TWST: Would you bring us up to date on Profit Investment Management and its investment philosophy?

Mr. Profit: We are a large cap equity firm, primarily focusing on institutional asset management. We currently manage in excess of $245 million in assets under management. Our investment process is best described as valuation-sensitive growth investing. What we invest in are companies that are trading at a discount to our calculated intrinsic value, for reasons that we think are correctable from a perception standpoint in the market. Secondarily, we invest in companies that are growing at a faster rate than the benchmark average on a trailing three- to five-year basis. We end up holding a portfolio of between 37 and 45 securities, each accounting for between 2% and 3.5% of the entire portfolio. Historically, we have exhibited strong performance. Six of the last seven calendar years, we have outperformed the S&P 500 and Russell 1000 Indices. We have been able to really provide consistent, high, risk-adjusted return to our clients. This has resulted in a very fast growth rate for Profit. We are picking up more and more clients, and we are excited about that. The PIM Style (Profit Investment Management Style) enables us to provide an investor with a pretty good degree of probability that they will receive alpha versus the benchmark, while limiting risk through careful stock selection. We are absolutely bottom-up fundamental stock pickers. We use the raw data, the 10-Q's, the SEC filings by companies, to build investment stories of the companies which we would like to consider for inclusion in our portfolio. We have low turnover in the portfolio, in the 30% to 40% a year range. This style of investment leads to a high degree of tax efficiency. If tax efficiency is an issue for you, we are good at that, but it doesn't really play directly into our investment process. Just being buy and hold investors provides you with some degree of tax efficiency. We also run a social product under the same investment style, which we subadvise. It is a portfolio for the Calvert Fund and their balanced portfolio. The performance of that has been as strong as our Profit Fund. We've managed that since November 2002. We use language that people understand when talking about the investing process. It is important that investors know what we are talking about. Although we are concerned with beta and most of the modern portfolio theory that other investment managers are concerned with or aware of, we feel strongly that when we are talking to investors, or the public at large, we try to speak in common, everyday language about what we are trying to do. The bottom line is that even if you say the market is efficient, we don't argue that, but we do think that there are times in the market cycle when there is a disconnect between the company's market valuation and the company's valuation as an ongoing entity. Whether you are looking at discounted cash flow analysis or some other fundamental analytics, you can find gaps between the current stock price of a particular company and the actual projected market value. To the extent that we can find companies mispriced that are growing at a fast rate, that have high return on equity and strong balance sheets, we'll add securities to the portfolio. We are broadly diversified, with holdings in almost all sectors in the marketplace, but that's not really a primary consideration. Over- or underweighting of sectors is the result of bottom-up stock picking.

TWST: Do you do any top-down macroanalysis of the economy and the market before you select stocks?

Mr. Profit: We want to know what is going on in the world. I have an economics background, so from a macro perspective, I do want to know where interest rates are; I do want to know what the global environment is, but that is all. Themes like demographics, aging of the population, or employment outsourcing, we would look at once we got to the stage where we have a company that we are interested in, but only to the extent that these might impact an individual company. For instance, looking at a homebuilder like Pulte, knowing where we are with interest rates and looking at the actual numbers of new houses, plays slightly into our valuation of the company, but it is not a driver of the process. It just makes us a little bit more careful if the macro environment seems to be against a particular company or a particular industry at a certain point in the market cycle. Our portfolio holdings really are the result of bottom-up analysis more than a top-down perspective.

TWST: What are the specific characteristics of the companies you're looking for?

