2nd Quarter, 2010

Your companies’ good to excellent second quarter earnings had little effect on the majority of their share prices. Investors and traders chose to ignore the results. The focus instead turned to other factors such as the wisdom of prices paid for acquisitions in a few instances and well-publicized apprehensions about any company’s ability to thrive when the economic and political outlook is so uncertain. Pervasive pronouncements of impending doom, which invariably have proven inaccurate, have kept the earnings multiple for your companies down near decade lows despite the competitive strengths they realized from measures taken to preserve profitability during the recession. Our initial discussions with the managers of your companies about what they learned and how operations were improved during the recession confirms our belief that they will prosper. The S&P has gone nowhere since Memorial Day.

C.H. Robinson Worldwide Inc.

CH Robinson delivered another quarter of strong results. Total revenues, which include the cost of hired transportation from third party transportation providers, rose 27.4% to $2.45 billion. Robinsons’ customer’s transportation needs rebounded from depressed recessionary levels last year, and the company increased market share in most of its service offerings. Earnings of 59¢ per share were 9.3% higher than a year ago while operating expenses increased 3.2%. Robinson made tangible progress in passing higher transportation costs through to its customers throughout the quarter. Total net revenues of $364.6 million rose 3.7% marking the return of growth in total net revenues on a year-over-year basis after declines during the previous two quarters. Additional progress was made in July as net revenues rose 7% during the month. Excluding fuel, truckload pricing to Robinson’s customers increased 5% during the quarter from the same period a year ago, while truckload costs rose 11%. In LTL (less than truckload) Robinson reported 20% growth in net revenues on total shipment growth of 25%. Net revenues from sourcing fresh fruits and vegetables rose 20% on an 11.5% increase in total revenues provided primarily from the September 2009 acquisition of Rosemount Farms. Freight forwarding and other logistics services rose 29% during the quarter. Robinson hired 116 employees during the quarter, representing a 1.5% increase as it began hiring to meet customer volume demands. This tiny increase came despite a more than 20% increase in truckload volumes because its employees have become proficient at utilizing technology based tools which enable them to price and commit to more shipments each day across its network of branch offices. The resulting improvement in productivity is sustainable. Robinson’s shares rebounded after the company’s results were reported and are up 17% since Memorial Day.

CME Group Inc.

CME’s stock is down 15% since Memorial Day amidst uncertainty caused by the undefined regulatory requirements included in the Dodd-Frank Financial Reform Act. The derivatives portion of the legislation calls for regulators to require standardized over-the-counter derivatives to be placed into a clearing house. This, theoretically, should benefit the CME which clears more than 95% of futures transactions in the US. CME’s near term stock price movement contrasts sharply with its recent transaction volume, revenue and earnings per share growth. During the quarter, average daily volume was 13.5 million contracts up 31% and revenues of $814 million rose 26% compared to the same period a year ago. Earnings of $4.43 per share rose 33% during the quarter excluding a $20.5 million goodwill impairment charge related to CMA, a credit derivatives market data provider acquired in March 2008.

Futures transaction volumes were strong across CME’s diversified product base, led by increases of 82% and 38% respectively in foreign exchange and interest rate contracts. Electronic volumes, representing 87% of the exchange traded total, rose 37%. Transaction volume executed via its eight international hubs during non-US trading hours rose 68% from a year ago and now comprise 13% of total electronic volume. The average rate per contract declined 3.3% to 79¢ from the same period a year ago.

Express Scripts Inc.

Express Scripts reported second quarter earnings per share of 56¢, an increase of 27% over the second quarter of 2009. Gross profit of $757.5 million rose 28% over $592.6 million reported a year ago. Operating income per claim rose from $2.92 in the first quarter of this year to $3.10 in the second quarter as the company’s generic drug usage rose one percentage point to 71.4%. Express Scripts has now moved over 50% of the NextRx membership onto its IT platform and expects to complete the implementation by the end of the year, at the early end of its 12-18 month forecast made at the beginning of 2010. The sooner Express Scripts completes this implementation, the sooner it can increase the use of generic drugs, home delivery services and other clinical programs to lower drug costs for WellPoint’s members. Express Scripts expects to retain 95% of its existing clients up for renewal and has added over 140 clients, including two with more than one million claims per year. The company’s stock price dropped 4% on July 22 when Medco Health Solutions, one of its major competitors, announced its second quarter earnings. Fund managers sold both stocks because they feared that increased pricing pressure for new contracts and the lack of new generic drug launches until late in 2011 will reduce profits. Express Scripts’ stock price is down 7% since Memorial Day.

