4th Quarter, 2009

Our companies’ fourth quarter results, most of which were good, confirmed the assessment we had formed from discussions this year with managers of our companies and other well-run businesses. Achieving revenue growth is difficult even for companies with strong customer relationships, which reinforces good managers’ emphasis upon delivering timely, precise execution within every business unit to ensure quality while maintaining tight cost controls. Moments of exhilaration upon meeting demanding goals temporarily relieve the strain on everyone and are used by good managers to renew the commitment to rigorous execution. Because customer caution, not just bad execution, may thwart efforts to realize growth more often nowadays than in past periods experienced by most managements, we see a rising interest among companies in buying growth through acquisitions. Many of these acquisitions will not add value. Those that do will be made by managers who know the difficulties of bringing the businesses they acquire up to the standard of those they already own. Our companies excellent managers’ memories of how hard it was to make the cuts to build cash while revenues dropped should shield them from making value destroying deals. Several of our companies are experienced at making small acquisitions which broaden a product line or provide a complementary add-on service. Acquisitions of this sort by managements who know the acquired business well usually produce a rapid payback, which the capable managers of our companies seek. They are reluctant to make investments that might diminish the financial strength they painfully preserved during the downturn. The stock market measured by the S&P 500 is unchanged since the beginning of the year.

C.H. Robinson Worldwide Inc.

Robinson’s fourth quarter earnings of 52¢ per share were flat while net revenues of $339 million declined 1.5% from the same period a year ago. Its full year earnings were $2.13 per share, up 2.4%, on net revenues of $1.38 billion up 0.5%. Total revenues, which include the cost of hired transportation, were $2.0 billion in the fourth quarter, up 2.7% and $7.6 billion for the full year, down 11.7%. These are good results during a year characterized by many as one of the worst freight environments in decades. During the fourth quarter, truck net revenues declined 2.3% despite a 13% increase in truckload volumes from its customers. About one-half of the lower rates obtained by Robinson came from lower fuel prices relative to the same period a year ago. The company’s other freight forwarding and information services posted a combined 10% decline in net revenues. Robinson’s fruit and vegetable sourcing business delivered exceptional results with net revenue surging 27% during the quarter. Two-thirds of the 16% increase in Sourcing volume came from the September acquisition of Rosemont Farms, based in Florida.

Investor concerns about Robinson’s ability to pass along higher transportation prices to its customers drove the stock price down 9% since the beginning of the year. The fourth quarter marked a reversal in the operating environment from what prevailed in the previous four quarters. During the recent downturn, reduced demand for trucks led to lower cost of hire which Robinson passed along to its customers over time, benefitting margins. Now, truck demand is rising and volumes are picking up resulting in a higher cost of hire for Robinson. These higher rates likewise are passed along to Robinson’s customers over time, crimping near term margins. We think Robinson’s ability to continue to gain market share by sacrificing some margin to provide transport to its customers helps sustain profitable future growth. We know that this is a part of the cycle which Robinson management ably adjusts to during shifts in demand for trucking services.

The CME Group

CME’s pro forma fourth quarter revenues of $667 million and earnings of $3.37 per share declined 4% and 6% respectively from the prior year. Average daily volume during the quarter of 10.2 million contracts was down 1% from a year ago and up 1% from the third quarter. The average rate per contract of 85¢ decreased 2% from a year ago, but increased 2% from the third quarter. During January, average daily volume of 11.2 million contracts rose 19% from a year ago as interest rate volumes surged by one-third from the same period a year ago. During February average daily volume of 12.5 million contracts rose 17% as interest rate volumes rose 37% and foreign exchange contracts surged 82% from a year ago. Despite a return to growth in average daily volume during January and February, CME shares are down 8% year-to-date as a result of the confusion surrounding disparate proposals for financial regulatory reform. Last year the shares rose 61%.

On February 10, CME announced it would purchase a 90% stake in the Dow Jones Stock Index business for $607.5 million. Last year this business generated $75 million in revenues and an operating profit margin of 61%, similar to CME’s 62% operating margin. Its revenues have grown at a 16% compound annual rate during the past three years. Today, CME licenses the Dow Jones indexes for futures trading. These indexes, primarily the Dow Jones Industrial Average, comprises 5% of CME’s stock index futures business. On February 12, CME announced an expanded strategic relationship with BM&F Bovespa in Brazil, the world’s third largest exchange by market capitalization, whereby BM&F Bovespa has agreed to increase its stake in CME from 2% to 5% by purchasing 2.35 million shares from the company at $275 per share. CME plans to repurchase these shares in the market. CME already owns 5% of BM&F Bovespa. In addition, CME will develop a new futures and equities trading platform for BM&F and will receive $175 million in payments for the system over the next three years.