Mr. Profit: What you generally see in our portfolio are stocks that are selling at a discount to the benchmark, so I'm looking at low price to earnings in relationship to the benchmark. Also we generally try to find 20% to 30% discount to the benchmark valuation from a p/e standpoint for new securities purchased. We look for double-digit earnings growth, return on equity in excess of 17%, and price to earnings growth below 2%. We do not buy all the companies that meet the above criteria. We do not run a quantitative product. Some people have referred to our valuation-sensitive growth style as GARP (growth at a reasonable price). I'd rather say growth at value prices, because there is so much relativity involved in saying reasonable price that you can almost justify anything. We are very disciplined regarding what we are looking for in companies in which we invest. We think, quite frankly, if we are buying companies that are selling at a discount, we have a margin of safety built in. We make money from the closing of the gap between the current market price and what we consider to be its current business value calculation. In other words, we wait for market participants to recognize the mispricing in a particular security. Secondly, if we are buying companies in which earnings are growing faster than the benchmark itself, and those companies are not going up in price but are actually cheaper from a p/e standpoint, eventually market participants will want to invest in these companies. The idea is simple. If the market is not adjusting in terms of market price and the stock is not adjusting to reflect faster earnings growth, the cheapness of the stocks will show up on investors' screens. So in some respects, it's really a very elementary look at the mathematics of the fundamental data that you are looking at. You have two factors working for you: one, buying something that is respectively cheaper; and two, buying something that is growing faster. This means that if other investors do not come along and drive up the price, you are going to widen the gap with your purchase of a mispriced security that, in itself, adds a secondary margin of safety. You hear us talk a lot about risk-adjusted return, and this is because we do try to take care of money that we are entrusted with, and if the market is going down, we are fully invested. We are not running an absolute return strategy, but we are trying to minimize the downside impact on our portfolio. This is done by careful selection, but also if you are buying companies that are cheap or inherently mispriced, obviously they could get cheaper, but you probably are closer to their cheapest point if you buy them already discounted. Our investment process focuses on the actual stock selection, determining what the individual companies do, what their operating margins are, what the balance sheet looks like, whether or not they'll continue to earn a profit, whether the reason that the market has them mispriced can be identified, and what catalyst can begin to move the company back into a normalized relationship from a price standpoint to the market.

TWST: The name of the Fund has changed. What other changes have there been in the Fund since we last talked to you?

Mr. Profit: It has gotten a bit larger. We purchased the Kenwood Growth & Income Fund, which was about a $3 million fund, and merged it into the Profit Fund. The reason for the name change is because there exists a very strong labeling of value and growth, and because we invest so much in the core space and really focus on the growth aspects, we didn't want investors to be misled, thinking that this was a traditional value investment process. It never has been. So we decided to drop Value out of the name and just call it the Profit Fund. Nothing about the investment approach or philosophy changed; the same can be said of the Fund's performance. Other than that, we have just gotten larger in assets under management for pension funds on a separate account basis. The Fund has always been relatively small. Now it is almost $7 million, and we're in the process of acquiring another $6 million mutual fund to merge into the Profit Fund. I have already taken over the reins as the advisor of the Fund, it is called the Lake Forest Core Equity Fund. Interestingly enough, that particular Fund always had poor performance throughout its history. We took it over in March of this year. Looking at the Morningstar Report, that Fund had been in the bottom 1% for the past three years but has performed in the top 1% during our three months of ownership. We are rather excited about being able to show that our process works very effectively.

TWST: In what areas are you overweight?

Mr. Profit: In our current portfolio, I would say we are starting to look at telecom and health care. Health care tends to be overweight in our portfolio in this environment. We also have been looking quite aggressively again in the technology space. We have not quite gotten to an overweight position there yet, but going forward, that is where we see a lot of mispricing and opportunity. You will see us looking a lot in health care, telecom, technology, and financial services. We own holdings in MGIC Investment (MTG), for instance, which we think is a counterplay to interest rates increasing. We even see opportunities in some large cap technology names.

TWST: What are some of the healthcare names that you have bought in recent months and the reasons why you were attracted to them?

Mr. Profit: We actually have started to buy Medtronic (MDT), which is primarily a stent and pacemaker manufacturer. We owned them five or six years ago and have not owned them since. But looking at relative valuation of Medtronic versus Guidant (GDT), which had a very large run- up here, and Boston Scientific (BSX), we think that Medtronic, because it did not have a lot of market share in the drug coated stent area, really was underperforming. It is still growing in the 15% range with a forward p/e of about 25%, slightly above the market. But historically, Medtronic has sold at a premium to the market because of its growth rate. With demographics being what they are, we think that currently this is a very good security to own in the healthcare space. We actually sold Guidant, because we have reached the target price, and the risk/reward relationship is no longer favorable. Medtronic's current mispriced valuation provides us with a good reentry opportunity. Another healthcare name that we have been adding to is Pfizer (PFE), a controversial name in some respects, because there is some concern that Lipitor sales might be winding down with generics coming online, and there is always concern with the pharmaceuticals about whether the drug development pipelines are full. In Pfizer's case, the pipeline is fine. What we see here is a below market p/e ratio of 17 with a double-digit earnings growth rate of 13. You probably know that the large cap pharmaceuticals have been underperforming the market for probably much of the last two years for a variety of reasons ' drug pricing being paramount and Medicare reform, etc. There is some indication that these companies will be able to repatriate in profits, so they might get a windfall in cash, which certainly would not hurt them in a turnaround scenario. With demographics being what they are, you are able to buy companies growing at a fast rate that historically have traded at a premium to the market, and they are trading at a discount to the market. Medicare reform and/or drug pricing is not going to impact Pfizer to such an extent that this mispriced valuation is going to hold up. Pfizer is a very good example of what we look for when we make determinations of whether the market has the valuations right for particular companies.