Varian Medical Systems Inc.

Strong North American orders for Varian Medical Systems’ newest products in both Oncology Systems and X-ray Products contributed to 14% net order growth to $629 million during the fiscal third quarter. The company reported revenues and earnings of $578 million and 74¢ per share, increases of 13% and 9% over the same period last year. Oncology Systems’ orders grew 10% to $507 million with 12% growth in North America and 9% growth in international markets. Clinics have ordered more than 60 TrueBeam radiation systems since its launch in April. About half were new orders and half were upgrades of orders already in backlog. One cancer center in India ordered one TrueBeam system and five Uniques, low-cost systems with sophisticated accessories that can perform advanced RapidArc treatments. Oncology Systems’ service business grew 18% during the quarter to $137 million or 23.7% of sales. As radiation systems become more sophisticated, customers rely on Varian to ensure clinical uptime, to maintain their systems and to keep software current. Varian has improved its service offering and become more adept at selling service contracts alongside the new machines. Their 1,700 service technicians and requisite parts are within hours of every Varian machine in the world. The company’s training center in Las Vegas is the largest in the industry. Varian also has training centers in Beijing and in Zug, Switzerland.

Increased demand for flat-panel detectors to retrofit X-ray machines that currently use film lifted revenues for the X-Ray products division by 52% to $102 million. In addition, the company is seeing strong growth in the panel business among dental, vet and industrial imaging equipment manufacturers as the market for digital imaging continues to strengthen. Varian’s stock price has risen 20% since the end of May.

Gen-Probe Incorporated

Gen-Probe’s second quarter revenues of $138.6 million and earnings of 54¢ per share increased 15% and 28% over the second quarter of 2009. The company’s stock price has risen 9% since the end of May because of these excellent quarterly results. Clinical Diagnostics sales rose 10% in constant currency to $73.9 million while $5.5 million of TIGRIS sales to Novartis along with strong sales of its blood screening assays lifted blood-screening revenues 22% to $55.7 million. On July 26, the FDA cleared Gen-Probe’s flu assay which differentiates between two types of seasonal flu viruses and the H1N1 virus. Gen-Probe also made a $50 million strategic investment in Pacific Biosciences during the quarter. Pacific Biosciences has developed a single-molecule sequencing technology that is fast and can read long sequences of DNA with high resolution. The two companies will collaborate on an exclusive basis for 30 months to develop new clinical diagnostic systems for oncology and personalized medicine using this innovative sequencing system.

Techne Corp.

Techne reported fourth quarter and fiscal year 2010 sales of $66.7 million and $269.0 million, increases of 2.8% and 1.9% respectively over the same periods in 2009. Earnings for the quarter were 69¢ compared with 68¢ per share in the fourth quarter of 2009. Full year earnings rose 2% to $2.82 from $2.78 in fiscal year 2009. Foreign exchange losses and lower interest income on Techne’s investment securities reduced annual earnings by 2¢ and 7¢ respectively. Biotechnology and European sales continue to strengthen. Fourth quarter biotechnology sales grew 7% to $45.3 million, the strongest sales growth in six quarters. Sales to life science research labs in the pharmaceutical and biotech industries rose 11.7% while sales to academic researchers rose 4.3%. European sales of $17 million during the quarter increased 3.8% in constant currency, the strongest quarterly performance for R&D Systems Europe in 2010. Full year sales growth reflects cautious spending by both industrial and academic research scientists that result from uncertain economic conditions and concerns about future research funding. Biotechnology’s full year sales rose 2.3% to $178 million while European sales of $72.9 million declined 0.9% in constant currencies. With increased product sales volumes contributing to 2010 gross margins of 79%, Techne had ample resources to increase its research and development expenses by 16% to $25.1 million. The 1,400 products introduced during the year had sales of $2.8 million. Techne distributed $55.3 million of its $111 million of cash flow from operations to shareholders through dividends and the repurchase of 284,000 shares at an average cost of $59.50 per share. Techne’s stock is up 1% since the end of May.

IDEXX Laboratories Corp.