Automatic Data Processing

ADP’s fiscal second quarter results reflect its customers’ continued difficult but stable economic environment. Revenues of $2.2 billion were flat with the prior year and benefited 2% from favorable foreign exchange rates during the quarter. Earnings from continuing operations of 60¢ per share excluding a 2¢ per share one-time tax benefit were one penny higher than the same period a year ago. The 5% decline in the number of employees on clients’ payrolls during the quarter is a slight improvement from the 6.5% decline experienced the previous quarter. Client retention is stable but new business sales are off 3%, worse than the 2% decline experienced last quarter. CEO Gary Butler explained to us at a recent meeting that new bookings are a bit stronger than this metric indicates, but are being offset by several customers slowing project implementations. The 2% decline in Employer Services total revenues to $1.6 billion was comprised of a 7% drop in the traditional US payroll business offset by a 3% increase in add-on products and services. Sales of benefits administration and 401k plan recordkeeping were particularly strong during the quarter. Revenues of $311 million during the quarter from ADP’s Professional Employer Organization business rose 9% and matched the revenues generated during the quarter from Dealer Services, which declined 5% from a year ago.

During the past eighteen months, ADP cut $85 million of mid-management level staff costs and deferred merit increases. Now, ADP management is implementing a plan to hire more than 300 additional people, primarily in sales but also in project implementation, adding 6% to total headcount in order to drive profitable revenue growth in the years ahead. ADP shares have declined 2% since the start of the year.

Global Payments

Global Payments’ fiscal second quarter revenues of $409 million and earnings of 71¢ per share from continuing operations rose 12% and 25% respectively. Foreign currency translation boosted earnings by 3¢ per share or 5% during the quarter. Revenue growth was strong in the US where a 19% increase in credit card transactions processed drove revenues 15% higher than a year ago to $221 million. The average dollar value of each card transaction declined 9% year-over-year but was flat with the previous quarter. Revenues from card transactions processed in Europe, primarily in the UK, rose 18% to $84 million while Asia-Pacific revenues of $26 million were up 7%. Revenues from Canada declined 1% to $78 million on a reported basis but dropped 7% in local currency. In addition to a lack of transaction growth as a result of a weak economy, there was a 3% shift in spending from mid-size merchants to larger merchants which generate significantly less revenue for Global.

Global Payment’s stock price has dropped 19% since the start of the year after rising 44% during the previous six months. We think traders and investors are over-reacting to management’s prudent assessment about some slowing in the pace of revenue growth and margin expansion during the next two quarters based on the

expectation of little global improvement in credit card transaction growth, a persistence of lower average consumer spending per transaction and a shift toward lower margin, larger retailers.

Express Scripts, Inc.

Express Scripts’ fourth quarter and 2009 earnings per share rose 12% and 23% over the same periods a year ago to 93¢ and $3.48 respectively. Gross profit of $689.7 million for the quarter and $2.4 billion for the year increased 25% and 19%. Operating income per adjusted claim rose 9% to $3.16 for the quarter and 17.6% to $3.20 for the year. Generic utilization rose 1.8 percentage points to 69.1% for the fourth quarter and 2.2 percentage points to 68.3% for 2009. In November, Express Scripts launched its new platform to adjudicate pharmacy claims for the 9.1 million men and women in uniform, their dependents and military retirees. The Department of Defense did not receive any calls from its members regarding their new drug benefit. This flawless implementation and the company’s commitment to exceeding the high quality standards set by DoD contributes to the high customer satisfaction and retention rates of their less demanding commercial and state health plan sponsors. Express Scripts’ stock price rose 10% on the news that including the Next Rx business, total adjusted claims will rise 40% in 2010 to 740 to 760 million. This claims growth and a stronger year for generic launches of blockbuster prescription drugs underpins their forecast of 34% earnings growth to $4.65 per share in 2010. Express Scripts’ stock price is up 14% since the beginning of the year, following a 61% rise in 2009.

Varian Medical Systems, Inc.