TWST: Which names do you have in technology and telecom?

Mr. Profit: Looking at the names that we are most focused on, such as Verizon (VZ), telecom earnings are not normalized yet. We know long distance is kind of a giveaway business right now, so you are not going to make any real money in it. There is some debate over whether or not the Baby Bells are going to have to share access to their lines. Some important legislation has recently expired. But in the case of Verizon, we see the p/e down around 14. We know the growth rate is generally not as high as we like in the companies we own. They show a growth rate down around 6 or 7, but this is not a normalized number. What Wall Street has wrong in the case of Verizon is that Verizon is seemingly winning the number portability war. Their network is built-out more than the other companies, at least from a voice standpoint, and they actually are picking up a lot of market share from the other carriers in the wireless space as number portability comes into play. When you look at a valuation of Verizon, you are not getting any real accurate valuation on Verizon wireless. You almost get a free play on the telecom sector in general, a safe way to play it, because the regional Bells merge a variety of telecom services. Even though long distance is suffering, direct access into houses is still a very major and viable business. DSL is not growing as rapidly as they would have liked, but that is starting to pick up speed. Cable came out of the box faster, but DSL seems to be catching up. As far as wireless, which is the wave of the future, Verizon is probably the best provider. I am very comfortable holding this company in this environment, taking the 4% dividend yield, and letting the rest of Wall Street figure out what the valuation really should be on Verizon Wireless. If you go back to the top of the bubble, there was discussion, and they almost initiated a spinoff of Verizon Wireless, but they stopped right at the last minute, because the capital markets were drying up in the telecom space. You can really see money managers looking at the short-term popularity issue and saying, 'Telecom has so many issues. The demand is still not there, long distance is suffering, and there is that whole MCI bankruptcy issue.' But I invest in a three- to five-year window, and when I see situations where companies are underperforming as dramatically as Verizon is, and I can get beneath the numbers to find some reason that the stock will move significantly higher over the market cycle, we are able to step up as buyers sooner. The other name that we've started to build a position in is Nokia (NOK), which had a tremendous drop over the last two or three months, and the primary reason, if you paid close attention, had to do with the fact that their particular phones were not as technologically savvy as some other offerings from Motorola (MOT), LG or Samsung. The market absolutely sold them off, thinking number portability, there were more phones being sold, and Nokia was losing market share. But those were in no way reflective of the amount of selloff the stock generated. In our opinion, that is easy to fix in terms of multiple offerings. They still have one of the best distribution systems out there into the wireless carriers. They are still selling more phones than any other provider. And again, something as simple as updating their interfaces and updating their phone offerings is an easily identifiable catalyst, and I think you will see that company, along with telecom, move up substantially higher than its current $14 price. But again, the market is so short-term focused and information-focused in its current state that you find situations like this. We are not generally big ADR buyers, but we thought that this was just one we could not pass up. And even looking through some of the headlines, you see that Nokia is starting to change their dynamic. They are licensing patents from Research in Motion's (RIMM) BlackBerry, so you will probably see them coming out with more full-featured phones. And at that point, you will see the stock begin to move higher. But again, the downside is so minimal here that it is a very attractive name to be able to pick up at these prices.

TWST: Do you think the financial services stocks have taken into account the impending rise in interest rates?