IDEXX Laboratories reported second quarter earnings of 62¢ per share, an increase of 13% over the second quarter of 2009. Revenues of $281.5 million increased 6% over the same period last year. Vets recognize that the company’s products and services allow them to improve the profitability of their practices even when traffic to clinics remains slow. During the quarter, the company sold a record 950 Vet Test and Catalyst Dx chemistry analyzers, the two most important generators of consumables revenue. Of the 556 Catalyst Dx analyzers sold, 30% went to new customers. The remaining 70% went to vets that currently use the VetTest analyzer. Upgrading to a Catalyst Dx typically increases a clinic’s testing volume and its use of consumables by 15%. The sale of more than 1,000 IDEXX Lab Vet Stations (ILVS) demonstrates the high level of interest in improving the productivity of in-clinic labs. The ILVS collects and organizes test records from the company’s suite of instruments and connects to the clinic’s practice management software to deliver the results and the charges for all diagnostic tests ordered or performed at the clinic. The ILVS automatically orders tests from IDEXX reference labs. The ability to offer unique bundles of in-house and reference testing contributed to the 8% revenue growth in the reference lab and consulting business as well. IDEXX released a new 15-inch touch screen for the ILVS which makes it much easier to use. Interlink software now connects the ILVS to the two widely used practice management software programs in addition to Cornerstone, IDEXX Lab’s offering, increasing the market to 70% of all U.S. vet clinics. Smart Service, a direct link between the ILVS and IDEXX technical service has significantly improved clinic productivity by allowing the company to perform preventive maintenance on its instruments in the field. Smart Service identifies potential issues with an instrument and sends a software fix, a new calibration curve or a technical service engineer with the correct parts to fix the problem before the operator has noticed any deterioration in performance. Smart Service has also significantly reduced the time required to diagnose and repair problems with instruments that have been returned to IDEXX for servicing. IDEXX Labs’ stock price is down 7% since May 28th.

Stryker Corp.

Stryker’s second quarter earnings per share grew 9.6% over the prior year to 80¢. Revenues of $1.8 billion increased 6.9% in constant currency. MedSurg sales grew 16% to $722 million with 6% of the growth contributed by the Ascent business acquired at the end of 2009. Orthopaedic Implant sales of $1.0 billion grew 1% in the quarter led by 7% growth in Trauma whose products are used to surgically repair bone fractures and skeletal abnormalities. MedSurg, accounting for 41% of Stryker’s total sales, benefited from a resumption of capital spending by its hospital customers following declining spending levels in 2008 and 2009. Sales growth of 8% for instruments, 7% for endoscopy and 19% for its medical businesses provides solid evidence that Stryker’s hospital customers are investing in capital equipment. Overall revenue growth in the quarter illustrates the strength of the diverse mix of Stryker’s businesses. The sales growth in MedSurg offset a downturn in Orthopaedic Implant products that was anticipated because of Stryker’s decision in late 2009 to discontinue certain products and distributors in Europe to improve profitability and compliance. New products for hips, knees and spine have been introduced, but typically take several quarters for growth to hit full stride. Training the surgeons to use new instruments designed for new implants results in a natural lag of sales growth after FDA approval. Stryker’s stock price has declined 8% since Memorial Day.

Patterson Companies Inc.

Patterson’s current fiscal year includes 53 weeks instead of the usual 52. The extra week is included in the fiscal first quarter ending July 31, which skews comparisons with results from a year ago. Sales of $850 million and earnings of 45¢ per share for the past quarter are respectively 8% and 14% above last year’s results. After subtracting sales attributable to the extra week from Patterson’s consumable sales which constitute 70% of the year-to-year increase, growth realized in the quarter diminishes to less than one percent for dental. It is a bit more for Patterson’s veterinary and medical businesses even after adjusting for changes in agreements with suppliers of pet medicines and an acquisition completed by Patterson Medical which distributes supplies and equipment to physical and occupational therapy practices. Management interprets the slight improvement in consumable sales as evidence that its markets have stabilized. For the third successive quarter Patterson’s new management team, led by Scott Anderson, has improved the operating margin which attests to their skill and focus on the business. It is extremely difficult to improve margins with little sales growth.

Although dental equipment sales in the quarter were less than 5% higher than a year ago, the past quarter marked the first upturn in sales of basic dental equipment such as chairs, cabinetry and lights after an eighteen month uninterrupted decline. Sales of these items were up 17%. Investors overlooked this sign of dentists’ revived interest in investing in their practices because sales of CEREC chairside tooth restorative systems fell 20% below the sales level attained during the year ago quarter when in response to pricing incentives and financing sales leapt 90%. The decline in CEREC sales caused Patterson’s management to reduce their forecast for CEREC sales growth during fiscal 2011 from 15% to 10%. That, plus reduction of growth comparisons for Patterson’s dental, veterinary and medical businesses from adjustments for the extra week, helped push Patterson’s stock price down. The current stock price is 7% less than it was at the end of May.


