also rose 23% while earnings of 37¢ per share surged 46%. The quarterly earnings figures reported by Ritchie Bros. can be lumpy based upon auctions conducted and costs incurred to hire and train staff and to implement information technology projects. The stock rose 6% the day it announced these strong results, but has since declined 8% and is 4% below the price it stood at on May 1.

During the second quarter, Ritchie Bros. conducted 60 unreserved industrial auctions throughout North America, Europe, the Middle East, Asia and Australia. Of the 80,000 registered bidders, 25,000 were successful buyers of 74,000 different lots from 11,000 consignments. Twenty percent of gross auction proceeds came from bidders using the company’s internet bidding service, rbauctionBid-Live. This unique capability facilitates the efficient sale of equipment to bring sellers a market price which transcends local market conditions.

Express Scripts, Inc.

Express Scripts’ second quarter earnings increased 33% over the same period last year to 76¢ per share. The quarter’s gross profit rose 15% to $504.4 million and operating profit per claim rose 18% to $2.67. The Department of Defense, the company’s largest client, renewed and expanded its contract to include specialty drug services in addition to retail and home delivery services that the company has provided since 2003 and 2004 respectively. Express Scripts has saved the DoD $414 million over the contractually guaranteed savings target for retail pharmacy services since 2004. Express Scripts’ member satisfaction rating of more than 97% is the highest rating of all contractors serving the DoD. The company’s stock price is unchanged from the beginning of the year, but has risen 30% from its 2008 low on March 17.

Stryker Corporation

Stryker’s MedSurg business plan focuses on increasing sales in key countries outside the U.S. by adding dedicated sales representatives in the Instruments and Endoscopy businesses. Successful execution of this plan contributed to MedSurg’s 25% operational revenue growth during the second quarter. Total MedSurg sales increased 17.8% over the same period last year. The Instruments business delivered exceptional revenue growth of 20% during the quarter because of increased demand for certain products that a competitor temporarily removed from the market. Revenues of the five Orthopaedics Implants businesses (hips, knees, spine, trauma and head and jaw) rose 9.2% during the quarter. All businesses except hips posted 13% to 18% revenue growth. Stryker reported second quarter revenues of $1.7 billion, up 12.3% over the second quarter of 2007. Earnings rose 19.7% to $.73 per share. Stryker’s research pipeline remains strong even though second quarter Research and Development expense declined 2% to $90 million, 5.3% of sales during the quarter. Progress on a few R&D projects has slowed as the company focuses some R&D resources on its quality effort. Stryker remains confident in the strength of its pipeline having invested an industry-leading 6% of sales in R&D from June 2005 through December 2007. Stryker’s stock price is down 13% since the beginning of the year, but has risen 8% since its 2008 low on March 13.

Varian Medical Systems, Inc.

Varian Medical Systems’ stock price is up 21% since January 1. It rose 10% on July 24, the day after the company reported excellent fiscal third quarter results. Revenues grew 21% over the same period a year ago to $513 million, while earnings grew 16% to 58¢ per share. Demand for Varian’s RapidArc technology continues to outpace demand for previous new radiation therapy technologies with more than 150 orders since the product was launched in April. Oncology System’s orders increased 12% over the same period last year to $461 million with over 80% of the high-energy radiation systems ordered during the quarter including the on-board imager, a pre-requisite to performing RapidArc treatments. Varian expects to complete 1,000 installations of systems with the on-board imager by September 30, the end of its fiscal year. Reports of initial treatments with RapidArc are compelling. One cancer center reduced the treatment time for a complex head and neck cancer from twelve minutes to less than 90 seconds with a tighter conforming radiation dose than standard image-guided radiation therapy. X-Ray products posted second quarter net order growth of 45% to $85 million as more medical diagnostic equipment manufacturers install flat panel digital imagers to replace X-Ray films. As X-Ray imaging transitions from film to digital, Varian expects the flat panel market to grow to several hundred million dollars.

Genentech

On July 21, Roche surprised Genentech and its investors with an offer to acquire the shares it does not own for $43.7 billion in cash or $89 per share. Genentech’s shares trade at about a 10% premium to the offer, lifting the company’s stock price 43% since the beginning of the year. On August 13 Genentech’s three independent directors formally rejected Roche’s bid because it was too low, but are willing to evaluate a better offer. We expect the company to accept a higher bid from Roche later this year.

Genentech reported second quarter revenues of $3.2 billion and non-GAAP earnings per share of 82¢, increases of 8% and 5% respectively. U.S. sales of the company’s oncology drugs increased 11.1% over the second quarter of 2007 to $1.8 billion and accounted for 69% of the quarter’s revenue. Oncologists continue to include Avastin in treatment regimens of a steadily rising percentage of eligible breast and lung cancer patients. Sales of Lucentis, Genentech’s treatment for age-related macular degeneration, rose 9% over the first quarter of 2008 with the new patient share growing from 40% to 45%. Although improved patient access and physician education programs contributed to this growth, it is too early to call this improvement a trend. Genentech has 23 new drugs in early stage development with 15 representing new mechanisms to treat cancer.

