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HomeMy WebLinkAbout2002-07-25 - Agendas - FinalFAYETTEVILLE • THE CRY OF FAYETTEVILLE, ARKANSAS FIRE PENSION AND RELIEF FUND BOARD AGENDA July 25, 2002 l . Approval of the minutes 2. Approval of the pension list Investment report 4. Other Business • • • • 113 WEST MOUNTAIN 72701 475621-7700 FAX 479-675-8257 • • • • • MINUTES OF A MEETING OF THE FIREMEN'S PENSION AND RELIEF FUND BORD June 27, 2002 A meeting of the Firemen's Pension and Relief Fund Board was held on June 27, 2002 at 11:00 a.m. in Room 326 of the City Administration Building located at 113 West Mountain Street, Fayetteville, Arkansas. PRESENT: Mayor Dan Coody, Pete Reagan, Robert Johnson, Marion Doss, Danny Farrar, Ronnie Wood, Gina Robert, Kit Williams. MINUTES Mr. Reagan moved to approve the minutes. Mr. Johnson seconded. The motion passed unanimously. PENSION LIST Mr. Reagan moved to approve the pension list. Mr. Johnson seconded. The motion passed unanimously. INVESTMENT REPORT Mr. Gib Weisbecker, Memll Lynch, gave the investment report. Stated interest rates were near an a forty year low In response to questions, he stated they had no World Com stock: Ashland in 19999 was 8% over the S&P, in 2000 and 2001 they were down, but overall in the history of the stock market they looked okay. Mercury was under performing. In 1999 MIAM was up 5.87%. OTHER BUSINESS Ms. Peggy Vice, Purchasing, stated she had sent out the RFP yesterday to thirteen different firms. She had two more firms to send the request out to. The proposals were due back on July 12, 2002. A meeting was set up for July 18 to make a short list of the firms. Interviews were to be set up on July 24, 2002, thirty minute interviews for each firm. Mr. Reagan stated he would like Marsha Farthing there at the next meeting to answer questions about the budget performance report handed out The meeting adjourned at 12.:05 p.m. 4 FIREMEN'S RELIEF AND PENSION FUND JULY, 2002 THE FOLLOWING ARE THE OBLIGATIONS OF THE FIREMEN'S RELIEF FUND FOR THE erONTH OF JULY, 2002. YOU ARE HEREBY INSTRUCTED TO ISSUE CHECKS TO THE AYEES, IN THE AMOUNTS SHOWN, AND FOR THE PURPOSE SO STATED • • • DATE OF EMP# RETIREMENT NAME 79 11/99. ARMSTRONG (DILL), PAMELA 74 3/86 BAIRD, JULIA 2 3/75 BLACKARD, PAUL 63 5/72 BOLAIN, ANN 68 7/99 BONADUCE, MICHAEL 44 9/86 BOUDREY, BETTY MRS. 45 9/86 BOUDREY, HOWARD 49 7/88 BOUDREY, JACK 4 6/67 CARL, FLOYD JR 5 5/72 CASELMAN, ARTHUR 57 5/90 CATE, ROY 6 4/68 CHRISTIE, ARNOLD 84 03/01 CIRCUIT CLERK WASHINGTON CO 85 03/01 CIRCUIT CLERK WASHINGTON CO 8 10/76 COUNTS, WAYNE 61 6/66 DAVIS, BEULAH F. 78 11/99 DILL,GARY JOHN 11 2/76 FARRARALONZO • 38 5/84 FRALEY, JOSEPH G. 91 03/02 GAGE,TOMMY 34 6/79 HARRIS, JAMES E. 70 11/99 HARRIS, MARY RUTH 93 01/03- JENKINS, JOHN 86 07/01 JOHNSON,ROBERT 64 4/95 JORDAN, CHARLIE 76 5/88 JUDY, JAN 37 3/84 KING, ARNOLD D. 54 5/89 KING, ARVIL 12 3/60 LANE, HOPE MRS 13 10/67 LAYER, MERLIN 14 7/74 LEE, HAROLD 51 10/88 LEWIS, CHARLES 60 12/89 LEWIS, MARVIE 55 12/89 LEWIS, ROGER 40 9/85 LOGUE, PAUL D 50 9/88 MASON, LARRY 39 4/85 MC ARTHUR, RONALD A. 35 2182 MC CHRISTIAN, DWAYNE 15 4/77 MC WHORTER, CHARLES 29 8/81 MILLER, DONALD 73 2/00 MILLER,KENNETH 42 2/86 MOORE, JAMES H. 17 2/66 MORRIS, WILKIE MRS. 16 4/64 MORRIS, WILLIAM H. 62 10/68 MORRISON, ELIENE 48 7/88 MULLENS, DENNIS W. 58 9/90 OSBURN, EDWARD 46 5/88 OSBURN, TROY 81 02/01 PHILLIPS,LARRY 53 2/89 POAGE, LARRY 22 4/73 REED, JOE 30 3/81 SCHADER, EARVEL 41 9/85 SCHADER, TROY 82 03/01 SKELTON,KELLY 83 03/01 SKELTON, KIMBERLY 23 4/71 SKELTON, LAWRENCE BURL 66 8/98 SKELTON, PAULINE 36 5/76 SPRINGSTON, CARL 90 03/02 STOUT, IMOGENE W. 25 2/75 STOUT, ORVILLE (DECEASED) 26 3/66 TUNE, BILLIE SUE 6810-9810-5335-0 6810-1112-00 GROSS 1,658.91 1,649:16 55.00 55.00 2,735.14 2267.18 1,911 99 1 507 82 55.00 75.00 1,637.10 55.00 55.00 377 50 1,658.92 914.10 1,618.08 2,376.34 55.00 55.00 3,273.93 2,812.66 2,081 90 1,507.82 1,393.18 1,566.00 55.00 417.50 55.00 1,507.82 790.49 790.50 2,624 88 1,492.83 1,604.92 55.00 1,221.26 1,193.41 2,910.17 55.00 55.00 70.00 80.00 2,005.35 2,248.33 1 738 46 2,530.45 2,147 56 55.00 1,268.40 1,395.58 1,114.17 1,114.17 870.50 390.00 737.78 702.65 0.00 80.00 FED. TAX 300.00 550.00 475.38 30000 287 68 100.00 75.00 200.00 226.00 700.00 500.00 200.00 300.00 130.00 75.00 50.00 325.00 78.16 150.00 30.00 150.00 125.00 160.00 200.00 300.00 57.00 125.00 125.00 70.00 6810-1113-00 6810-0100-00 ST. TAX 100.00 145.00 50.00 50.00 15.00 50.00 200.00 100.00 50.00 200.00 25.00 10.00 75.00 50.00 25.00 38.00 100.00 25.00 25.00 17.00 NET 1,258.91 954.16 55.00 55.00 2,259.76 1,917.18 1,911.99 1,170.14 55.00 75.00 1,637.10 55.00 55.00 377 50 1,558.92 839.10 1,403.08 2,100.34 55.00 55.00 2,373.93 2,212.66 2,081.90 1,257.82 893.18 1,436.00 55.00 417.50 55.00 1,407.82 790.49 730.50 2,224.88 1,414.67 1,404.92 25.00 1,07126 1,043:41 2,910.17 55.00 55.00 70.00 80.00 2,005.35 2,088.33 1,500.46 2,530.45 1,747.56 55.00 1,268.40 1,338.58 964.17 964.17 870.50 390.00 650.78 702.65 0.00 80.00 • • • 27 71 28 59 88 52 3/71 1/00 7/68 5/91 01/02 9/88 TUNE, MILDRED MRS. WARFORD,THOMAS WATTS, DONALD WATTS, WAYNE WOOD,RONNIE 0 WRIGHT, RANDALL DROP DATE DROP EMPLOYEES 05/01/98 02/01/99 02/01/99 05/01/99 04/01/00 07/01/00 01/01/01 FREEDLE, LARRY LEDBEITER, DENNIS TATE, RALPH BACHMAN, EDDIE NAPIER,LONNIE REAGAN,PETE DOSS,MARION 80.00 2,290.35 400.00 1,642.10 2,816.02 1,547 82 75,561.20 300.00 130.00 200.00 20.00 25.00 6,994.22 1,395.00 80.00 1,990.35 400.00 1,492.10 2,816.02 1,322.82 67,171.98 NEW BENEFITS 3,492.86 3,455.40 3,356.83 2,396.34 3,219.73 3,235.68 4,920.63 WE, THE UNDERSIGNED, DO SOLEMNLY SWEAR THAT THE ABOVE OBLIGATIONS ARE JUST AND CORRECT THAT NO PART THEREOF HAS BEEN PREVIOUSLY PAID; THAT THE PENSION PAYMENTS SO CHARGED ARE IN ACCORDANCE WITH THE ACTIONS OF THE BOARD OF TRUSTEES OF THE FIREMEN'S RELIEF AND PENSION FUND; THAT THE SERVICES OR SUPPLIES FURNISHED, AS THE CASE MAY BE, WERE ACTUALLY RENDERED OR FURNISHED; AND THAT THE CHARGES MADE THEREFORE DO NOT EXCEED THE AMOUNT ALLOWED BY LAW OR THE CUSTOMARY CHARGE FOR SIMILAR SERVICES OR SUPPLIES. SECRETARY CHAIRMAN AND PRESIDENT ACKNOWLEDGEMENT STATE OF ARKANSAS ) COUNTY OF WASHINGTON) )SS •WORN TO AND SUBSCRIBED BEFORE ME THIS DAY OF 2000. NOTARY PUBLIC MY COMMISSION EXPIRES: • • • Osborn, Carreiro & Associates, Inc. ACTUARIES • CONSULTANTS • ANALYSTS July 10, 2002 Ms. Cathyrn Hinshaw, Executive Director Arkansas Fire and Police Pension Review Board One Union National Plaza_ 124 West Capitol; Suite 1750 Little Rock, AR 72201 Re: Actuarial Valuations Exhibit 3, page 9 Dear Cathyrn: One Unlon•National P1ara,Suite 1690 124 West Capitol Avenue Little Rods, Arkansas 72201 (501)376-8043 We found a calculation error on page 9 which is the GASB disclosure page for some plans. We have corrected it for all valuations to be completed in the future We have corrected the page for the 14 plans in which the error occurred Here are 3 copies of the corrected page 9 for the following plans: Blytheville Fire Brinkley Fire Fayetteville Fire Helena Police Jonesboro Police Little Rock Fire' Little Rock Police Magnolia Fire Magnolia Police Monticello Fire Pine Bluff Fire Pine Bluff Police `Texarkana Fire Texarkana Police If you have any questions or comments please let me know. Sincerely, 1 Joh Carreiro, A.S.A. Actuary dna • • EXHIBIT 3 (Continued) • Fayetteville Firefighters Pension Fund Reconciliation of Net Pension Obligation ACCOUNTING INFORMATION This page is included to provide the information required by the Governmental Accounting Standards Board Statement No. 25 and 27. The values below are based on the assumptions contained in Exhibit 8. The Annual Pension Cost disclosed in this exhibit will almost always differ from the actual cash contribution to the fund. We must emphasize that these disclosures are shown in the city's financial statements; Sound actuarial projections should be used to determine the actual cash contribution requirements. <--r RECONCILIATION OF NET=PENSION OBLIGATION (NPO) 1. Actuarially Required Contribution 2. htterest on NPO 3. Adjustment to (1) . 4. Annual Pension Cost (1)+(2)-(3) 5. Actual Contribution Made 6. Increase in NPO (4)-(5) 7. NPO Beginning of Year 8. NPO End of Year (a) Actuarial Valuation Date 12/31/1993 12/31/1995 12/31/1997 12/31/1999 12/31/2001 (b) Market Value of Plan Assets* 7,271,255- 8,897,591 11,225,602 12,880,300 11,403,332 * Note: ** Note: 2000 124,741 (109,572) (251,093) 266,262 506,689 (240,427) (1,826,196) (2,066,623) 2001 • 124,741 (123,997) (284,151) 2002 1,279, 840 (130,976) (392,806) 284,895 1,541,670 401,207 REQUIRED SUPPLEMENTARY INFORMATION (c) Entry Age Actuarial Accrued Liability 7,816,034 9,045,983 12,093,450 12,940,843 17,239,942 (d) Unfunded Accrued Liability (UAL) (c) -(b) 544,779- 148,392 867,848 60,543 5,836,610 (e) Funded Ratio (b)/(c) 93.0%7- 98.4% 3.0%98.4% 92.8% 99.5% 66.1% (116,312) (2,066,623) (2,182,934) (2,182,934) (1) (g) Annual Covered Payroll UAL as a% of Covered Payroll (d)/(f) 620:1167'7 "7-'87.9%- 676,847 608,602 367,188 234,765 12/31/1993 and 12/31/1995 are at amortized cost value. 21.9% 142.6% 16.5% 2486.1% For volunteer/part paid members, Annual Covered Payroll is $200 for such active members 9 Revised 07/10/2002 FIRE PENSION AND RELIEF FUND JULY 18, 2002 • PROPOSED QUESTIONS FOR THE SELECTION OF FUND MANAGER 1. Describe your view of investments for a closed pension plan. 2. What percentage of assets should be in equities? 3. What is your firm's track record on asset preservation of trust funds? 4. What is your firm's corporate policy on investment research and investment considerations? 5. How did your firm do in predicting the change in market? 6. If you were managing this fund, would you invest in funds / stocks where your firm is the market maker? If so, under what circumstances? Would you forego any commissions? 7. Do you have any complaints filed against you at either the State or Federal level? 8. Because this fund has an unfunded actuarial liability of over four million dollars, what strategy would you proposed for this gap? • • • 0 .w O. T en t- \ 0o 00 N ON CO O\ 00 N o, rn b N 00 O\ CIN O 1/40 N V Portfolio Group (12/1/98) O CO CO O r 00 00 en 00 VD) ortfolio Group(5/15/00) O O 00 00 00 V1 00 rn r 00 0 ■ 55-5 C tn O C > > 0 co) 104 Cr r Q00 lit rn Q 0 E c m o a M143 M 8 M„ M O 00 N O N b wo N O 0 0' O r M N h O ▪ O.on 00 O\ N b b 00 b + O N 1/40 M i O 01 00 ON O .