Varian Medical Systems reported fiscal first quarter revenues of $540.9 million and earnings of 63¢ per share, increases of 6% and 13% over the first quarter of 2009. The backlog at the end of the quarter was $2.0 billion, up 4% from a year ago. North American clinics are installing more high-end Trilogy and Novalis Tx systems as radiosurgery becomes a standard offering of radiation oncology clinics. Growth in international markets for both Oncology Systems and X-ray Products offset weak performance in North America. Oncology Systems revenues rose 8% to $430 million with orders up 2% to $430 million. International orders rose 19% to more than offset the 13% decline in orders from North American hospitals and free-standing clinics. Japan, China and India led the growth in the Asian market. In Japan, Varian benefitted from a government stimulus program to enhance cancer treatment capabilities. Demand for high performance systems was high in China and India. X-ray Products sales of x-ray tubes and digital detectors rose 6% to $91 million. The on-going conversion of film-based x-ray imaging systems to digital imaging resulted in higher sales of detectors than X-ray tubes for the first time. Rising sales of the profitable detectors increased the operating margin of this business by 100 basis points over the same period last year to 41.2%. The good first quarter results and the expectation that North American hospitals will begin to order new radiation therapy systems when they begin their 2011 fiscal year on July 1 encouraged management to raise its sales and earnings forecasts for the year. Varian’s stock price has risen 8% since the beginning of the year.

IDEXX Laboratories

IDEXX Laboratories reported fourth quarter and full year revenues of $270.3 million and $1.0 billion respectively, organic growth of 6% and 5% over the same periods last year. Currency exchange rate fluctuations added 5% growth to the quarter’s revenues and reduced full year revenue growth by 4%. Fourth quarter earnings increased 16% to 51¢ per share, while full year earnings rose 6% to $2.01 per share. Instruments and Consumables’ fourth quarter revenues rose 9.5% to $92.8 million. In-clinic diagnostic instrument sales rose 6% during the quarter, lapping 25% growth in the fourth quarter of 2008. The company placed 763 Catalyst Dx analyzers during the quarter, bringing the total for the year to 2,047 which surpassed the company’s 2009 goal of 2,000 placements. IDEXX’s focus on improving information systems that centralize the collection of lab results and posts them with billing information to a vet’s practice management system resulted in over 80% of instruments sold in North America during the quarter being placed with multiple instruments. Over 2,000 vet practices connect directly to the company’s customer service through SmartService. This Internet-based service allows IDEXX to diagnose problems, upgrade software and offer tailored promotions remotely. High margin consumable sales rose 6% during the quarter to $57.3 million. Consumable sales increase by 15% when a practice upgrades from a VetTest chemistry analyzer to a Catalyst Dx to take advantage of the addition of new protocols such as urine testing for kidney function or the ease of running single chemistry tests. Increased volumes of new tests and new customers lifted Reference Lab and Consulting revenues 7.4% to $75.4 million during the quarter. The company also expanded its global network to 44 labs from 41 at the end of 2008. Fourth quarter operating margins rose to 16.3% from 15.3% as reference lab operations and Catalyst manufacturing processes became more efficient. IDEXX’s stock price has risen 4% since the beginning of the year.


Techne reported fiscal second quarter earnings of 66¢ per share, an increase of 4.5% over the same period last year. Sales for the quarter rose 5.9% to $65.5 million with foreign currency accounting for 4.3% of the growth. New product sales accounted for 1% of the quarter’s sales. Biotechnology reported net sales of $42.4 million, an increase of 5.7% over the second quarter of 2008. Sales to pharmaceutical and biotech companies and academic labs outside of Europe rose 5.7% and 4.5% over the same period last year. Sales to the smaller China and Pacific Rim distribution businesses rose 13% and 21.8% respectively. Second quarter net sales in Europe rose 8.6% to $18.8 million with foreign currency contributing 15.4% to revenue growth. The 6.6% revenue decline in constant currency results from reduced spending by large pharmaceutical companies in the U.K., France and Germany. The economic slowdown in Europe began about six months after that in the U.S. Increased sales volumes contributed to a company-wide gross margin of 79.7%. Techne applied savings from lower selling, general and administrative costs to research and development, increasing its quarterly investment in the development of new products at the cutting edge of life science research by 9.7% to $6.4 million. The company’s stock price is down 4% from the beginning of the year.

Patterson Companies Inc.