SGS Group

SGS Group’s revenues of $2.26 billion during the first half of 2008 rose 17% on a currency neutral basis and 10% on a reported basis. Organic growth was 15% while acquisitions contributed 2%. Earnings of 34¢ per share prior to an extraordinary gain rose 14%. By geography, revenue growth was strongest in Asia, up 22%, followed by the Americas and Europe/Africa/Middle East which rose 21% and 14% respectively. The company’s minerals services business posted the fastest growth with revenues up 31.5% and profit up 47% on strong demand for minerals processing and analysis services. The company built 13 new labs during the period deploying new robotic sample preparation and analytic systems. SGS’ consumer testing services business generated 10% revenue and 12% profit growth during the period, boosted by toy testing volume growth and share gains in restricted substances testing. SGS shares remain unchanged since the beginning of the year. Since July 1, the shares have declined 14% in dollar terms, largely because the dollar gained 12% relative to the Swiss Franc.

Amdocs

Amdocs’ stock price is down 16% since January 1 in spite of good fiscal third quarter results. Revenues and earnings per share each rose 15% over the same period a year ago to $820 million and 46¢ respectively. The company’s 12-month backlog grew $60 million to $2.42 billion during this quarter as it did last quarter. Amdocs has not seen any weakening in the demand for its software or services to date. The company extended its record of strong execution of large complex projects with the first full quarter of revenues from managing AT&T’s legacy billing system and the successful conversion of 46 million pre-paid and post-paid SprintNextel customers to Amdocs’ customer relationship management (CRM) and billing systems. Rogers Communications, the second largest communications service provider in Canada, deployed Amdocs CRM system for its 12 million quadruple-play customers (wireline, wireless, cable and broadband internet). This system allows Rogers’ customer service representatives to see all customer services and prior inquiries on one screen, which makes it easier to resolve issues on the first call. Amdocs also won several bids to install operation support solutions for cable operators, meeting the company’s goal to sell more than billing systems to these customers. The recent Jacobs Rimell acquisition helped the company win these contracts.

Donaldson Company, Inc.

Donaldson’s fiscal fourth quarter and full year revenues of $607 million and $2.2 billion each rose 16% while its earnings of 60¢ and $2.17 per share rose 13% and 16% respectively. The positive impact of foreign currency translation boosted sales 7% during the quarter and 6% for the full year. Donaldson’s return on invested capital was 21% during the fiscal year, the third consecutive year above 20%. North America accounted for 43% of total sales while International was 57%. During the quarter European, Asian and North American sales rose 24%, 17% and 9% respectively. Replacement filters generated 43% of total sales while first fit filter solutions provided 57%. The company’s engine products, which comprise 55% of revenues, rose 13% during both the fiscal fourth quarter and for the full year, even as its on-highway truck filter sales declined 9% and 26% during the quarter and the year respectively. This business will pick up during the coming year in advance of new EPA diesel particulate emissions legislation effective 2010. Off-road engine filter products rose 18% during the quarter and 27% for the year as strong demand from mining, heavy construction and agriculture offset weakness in residential construction.

The company’s Industrial filter products revenues rose 20% during the quarter and during the full year, driven by 35% growth in gas turbine products. Dust collection in manufacturing environments and filters for disk drives each grew 17% during the past year. During the quarter Donaldson repurchased 542,000 shares for $22.9 million or $42¼ per share, bringing the full year total to 2,245,790 shares for $92.2 million or $41 per share. This represents nearly 3% of shares outstanding. Donaldson’s stock has declined 12% year to date.

Emerson Electric

Emerson’s good fiscal third quarter earnings of 82¢ per share, 15% above earnings during last year’s comparable quarter failed to stop the slide in its stock price. It accelerated in late June, dropping the price 16% below our $52 valuation, although Emerson’s sales, orders, and profit growth remains robust. The drop reflects investor apprehension that the economic slowdown in the U.S. and Europe will become a worldwide contraction which would curtail Emerson’s growth. The company’s sales growth in the U.S. and Europe was only 4% and 3% respectively during the quarter. Emerging markets in Asia, the Middle East, Latin America, and Eastern Europe, which account for 30% of Emerson’s sales, grew 17%.