-. O r N N 10 O O nj N br N h •-•0' 00 r ? in `o ., 00 O M M — V V + + + r i + co en N O 00 N M Noo N + + + r 1/40 C M 00 M ' co M in N (M+t ( + O VI 1/40 W 00 rn r n r N N r rn r + ■ en r- • 7 r ON 51-1 r 1 O V O 00 00 M O vO M + + Ashland Asset Mgmt. • $484,120 sent to checking account thru 6/28/02 O O O ttl b •UD c 0 0— as c - o T M M enJ a a a 2 50 .c L .c iF O • O O w 0 co 00 co c c c CU) 8 v o a./ V O O O Vii 0 H 00 T O O O 0 N rh N 5-. In u En in En 5a5 A U a R C15 a a * Income account: • Keep The Faith July 2002 Problems, Problems... Investor sentiment is about as negative as it can possibly be: "The world is going to hell in a hand basket." "Corporate CT' Os are all a bunch of crooks." "I can't wait on this market forever." We have been saying for some time that capitulation is one of the essential ingredients for a stock market recovery. The above comments certainly sound like capitulation to us. • Buy Low; Sell High Keep in mind, in early 2000 everything looked rosy, and everyone was making money in the market (buy high approach). Now everything is gloomy terrorist threats, middle -east strife, Enron, Tyco, Arthur Andersen, WorldCom Has there ever been a clearer "buy" or at least "stay" signal? At the moment, investor psychology (and media headlines) is driving the market Meanwhile, the economy is improving. Corporate earnings hit bottom in Q3, 2001 and are on an upward trend. • Past Market Rebounds In the short run, investor psychology can (and does) drive the market. In the long run, it is market fundamentals which drive the market. When things turn around after a weak period, there is usually a good "pop". Throwing in the Towel? S&P 500 Rolling Two -Year Quarterly Returns 70 60 50 40 30 20 10 0 -10 -20 t 30 42 46 50 54 58 62 66 70 74 78 82 86 90 94 98 02 Source: ISI Corporate Earnings are Bouncing Back 15 5 -5 -15 -25 -35 -45 1Q00 Source: ISI 3Q00 After the Troughs 35 30 25 ti 20 a 15 10 5 0 1Q01 3Q01 1Q02 3 Months 6 Months 12 Months Source: Salomon Smith Barney. Based on Average Monthly Index Data Since 1970. 12/79, 7/82, • Keep The Faith Page 2 • • Don't Bail Out Now • On the other hand, investors who bail out near the bottom could face a long chmb back to breakeven. The S&P has declined 36.8% from peak to trough. We've Been There Before 'lherc have been bears in the woods before. After the bear market of 1973-1974, the Dopy Jones Industrials stood at 602. The Dow is currently near 9/XM1. Every decade has had its share of bear markets. Keep The Faith In the past three decades we have experienced the Vietnam \Var, Watergate, the energy crisis, double digit inflation, the 1987 market crash, fall of the Berlin \Nall, and two impeachments. Through it all, investors who followed the four kcv investment principles did extremely well: • Stock market demands long tens commitment • Stay fully invested- dont market time 2 100 • Structure portfolio to meet your long tern financial goals • Diversify across: styles, asset classes 10 • How Long Will It Take to Breakeven? Return* Time Needed to Breakeven Large Company Stocks 11.2% 4 3 Years Money Market 3.00/0 15.5 Years 'Rates of return are: 3% Money Market Return; Large Company Stock Return from 1926-2000 Source: INVESCO Bad News Bears -21.2% 1 1 1 1 1 1 1 90 91 92 93 94 95 96 97 98 99 -19.3% 1 mac -24.10 16m0. 80 81 82 83 -36.1% I I I I 2ma1 84 85 86 87 88 89 I I i 71 72 Source: INVESCO 23 mo. i 73 '74 75 -26.9% pt T— l /Imo.i - 76 77 78 -16.40/0 19 ma. 79 80 $100 Grew to $3,104 10000 3000 0 o 1000 4A- 500 0 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 Source: INVESCO You can gain insight to our thoughts on the markets and our portfolios through the Portfolio Update Line 1-800-938-2316 (Toll -Free) and our web site at www.managedaecounts.invesco.com n material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. Past performance is not an ._ __.._ ._ __Y. -....w ..• ,.. „N-.... M n. n. �nll ana fi.vnrial men'rents. As with all Investments, there are associated /1 • • Merrill [synch 19 July 2002 Global ' • Global Research Highlights The Merrill Lynch View >1 mg m d .12 0 t9 Watch the Clock Like people sitting through a bad play, investors arc asking. "When will it be over?" For clues, we suggest watching the clock. Not a time clock, the "earnings expectations life cycle" clock that chief U.S. strategist Rich Bernstein uses to help gauge the state of the investment cycle. We reproduce the clock at thc right. The labels on the inside of the circle note the broad, general level of earnings expectations; those on the outside identify the topics that arc on investors' minds and that dominate the "investment buzz" as the cycle progresses. For example. when earnings expectations are highest (12 o'clock). investors tend to focus on growth and to expect it to continue even though experience shows that thc next move generally is down. Where is the clock now in terms of the market as a whole? Rich thinks that it's somewhere near four. In thc market's current context, that means that investors are very uneasy in thcir thinking about eamings. and they recognize that expectations need to come down in relation to valuations and risks (including corporate credibility, accounting problems. and geopolitics). In other words, Rich continues to think that investors haven't shitted from "realization" (acknowledging that thc market has problems) to "capitulation" (which often sets thc stage for a recovery). When investors finally do throw in the towel, we believe that it will be time to adopt a contrarian view, look for signs of positive earnings surprises, and be in position to take advantage of the next upswing. While they're waiting, investors need to remember that the expectations clock moves in fits and starts, not at a steady rate. Don't try to read the clock to the minute. What's important is thc inter- action between time and expectations—particularly now, when many investors arc tempted to be out of the market. Despite the current turbulence, bcing out of the market carries a high opportuni- ty cost because it is impossible to call a tum precisely. We believe that it is more prudent to focus on the long tern, diversify, and emphasize conservative, higher -quality issues. In the fixed-income market, we think that investors should avoid extremes; for example, don't move too far down thc quality spectrum in search of yield. Similarly, the shortest points on the maturity spectrum provide low returns, while the far end generally doesn't offer enough extra yield to compensate for the increase in price volatility inherent in long -tern issues. We recommend laddered portfolios of one -to -five-year issues. premium bonds, and selected callable corporates. In the stock market, the watchwords remain quality, conservatism, and dividends. and we continue to favor utilities (the "boring" ones that pay reliable dividends), consumer staples, and industrial issucs (particularly aerospace/defense). Looking back, chief market strategist Dick McCabe notes that only twice in the past century has thc DJIA declined for three consecutive years, and only once (1929-32) did it have a "four -peat." The record suggests that better times lie ahead. Refer to important disclosures at the end of this report. Merrill Lynch Global Securities Research & Economics Group Equity Research Marketing Services Department k16883 Steven R. Narker Director of Research, Private Client Investors should assume that Merrill Lynch is seeking or will seek investment banking or other business relationships with the companies in this report. RCk41220009 • Global Research Highlights — 19 July 2002 !' Merrill Lynch • • Economic Focus United States • The pervasive gloom gripping the equity market threat- ens to spill over into the real economy. So far, that hasn't happened, and we remain optimistic that growth will be reasonably robust during the next few quarters. Nonethe- less, the massive wealth meltdown of recent months, when overlaid with the breakdown in trust evident in recent polls, could feed back to the economy. The Federal Reserve is well aware of the risks. Based on its current forecast, we think that the Fed won't tighten monetary policy this year. • In delivering his monetary policy report to Congress. Fed Chairman Alan Greenspan sought to re -assure both Wall Street and Main Street. We're not sure that he succeeded. We agree with his claim that "the fundamentals arc in place for a return to sustained healthy growth" Industrial production and housing activity for June were strong, the labor market is slowly improving, and thc economy remains on a solid upward path. Second-quarter carvings are coming in above expectations. but the markets don't seem to notice. • Although we found his economic analysis cogent. we're uncomfortable with Mr. Greenspan's latest contribution to Bartlett's Familiar Quotations. In words that will probably join "irrational exuberance" for posterity, the chairman sternly spoke of the "infectious greed" that had "gripped much of our business community." That broad -brush characterization of business practices plays to the current feeding -frenzy that puts all of corporate America in the dock, even though only a handful of companies were involved in dubious practices. By maximizing thc scale of the problem, Mr. Greenspan may have further frayed confidence. • Macro data don't support the case that earnings were systematically exaggerated during the 1990s. On a GAAP basis, EPS during the 1990s cycle grcw at exactly the same pace as they did during the entire post -World War II period— about 7.5% a year measured from cycle peak to cycle peak. That's a powerful circumstantial case that, in the aggregate, earnings were not overstated during the 1990s expansion. • Even so, investors arc certainly suffering a severe crisis of confidence. More than $7 trillion of equity wealth has been wiped out since March 2000, roughly a third of that since the beginning of this year. However, real-estate wealth has in- creased by $2.7 trillion since March 2000. Our work shows that the wealth effect from housing is more than double the wealth effect from equities. That suggests that, so far, the negative wealth effect from equities has been largely neutral- ized. It also suggests that further equity declines would probably feed into spending. • The effect that recent events will have on business spending is difficult to quantify. One possibility: companies may feel a need to conserve cash and/or pay dividends, which could delay a pickup in capital spending even as earnings improve. Another consideration: quality spreads have widened, increas- ing the cost of capital and clouding the outlook for capital spending. 