Mr. Profit: We play that sector a little differently. In any cycle, Citibank and the brokers are going to say that. But where we have been buying and placing assets for quite some time is in MGIC Investment, which is the largest private mortgage insurer. They have a very strong balance sheet. MTG does best when customers hold a mortgage long term. It costs more to acquire new accounts than it does to maintain a long- term loan. Because we have been having a low interest rate environment, many new homeowners have held mortgages for short periods, and many customers have gone through multiple refinancings. This has caused MTG to not perform as well as before and their stock price to falter. We started building a position in the mid-$40s or $50s, and I kept saying that this company makes money on persistency. They write the private mortgage insurance, and they do not want that house to be sold or to be refinanced, because then they have to rewrite the insurance again if they, in fact, get the insurance written. All they want to do is clip coupons every month as that homeowner is paying for the private mortgage. At any rate, as interest rates began to move higher, so did this company, to the extent that it is now in the mid-$70s, and even at that price, it is still quite compelling, because you still are in about a 15 p/e, and the growth rate is 12.5. So I'm able to buy this company even today at a PEG of 1.16, and it actually will benefit as interest rates move higher. In some respects, because interest rates are so low, you would imagine that most financially savvy people were buying fixed rate mortgages. So as long as interest rates are moving higher, the valuation of MTG stock should rise as well. MTG's persistency will increase more and more, and their profitability margins will expand more and more. This is one example of how we have played the financial services sector after we made the bottom-up decision that this company was inexpensive for a reason that we found to be correctable. In fact, when we bought shares, it was selling below its growth rate, and if the top-down analysis dictated anything ' in this case interest rates moving higher, we still were in good shape ' because that actually would help this company, even though a lot of people would not know that at first glance. Regarding the other financial services names we own, with Bank of America (BAC) we are more concerned about the move up in interest rates. But again, Bank of America is so well-diversified that we think that you might see a little bit of a hiccup there, but it will not be as bad as in some past cycles. We also own Fannie Mae (FNM), and that is the one that has been under a lot of pressure in some respects with what has been going on in Freddie Mac (FRE). But in Fannie Mae, you are still looking at a single-digit p/e, even at this price. We do not think that the regulatory changes will be so dramatic that they will cause disruption in the ability of mortgagers and banks to offload mortgages to replenish their ability to make mortgages. And Fannie Mae has done a very good job of running their portfolio with respect to duration, so I'm not that concerned, as interest rates move higher, that owning the stock down here at a 9 p/e is a bad idea. In fact, it is going to be one of the outperformers over the next three years. We have looked at Freddie Mac but have not made a full commitment there; however, Fannie Mae is one of the stocks that we think Wall Street, again, has absolutely wrong. There are not many times when you can buy a stock with a single-digit p/e with almost a 3% dividend yield and a strong balance sheet; over time you're bound to make money with it.

TWST: What are the reasons that you would sell a stock from your portfolio?

Mr. Profit: The primary reason is simple. It is when an investment story changes, and that could be the fundamentals in the company changing all of a sudden or the earnings declining precipitously, and we cannot really understand exactly why or we are surprised by that. We are going to sell that security, because in our opinion, our investment thesis has changed. If there is a major management shakeup, and we are not familiar with the incoming management, we are going to sell. The best way to sell is if a stock reaches our target price and we go out and find another name that has a better risk/reward relationship. That means that our analysis was right, and we have made a nice return on the security, so we sell for that reason. We also, in the current environment, become a little bit concerned if a stock is underperforming the benchmark quarter after quarter, even though there is nothing inherently wrong that we can identify. We begin to ask questions and try to get a sense of whether there is something that we are missing, or we begin to wonder if we have the catalyst wrong, if our investment thesis is wrong. Our objective is to make money for our clients, not to be right, so we do not try to prove that our analysis is right by sticking to securities that are not performing or have declined precipitously if the market is going higher. We do not see a reason for that, so we will probably exit the security and find another name.

TWST: Have you sold off any stock or trimmed back on any in recent months that you could tell us about?

Mr. Profit: Really, from a positive standpoint, we made a lot of money in Polaris (PII), an all-terrain vehicle manufacturer. Polaris is about a $1.5 billion market cap, so it is on the small end of the scale, and it had gotten to be a large weight in our portfolio in our estimation. So we cut that position in half, even though we think that it still has some upside; we think that it is still reasonably valued. But from a portfolio management aspect, it had become risky within our particular portfolio. I mentioned that we did sell the majority of our holdings in Guidant early this year, and that was a case of the stock really meeting our target price. We talked quite a bit about the homebuilders and decided that they just still are too inexpensive in our estimation to do anything about, so we still are holding those securities. I can't think of any that we got just wrong. Nothing comes to my mind. We trimmed the position of Barr Pharmaceuticals (BRL). That was another name that we had quite a run-up in. Last year, we had a good year, and we had some names that were up 80%, Polaris being one of them. Whenever that happens, you are going to have to take some profits, because the weight in your portfolio gets to be so large.

TWST: Tell us about the risk in the portfolio and what attempts you make to try to control it.