Patterson Companies’ revenues and earnings for its fiscal third quarter ending January 23 rose 1% and 6% respectively. Earnings were 47¢ per share. The results marked the first quarterly upturn in dental consumable sales after declines for five successive quarters. These consumable sales constitute just over 50% of the revenues of Patterson Dental Supply, the company’s largest and most profitable business which generates 70% of total revenues and 82% of company operating profit. Management foresees a gradual sustainable rise in sales of these consumables. Dental equipment sales declined 10% during the quarter as dentists’ caution caused them to continue deferring purchases of basic dental equipment such as chairs, cabinets and lights. Sales of CEREC chair-side tooth restorative systems, though higher than the previous quarter, fell slightly below the year ago level when sales were spurred by promotional financing on existing customers’ trade-ins to acquire an upgraded 3D imaging unit for use with their CEREC system. Management anticipates that dental equipment sales may rise by 5% or more during the second half of this year if the overall economy grows modestly.

Patterson’s veterinary sales grew 4% during the quarter which is the seasonally slowest for vets treating companion animals. Its operating margin on sales comprising 18% of total company revenues improved slightly, although it remains depressed by integration costs of an acquisition of a large distributor in the mid-West and mid-Atlantic states. These costs will persist for another quarter. Sales of Patterson Medical’s physical therapy and rehabilitation consumable supplies and equipment were 18% higher than the year-earlier quarter, boosted by two acquisitions. Without these additions sales grew 1%, which management views as confirmation that the market has stabilized and is improving. Patterson’s stock price is up 11% since December 31.

Stryker Corporation

Stryker’s fourth quarter and 2009 sales rose 2.5% and 1.7% in constant currency to $1.8 billion and $6.3 billion respectively. Currency added 4.3% to the quarter’s revenue growth and reduced full year growth by 1.6%. Stryker reported earnings of 76¢ for the quarter and $2.95 for the year, increases of 11% and 4.2% over the same periods last year. A 3.4% reduction in share count accounted for most of the increase in the full year earnings per share. Strong sales of consumables in Stryker’s MedSurg businesses contributed to fourth quarter revenues of $718.7 million, a decrease of less than 1% in constant currency over the same period last year, steady improvement from the year-over-year sales declines of 8% and 7% reported in the preceding two quarters. Instrument and Endoscopy sales were up 1% and 3% respectively with revenues of the international divisions, a focus of Stryker’s growth strategy, rising 6% each. Both businesses reported revenue gains in all international markets. The Medical business remained weak because of constrained hospital capital budgets and revenues were down 10%.

Fourth quarter sales of Orthopaedic Implants rose 4.7% during the quarter to $1.1 billion and accounted for 61% of Stryker’s sales. Three of Stryker’s five implant businesses delivered double-digit fourth quarter revenue growth in the U.S. Spine revenues rose only 4% which management attributed to new product introduction delays and some gaps in their offering. They expect sales to strengthen in the second half of the year. The business environment in Europe remains challenging for the implant businesses. Trauma implant sales are down because fewer people were injured in construction or car accidents. Weak European economic conditions have reduced the funds nationalized health plans allocate to hip and knee replacements; however, deferring these procedures increases future implant sales. The company expects to see better top and bottom-line growth in 2010. Stryker’s stock price is up 8% since the beginning of the year.

SGS Group

SGS’ second half revenues were down 0.7% and full year 2009 revenues rose 2.5% in constant currencies. Revenues from the Asia/Pacific region rose 7.4%, while Europe, Africa and Middle East was up 1.6% and the Americas were down 0.6%. Profit for the year was up 5.6% before the negative impact of foreign currency translation into the Swiss Franc. SGS’ business continues to generate substantial cash and management and the Board continue to return excess cash to shareholders through dividends after funding capital expenditures and acquisitions which meet the company’s disciplined rate of return criteria. SGS’ Board approved a special dividend of CHF 30 per ordinary share (28¢ per ADR) in addition to its regular annual dividend of CHF 30 per share. The dividend will be paid on March 29 to shareholders of record on March 23.

Eight of SGS’ ten businesses posted revenue growth during the year. The Consumer Testing business grew the most with an 11% increase in revenues, driven by additional consumer product safety legislation largely from more stringent US toy regulations. Consumer Testing also gained market share in textiles, hard goods and food testing which offset weakness in electronics testing in Europe. The Minerals Services 10% revenue decline was the worst among SGS’ business segments. Mining and exploration spending dropped to $8 billion during 2009 from $13 billion the prior year, reducing demand for SGS lab and metallurgical testing services. The Minerals business is starting 2010 with a slight uptick in demand and has opened three new mine site labs in January. SGS shares are up 4% year-to-date.