2 • In its latest forecast. the Fed assumes that negative wealth effects and the spillover from corporate accounting scandals will hold GDP growth below potential during the second half of 2002; it also expects the economy to grow in-line with potential during 2003. Looking at the numbers. the Fed forecasts GDP growth of about 3% during the second half of this year and 3.54o-4% during 2003. With growth at or below potential through 2003. the central bank expects inflation to remain low and steady. • We agree with thc Fed's broad analysis. "Imbalances in inventories and capital goods appear largely to have been worked off; inflation is quite low and is expected to remain so: and productivity growth has been remarkably strong, implying considerable underlying support to household and business spending as well as potential relief from cost and price pressures." Because we assume that those positives will more -than offset any negative wealth effects, we expect growth during the second half to be stronger than the Fed thinks it will be. • The latest economic data support our case. Mortgage applications for home purchases continue to run at a record pace. Initial unemployment claims fell to a 17 -month low for the week ended July 13. Industrial production jumped by 0.8% for June, its sixth consecutive increase. Manufacturing inventories continued to shrink during the second quarter, and production has yet to catch up to demand. • The Philadelphia Fed's July index of economic activity in its region was one negative indicator among thc recent batch. It showed that activity might have slowed early in July. How- ever, the index polls 150 companies in only one geographic area, and it has a history of large month-to-month swings. We hesitate to read too much significance into its performance. • Meanwhile, the market's malaise persists, despite the fact that second-quarter earnings are running ahead of expecta- tions. Based on reports from roughly one-third of the com- panies in the S&P 500, operating EPS appear to be more than $12 on a GAAP basis. That's about 500 more than the bottom- up consensus and our own top-down projection. More to the point, operating earnings are up by more than 30% on a year- to-year basis, and reported EPS are up by more than 100% from a very -low base that includes large writcoffs. • Our top-down projection is for S&P 500 operating EPS to jump by 21% to $47.00 this year and by 19% to $56.00 next year. With first-half EPS likely to be about $23, the 2002 target appears to be within easy reach, even if the economy grows more slowly than we currently expect. Despite the deep market gloom, earnings risks appear to be more to the upside than the downside. Bruce Steinberg Chief Economist • Refer to important disclosures at the end of this report • • • Merrill Lynch Global Research Highlights — 19 July 2002 Strategy Focus United States • 1f it's true that "one bad apple doesn't spoil the whole bunch," it ought to be equally true that "one good apple doesn't make the whole bunch sweet." The latter sentiment sums up how we view Dell Computer (DELL; $26.05; C -I-1-9) and the technology sector. The company is one of our favorites; the sector isn t. Indeed, we continue to think that investors should sell tech stocks in general into strength and re -deploy the funds into other sectors, such as utilities (the dividend payers), consumer staples, and industrials (particularly aerospace/defense). • It is rare that we comment on an individual company, but recent events seem to warrant such a discussion. Although we have underweighted the tech sector for some time, we have consistently favored Dell Computer. The company's recent announcement regarding its stronger -than -expected funda- mentals provided a lift to much of the tech sector. However. we'd caution investors against extrapolating Dell's success to other tech companies. As we see it, Dell's success night actually come at the expense of other companies. Dell appears to be a true "growth company" within a sector of faux "growth stocks." • The low cost of capital for tech stocks during thc bubble provided free money to any company that wanted funding. History shows that such underpriced funding leads to tremendous overcapacity in an industry and a predictable string of events: fragmentation, severe pressure on margins as companies fight for market share, and consolidation. • Following that model, the tech sector will probably need to go through a dramatic consolidation before it can again be classified as a growth sector. Unfortunately, that's not happening yet. By and large, the CEOs of tech companies apparently don't believe that the sector's secular backdrop has significantly changed. We think that it clearly has. Number of Technology Companies in the Merrill Lynch Universe 1980 to June 2002 Source: Meant Lynch Quantitative Strategy • There are hundreds more tech companies now than there were in 1995 (see chart). In our view, it is safe to say that increases in tech -related demand will be slower between 2000 and 2005 than it was between 1995 and 2000. That isn't a good environment for growth. • • In our judgment. Michael Dell, founder of Dell Computer, seems to understand the industry's current business model. While other CEOs arc attempting to prove to the Street that their companies are still "growth" companies, Mr. Dell basically states that everything in technology is becoming a commodity and that the low-cost producer is the winner in a commodity industry. His model is not based on finding the next "killer app." Rather, it emphasizes the "old economy" concepts of efficient manufacturing and distribution. • Note that few, if any. tech companies have attempted to mimic Dell Computer's business model. As a result, they may be suffering. Referring to Dell's recent announcement, Steve Fortuna, our PC analyst. wrote on July 12, "Dell's out- performance for the July quarter is primarily market -share - driven, and we do not interpret this as an improvement in the demand environment." The low-cost producer appears to be winning. • That brings us to the issue of how growth companies differ from growth stocks. En the 1950s, Peter Bernstein (no relation) noted that, although most investors use the terms interchangeably, the terms have different meanings (sec ` "Growth Companics vs. Growth Stocks," Harvard Business Review, September/October 1956.) • Bemstein described a growth stock as a company that responds to a trend in the economy. The example he used was the steel group: in the 1950s. the companies were simply responding to the economy's rising demand for steel. He described a growth company as one that does much more than that: it shapes the way business is done. In our view, one hallmark of a growth company is that it puts its competitors out of business. • In recent years, there have been many more "growth stocks" than "growth companies" in the tech sector. In our view, it might not be stretching things to say that Dell may be the only true "growth company" in the tech sector. It is changing the way business is being done, and it has (and probably will) put competing companies out of business. • The market appears to appreciate that distinction. Dell's stock has significantly outperformed other stocks (not just tech stocks) since mid -2001. It has declined by about 7% during the past 12 months vs. 40% for the Merrill Lynch 100 Technology Index, 36% for the Philadelphia Semiconductor Index (SOX), 34% for the NASDAQ Composite, and 27% for thc S&P 500. We'd continue to put Dell in a special category and underweight tech as a whole. Richard Bernstein Chief U.S. Strategist Refer to important disclosures at the end of this report 3 rro Iso en ISO ZOO ,N rn 0 SO Sumba m 1Mlnelwgy W.u9m*tm the Merrill LTM Universe M•MM Dahl n 12 11 M o a 41 IS n a n a n ee 45 a n a n. ea m Source: Meant Lynch Quantitative Strategy • There are hundreds more tech companies now than there were in 1995 (see chart). In our view, it is safe to say that increases in tech -related demand will be slower between 2000 and 2005 than it was between 1995 and 2000. That isn't a good environment for growth. • • In our judgment. Michael Dell, founder of Dell Computer, seems to understand the industry's current business model. While other CEOs arc attempting to prove to the Street that their companies are still "growth" companies, Mr. Dell basically states that everything in technology is becoming a commodity and that the low-cost producer is the winner in a commodity industry. His model is not based on finding the next "killer app." Rather, it emphasizes the "old economy" concepts of efficient manufacturing and distribution. • Note that few, if any. tech companies have attempted to mimic Dell Computer's business model. As a result, they may be suffering. Referring to Dell's recent announcement, Steve Fortuna, our PC analyst. wrote on July 12, "Dell's out- performance for the July quarter is primarily market -share - driven, and we do not interpret this as an improvement in the demand environment." The low-cost producer appears to be winning. • That brings us to the issue of how growth companies differ from growth stocks. En the 1950s, Peter Bernstein (no relation) noted that, although most investors use the terms interchangeably, the terms have different meanings (sec ` "Growth Companics vs. Growth Stocks," Harvard Business Review, September/October 1956.) • Bemstein described a growth stock as a company that responds to a trend in the economy. The example he used was the steel group: in the 1950s. the companies were simply responding to the economy's rising demand for steel. He described a growth company as one that does much more than that: it shapes the way business is done. In our view, one hallmark of a growth company is that it puts its competitors out of business. • In recent years, there have been many more "growth stocks" than "growth companies" in the tech sector. In our view, it might not be stretching things to say that Dell may be the only true "growth company" in the tech sector. It is changing the way business is being done, and it has (and probably will) put competing companies out of business. • The market appears to appreciate that distinction. Dell's stock has significantly outperformed other stocks (not just tech stocks) since mid -2001. It has declined by about 7% during the past 12 months vs. 40% for the Merrill Lynch 100 Technology Index, 36% for the Philadelphia Semiconductor Index (SOX), 34% for the NASDAQ Composite, and 27% for thc S&P 500. We'd continue to put Dell in a special category and underweight tech as a whole. Richard Bernstein Chief U.S. Strategist Refer to important disclosures at