Intel, in its second quarter, achieved record high quarterly revenues, gross margins, operating earnings and fully diluted earnings per share. They were respectively: $10.8 billion; 67%; $4.2 billion and 51¢. Fully diluted earnings per share were three times last year’s earnings of 18¢ after adjustment to eliminate the charge for the European Community’s $1.4 billion fine paid by the company in 2009. During the first half of this year, cash generated from operations increased Intel’s holdings of cash equivalents to $17.8 billion on June 30. During the quarter, revenues rose 42% to $2.1 billion for Intel’s data center group which produces server microprocessors, the company’s most profitable product. Strong server demand comes from capacity needs of internet data centers and growing recognition of rapid payback and ensuing high returns by businesses upgrading their data centers. Over 90% of the server market worldwide is based on Intel’s microprocessors. Intel is bringing $400 million of capital spending planned for next year into the fourth quarter to achieve economies of scale faster from high volume production of its new 32 nanometer processors. Remarkably few defects have occurred in the initial manufacturing to the exactingly close tolerances of 32 nanometers, a feat no other manufacturer has attempted yet. The advantage obtained from 32 nanometer connections goes beyond achieving lower cost, faster speed and less energy consumption. The infinitesimal connections reduce the area on the chip required for microprocessor operating instructions, leaving space to add other functions.

On August 19 Intel announced an agreement to pay $7.7 billion in cash to buy McAfee Inc., the world’s leading dedicated provider of software solutions for data security to over 200 million customers worldwide. McAfee’s annual sales are $2 billion. It derives 60% of its revenues from corporate and government users. Intel’s offer is 60% higher than the price McAfee’s stock sold at immediately before the agreement was announced. The multiple paid for McAfee’s earnings is 50% higher than Intel’s. Nonetheless, the earnings impact is slight because Intel is paying cash, which currently generates a meager return. Paul Otellini, Intel’s President and CEO believes that the three pillars of computing are “energy efficient performance, internet connectivity and security.” Intel’s goal is to provide the best products to strengthen the reliability and performance of each of these pillars and thereby sustain its growth. Paul pointed out in his announcement that “we now live in a world of billions of connected computing devices. Internet traffic is growing at 40% per year compounded.” In the first six months of this year, McAfee added over 10 million new malware variants to protect customer security. The decision to acquire McAfee was reached after Intel and McAfee had worked together for eighteen months to devise improved security solutions. The initial products of this collaboration will be released early next year. The reason for the acquisition is that having security embedded in the processor is safer than a software only solution. Enabling the processor, which runs all programs, to quarantine viruses, prevents them from spreading. The timing of the acquisition is dictated by Intel’s two-year innovation cycle where a new micro-architecture is designed in one year and then implemented in manufacturing the next. The success of manufacturing at 32 nanometer tolerances provides space for a security solution on the next upgrade on Intel’s yet-to-be-released new Sandy Bridge micro-architecture. That leaves but two years to get a new embedded hardware security solution connected to the microprocessor in a way that does not slow its processing speed.

After the acquisition of McAfee and Intel’s August 27 announcement that its third quarter revenues might be no higher than the second quarter’s $10.8 billion, the purchase of Infineon’s Wireless Solutions business on August 30 for $1.4 billion in cash was anti-climactic. Infineon is the second largest producer of wireless chips and chipsets for mobile phones, primarily low-cost cellphones and smartphones. Intel has been producing wireless chipsets for a decade but exponential growth of wireless devices and their ubiquity compels Intel to acquire sufficient market share to justify applying its manufacturing process technology to lower cost and improve reliability by putting baseband connectivity with the microprocessor on the same chip.

Intel’s stock has performed poorly. So much so, that the stock now yields 3.4%. The trailing price earnings ratio of 10 is one integer above the 2008 low. Before then, the last time the stock sold at its current low multiple was in 1990. The stock price has declined 13% since Memorial Day and is also down 13% since it reported its second quarter earnings in mid-July. The bulk of the decline occurred after the McAfee acquisition was announced. Traders and investors thought Intel overpaid.

Donaldson Inc.