Mettler Toledo

Improved market conditions in Mettler-Toledo’s laboratory business and in China kept the fourth quarter local currency sales decline to 5% below the sales level in the year ago quarter. Revenues for the year declined 10%. Currency contributed 5% to revenue growth during the quarter and reduced full year revenues by 2%, yielding reported sales of $511.7 million in the fourth quarter and $1.7 billion for 2009. Earnings per share for the quarter rose 7¢ to $2.07 from $2.00 in the fourth quarter of 2008 and were down 4.5% to $5.50 for the year. Market conditions in the Americas and Europe remained difficult with fourth quarter sales down 3% and 10% respectively. Sales in Asia were up 3% with sales in China growing 12% over the fourth quarter of 2008. Sales in China account for about half of Mettler-Toledo’s sales in emerging markets. Laboratory sales were down only 1% with sales of services and consumables up 7%. Fourth quarter Industrial and Food Retailing sales declined 7% and 14% respectively.

The company’s focus on execution and cost control resulted in a 120 basis point expansion of the fourth quarter operating margin to 21% of revenues, the first time operating margin has exceeded 20%. Days sales outstanding declined 8 days to 41 days as efforts to counter typical slow payment by customers during a downturn yielded excellent results. The company acquired two small companies during the quarter, paying $14.3 million for Vision Technology, and $12.5 million to acquire the leading distributor of pipettes and tips in the U.K. Vision Technology offers a system that visually inspects packages at high speeds to detect defects as well as incorrect labeling or filling. The U.K. distributor rapidly expands Mettler-Toledo’s market share in this large life science research market. Mettler-Toledo’s stock price is down 1% since January 1.

Donaldson Company, Inc.

Donaldson’s fiscal second quarter revenues of $436 million declined 5% while operating income surged 40% from the depressed level a year ago. Sales of filters for engines rose 3% overall to $250 million. Engine replacement filter sales rose 23% to $149 million as utilization of both heavy trucks and off road equipment has picked up. Adoption of proprietary Power Core technology is also spurring market share gains for Donaldson-branded replacement filters. Engine filter sales to original equipment manufacturers declined 17% as a 16% increase in on-road filter sales was offset by declines of 23% and 8% in off-road filters and aerospace and defense filters respectively. Sales of industrial filters declined 15% overall to $186 million as gas turbine filters dropped 46% to $31 million due to slowing demand from large power generation projects. Disk drive filters and membrane products rose 34% to $46 million during the quarter.

Since January 2009, Donaldson has spent $24.2 million to restructure its operations in order to reduce costs by more than $100 million annually. These difficult actions are now beginning to pay off as overall business activity continues to improve. Donaldson’s stock price is down 1% since the start of the year, after advancing 26% last year.

EnCana Corp.

On February 11, 2010 EnCana reported its first quarterly results after transferring to Cenovus Energy at the end of November 2009 one third of its assets and the proportionate debt related to its oilsands refining joint venture with Conoco, its undeveloped Athabasca oilsands acreage, and its Canadian shallow gas production. EnCana’s reported pro forma fourth quarter earnings of 50¢ per share and $1.50 for the year attest to the strength of EnCana’s management focus upon lowering operating costs, allocating its capital efficiently, and judiciously using hedging contracts to secure adequate prices for its planned natural gas production. During the quarter EnCana shut-in almost 10% of its production rather than sell additional gas from new wells ready for connection to pipelines at an average price below $4 per mcf (thousand cubic feet). Profit on existing hedging contracts raised EnCana’s average realized natural gas price by $2.27 per mcf. It has hedged 30% of its planned 2010 production of 3.2 million mcf at $6.04 per mcf, 65¢ above the current NYMEX price. The company’s cost control skills are evident in it lowering its break-even cost to $2.73 per mcf, making it one of the lowest cost natural gas producers in North America. The company holds 15.6 million net acres with proven reserves of 12.8 billion mcf of natural gas which makes its goal of economically managing a 10% annual production increase realistically attainable. Production in 2009, after shutting in gas was 2.84 million mcf per day. The company’s record of reliably executing prudently conceived plans makes its stock, which pays a 20¢ quarterly dividend, a good long-term investment. Since the early December distribution of Cenovus Energy, EnCana’s stock price has risen 22%.