the end of this report 3 • Global Research Highlights — 19 July 2002 Merrill Lynch • • Technical Focus United States • Although the summer recovery that we had expected has yet to materialize, we still believe that it will evolve later in July or in August. In the meantime, however, there may be some additional, and volatile, weakness in coming days before a durable market upturn occurs. Momentum indicators have compounded their recent oversold condition, and sentiment measures have continued to Improve. Setbacks in previously strong stocks often indicate that the market is in a mature stage of a decline. • The stock -market averages' accelerating rate of decline. the market's recent emotional tone, and the media's increasing emphasis on the negative aspects of the market suggest that it is quickly approaching a climactic or benchmark low on its 2002 decline. Such a low could serve as the starting point for at least a mid -to -late -summer bottom and recovery trend. Getting through the next week or two, however, may be the most -difficult part of the process. • One noteworthy aspect of the market's recent decline is that many of the groups and stocks that had been holding at or near multi-year or all-time highs have declined as they have done some "catching up" on the downside, while some of the previously battered technology stocks have held above their recent lows. That combination of strong stocks weakening and weak stocks strengthening has often been a sign of a maturing market decline that is nearing a low. It is also the kind of market condition that produces the "no place to hide" attitudes that tend to characterize a bottom. • Furthermore, we suspect that, with recent concerns—about a "double -dip" in the economy, still -high valuations, corpor- ate earnings prospects, accounting, and corporate governance scandals—now reaching a fever pitch, a "contrary play" in terns of an interim stock -market recovery trend could develop. If there arc no major "new" negative surprises in coming weeks. the market could tum up from its oversold condition on the slightest hint of good news. • From a long-term trend technical perspective. two factors should provide some encouragement in thc face of growing gloom in the market. One is that the four-ycar cycle, which has been one of the most -reliable in the market, is scheduled to bottom and turn up this year The other is that, with the ODA down by roughly 20% for the year-to-date, there is a possibility that 2002 will be the third consecutive down year for that index. 'However, a "three -peat" has occurred only twice before, and a "four -peat" once, making another decline unlikely, in our view. • We would take advantage of further weakness in groups with strong underlying bases to accumulate positions. Those that we favor are aerospace/defense, auto parts, building products, chemicals, healthcare services. paper and forest products, and selected retailing issues. Richard T. McCabe Chief Market Analyst Strategy Focus Global • So far, the baby is still in the bathtub. That's the message in our Fund Managers' Survey for July. Despite another difficult month for world equity markets, the Merrill Lynch Stock Market Conditions (SMC) Indicator improved for the second consecutive month—from 12.3 for June to 15.6 for July, its highest level since November 2001. As was the case in June, the equity valuations component of the SMC indicator again provided the greatest lift, while a store -positive interest -rate outlook offset softer profit expectations. • The SMC's Equity Valuations component rose from +16 for June to+26 for July. However, there was a slight deterioration in the Investor Sentiment and Profit Expectations compo- nents, which fell to I4 and 48 for July from 15 and 51 for June. respectively. There was also a softening in expectations of EPS growth—to 10% for the next 12 months from the I I% forecast in the June survey. On the plus side, thc Interest -Rate Prospects component improved from -33% for June to -25% for July. • The survey also revealed that perceptions of U.S. equities remain negative: 36% of the panel now believe that the U.S. has the least -favorable outlook for corporate profits, up from 32% in June. In addition, 34% believe that the American market has the worst quality of camings (in terms of volatility, predictability, and transparency), up from 27% in June, and 57% think that U.S. equities are relatively the most expensive in die world, although that is a slight improvement vs. a couple of months ago. As a result. the U.S. equity market is still the one that most fund managers would be most likely to underweight. Eurozone and global emerging -market equities remain the ones that fund managers would be most likely to overweight. • Anyone looking for signs of investor capitulation in the latest survey is likely to be disappointed. Despite a major decline in global stocks (including a 20% underperformance in relation to global bonds during the past three months), the survey does not suggest that a major loss of confidence in equities as an asset class has yet taken place. Indeed, several questions elicited responses that we regard as optimistic. For example, 74% of fund managers still expect equities to be higher a year from now, and 37% expect them to be `a lot higher'. Moreover, 67% think it unlikely that bonds will do better than equities during the coming year. Cash levels arc 4.8%. but they are still significantly below those seen last year. In addition. although the pro -equity stance has been reduced, 48% of asset allocators remain overweight equities, while 49% are underweight bonds. • Although the number of respondents that regard the U.S. dollar as overvalued fell from 57% in June to 43% in July, 45% still want to be long the euro and short the dollar— more-or-less unchanged during the past couple of months. David Bowers Chief Global Investment Strategist 4 Refer to important disclosures at the end of this report. • h Merrill 'synch • Global Research Highlights - 19 July 2002 Focus 1 List Merrill Lynch Research selects one stock each week as its Focus I stock. This focus recommendation either reflects Merrill Lynch's current economic and investment outlook or an unusual fundamental and/or investinent development. The selected stock remains as one of our Focus I stocks for a period of 12 months unless the Focus 1 committee. at its discretion. removes the stock in connection with an analyst downgrade or otherwise. The following shows the Focus 1 selections currently on our actively managed Focus I list. Focus 1 Company Affiliated Computer Services AMB Property Corp. Amerada Hess American International Group AmerisourceBergen Avon Produces Boeing Burlington Resources Cidgroup ConAgra Costco Wholesale Dell Computer First Data Corp Ford Motor HCA, Inc. loco Ltd. Lowe's Philip Morris Southwest Airlines SPX Corp TXU Corp. United Parcel Service Universal Health Services Viacom Weatherford International Weyerhaeuser Co NOTE: Kroger (KR 119.35; C-1-1-9) was removed from the Focus 1 list on 7(17102 because 1 had exceeded the 12 month tune lima. ACE Limited (ACE: $25.40;13-1-1-7) was removed from the Focus 1 Est on 7/78/02 because of near term price performance concerns. Barra (BAX: $32.00; B-2.1.7) was removed from the Focus 1 fist on 7/18/02 because of an opinion downgrade. Johnson & Johnson (JNJ: $49.73: A-2-1-7) was removed from Me Focus 1 list on 709102 because of near -tam price pedomiance concerns. Investors should review the most recent research report on a company prior to making an investment decision. -- RESTRICTED. SOLICITATION OF COMMISSION ORDERS 15 PROHIBITED. [C. FDC, VIA 8] One or more analysts responsible lor covering the securities Si dila report owns such sttvraies. [SPW. UHS, WFT] MLPF&S or one of its affiliates was a manager of the most recent offering of securities al this company within the lass three years. IAIG, AVP, BA, C. CAG, FDC. F, N. LUV, TXU, UPSI MLPF&S or an affiliate was a manager of a pubic offering of securities of this company within the last 12 months. [AIG. CAG, F, HCA, N. JNJ, LOW, LUV, TXU, VIA B. ACE] MLPF&S was a manager of the most recent public offering of securities of this company within the last Three years. [COST. DELL] The securities of the company are not fisted but trade over-the-counter in the United States. In the US. retail sales and/or disoib lion of this repot may be made only in stales where these securfies are exempt from registration or have been qualified for sale MLPF&S or its affiliates usually make a market in the securities al this company. IAIG, ABC. AVP. 8A, BR, C, CAG. FDC, F. HCA, N. JNJ. LOW, LUV, SPW, TXU, UPS, UHS, VIA B, WFT) MLPF&S or an afliate has received compensation for investment banking services from this company within the past 12 months. IACS, AMB, AMC, AIG, ABC. AVP. BA, BR. C. CAG. COST. DELL. FDC, F, HCA, N. JNJ, LOW, MO. Ll1V, SPW, TXU, UPS. UHS, VIA B. WFT, WY, ACE, BAX] MLPF&S or an affiliate expects to receive a intends to seek compensation for investment banking servoes from this company within the next three months. Current Price 7118102 Symbol Opinion Country $41.95 ACS B-1-1-9 US 27.55 AMB B-1-1-7 US 73.89 AHC B-1-1-7 US 57.23 AIG A-1-1-7 US 63.29 ABC C-1-1-7 US 44.92 AVP 6-1.1.7 US 4129 BA C-1-1-7 US 35.67 BR B-1-1-7 US 36.90 C B-1-1-7 US 23.75 CAG B-1-1-7 US 33.88 COST B-1.1.9 US 26.05 DELL C-1-1-9 US 34.36 FDC B-1-1-7 U5 12.81 F C-1-1-7 US 44.83 HCA C-1-1-7 US 19.14 N C-1-1.9 Canada 37.85 LOW 8-1-1-7 US 42.45 MO D-1-1-7 US 13.28 LUV B-1-1-7 US 97.98 SPW C-1-1-9 US 40.39 TXU B-1-1-7 US 62.05 UPS 8-1-1-7 US 45.25 UHS C-1-1-9 US 37.30 VIAB 6-1-1-9 U5 41.14 WFT C-1-1-9 U5 56.30 WY 8-1-1-7 US Date Added to Focus List 10/3)01 7/9/02 3/18/02 2/7/02 10115101 615/02 4/26/02 4112102 10/22/01 6/26102 12114/01 5/22102 6/6/02 5120102 10/29/01 6/25102 8/27/01 5(28102 1/29102 614/02 11/2/01 11/27(01 5/14/02 215102 2/22/02 5/6/02 Price When Added 41.83 28.40 75.91 71.11 68.41 51.97 41.51 39.15 47.01 24.89 42.27 27.40 39.40 16.73 39.55 21.86 38.51 55.11 18.23 131.20 46.83 55.00 43.50 37.46 45.14 63.70 Refer to important disclosures at the end of this report 5 • • Merrill Lynch 17 July 2002 A.J. Rice First Vice President Tom Gallucci Director i United States I Hospital Management HCA Positive Long -Term Vision Outlined in Meetings Reason for Report: Company Update STRONG BUY Long Term STRONG BUY Symbol: Price: 12 -Month Price Objective: HCA $44.40 $56-58 Estimates (Dec) 2001A 2002E 2003E EPS: P/E: EPS Change (YoY): Consensus EPS: (First Call: 17 -Jun -2002) Q2 EPS (Jun): Cash Flow/Share: Price/Cash Flow: Dividend Rate: Dividend Yield: Opinion & Financial Data $1.94 23.2x $2.41 18.6x 24.2% $2.45 50.50 50.62 $6.36 7.0x $0.08 0.2% 57.05 6.3x 50.08 0.2% 52.80 15.9x 16.2% $2.86 $7.79 5.7x 50.08 0.2% Investment Opinion: Volatility Risk: Mkt. Value / Shares Outstanding (ran): Book Value/Share (Mar -2002): Price/Book Ratio: ROE 2002E Average: LT Liability % of Capital: Est. 5 Year EPS Growth: Next 5 Year Dividend Growth: Stock Data C -I-1-7 Above Average $23.132.5/521 $10.03 4.5x 21.0% 53.1% 17.5% 5.0% 52 -Week Range: Symbol / Exchange: Options: Institutional Ownership -Vickers: Brokers Covering (First Call): 552.05-536.44 IICA / NYSE Chicago 78.5% 24 ML Industry Weightings & Ratings" Strategy; weighting Rel. to Mkt.: Income: In Linc Growth: Overweight Income & Growth: In Line Market Analysts; Technical Rating: Above Average (24 -Oct -2000) (24 -Oct -20001 (24 -Oct -20001 (13 -Feb -2002) "•The views expressed are those of the macro department and do not necessarily coincide with those of the Fundamental analyst. Merrill Lynch Global Securities Research & Economics Group Global Fundamental Equity Research Department 6 Refer to important disclosures at the end of this report Highlights: • In recent meetings with HCA in the United Kingdom, the company's management was upbeat about the current tone of business as well as about the intermediate-term prospects for the hospital -management industry. • HCA is scheduled to report Q2 earnings on July 24. We expect the company to meet, or probably beat, expectations, which are that EPS were 62¢ for the quarter vs. 50¢ a year earlier. We also think that Q2 pricing increases continued in the mid -to -high single digits. Same -facility admissions probably increased by 2 -to -3% year-to-year, and the improvement in the EBITDA margin was likely gradual and primarily concentrated on other operating expenses and, to a lesser extent, labor costs. • We reaffirm our Strong Buy ratings on HCA. Our S56 -to -58 price objective assumes that the company's stock will be valued at nine times forward EBITDA during the next year. We believe that that is reasonable in view of the high liquidity and visibility that we think HCA offers. Our price objective would be at risk if anticipated price and volume gains for the industry do not materialize. Stock Performance u 4e 44 40 32 ID 24 20 16 1990 2001 2002 - HCA Inc - Rat to SAP Campeslte Index (503)(RIOM Stale) 0.052 0.048 0.040 0.036 0022 0024 0,011 0.012 • `� Merri116ynch • • Global Research Highlights — 19 July 2002 Investment Summary We reaffirm our Strong Buy ratings on the shares of FICA. a leading healthcare provider. The company's hospitals, situated in some of the most -rapidly growing metropolitan areas, continue to increase their admissions, revenues, and— because costs arc well-controlled—margins and earnings. Because pricing probably rose at mid -to -high single -digit rates during thc sccond quarter, we think that earnings advanced by at least 24% to 62¢ a share from 500 a year earlier. We expect annual cam ings increases of at (cast 24% for 2002. 16% for 2003, and 17 -to -18%, on average, for the next five years. Company Description !ICA (previously Columbia/HCA) is the leading U.S. provider of healthcare services. The company owns and operates 180 acute-care hospitals. It also provides diagnostic. ambulatory surgery, cardiac rehab. physical therapy, and radiation oncology services. Reasons for Recommendation • At our recent meetings with RCA's management, the company reiterated its long-term financial objectives, which include annual earnings increases in the mid -to - high teens for the foreseeable future. That goal is based on an intcmal revenue -growth projection of 7 -to -9%, which we think is reasonable if same -facility admissions continue to run at slightly higher -than -average rates of about 2 -to -3%. Furthermore, management expects outpatient volume to increase by 4 -to -6% a year for the long tern and the EBITDA margin to improve by 10 -to - 30 basis points as a percentage of revenues in each of the next few years. • Management attributes the company's ability to generate above-average volume growth to the fact that its facilities arc situated in demographically attractive markets. HCA has the largest or second-largest position in 16 of the 20 fastest-growing U.S. metropolitan markets. In many of those markets, HCA's facilities arc in the suburbs, where the population is usually growing even -more rapidly than in the metropolitan area as a whole. • Looking ahead, HCA's management reports that the company has completed the 2003 recontracting cycle with physicians on about 35% of its managed-care contracts. So far, prices appear to be up by 6 -to -8%. about the same rate as for 2002. Roughly 84% of FICA's managed-care contracts are renewed annually. • In terms of costs, FICA has completed two-thirds of its ongoing shared -services initiative, which is designed to create centralized billing, collections, and supply -cost management. Management noted that, in addition to thc direct cost savings, the shared -services program has freed important local space that can be used to address capacity issues in certain facilities. During the past two years, however, the shared -services initiative has required in- cremental investment that cost the company 40 and 80 a share in carvings for 2000 and 2001, respectively. • Labor continues to be HCA's biggest cost item. On the plus side, there has been an casing of overall wage -rate growth. During the first half of the year, increases were running at 5 -to -6%, down from 7 -to -8% a year earlier. Because of labor shortages for some positions. RCA's use of contract labor continues to increase. albeit at a moderating rate. Contract labor is said to represent roughly 7.5% of total full-time employees today. In recent years, FICA's year-to-year spending for contract labor has risen at an average of 25% a year. In the first half of 2002, its use of contract labor reportedly rose by 9 -to -10%. • We expect supply costs to remain at about 16% of sales fot the intermediate term. That includes drug costs, which arc still increasing by at least 1 S% a year. HCA. along with the rest of the healthcare industry, has reported some upward pressure on malpractice costs. However, as a proportion of revenues, those costs remain relatively small (about 1.6 -to -1.7% of revenues). FICA has been able to hold down its rate of increases in malpractice because it operates a fully funded captive insurance subsidiary, Health Care Indemnity. • Meanwhile, HCA has aggressively reinvested a major portion of its excess cash flow in its existing facilities. The company allocated SI.4-to-1.5 billion in develop- ment capital for projects that will begin to come on-line in the sccond half of 2002. Over time, SI spent for development capital has contributed $I in incremental revenue. HCA expects its total capital spending to be S1.6 billion for 2002 and $1.8 billion for 2001 with the rise almost entirely attributed to increases in growth - oriented investments. Development -oriented capital spending is scheduled to rise from $580 million in 2002 to $1.115 billion in 2003. Ncw construction and expan- sion are scheduled to add 1,200 new beds to the compa- ny's total. In addition, HCA has projects under way to add four de novo facilities and 378 beds during the next several years. We expect HCA to generate $700 -to -800 million in free cash flow after capital spending, but bcforc any further outlays to the government to resolve issues associated with its long-standing investigation. • Looking at that investigation, prosecutors in the Middle District of Florida have closed their criminal inquiry against individual HCA employees. Significantly, that is where we believe the focus on individual criminal cases had been centered. The news of the closing would appear to open the door for both parties to recommence discovery depositions. By way of background, as part of the government's investigation, depositions of company personnel had been taken by federal prosecutors Earlier this year, depositions were stopped after certain I -ICA personnel were advised by their personal attorneys not to grant depositions unless they were clearly told by the government that they were not personally targets of any criminal investigation. At this point, the Department of Justice appears to have indicated that there are no further criminal targets as part of its investigation. If that is indeed so, it would likely free HCA executives to provide depositions to the government. Refer to important disclosures at the end of this report. 7 • Global Research Highlights — 19 July 2002 � Merrill Lynch • • • HCA executives have generally denied wrongdoing throughout the process, and we have no reason to believe that their testimony would be negative for HCA. In fact, a company spokesman has been quoted as saying, "were interested in letting these folks toll their story because we think it will benefit us." Meanwhile, we expect the com- pany to continuc to negotiate a final settlement with the government. Essentially, we believe that both sides are pursuing a two -track strategy: a settlement out of court (the preferred one) and civil litigation. Of interest, the government filing indicates that the government is eval- uating HCA's response proposal for settlement of remain- ing outstanding issues that was provided on June 20, after the government's initial settlement offer on May 8. • We note that two HCA executives in Florida were indicted on criminal charges several years ago as part of the government's investigation of HCA; they were exonerated this year when the government dropped its criminal probe against them. • We also note that, as part of its past settlement with the government, HCA as a company has settled all outstand- ing criminal issues associated with the government's investigation of the company. HCA also settled three of five civil issues, with two broad issucs still unresolved: claims associated with Medicare cost reports and physician relations. • While we await the finalization of outstanding regulatory issues by HCA, we note that the government's investiga- tion docs not appear to be affecting the company's day- to-day operations, and it appears to be essentially a non - issue from that perspective. Footnotes: p, s, r please see footnotes on last page. 8 Refer to important disclosures at the end of this report. • • • Merrill Lynch 15 July 2002 Mark Husson First Vice President Monica Aggarwal, CFA Vice President United States Retailing -Wholesale & Logistics Sysco Quality Stuff, Everyday Price STRONG I3UY Reason for Report: Opinion Upgrade Long Term STRONG BUY System: Price: 12 -Month Price Ob)ective: SYY $24.55 $32 Estimates (Jun) 2001A 2002E 2003E EPS: PM: EPS Change (YoY): Consensus EPS: (First Call: 05 -Jun -2002) Q4 EPS (Junk Cash Flow/Share: Price/Cash Flow: Dividend Rate: Dividend Yield: Opinion & Financial Data S0.88 27.9x 50.99 24.8x 12.5% 31.00 S0 26 50.28 S 1.25 19.6x 50.26 1.0% 51.39 I7.6x 5236 1.4% 51.15 21.3x 16.2% 5115 S1.56 15.3x 50.36 1.4 Investment Opinion: Volatility Risk: Mkt. Value / Shares Outstanding (mn): Book Value/Share (Jun -2001): Price/1300k Ratio: LT Liability % of Capital: Est 5 Yctr EPS Growth: Stock Data 13-3-1-7 to E-1-1-7 Average 516.522.2/ 673 53.17 7.8x 32.1% 13.0% 52 -Week Range: Symbol / Exchange: Options: Institutional Ownership -Vickers: Brokers Covering (First Call): 530.35-521.75 SYY / NYSE Chicago 69.2% 12 ML Industry Weightings & Ratings" Strategy; Weighting Rel. to Mkt.: Income: Growth: Income & Growth: Not Ratcd Not Rated Not Rated Market Analysis; Technical Rating: Above Average (13 -Feb -2002) "The views expressed arc those of the macro department and do not necessarily coincide with those of the Fundamental analyst. Merrill Lynch Global Securities Research & Economics Group Global Fundamental Equity Research Department Refer to important disclosures at the end of this report Highlights: • We have raised our intermediate-term rating on Sysco's stock from Neutral to Strong Buy and reaffirmed our long-term rating of Strong Buy. • The upgrade reflects our belief that Sysco is a stable, conservative real -growth company with visible earnings and strong corporate ethics. • Sysco has had unbroken growth in sales, earn- ings, and dividends for more than 26 years We expect this year to mark 27 years and 2003 28. • We admire the company's business model, which generates high -30% ROIC—the highest in our coverage—and cash. Both are important quality touchstones in this environment. • Recent productivity improvements and the consolidation of the second-, third-, and fourth- largest companies in the industry into a very rational Ahold parent company means that earnings visibility is especially good right now. • The enactment of pending accounting legislation to require that options be expensed would reduce S&P 500 earnings by 10%, but trim Sysco's earnings by only 2%, in our view. • We have established a $32 -a -share price objec- tive, based on a three-year average multiple of 27.5 times forward EPS. SYY has not traded below current fonvard multiples in the past five years Stock Performance — Sysco Corp — Rel to SSP Composite Index 1S0]1 Wight Scale) 0.026 0.026 0.024 0022 -0020 o 016 0.016 0.014 0.012 0.010 0.000 9 • Global Research Highlights — 19 July 2002 � Merrill [lynch • • Investment Summary Sysco is the leader in the $170 billion foodservice industry, with 13% of the market. Economics of scale in procurement, private brands. infonnation technology, and client manage- ment have enabled thc company to record an EBIT margin of 5% or more and to bring acquired companies up to (or dose to) its standard of profitability. At 20 times our calendar 2003 earnings estimate of $1.23, Sysco's shares have slipped from their unusually high multiple of 35 in 2000 and are now trading below their average five-year P/E of 25. We believe that the current relative P/E of 1.2 is too low in view of the company's near-term camings visibility and potential for a cyclical recovery when business picks up at thc white table- cloth restaurants, hotels. resorts, cruise ships. and airports that Sysco serves. A return to the stock's three-year average P/E of 27.5 times our fiscal 2003 camings estimate of $1.15 a share could produce a 1 2 -month price $32. Company Description Houston-based Sysco, the largest foodservice distributor in North America. markets food and related products to about 325,000 restaurants, hospitals, schools, hotels, and other customers. It has 72 facilities in 39 states, British Columbia, and Ontario. Reasons for Opinion Change • Sysco's profitability accelerated to new levels in its June 2000 and 2001 fiscal years. The rise to a mid -20% rate of growth in operating earnings was driven by a number of factors. The company shifted its mix away from low - margined chain business to associate -serviced indepen- dent (`street') business: improved private -brand pene- tration; benefited. along with the rest of the industry, from the bankruptcy of a competitor that had disrupted the pricing environment; got increasing contributions from high -margined fresh products such as high-quality steaks; and achieved better control and the sharing of best practices through new enterprisewide software. • In addition to those longer-term trends, Sysco is develop- ing a number of new sales and efficiency initiatives. First, Sysco aims to improve real sales trends. Sales have been rising month-to-month, and real internal year-to- year sales growth for the fourth (June) quarter should be stronger than the 2.7% level reported for the second (March) quarter. We believe that, as the economy recovers, Sysco's internal sales should begin to increase at mid -to -high single -digit rates beginning in calendar 2003. Overall sales growth probably won't accelerate by much, however, because of a more -recent deflationary trend, which is normally good for gross margins. • Thc second initiative is to improve long-term sales leverage. Sysco believes that it could leverage high - single -digit internal sales growth by more than five percentage points by increasing its 'street' business from 55% of broadlinc sales to 60% and by increasing sales of companycontrollcd brands. Footnotes: s v; please see footnotes on last page. • • Third, the company intends to boost growth with acquisitions and foldouts. We expect acquisitions to add 3% to Sysco's annual sales volume. The company has made about 70 small acquisitions during the past 25 years while maintaining a high return on invested capital. We believe that Sysco will be able to continue to execute its business acquisition model. • The company is aggressively executing its foldout strategy of adding new distribution facilities to capture greater volume (in areas where existing warehouse volume is more than 5140 million and the population count is more than two million). Recent foldouts have been in Sacramento, California. and Columbus, South Carolina; one in Las Vegas. Nevada is expected to be completed in September or October, with another in northern Los Angeles next year. Although investments in foldouts tend to hurt margins and inventory turns in the near term, they provide significant opportunities to capture higher sales volume and market share and generally provide attractive returns on investment. • Fourth, as part of Sysco's initiative to revamp its supply chain and distribution network. the company plans to open its first redistribution facility in the Northeast late ncxt ycar. That should boost cash flow by making smaller distribution facilities unnecessary and taking costs such as procurement, freight. and excess inventory out of the system and improving service levels. • As its fifth initiative, Sysco intends to increase customer penetration and profitability. About 10% of its customers account for 52% of its profits. With customers that are less profitable or unprofitable. Sysco plans to reduce the number of deliveries and increase drop size, add a service charge of $25 -to -50 for small orders, remove high-cost marketing -associate service. and, in a small number of cases, eliminate the customer altogether. • Sixth, Sysco plans to continue to improve its efficiency through technology initiatives. The company wants to reduce its average inventory days from 17.5 by taking divisions that operate on 22 days down to the level of its best divisions, which operate on 10 days' inventory. • Sysco has continued to meet our estimates, despite the recent sales slowdown. Our forecast for fiscal 2002 is 99¢ a share, 12 -to -13% above 88¢ for fiscal 2001. Our fourth-quarter earnings estimate of 28¢ (scheduled to be reported on July 31) represents a year-to-year gain of 8% and includes the expectation of somewhat lumpy costs from the soon -to -be -opened foldout warehouses. • We recently raised our fiscal 2003 forecast by 30 a share to $1.15 to reflect the change in accounting for goodwill. Because our forecast assumes internal sales growth of 4.5% and excludes a possible contribution from the re- cent Serca acquisition in Canada, it could prove to be conservative. Although our estimates could have consid- erable upside if the economy improves, prolonged eco- nomic weakness could impede sales and carvings. How- ever, industry data point to a month-to-month accelera- tion in real sales growth. which bodes well for Sysco. • 10 Refer to important disclosures at the end of this report • Merrill Lynch • • Global Research Highlights - 19 July 2002 Industry Focus Tobacco We believe that tobacco stocks. traditionally defensive investments, remain attractive for purchase. For the year-to- date. the S&P and DJIA have fallen by 20% and 14%, respectively. By contrast, the shares of Philip Morris have declined by 7.5% and those of R.J. Reynolds Tobacco, Carolina Group, and UST have retreated by 7%. 