Donaldson’s fiscal fourth quarter sales of $515 million and earnings of 65¢ per share rose 22% and 86% from the same period a year ago, excluding $6.7 million of restructuring costs during the year ago period. Bill Cook, Donaldson’s CEO, along with his able management team has focused relentlessly during the past eighteen months on those things within their control. That means reducing manufacturing costs through dozens of continuous improvement initiatives, investing in and rolling out innovative new products to its customers and distributing its products more broadly to existing and new customers especially in China, India and Brazil.

Sales during the quarter rose 28% in the Americas, 25% in Europe and 18% in Asia. Engine products, which comprise 58% of total sales rose 35% from a year ago. Replacement filter sales, representing 60% of engine products revenues, rose 38%. Sales of filters to off-road and on-road original equipment manufacturers rose 55% and 68% respectively as construction and mining equipment makers produce more equipment and build rates of medium and heavy duty trucks improve. Industrial filters, which represent 42% of company sales, rose 7% from a year ago. A fifth of these sales are air intake filters and assemblies for gas turbines which declined 7% during the quarter. Management expects that global demand for these large scale power systems has bottomed and expects sales to stabilize at current levels. Disk drive filter sales rose 10% and dust collectors and other industrial filters rose 12% during the quarter.

Donaldson used 42% of $160 million free cash flow generated during its fiscal year ended July 31 to repurchase 2.1% of shares outstanding at $40.72 per share. Management anticipates continued recovery in most of its end markets in the coming year. Its replacement filter sales will grow as equipment utilization rates remain strong and more equipment in production requires Donaldson’s proprietary filters. Donaldson’s stock is up 4% since Memorial Day.

SGS Group

SGS revenues for the first half of 2010 rose 1.7% in constant currency to $2.2 billion. Earnings per share rose 4.8% as the operating margin reached 21.2%. Four tuck-in acquisitions made during the period generated 40% of the modest revenue growth. The loss of the statutory vehicle testing concession in Ireland as of January 1 reduced revenue growth by 1.4%. Revenues were up 7.6% and 1.1% in Asia/Pacific region and Europe/Africa and Middle East respectively while the Americas declined 4%. Agricultural, Environmental and Industrial Services each declined less than 5%. Consumer Testing, System and Services Certification, Mineral Services and Government and Institutions Services generated revenue growth above 5%. The largest contributor to profit growth during the period was Minerals Services which recovered during the second quarter along with improving trade volumes in all major bulk commodities, especially in iron ore. Sample volumes requiring metallurgical and geochemical testing increased in its labs in Australia, North America and Africa. Five new on-site labs were opened during the period to support mining customers and an additional six are planned for the second half of 2010. SGS ADR’s have risen 25% since Memorial Day which is partially attributable to a 13% increase in the value of the Swiss Franc relative to the dollar.

Mettler-Toledo International Inc.

Mettler-Toledo had a terrific second quarter with sales growing in all three businesses and all geographies. The company reported revenues of $468.5 million, a 16% increase in local currencies with foreign currency reducing growth in U.S. dollars by 1%. Revenues rose 15% in the Americas and 10% in Europe as customer spending returned to 2008 levels in the Western World. The spending decline in the fall of 2008 was so abrupt that it was unsustainable. Gross margin rose 200 basis points to 52.6% with increased production volumes and price increases contributing 120 and 50 basis points respectively. Earnings per share of $1.55 are 32% higher than last year’s. The company continues to add people and to invest R&D in its high margin businesses with good growth prospects such as process analytics, pipettes and product inspection.

Process Analytics, which is part of the Laboratory business, had second quarter sales of $36 million with revenues growing faster than the 17% revenue growth reported by its parent business. Process Analytics sells sensors and transmitters that measure specific analytical parameters such as the acidity or the amount of dissolved oxygen in ultra pure water used in many manufacturing processes. Mettler-Toledo’s market-leading sensors must be calibrated, maintained and replaced on a timely basis to ensure proper operation. A sensor malfunction in a vessel manufacturing a batch of a prescription drug can result in the loss of an entire batch valued at $1 to $2 million. Mettler-Toledo has placed a microchip in each sensor which allows the sensor to take the actual measurement rather than send an analog signal through a cable to the transmitter which records the data. The sensors monitor process conditions to track the life of the sensor, calibration requirements and any malfunctions. These predictive diagnostics ensure on-time replacement and minimize unplanned down time. Mettler-Toledo continues to improve the accuracy of its sensors and has developed an entry-level ultra pure water analytic system for factories in emerging markets. The presence of the microchip and embedded diagnostic software makes it very difficult for competitors to copy the sensors. Consumables and service account for 40% of revenues. Mettler-Toledo’s stock price is up 8% since the end of May.

