2004 Quarter 3 Update

October 15, 2004

The quarter of 2004 has been a challenging one for the markets and its participants, our clients included. The specter of a slowing economy, higher oil prices, fears about terrorism, election uncertainty and rising interest rates all contributed to a decline in equities in the third quarter. As indicated in our August letter, we felt that the prudent thing to do during this period of time was to begin raising cash in our client accounts and take a more defensive posture in the event that the markets continued to erode. Fortunately the period from mid-August through September turned out to be a more benign climate and even saw some strengthening in the indexes. With the Olympics and the political conventions passing with no major terrorist activity it appears that the markets breathed a sigh of relief and resumed an upward trajectory. Oil prices also weakened somewhat during late August and early September, another tailwind for the markets during this period of time. Since mid-September, however, oil has resumed its climb and sits at roughly $51/barrel at the time of this letter. This far the markets seem to have taken this price increase in stride. And what of the current economic outlook? It would appear that people are divided over whether or not the summer “soft patch” was transient or in fact a true correction in the direction of the recently strong economy. In either case, it would appear that the Federal Reserve will be moving gradually to raise interest rates over the near term, something for which equity market participants are grateful.

While many of our clients may be aware of our firm’s overall investment strategy and philosophy, we feel that it is prudent to explain our approach to investing here in order to provide you with more insight into our thinking and decisions going forward. While at times we feel compelled to alter client accounts based on market direction and the current reality, we are not market timers and therefore have a much longer term view of investing. We are constantly searching for good value in the marketplace, often times in places that might be ignored by many market participants and therefore underappreciated in our opinion. In order to execute this strategy we must have a longer time horizon in order to realize those values, giving other investors time to come to the same conclusion, thereby driving up the value of the companies in question. Certainly there will be times when our approach does not move in lock-step with the overall equity markets, however over the long term we are confident in our ability to identify undervalued opportunities that will outperform the overall markets over time. In short, we realize that it is virtually impossible to be right in all of our investment decisions; however we believe that in the majority of instances we will be able to realize increased value over time.

This brings us to the coming quarter and the end of the year. While there remain a number of unresolved issues on the macro-economic and political fronts, we are optimistic about the opportunities in equities going forward. There is no question in our minds that the weak markets in July and early August have created some value opportunities in individual equities and, as always, we will look to take advantage of these situations. We feel confident that the economic “soft patch” witnessed over the summer will have been transient and that the economy will prove to be stronger in the near term. We’re also confident that the national election in November will remove a fairly substantial obstacle to the markets and should open the door to more upward momentum into the close of the year. Terrorism always remains a concern, and while it is impossible to know for sure whether or not a future incident can/will be prevented, we do believe that our government, along with others across the globe, have made substantial progress in reducing the probability and severity of any future attacks. Finally, we do believe that the price of oil will stabilize, thereby diminishing some of the market participants’ concerns over inflation and consumer spending. In short, we’re positive about the upcoming quarter and feel confident in our ability to take advantage of an improved environment.

In conclusion, the third quarter of 2004 has been a challenging one. While we are not satisfied with the short term performance we are confident that our overall approach is sound and will allow us to achieve excellent results going forward. We continue to work hard to make money for our clients in all market environments and are optimistic about the future. As always, we appreciate the opportunity to work with you.

Cordially,

Paul R. Ray III Brian M. Phillips