A 5% benefit from currency translation brought Emerson’s quarterly sales up to $6.5 billion, a 14% gain. Sales of Emerson’s Process Management Division which generates 26% of sales and 30% of company profit grew 18% during the quarter driven by heightened demand from customers in the oil and gas industry. U.S. sales for the division rose 12%, while Asia and the Middle East/Africa were up 21% and 14% respectively. The company’s Network Power Division, which provides equipment services for uninterrupted operation of telecommunication and data centers, achieved sales growth of 10% before currency gains and sales added from acquisition of Motorola’s embedded computer business. Emerson’s management, in contrast to its view of the outlook for Process Management, forecasts a progressive slowing in this business. Emerson’s Climate Technology Division, whose sales and profit declined 1% and 3% respectively during the quarter, is doubling its scroll airconditioning compressor manufacturing capacity to two million units annually to meet demand for units conforming to new energy efficient standards imposed by the Chinese Government.

PepsiCo, Inc.

PepsiCo delivered solid results in the second quarter despite higher commodity prices. Quarterly revenue increased 14% from the previous year to $10.9 billion, and earnings per share increased 11% to $1.03. Strong revenue growth in Frito-Lay’s core snack brands and the international division were offset by weaker revenue growth in beverages. North American beverages reported a 1% increase in sales and a 7% decrease in division operating profit from a year ago due to declining volumes and slower growth in bottled water. U.S. consumers are substituting tap water for bottled water as they look for ways to save money in a slowing economy, although consumption of snack foods remains strong.

The North American Foods division reported a 16% increase in revenue and a 13% increase in division operating profit for the quarter. Frito-Lay has drawn on the company’s experience operating in countries with high inflation to develop successful strategies to increase prices in the U.S. without decreasing consumption. In addition, the division has reduced costs through operational efficiency initiatives. The international division remains strong, reporting a 25% gain in revenue and an 18% gain in operating profit for the quarter. In August the company paid $1.4 billion for 76% of Lebedyansky, Russia’s largest juice manufacturer and the world’s sixth largest. Pepsi’s share price has declined 5% since the beginning of the year.

Intel Corp.

Throughout 2008, Intel’s stock price has fluctuated with investors’ views about the 12-month demand for personal computers and servers. Investors began selling technology stocks in early September when forecasts suggested that global economic growth was slowing. The company’s stock price is down 24% since January 1, returning to price levels seen in mid-March. Intel reported strong second quarter results with revenues of $9.5 billion, up 9% over the second quarter of 2007. Earnings per share were 28¢. Strong consumer demand for notebook computers pushed unit sales of notebook microprocessors to record levels. This demand contributed to the 15% year-over-year growth in the Mobility Group’s quarterly revenues, even though faster growth in lower-priced notebooks reduced the average selling price of these microprocessors more than management expected. Intel expects to ship over 100 million units produced with its 45 nanometer manufacturing process before year’s end. Higher yields and throughput times have lowered unit costs ahead of the company’s original plans, helping Intel to maintain its margins on lower-priced microprocessors.

Western Union

Western Union shares have risen 6% since the beginning of the year. Revenues of $1.35 billion during the quarter rose 12% while earnings of 31¢ per share rose 19%. Included in this is a 2¢ per share restructuring charge taken to close and relocate certain facilities and operations which will result in lower ongoing expenses. Total consumer-to-consumer revenues and wire transfers rose 14% and 13% respectively, while consumer-to-business revenues and transactions increased 3% and 2% respectively. International consumer-to-consumer money transfers, which generate two-thirds of total company revenue, rose 18%. Domestic transfers declined 3% and transfers to Mexico increased 1%. Money transfers that originate outside the U.S., which comprise 55% of company revenue, generated revenue and transaction growth of 26%. During the quarter the company renewed its agent agreement with the State Bank of India and its 4,700 branches across the country. Western Union continues to gain market share in India, the world’s largest receiver of overseas remittances, posting transaction growth of 65%.

ExxonMobil

ExxonMobil reported record earnings of $2.27 per share in the second quarter of 2008. Higher oil and gas prices helped drive the company’s results, though refining margins were significantly lower due to the inability to pass on the full impact of higher raw material costs to customers. To offset production declines in maturing fields, Exxon has announced plans to spend $25-30 billion per year over the next several years on capital expenditures and exploration, representing an increase of two-thirds from 2007.

Production began at two new projects during the quarter—one offshore of Nigeria and a deepwater platform in the Caspian Sea off the coast of Azerbaijan. ExxonMobil plans to begin the commercial evaluation of an unconventional natural gas field covering 184,000 acres in southeastern Hungary. The program draws on Exxon’s proprietary drilling technology and expertise gained in the Piceance Basin of Colorado to extract tight gas deposits. Some of the multi-zone wells planned may reach depths of 2.5 miles and require pressurized injection of sand to fracture the shale in as many as fifty zones. The company owns rights to and is exploring an additional 387,000 acres in the area.

Exxon’s share price is down 20% since the beginning of the year having fallen 14% in lock-step with the price of oil following its peak of $147/barrel in mid-July. The company spent $8.8 billion on share repurchases during the second quarter, reducing the number of shares outstanding by 1.7%.

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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