EnCana Corporation

EnCana’s stock price has fallen 8% since the end of May. It has followed the ups and downs of the NYMEX spot natural gas price which currently is $4.19 per mcf (thousand cubic feet). The high in June was $5.17. EnCana’s stock price is linked more closely to natural gas price fluctuations because its hedging contracts now provide less financial protection against price declines. Increased production and periodic gluts of gas from shale formations that EnCana and other producers must drill to fulfill contractual lease terms to retain acreage, lessen the amplitude of price fluctuations which EnCana skillfully exploited to hedge its production. As a consequence, only 55% of its scheduled production for the remainder of this year is hedged at $6.05 per mcf, and only 33% of its planned 2011 production is hedged at $6.33 per mcf. The average price realized during the second quarter, without counting hedging gains, was $4.30 per mcf, compared to $3.51 last year. The hedging gains added only $1.16 per mcf this year versus $3.29 a year ago. The diminished hedging gain accounts for the decline in EnCana’s reported second quarter earnings to only 11¢ per share compared to 63¢ last year. The realized after tax hedging gain a year ago amounted to 57¢ per share. Operating cash flow, which includes hedging gains, was $1.65 per share compared to $1.90.

During the second quarter EnCana began negotiating terms with China National Petroleum Corporation CNPC for an investment of $4 billion to develop production on EnCana’s acreage in British Columbia. The preliminary terms resemble those of EnCana’s and Kogas’ February 28th farm-out agreement which allows Kogas to earn a 55% producing interest by spending $565 million over three years developing production on sites EnCana will select and operate on its Horn River and the Montney shale gas acreage in British Columbia. Even with this farm-out added to others that together amount to investments of $1 billion over the next three years, the development pace would take eighteen years to drill EnCana’s inventory of promising locations on its acreage. Kogas, a wholly-owned subsidiary of state-owned Korea Gas Company, is the world’s largest importer of liquefied natural gas.

Included among properties specified in the CNPC deal is the Horn River Basin in the northeast corner of British Columbia which is ideally suited for implementation of EnCana’s “gas factory” centralized technology-based production process that cost effectively achieves high volume rapidly, while minimizing the environmental impact. The gas-bearing shale, 9,000 feet beneath the surface in the Horn River, is sufficiently strong yet porous enough to permit horizontal drilling extending almost 10,000 feet from the well head. Along the extended length of the horizontal pipe, EnCana then injects in carefully controlled stages pressurized water containing sand-sized grains to keep open the fissures created in the formation by the “hydro fracturing.” The horizontal reach of the pipe permits as many as 28 such “fracs” along its length to activate the gas flow. Over the past two years, EnCana has reduced its completion costs in the Horn River by 66%. The application of drilling technology on this scale permits extraction of gas from five square miles around a single drill site. The efficiency attained from concentrating production on a single site lessens the costs of roads, pipelines and settling pools or above-surface tanks to hold water removed from the gas for reinjection into the well. EnCana currently produces 112 million cubic feet (mmcf) of gas from the Horn River, up from 4.6 mmcf in 2008. Its current production cost of $3.93 per mcf includes a non-cash charge of $2.57 for depletion. That is 18% higher than a year ago due to a stronger Canadian dollar and higher reserve valuations, which reduces reported earnings.

Cenovus Energy Inc.