Cenovus’ good earnings for the fourth quarter of 2009 of 20¢ per share are its first as a separate company. These earnings are pro forma, as though Cenovus were separated from EnCana for the entire quarter. On a similar accounting basis, the company earned $1.74 for the past year. An initial quarterly dividend of 20¢ Canadian per share is scheduled for payment on March 31, 2010. In U.S. dollars, it amounts to 18.5¢. Last year Cenovus expanded production of heavy oil from Foster Creek and Christina Lake, which are jointly owned with Conoco, to 100,000 barrels a day, a 48% year-to-year increase. The next expansion in progress at Christina Lake will add 40,000 barrels a day when completed in 2011. Until then, production will remain near the fourth quarter rate, which means earnings this year will not rise unless refining margins at the two newly upgraded U.S. refineries jointly owned with Conoco rise remarkably. Completion of Cenovus’ long-term plans would raise the combined production at Foster Creek and Christina Lake to 428,000 barrels of heavy oil per day. Since trading in its shares started in early December, Cenovus’ stock price is down 3%.

Exxon Mobil

Exxon’s proposed merger with XTO Energy, whose natural gas production and proven reserves compare favorably with EnCana’s, has pushed Exxon’s stock price down 11% since the announcement on December 13th. The decline results from Exxon’s decision to exchange .71 of its shares for each XTO share. Upon consummation of the merger, XTO shareholders would receive 414 million Exxon shares or 8% of the total amount outstanding. Perspective on the share issuance is provided by comparing it to Exxon’s purchase of 249 million shares last year for $18 billion. It reduced the share count by 5%. Acquisition of XTO is an investment in the future. It adds 13.9 trillion cubic feet of proven U.S. natural gas reserves, expanding Exxon’s resource base by 10% and almost triples the combined companies’ U.S. natural gas production. Exxon’s success in finding, producing, and processing natural gas into LNG in Qatar and Australasia already has increased the company’s commitment to natural gas as a source for future growth. The acquisition of XTO while natural gas prices hover near a seven year low secures operating and technical expertise to safely manage the engineering challenges to economically extract natural gas from unconventional tight sand and shale formations the combined companies will own in North America and Western Europe. The furor over the danger of contaminating drinking water tables with chemicals used in hydraulic fracturing of shale many thousands of feet beneath the acquifers makes it prudent for Exxon to pay a premium to deepen its technical experience. XTO obtains 30% of its production from operations in every major shale gas formation in the U.S. Almost 45% of the company’s gas production comes from tight gas basins including The Piceance, where Exxon also operates. After the acquisition, natural gas will comprise 45% of Exxon’s worldwide hydrocarbon production.

Exxon earned $1.27 per share during the fourth quarter. These earnings were 29% better than its third quarter results but 19% below those for the fourth quarter of 2008 when natural gas prices outside the U.S. were 70% higher. Exxon’s oil and gas production rose 3% during the quarter after adjusting for production sharing payments and OPEC quotas. The increased production came from a 31% seasonal increase in gas demand in Europe, which consumed higher LNG volumes from Qatar. Exxon’s stock price is down 4% since the start of the year.

PepsiCo, Inc.

PepsiCo reported fourth quarter net revenues and earnings of $13.3 billion and 90¢ per share, increases of 4.5% and 6% respectively over the same period a year ago. Full year net revenues of $43.2 billion were unchanged from last year, while earnings rose 1% to $3.71 per share. Foreign currency contributed 1% to revenue growth during the quarter and reduced revenue and earnings growth for the full year by 5%. Frito-Lay continues to show strength in a difficult economy with fourth quarter net revenue growing 7% and operating profit growing 8%. In 2009 Frito-Lay accounted for 31% of the company’s revenues and 42% of its operating profit.

PepsiCo Americas Beverages posted an operating profit growth of 10% during the quarter, its first operating profit growth of the year. Net revenue declined 2%. Good execution in Latin America partially offset the 6% revenue decline in the North American Beverage business. 2009 net revenue and operating profit fell 6% and 3% respectively. Consumers have responded positively to the company’s drinks made with a zero calorie sweetener made from the stevia plant. Trop50, orange juice with half the calories of regular orange juice, has reached almost $100 million in sales since its launch in 2009. It is the most successful product launch in the chilled juice category. In 2009 PepsiCo International reported constant currency net revenue and operating profit growth of 11% and 17% respectively.