8.2%, and 7.9%, respectively. We reaffirm our intermediate-term ratings of Strong Buy on the shares of Philip Morris (MO; $42.40; 13-1-1-7) and UST (UST; $32.22; C-1-2-7) and of Buy on the shares of R.I. Reynolds Tobacco (RJR; $52.35; 0-2-2-7) and Carolina Group (CG; $25.70; D-2-2-7). Investment Overview • We consider the earnings -growth potential of the major tobacco companies to be reliable and attractive for 2002 and 2003, and wc think that their growth is likely to significantly exceed that of the overall market in both years. For 2002. we estimate that earnings will rise by about 10% for Philip Morris, by 6.2% for R.J. Reynolds, by 4.2% for UST, and by 5.7% for Carolina Group. For 2003, we think that thc rate of earnings growth is likely to accelerate. • Much attention has been focused recently on Philip Morris's second-quarter U.S. domestic shipment volumes. Although those volumes clearly fell sharply year-to-year, wc attribute virtually thc entire decline to issucs associated with trade loading and the timing of buying patterns. For both the quarter and all of 2002. we expect the company's four core brands -Marlboro. Par- liament, Virginia Slims, and Basic -to show, in aggre- gate, essentially flat -to -modestly rising retail market shares. Furthermore, the weakness of the U.S. dollar should provide Philip Morris with significant potential additional operating income. Whether the company decides to reinvest that income or to allow it to fall to the bottom line, we believe that shareholders will benefit from value creation regardless of the method chosen. • In our view, the balance sheets of the key tobacco equities remain conservative and generally underlev- eraged, especially in relation to the group's strong cash Bows. For 2002, we expect EBITDA -to -interest -expense ratios of 16.2 for Philip Morris, 10.2 for R.J. Reynolds,' 6.9 for Carolina Group, and 24.8 for UST. • We think that shareholder returns arc likely to accelerate during 2002 and 2003. We expect Philip Morris to raise its dividend per share in August by 10.3% to $2.56 from $2.32. In addition, Philip Morris is likely to invest $6.1 billion in its buyback program this year vs. $4 billion in 2001. At the current price, we expect the buyback pro- gram to absorb about 13.5% of the company's average daily traded volume. • In the case of R.J. Reynolds, we expect the company to invest about S500 million in its buyback program in 2002, compared with $492 million in 2001. At current • prices, a $500 million buyback represents about 10.2% of the company's $4.9 -billion market capitalization. Early in June. the company raised its dividend per share by 8.6% to $3.80. • We think that UST may initiate a buyback program at a rate of $150 million annually toward the end of this year. We expect UST to raise its dividend by 4.2% to $2.00 a share this December. • Carolina has no buyback program. Its current dividend per share of $1.78 provides a yield of 6.9%. We expect the company to raise its dividend to $2.09 a share in 2003 and to $2.35 in 2004. • Based on the current price of $42.40 for Philip Morris's stock, we estimate that thc food businesses 'alue per Philip Morris share is about $30.35 (using the EV/ EBITDA method and allocating debt across Philip Morris by division). On that basis, the company's global tobacco business appears to be trading at 2.3 times our 2002 estimates. By comparison, R.J. Reynolds and Carolina Group are selling at respective multiples of 3.3 and 4.2 times our 2002 estimates. • In terms of the industry's litigation situation, we expect California's Supreme Court to rule soon in the Naegcle/ Myers matter. That claim concerns the immunity statute that prevented the tobacco industry from being sued in California between 1988 and 1998. Oral arguments were on May 7, and a decision is typically published within 90 days of the arguments. Even a partial application of the immunity statute could aid the industry in both past and future individual claims in California. At this point, we believe that thc market is expecting the court to rule against the tobacco industry. However, we also believe that current valuations fully reflect the uncertainty asso- ciated with the West Coast challenges. In other words. even with the upcoming Bullock trial in California and the imminent decision in the Naegele/Myers matter, we believe that tobacco equity valuations should be able to plateau and then rise. • Finally, we remind investors that the performance of the tobacco sector remains inversely correlated to that of the overall market. To the extent that thc broader market indexes either continue to fall or remain volatile, we think that there is a good chance that the tobacco sector may outperfonn. On the other hand, if the overall market were to return to rapid growth, the tobacco sector's superior fundamentals could be less -highly valued by investors -a scenario that we think is less likely than the broader market either stabilizing or continuing to slip. Martin Feldman Footnotes: CG, g: CG, RJR p; CG, MO, RJR. UST, v; please see footnotes on last page. Stat prices as of7/16/02. Refer to important disclosures at the end of this report. 1I • Global Research Highlights - 19 July 2002 • • Merrill Lynch Intermediate -Term Ratings Distribution: Coverage Universe Strong Buy Buy Neutral _ ReducelSell Intermediate.Tenn Ratings Distribution: Autos Group (as of 05 July 2002) Coverage Universe Count Percent Strong Buy 12 17.14% Buy 24 • 34.29% Neutral 31 4429% Reduce/Sell 3 4.29% Intermediate -Term Ratings Distribution: Banks Group (as al 05 July 2002) Coverage Universe Cotmt Percent Strong Buy 15 8.67% Buy 62 35.84% Neutral 83 47.98% ReducelSell 13 7.51% Chemicals Group (as of 05 July 2002) Count Percent Inv. Banking Relationships' 9 13.43% Strong Buy 23 34.33% Buy 32 47.76% Neutral 3 • 4.48% ReducelSell Aerospace/Defense Electronics Group (as of 05 July 2002) Count Percent Inv. Banking Relationships' 2 7.41% Strong Buy 19 70.37% Buy 6 22.22% Neutral 0 0.00% ReducelSell Inv. Banking Relationships' Strong Buy Buy Neutral ReducelSell Inv. Banking Relationships' Strong Buy Buy Neutral ReducelSell Intermediate -Term Ratings Distribution: Coverage Universe Strong Buy Buy Neutral ReducelSell Intermediate -Term Ratings Distribution: Consumer Products Group (as of 05 July 2002) Coverage Universe Count Percent Strong Buy 11 16.18% Buy 32 47.06% Neutral 23 33.82% Reduce/Sell.94% Intermediate -Term Ratings Distribution: Energy Group (as of 05 July 2002) Coverage Universe Count Percent 39 25.32% 76 49.35% 36 23.38% 3 1.95% Strong Buy Buy Neural Reduce/Sell Intermediate -Term Ratings Distribution: Financial Services Group (as of 05 July 2002) Coverage Universe_ __. Count Percent �.Sbong Buy Buy Neutral ReducelSell 12 47 27.65% 74 43.53% 7 4.12% Inv. Banking Relationships' _ Strong Buy Buy Neutral ReducelSell Inv. Banking Relationships' Strong Buy Buy Neutral ReducelSell Inv. Ranking Relationships' Strong Buy Buy Neutral ReducelSell Count 2 Percent 15.38% 9 69.23% 2 15.38% 0 0.00% Count Percent 4 16.00% 13 52.00% 7 28.00% 1 4.00% Count 13 31 33 5 Count 4 6 5 0 Count 3 5 3 0 Count 21 24 7 1 Percent 15.85% 37.80% 40.24% 6.10% Percent 26.67% 40.00% 33.33% 0.00% Percent 27.27% 45.45% 27.27% 0.00% Percent 39.62% 45.28% 13.21% 1.89% Count Percent 24 -.. 30.00% 23 28.75% • 29 36.25% 4 5.00% Refer to important disclosures at the end of this report • .� Merrill Lynch • • Global Research Highlights - 19 July 2002 Intermediate -Term Ratings Distribution: Coverage Universe Strong Buy Buy Neutral Reduce/Sell Intermediate -Term Ratings Distribution: Coverage Universe Strong Buy Buy Neutral Reduce/Sell Intermediate -Term Ratings Distribution: I Coverage Universe Strong Buy Buy Neutral Reduce/Sell Intermediate -Term Ratings Distribution: Coverage Universe Strong Buy Buy Neutral ReducelSell Intermediate -Tom Ratings Distribution: Coverage Universe Strong Buy Buy Neutral Reduce/Sell I ntennediate-Term Ratings Distribution: Coverage Universe Strong Buy Buy Neutral Reduce/Sell Intermediate -Tern Ratings Distribution: Coverage Universe Strong Buy Buy Neutral Reduce/Sell _ hnemrediate-Term Ratings Distribution: Coverage Universe Strong Buy Buy Neutral Reduce!Setl hmennediate-Term Ratings Distribution: Coverage Universe Strong Buy Buy Neutral Reduce/Sell Intermediate -Term Ratings Distribution: Coverage Universe Strong Buy Buy Neutral Reduce/Sef hiemrediate-Tent Ratings Distribution: Coverage Universe Strong Buy Buy Neutral Reduce/Sell Food Group (as or 05 July 2002) Count Percent 5 9.09% 30 54.55% 19 . 34.55% 1 1.82% Health Care Group (as of 05 July 2002) Count Percent 52 25.87% 62 30.85% 73 36.32% 14 6.97% ndustrials/Mutti-Industry Group (as of 05 Count Percent 11 21.57% 16 31.37% 23 45.10% 1 1.96% Inv. Banking Relationships' Strong Buy Buy Neutral Reduce/Sell Inv. Banking Relationships' Strong Buy Buy Neutral Reduce/Sell July 2002) Inv. Banking Relationships Strong Buy Buy Neutral ReducelSell Media & Entertainment Group (as 0l 05 July 2002) Count Percent Inv. Banking Relationships' 28 16.18% Strong Buy 64 36.99% Buy 74 42.77% Neutral 7 4.05% Reduce/Sell Non -Ferrous Metals, Mining & Minerals Group (as of 05 July 2002) Count Percent Inv. Banking Relationships' 21 27.27% Strong Buy 32 41.56% Buy 21 27.27% Neutral 3 3.90% Reduce/Sell Packaging Group (as of 05 July 2002) Count PercentInv. Banking Relationships' 1 . 25.00% Strong Buy 2 50.00% Buy 1 25.00% Neutral 0 0.00% ReducelSell Paper/Forest Products Group (as of 05 July 2002) Count Percent Ira. Banking Relationships' 15 31.25% Strong Buy 20 41.67% Buy 12 25.00% Neutral 1 2.08% Reduce/Sell REITs meal Estate Investment Trusts) Group (as o105 July 2002) Count Percent Inv. Banking Relationships' 9 9.0996 Strong Buy 52 52.53% Buy 34 34.34% Neutral 4 4.04% • Reduce/Ser Restaurants Group (as of 05 July 2002) Cotmt Percent 5 23.81% 10 47.62% 4 19.05% 2 9.52% Retailing Group (as of 05 July 2002) Count Percent 58 32.04% 42 23.20% 70 38.67% 11 6.08% Technology Group (as of 05 July 2002) _Cant Percent 45 1613% 88 31.54% 126 45.16% 20 7.17% Inv. Banking Relationships' Strong Buy Buy Neutral Reduce/Sef Inv. Banking Relationships' Strong Buy Buy Neutral Reduce/Sell Inv. Banking Relationships Strong Buy Buy Neutral Reduce/Sell Count Percent 3 2727% 6 54.55% 2 18.18% 0 0.00% Count Percent 34 53.13% 18 28.13% 11 17.19% 1 1.56% Count Percent 5 31.25% 5 31.25% 6 37.50% 0 0.00% Count Percent 12 23.53% 21 4118% 17 33.33% 1 1.96% Count Percent 8 40.00% 9 45.00% 3 15.00% 0 0.00% Count Percent 0 0.00% e 0.00% 0 0.00% 0 0.00% Carat Percent 7 58.33% 4 33.33% 1 8.33% 0 0.00% Count Percent 4 9.09% 26 59.09% 12 2727% 2 4.S5% Count Percent 1 16.67% 4 66.67% 1 1667% 0 0.00% Count Percent 26 50.98% 10 19.61% 14 2745% 1 1.96% Count Percent 15 25.00% 24 40.00% 17 28.33% 4 6.67% Refer to important disclosures at the end of this report. 