Cenovus second quarter earnings of 19¢ per share were substantially below the 68¢ earned in the year-ago quarter and the 47¢ earned in this year’s first quarter. The poor results come primarily from a huge swing from profit to loss in the company’s refining operations that was caused by a $180 million increase in the cost of crude processed because Canadian accounting requires First-In, First-Out inventory accounting. The U.S. does not. This method results in a vast mismatch between the price of crude processed and the relative price realized for the products produced when oil prices suddenly move up or down. In May, the price of crude dropped 19% from over $86 to less than $67. The inventory-product price mismatch reduced earnings by 24¢ per share. Coincident reductions in gains realized on oil and natural gas hedges chopped 24¢ off the comparative amount realized from hedging a year ago. The price of Cenovus stock however has risen 2% since the end of May. We believe the slight appreciation indicates investors are focused not on near-term earnings but on Cenovus’ progress in increasing production from its 7.8 million acres in the Canadian oilsands, which contain 1.3 billion barrels of proven bitumen reserves. Success is measured by managements ability to hold costs of expanding its oilsand production within budget while continuing to apply technology solutions it has pioneered to lessen water usage and lower operating costs while increasing the oil recovered from existing producing facilities. For example, at Foster Creek, Cenovus’ largest oilsand producing property where production accruing to its interest amounts to 51,000 barrels of oil a day, the drilling of 39 wedge wells between pairs of more expensive steam assisted gravity drainage (SAGD) wells has increased the flow of oil from the formation by 10%. Production at Foster Creek currently is 47% higher than a year ago. Operating costs per barrel are $11, 8% less than a year ago, which lowers the company’s costs to earn a 9% return on investment to $45 a barrel. Cenovus has received regulatory approval to commence construction at Christina Lake to install SAGD recovery facilities to extract an additional 80,000 barrels of oil, with half the production coming on stream in 2011.

Exxon Mobil Corp.

Exxon’s reported second quarter earnings of $1.60 per share, 90% higher than last year’s depressed quarterly results had little effect on its stock price. It already had recouped a drop earlier in July after Exxon consummated its $36 billion acquisition of XTO Energy, paid for through issuance of 416 million Exxon shares. The merger makes Exxon North America’s largest producer of natural gas with average daily production of 3.7 billion cubic feet. The acquisition increases Exxon’s proven natural gas reserves by 45 trillion cubic feet and raises the natural gas component of Exxon’s energy production to 45% of its total. Investors have shown a decided dislike for the merger. Exxon’s stock declined immediately after the merger announcement last December and has remained in a downtrend since. During the July 29 discussion of the second quarter earnings, Exxon’s management declined to commit to stock repurchases beyond $3 billion scheduled for the current quarter. That expenditure equals the cash accumulated during the second quarter after spending $1.4 billion to buy back stock. Exxon’s stock price rose less than one percent over the course of the summer. Exxon’s management needs to prove that the acquisition of proven gas reserves at a cost of less than $1 per thousand cubic feet will add to shareholder value. Remarkably the acquisition adds less than $50 million to the goodwill on Exxon’s balance sheet. That number, the amount paid for the purchase over the value of the tangible assets acquired, when low usually indicates an astute purchase.

PepsiCo Inc.

PepsiCo’s second quarter earnings per share of $1.10 increased 8% from the prior year. Revenues of $14.8 billion grew 37% on a constant currency basis. Excluding the bottler acquisitions revenues rose 2%. Division operating profits of $2.7 billion increased 26% from the prior year. PepsiCo Americas Foods’ revenues grew 2% to $5.1 billion. Frito-Lay reported revenues of $3.2 billion, a 1% increase over the same period last year. Well-received introductions of new Fritos corn chips and Ruffles potato chips with 50% less salt and all natural Lay’s Kettle Cooked potato chips helped offset the volume declines versus last year’s promotion which increased volumes by 3% during the second quarter of 2009. In Asia, Middle East & Africa snack and beverage volumes increased 16% and 8% respectively. India experienced double-digit growth in snacks and beverages where a tailored Do Us a Flavor program drove the highest snack volume ever in India in May. Excluding the impact of the merged bottlers PepsiCo Americas Beverages volumes were down 1% from last year, but improved 4.5% sequentially. The successful launch of the new Gatorade G-Series through targeted retailers led to the first quarter of volume growth in two years for this brand. PepsiCo’s stock price has risen 6% since Memorial Day.

Automatic Data Processing

ADP’s fiscal fourth quarter earnings declined 7% to 42¢ making earnings for the fiscal year of $2.37 below earnings of $2.38 in fiscal 2009. Revenues in the quarter grew 3.4% on a constant currency basis to $2.2 billion. Employer Services revenues rose 4% to $1.6 billion as U.S. payroll and tax filing revenues grew for the first time in six quarters by 0.4%. U.S. beyond payroll revenues grew 9% driven by human resources and retirement services. The number of employees on each client’s payroll increased for the first time in eight quarters by 0.3% above the same period last year and client retention increased 1.6%. New business for Employee Services and PEO (Professional Employer Organization) combined grew 25% over last year representing the first quarter of positive sales growth since the fiscal fourth quarter of 2008. PEO revenues of $330.9 million grew 13%, the result of an 8.5% increase in the average number of employees paid to approximately 211,000 as well as higher pass-through revenues from their client’s increased costs for healthcare benefits. The higher growth rate of paid employees in the fiscal fourth quarter exceeded the fiscal full year rate of 5% demonstrating momentum entering fiscal 2011. Dealer Services revenues declined 1% to $307.2 million, as share gains moderated the impact of closed dealerships.