In 2009, PepsiCo delivered free cash flow of $4.7 billion, 79% of net income, after capital expenditures of $2.1 billion and a voluntary contribution to its pension plans of $600 million after-tax. The company distributed $2.7 billion in dividends to shareholders and did not repurchase any stock because of the pending acquisition of its two largest independent bottlers. The company plans to add to its $10 billion business of good-for-you products by increasing the fiber content of Sun Chips, reducing the salt content of fried Lay’s potato chips and replacing high-fructose corn syrup in Gatorade sports drinks. While PepsiCo’s management announced that they expect 2010 earnings per share to grow 11 – 13%, they remain cautious because traffic in convenience and gas station stores, a key measure of confidence for the North American consumer, is still down 8% to 10% year-over-year. PepsiCo’s stock price is up 5% since the beginning of the year.

Western Union

We sold Western Union in February after analyzing the company’s disappointing fourth quarter results and reviewing management’s decision to spend $515 million for two different acquisitions during the year. Fourth quarter revenues of $1.3 billion were down 1% in constant currency and earnings of 32¢ per share declined 14% from the same period a year ago. Western Union processed 51 million consumer-to-consumer money transfers, up 5%, and moved $17.1 billion of cross-border principal during the quarter, down 1% in constant currency. The company’s fastest growing international remittance markets such as Dubai and India, have slowed from double-digit transaction growth to single-digit growth. They are unlikely to improve soon. The company’s global business payments segment reported a 9% revenue decline in the fourth quarter before including revenue from the recent acquisition of Custom House, a provider of cross border payments for small businesses. For the year, revenue of $5.1 billion declined 1% in constant currency and operating earnings of $1.29 per share fell 2%. The company also revealed that its 2003 International restructuring which resulted in a lower tax rate is being challenged by the IRS. Management chose to make a $250 million refundable deposit with the IRS which is one-half of the total potential liability. The company reported a 25.0% tax rate in 2009, down from 25.8% in 2008. Western Union’s stock dropped 12% in the days following the earnings announcement.

Western Union’s lackluster execution makes us doubt management’s ability to execute its plan to sustain growth. The third quarter acquisition of Custom House for $372 million is troublesome. It added only $23 million of fourth quarter revenues which is less than the quarterly run rate prior to acquisition and lost $12 million! The decision to buy full ownership of FEXCO, a European money transfer business, for $144 million has provided no measurable benefit. Our review of these two significant acquisitions, the first acquisitions made since the company was spun-off from First Data in 2006, convinces us that management is destroying value by paying a higher price for acquired companies earnings than Western Union’s own earnings multiple. This practice, which is not uncommon, destroys shareholder value.


We sold MSCI stock on March 1 after the company announced, and sought to justify, buying RiskMetrics for $1.55 billion, 75% payable in cash borrowed at more than 5% and the balance in newly issued MSCI stock. The purchase price is 17% above the RiskMetrics stock price before the announcement of the deal. This costly acquisition vastly changes the predictability of MSCI’s business by lessening its reliance on revenues from users of its difficult-to-replicate worldwide stock indices. Revenues from equity indices constitute 59% of MSCI’s total. After the deal, that percentage falls to 35%. The acquisition increases MSCI dependence upon portfolio and risk analytics products from 36% of revenues to 43%. These products are devoid of the proprietary strength of the company’s indices. Those the company currently offers have delivered no growth, and require investment to retain existing customers and attract new ones. RiskMetrics’ analytic products similarly require refreshing to retain their relevance. MSCI, through this acquisition is paying a multiple of earnings comparable to its own to expand in its least profitable, least persistent business. Even if management is correct about assuring investors that the acquisition will increase reported earnings before non-cash charges such as goodwill amortization, the acquisition weakens the quality of the company’s revenue base and leverages its balance sheet, making MSCI a riskier investment. Our sale price is 10% below the December 31 price.

Client portfolio holdings may change, and stocks of companies noted may or may not be held by one or more client portfolios from time to time. Investors should not consider references to individual securities as an endorsement or recommendation to purchase or sell such securities. Transactions in such securities may be made which seemingly contradict the references to them for a variety of reasons, including but not limited to, liquidity to meet redemptions or overall client portfolio rebalancing. Investing in the stock market involves gains and losses and may not be suitable for all investors. Investment return and principal value of an investment will fluctuate.