13 • Global Research Highlights - 19 July 2002 Merrill Lynch Intermediate -Term Ratings Distribution: Telecommunications Group (as of 05 July 2002) Coverage Universe Count Percent • Inv. Banking Relationships' Strong Buy 17 9.88% Buy 44 25.58% Neutral 77 44.77% Reduce/Sell 34 19.77% Intermediate -Term Ratings Distribution: Coverage Universe Strong Buy Buy Neutral ReducelSell Strong Buy Buy Neutral Reduce/Sell Tobacco Group (as al 05 July 2002) Count Percent Inv. Banking Relationships' 5 38.46% Strong Buy 7 5385% Buy 1 7.69% Neutral 0 0.00% Reduce/Sell Intermediate -Term Ratings Distribution: Transport/Infrastructure Group (as of 05 July 2002) Coverage Universe Count Percent Inv. Banking Relationships' Strong Buy Buy Neutral Reduce/Sell Strong Buy 29 27.62% Buy 27 25.71% Neutral 40 38.10% Reduce/Sell 9 8.57% Intermediate -Term Ratings Distribution: Utilities Group (as of 05 July 2002) Coverage Universe Count Percent 13 10.16% 42 32.81% 61 47.66% Strong Buy Buy Neutral Reduce/Sell 12 9.38% Intermediate -Term Ratings Distribution: Global Group (as of 05 July 2002) Coverage Universe Count Percent Inv. Banking Relationships' Strong Buy 521 1782% Strong Buy Buy 1048 3584% Buy Neutral 1163 39.77% Neutral Reduce!Seli 193 6.60% Reduce/Sell Companies in respect of which MLPF&S or an affiliate has received compensation for investment banking services within the past 12 months. Inv. Banking Relationships' Strong Buy Buy Neutral Reduce/SeU Count Percent 7 11.11% 17 26.98% 26 41.27% 13 20.63% Count Percent 0 0.00% 0 0.00% 0 0.00% 0 0.00% Count Percent 11 36.67% 8 26.67% 11 36.67% 0 0.00% Count Percent 4 7.55% 18 33.96% 26 49.06% 5 9.43% Count Percent 228 25.94% 339 38.57% 267 3038% 45 512% (CG] MLPF&S or an affiliate was a manager of a public offering of securities of this company within the last 12 months. [CG, HCA, RJR( MLPF&S was a manager of the most recent public offering of securities of this company within the last three years. (DELL) The securities of the company are not listed but trade over-the-counter in the United States. In the US, retail sales and/or distribution of this report may be made only in states where these securities are exempt from registration or have been qualified for sale. MLPF&S or its affiliates usually make a market in the securities of this company. (HCA, SYYI MLPF&S or an affiliate has received compensation for investment banking services from this company within the past 12 months. (CG, DELL, HCA, MO, RJR, SYY, UST) MLPF&S or an aflil-iate expects to receive or intends to seek compensation for investment banking services from this company within the next three months. In Germany, this repon should be read as (hough Merril Lynch has acted as a member of a consortium which has underwritten the most recent offering of securities during the last five years for companies covered in this report and holds 1% or more of the share capital of such companies. The analyst(s) responsible for covering the securities in this report receive compensation based upon, among other factors, the overall profitability of Merrill Lynch, including profits derived from investment banking revenues. OPINION KEY: Opinions include a Volatility Risk Rating, Intermediate -Tenn and Long -Term Investment Ratings and an Income Rating. VOLATILITY RISK RATINGS, indicators of potential price fluctuation, are: A - Low, B - Average, C - Above Average, D - High. INTERMEDIATE-TERM INVESTMENT RATINGS, indicators of expelled total retum (price appreciation plus yield) within the 12 -month period1rom the date of the initial rating, are:1 - Strong Buy (minimum 20% more for High Risk securities); 2 - Buy (minimum 10%) 3 - Neutral (0- 10%): 4 - Reduce/Sell (negative return); 6 - No Rating. LONG-TERM INVESTMENT RATINGS, indicators of fundamental company factors demonstrat ng potential total retum tor the 3 -year period from the date of the initial rating are: 1 - Strong Buy (aggregate minimum 40%); 2 - Buy (aggregate minimum 20%); 3 - Neutral (aggregate 0.20%); 4 - Reduce/Sell (negative return); 6 - No Rating. INCOME RATINGS, indicators of potential cash dividends are: 7 samelhgher (dividend considered to be secure); 8 - samellower (dividend not considered be secure); and 9 - pays no cash dividend. Copyright 2002 Menifl Lynch, Pierce, Fenner & Smith Incorporated (MLPF&S). AU nghts reserved. Any unauthorized use or disclosure is prohathed. This report has been prepared and issued by MLPF&S and/or one of its affiliates and has been approved for publication in the United Kingdom by Merrill Lynch, Pierce, Fenner & Smith Limited, which is regulated by the FSA; has been considered and distributed in Australia by Mernfl Lynch Equities (Australia) Lknited (ACN 006 276 795), a licensed securities dealer under the Australian Corporations Law; is distributed in Hong Kong by Menill Lynch (Asia Pacific) Ltd, which is regulated by the Hong Kong SFC; and is distributed in Singapore by MemV Lynch International Bank Ltd (Merchant Bank) and Merrill Lynch (Singapore) Pte Ltd, which are regulated by the Monetary Authority of Singapore. The information herein was obtained from various sources; we do not guarantee its accuracy or completeness. Additional information available. Neither the information nor any opinion expressed constitutes an offer, or an invitation to make an offer. to buy or sell anysecurities or any options, lutures or other derivatives related to such securities ("related investments'). MLPF&S and its affiliates may trade for their own accounts as od4ot dealer, market maker, block positioner, specialist and/or arbitrageur in any securities of this issuer(s) or in related investments, and may be on the opposite side of public orders. MLPF&S. its affiliates, directors, officers, employees and employee benefit programs may have a long or short position in any securities of this issuers) or in related investments. MLPF&S or los affiliates may from time to time perform investment banking or other services for, or solicit investment banking or other business from. any entity mentioned in this report. This research report is prepared for general circulation and is circulated for general information only. It does not have regard to the specific investment objectives, financial situation and the particular needs of any specific person who may receive this report. Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed or recommended in this report and should understand that statements regarding Inure prospects may riot be realized. Investors should note that income from such securities, if any, m y fluctuate and that each security's price or value may rise or fall. Accordingly, investors may receive back less than originally invested. Past performance is not necessary a guide to future pedormance. Foreign currency rates of exchange may adversely affect the value, price or income of any security or related Investment mentioned in this report. In addition, investors In securities such as ADRs, whose values are influenced by the currency of the underlying seamy, effectively assume currency risk. 14 Refer to important disclosures at the end of this report. Osborn, Carreiro & Associates, Inc. • • ACTUARIES • CONSULTANTS • ANALYSTS • July 10, 2002 Ms. Cathyrn Hinshaw, Executive Director Arkansas Fire and Police Pension Review Board One Union National Plaza 124 West Capitol, Suite 1750 Little Rock, AR 72201 Re: Actuarial Valuations Exhibit 3, page 9 Dear Cathyrn: One Unlon.Natkinal Ha a,Sulte 1690 124 West Caplool Avenue lIttle Rods, Arkansas 72201 (501)376-8043 We found a calculation error on page 9 which is the GASB disclosure page for some plans. We have corrected it for all valuations to be completed in the future. We have corrected the page for the 14 plans in which the error occurred. Here are 3 copies of the corrected page 9 for the following plans: Blytheville Fire Brinkley Fire Fayetteville Fire Helena Police Jonesboro Police Little Rock Fire Little Rock Police Magnolia Fire Magnoha Police Monticello Fire Pine Bluff Fire Pine Bluff Police Texarkana Fire Texarkana Police If you have any questions or comments please let me know. Sincerely, Jo Carreiro, A.S.A. Actuary • • • EXHIBIT 3 (Continued) Fayetteville Firefighters Pension Fund Reconciliation of Net Pension Obligation ACCOUNTING INFORMATION This page is included to provide the information required by the Governmental Accounting Standards Board Statement No. 25 and 27. The values below are based on the assumptions contained in Exhibit 8. The Annual Pension Cost disclosed in this exhibit will almost always differ from the actual cash contribution to the fund. We must emphasize that these disclosures are shown in the city's financial statements; Sound actuarial projections should be used to determine the actual cash contribution requirements. RECONCILIATION OF NET PENSION OBLIGATION (NPO) I. Actuarially Required Contribution 2. Interest on NPO 3. Adjustment to (1) 4. Annual Pension Cost (1)+(2)-(3) 5. Actual Contribution Made 6. Increase in NPO (4)-(5) 7. NPO Beginning of Year 8. NPO End of Year (a) Actuarial Valuation Date 12/31/1993 12/31/1995 12/31/1997 12/31/1999 12/31/2001 (b) Market Value of Plan Assets* 7,271,255 8,897,591 11,225,602 12,880,300 11,403,332 * Note: *' Note: • 2000 124,741 (109,572) (251,093) 266,262 506,689 (240,427) (1,826,196) (2,066,623) REQUIRED SUPPLEMENTARY INFORMATION (c) (d) (e) Unfunded Entry Age Accrued Actuarial Liability Accrued (UAL) Liability (c) -(b) 7,816,034 9,045,983 12,093,450 12,940;843 17,239,942 544,779 148,392 867,848 60,543 5,836,610 Funded Ratio (b)/(c) 93.0% 98.4% 92.8% 99.5% 66.1% 2001 124,741 (123,997) (284,151) 284,895 401,207 (116,312) (2,066,623) (2,182,934) (0 Annual Covered Payroll 620,116 676,847 608,602 367,188 234,765 12/31/1993 and 12/31/1995 are at amortized cost value. 2002 1,279,840 (130,976) (392,806) 1,541,670 (2,182,934) (g) UAL as a% of Covered Payroll (d)/(f) 87.9% 21.9% 142.6% 16.5% 2486.1% For volunteer/part paid members, Annual Covered Payroll is $200 for such active members 9 Revised 07/10/2002 • • • ASHLAND MANAGEMENT INCORPORATED NEW YORK TELEPHONE: (212) 425-2803 NEW YORK FACSIMILE (212) 425-6026 Mr. Richard Yada Assistant Vice President Merrill Lynch 2200 Rodney Parham Suite 300 Little Rock, AR.72212 COPY DO NOT PAY On altent ° �%,.4e€ W.4 10004-1405 July 17, 2002 Invoice for Investment Advisory Fees Fayetteville Fire Pension and Relief Fund Account #: 563-05G88 Enclosed is the bill for the quarter ended June 30, 2002, covering the investment advisory fee due to Ashland Management lncorporated. Please submit payment via wire transfer, with an email aclmowledgment to dgianninina,ashmgmt.com, instructions as follows: To: HSBC Bank ABA No. 021001088 Credit: Ashland Management Incorporated A/C No: 001-66624-0 Alternatively, you may mail your payment to Ashland Management Incorporated, One Battery Park Plaza, 26th Floor, New York, N.Y. 10004-1405. If you have questions with respect to this billing, you may contact your Portfolio Manager or call Ashland Management Customer Service, Diana Geraci at 212-425-2803. • cc: Ms. Heather Woodruff City Clerk City of Fayetteville • • • RELIEF FUND FAYETTEVILLE FIRE PENSION & 56305G88 rox w z 0 O u 4 w w a CLIENT STATEMENT FOR QUARTER ENDED 06/30/02 4 0 0• OD N M in CO 10 CO Ol .- co" in co 11 O _ H HI 10 l0 Lfl HI d' ul 0 0\ Ln Ln w \ 01 co O1 co 1/40 in ,7 o co El O 1.0 O N al (1 dr 4 co o t` Ln M Cr •J 0 Ln al CO t` III CO 0 V} F H H H Ln H w CO K CO CO r.14 • o H Ln zTr1 Tr co a GI Cu 0 a Z RC 001/40O O H •, 0O F N N N O o o Ln 4 o o ri o w n 0 4 \ \ - a 4 o a' Ln to 4 u . F o o o > to BILLING FOR QUARTER