While most of ADP’s key metrics improved during the quarter, management’s near-term view remains prudently cautious in recognition of persistently high U.S. unemployment and the impact from the Fed’s near zero interest rate policy on net interest income. ADP acquired the Cobalt Group in August for $400 million to complement its Dealer Services business. Cobalt provides digital marketing services to auto manufacturers, regional dealer networks and local dealers. ADP also signed a letter of intent with Asbury, a dealer group with 80 locations and 107 franchises, to be the sole provider of its management information systems. Including this agreement, ADP will be the exclusive management system provider to seven of the ten largest U.S. dealer groups. Internationally, ADP is awaiting Kuwaiti government approval for the purchase of PACC, a distributor of ADP’s dealer management system since 1992 to most of the major auto manufacturers in the region. The acquisition of PACC adds to the 180 dealerships ADP accesses to through its Chrysler China and Unitran South African ventures. ADP’s stock price has risen 1% since Memorial Day.

Global Payment Inc.

Global Payments reported fiscal fourth quarter sales of $425.1 million and earnings of 58¢ per share, up 12% and 21% respectively on a constant currency basis. The comparable figures for the full fiscal year were $1.64 billion in sales and earnings of $2.54 per share, up 11% and 16% respectively. The stock has declined 4% since Memorial Day because management forecast slower growth in the fiscal year ahead and surprised investors with news of expenses to be incurred related to the restructuring of its customer support functions. The miscommunication of the announcement regarding its new global service center in Manila, Philippines overshadowed the good news about the multi-year renewal of its referral relationship with CIBC in Canada. The start up costs related to opening the new service center are $14 million or 12¢ per share in the coming year.

During the quarter US merchant revenue rose 18% to $243 million on transaction growth of 19%. The average dollar amount per transaction declined 6% from the same period a year ago. Canadian merchant revenues, excluding the beneficial impact of foreign currency declined 1% during the quarter on a 7% increase in transactions processed and a 2% decline in the average amount per transaction. Global holds the number two market position in Canada. In response to intense competition, it has lowered pricing to its mid and large-size merchants to retain them as customers. Global’s International merchant revenues, which comprise its businesses outside of North America rose 9% to $425 million during the quarter. Global is the only foreign company to have received approval and to have begun processing Renminbi based transactions for China Union Pay customers at Chinese merchants.

Global has invested $55 million in its new front-end authorization platform G2 and plans to migrate all of its authorization systems to it in the coming years. This gives Global a technological advantage over competitors who for years have underinvested in the myriad of incompatible systems they operate. Global is in the midst of migrating its US platforms to its new G2 system. The US conversion is expected to be completed by the end of September and will result in faster customer authorizations and annualized cash savings of $6 million. Global plans to convert its Canadian business to G2 by May 2012 and the UK business by January 2013. G2 will provide significant scale advantages as the cost of authorizing incremental transactions will be nominal.

Verisk Analytics Inc.

Verisk Analytics’ revenues of $281.7 million and earnings of 31¢ per share rose 9% and 19% respectively from the same period a year ago. Adjusted earnings of 33¢ per share, which excludes amortization of intangibles, employee stock option plan and IPO related costs, rose 10% from the prior year. Revenues of the company’s Risk Assessment business rose just 0.7% during the quarter to $134.3 million. Growth during the quarter was reduced by 1.7% as the result of a one-time revenue catch up during the year ago period of previously deferred customer revenue. Industry standard insurance programs and property specific rating and underwriting information provided to property and casualty insurers is constrained by difficult industry conditions. Insurance companies experiencing pricing pressure on policy renewals are lowering premiums to retain business. Verisk’s Decision Analytics revenues of $147.4 million rose 18.3%. Fraud identification and detection comprising more than half of Decision Analytics revenues rose 19% led by continued strength in mortgage fraud analytics. Loss quantification rose 29% from new customers and more claims activity from existing customers. Loss prediction rose 11% with growth from insurance and healthcare customers. Verisk shares have declined 6% since Memorial Day.

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.