Mr. Profit: Our primary risk control measure is careful stock selection, just trying to make certain that we have the right names in the first place. We do try to, as I said, equally weight the portfolio to allow all the securities in it to have equal opportunity and to perform based on how we thought. Now that in itself provides some added risk, because the benchmark is not equally weighted. For instance, if I own Microsoft shares, and I am only at a 3.25% weighting, I am underweight with respect to the benchmark, even though Microsoft is an attractive holding and it is in our portfolio. By the same token, in the case of Polaris, if I had a 3% weighting, the stock might have less than a 1% weighting in the benchmark. So you have to focus on stock selection, otherwise our risk really would be defined as off the chart from a stock-specific standpoint. But that being said, we run a fully diversified portfolio. We have 37 to 45 names across multiple industry sectors. So as long as we are careful on stock selection and avoid major blowups with respect to stocks in the portfolio, we are able to handle the risk through that stock selection.

TWST: What is special or unique about the Profit Fund compared with other funds with a similar investment philosophy?

Mr. Profit: Our focus on valuation-sensitive growth really is unique. We can find mispriced businesses in any sector, at any point in the market cycle. At the end of the day, the final decision, the common-sense question that we ask is whether or not the investment story we are looking at makes sense, whether the company is making a product that is viable, that is in demand in the marketplace, that is making a reasonable operating margin, and if that is sustainable, it is really reflected in our investment performance. For any investment firm, the performance actually shows whether or not your investment analytics are sound. Some people might disagree with that, but since we all have the same market to work with, we have the same market cycle, and the decisions that we make to include or not include, at what weight in the portfolio, really is what results in our performance at the end of the day. We understand that, and we recognize that our clients pay us to provide alpha; they do not pay us to be right. You have to be right more than not to provide alpha, but sometimes portfolio managers get in their own way trying to prove that their investment thesis is correct and are not really listening to what market forces are telling them, that maybe on that particular security they are absolutely wrong. So we tend to hover right in the center of the market to be able to give performance throughout the market cycle. We tend to underperform at market inflection points when there is massive pessimism or when there is massive optimism. We really are, I think, a core holding in a portfolio. If we look at it from the perspective of information ratio, we have very high scores, and we also have very high manager market capture ratios in up and down markets. So we are quite proud of that, and I guess the major differentiator is performance. But we are getting there through low turnover, careful stock selection and buying what we perceive to be underpriced securities that are growing at faster rates than the benchmark.

TWST: What do you tell your investors about this valuation-sensitive growth investing of yours? What are their concerns at this time and how are you managing expectations?

Mr. Profit: If you look at what has happened over the last five years (1999-2004), we went from the peak of the bubble to three years of negative returns, and going into 2003, no one expected the market to be higher. There was so much pessimism around that we did not expect the degree of return we got from the market. But yet if you sat on the sidelines in 2003 because of the last year of market returns, you missed the best year of the last four. With what is going on politically, what is going on in Iraq, there are a lot of reasons to be nervous about the market; interest rates might be moving higher; jobs are being outsourced. But if you look at the historical context and you have a need to have equity exposure in your portfolio, you will find that a manager focusing on valuation sensitivity and growth actually provides you almost a barbell approach to investing, and you have some degree of protection in a portfolio. We are buying companies that are cheaper than benchmark securities, but growing at a faster rate, so you also have the ability to participate on the upside. It is better to be with professional money management in this type of environment, because we now have a scenario where post-Enron you are not sure all the time that even large cap companies are who they say they are or have the business, factories or plants, what have you, that they say they do. The SEC and all the reporting has tightened up, and you have a pretty good indication, better here than probably anywhere else in the world. But I think that there is so much data out there that it is very useful to have someone who is looking at this all the time making investment decisions for you. However, that being said, the last five years is a pretty good proxy to go back and look at how portfolio managers have performed. We have had maybe one of the roughest market periods in history. There have been a lot of things coming back to back that tripped market participants up, and past performance certainly does not guarantee future performance, but it might give you some indication of how a portfolio manager handles a certain environment or makes certain investment decisions. In this review, we show up quite well. We certainly tell investors to be very skeptical of bond portfolios now. With interest rates being as low as they have been, some folks started stretching for yield, and long duration portfolios really could be positioned to cause capital erosion in portfolios over the next three years. We have been trying to make certain that our investors are cognizant of that, and also equally cognizant of the fact that it does look, in our opinion, like the equity markets will be compelling over the next three years, so you definitely would want to participate.

TWST: Thank you. (PS)

Note: Opinions and recommendations are as of 06/29/04.

EUGENE A. PROFIT Profit Investment Management 8720 Georgia Avenue, Suite 808 Silver Spring, MD 20910 (301) 650-0059

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