4th Quarter, 2012

Since January 1, half of your company’s stock prices exceeded the 9.6% increase registered by the S&P 500 while the other half lagged. The diverging stock price movements come as many company managements provided investors with their preliminary business outlooks for 2013. Most managers of your companies cite continued customer caution and limited order visibility. The forecasts put forth for the year by these seasoned managers offered a wider than usual range for revenues and earnings. Many commented on demand being no better than stable. They are prepared to take out additional costs if sales weaken to protect the company. No one has any illusions about a sudden surge of rapid growth for their business if the economy stagnates, but most think growth is achievable. We are confident that our companies’ cost control and management discipline give them the capability of growing even when others cannot.

We believe it’s important to understand why large investors buy securities that seem to us unsuitably risky because if their speculation goes awry, it harms us. As always, Wall Street accommodates institutional and retail demand for financial instruments to further speculation. Leveraged loan demand is resurgent. The amount outstanding now exceeds $550 billion. Last year’s leveraged loan issuance was $42 billion, well below the record issuance of $160 billion in 2007 just before the financial market collapsed. Speculation is building and can go on for a while.

The creators and distributors of leveraged loans are large banks’ sales and trading desks that provide on a best efforts basis capital lent to financially weak borrowers at a flexible rate. The loans are leveraged so the yield is at least 3% to entice buyers after paying creation and distribution fees. The buyers are multi-strategy hedge funds, high-yield and bank loan mutual funds and ETF’s, distressed debt funds and institutional investors, including pension funds wanting higher yields than measly money market yields. It is worth noting that none of the borrowers need to have the financial strength to repay the loan. All loans are made on the assumption that refinancing will be available. Our rudimentary description of the leveraged loan market results from a conversation with a smart debt investor at Carl Marks Strategic Opportunities Fund. Any clarity or insight comes from him.

Donaldson Inc.

Donaldson’s stable but sluggish fiscal second quarter results reflect the reduced visibility it has from its OEM (original equipment manufacturers) customers of off-road and on-highway equipment who continue to reduce inventory to levels commensurate with reduced end market demand. This is the second quarter of sluggish demand which Donaldson first saw in Europe, but spread to North America and Asia during the last six months. The company is taking out costs and slowing its pace of capital expenditures for capacity expansions but is still spending on key efficiency initiatives, its global systems project and tooling for new products which are being adopted by new and existing customers in the year ahead.

During the quarter, revenues of $596 million rose 3% while earnings of 34¢ per share were one penny lower than the same period a year ago. Sales of engine-based replacement filters declined 1% from the same period a year ago with growth in the Americas and Asia of 4% and 6% respectively offset by a decline in Europe. Sales to on-highway truck and off-road OEM’s dropped 9%. The weak spots are Class 8 heavy trucks and mining equipment globally. Agricultural equipment remains robust. Industrial filter sales were flat during the quarter while gas turbine filter sales surged 79% to $66 million from the same period a year ago. Donaldson has good visibility into continued strong gas turbine filter sales. These products need to be ordered well in advance as they are built to order. Donaldson shares are up 12% since January 1.

Mettler-Toledo International Inc.

Mettler-Toledo’s Blue Ocean information system, which is now live in Switzerland and China, contributed to the company’s profitable growth in the fourth quarter and in 2012. Sales for the quarter and the year of $657.2 million and $2.3 billion grew 2% and 4% in local currencies over the comparable periods a year ago. Earnings for the quarter rose 20% to $3.47 per share, while earnings for the full year rose 16% to $9.67 per share. The company increased inventory turns to 4.9 times from 4.2 times a year ago and reduced inventory levels by $50 million. This significant improvement in inventory management contributed to the 20% increase in fourth quarter cash flow from operations to $93.7 million. With 100,000 unique products, Blue Ocean makes it easier for the company to raise prices selectively, a key source of operating leverage. The 2.9% net price increase Mettler-Toledo realized during the fourth quarter was higher than its revenue growth. The company’s forty country-based service organizations each have their own information system and approaches to delivering service. Consolidating these systems on Blue Ocean will allow the company to improve the service organization’s productivity by offering global service products and by ensuring that the sales force offers a service quote with a product quote. Mettler-Toledo’s stock price has risen 13% since the beginning of the year. It rose 31% in 2011.


SGS achieved strong results during 2012 with revenues growing 14.5% in constant currency to CHF 5.6 billion and adjusted operating income up 12.9% to CHF 941 million. The adjusted income excludes CHF 47 million in restructuring expenses, the majority of which are for the closure of the loss-making Life Science early-phase clinical trial operation in France. Organic revenue growth for the year was 10.2% in constant currency with recently acquired companies contributing an additional 4.3% to revenue growth. During the year SGS acquired 18 businesses for CHF 182 million. They generate a combined CHF 212 million in revenues and CHF 29 million in operating income. Once again the company has declared and this month pays a sizable special dividend of CHF 28 on top of its CHF 30 ordinary dividend for a total payout of 70% of the year’s adjusted net income. This equates to a dividend payment of about 61¢ per SGS ADR.

During the second half of 2012 organic growth of 9.3% slowed only slightly from the 11.1% rate achieved during the first half. Double-digit organic revenue growth during the second half was achieved by Consumer Testing, Industrial, Government and Institutions and Oil, Gas & Chemicals. The three biggest contributors to profits remain Consumer Testing, Minerals and Oil, Gas & Chemicals. For the year, including a few key acquisitions, Minerals produced 24.2% total revenue growth. Minerals’ organic growth of 8.1% in the second half slowed considerably from the 20.6% organic growth achieved in the first half. The weakness primarily was in coal and iron ore in Australia. Minerals Services will open 9 new onsite labs and 3 commercial labs during the coming year. SGS Oil, Gas & Chemicals Services produced strong growth in its Plant & Terminal Operations and Cargo Treatment Services in North America. Its internally developed GasPro technology-based service which measures the energy content of the gas coming out of the ground is being rapidly adopted with more than 30 units being deployed this year. Consumer Testing services generated 12.9% revenue growth driven by Asia, South America and Eastern Europe with strong gains in food testing and softlines. SGS ADR’s are up 13% since January 1 after increasing 35% last year.

Express Scripts

Express Scripts’ adjusted earnings for the fourth quarter and the year rose 28% and 26% respectively to $1.04 and $3.74 per share. Adjusted earnings exclude transaction costs and intangible asset amortization associated with the Medco acquisition. The company’s 2013 forecast for adjusted earnings per share growth of 12% to 15% has lifted Express Scripts’ stock price over 4% since it was announced on February 19 during the company’s fourth quarter earnings call. Express Scripts’ stock price is up 9% since January 1. Gross profit margin for the quarter was 8.6%, up 1.2 percentage points from the fourth quarter of 2011 as a result of higher generic drug usage as well as supply chain and integration efficiencies. Express Scripts generated $4.8 billion of operating cash flow in 2012, up from $2.2 billion in 2011! It expects to generate between $4.5 billion and $5.0 billion in 2013. On March 6, 2013, the company approved a 75 million share stock repurchase plan and will redeem $1 billion of its 6.25% Senior Notes due in 2014 before the end of June.

Varian Medical Systems Inc.

Varian Medical Systems’ fiscal first quarter earnings rose 9% to 86¢ per share over the same period a year ago. Revenues were up 6% to $678 million. Oncology Systems orders fell 2% to $477 million, with orders up 2% in North America and down 4% in international markets. Varian sees strong global demand for the newest version of Eclipse, its treatment planning software. Orders of Eclipse from competitive accounts contributed to North American order growth during the quarter. The FDA approval of the EDGE radiosurgery system on January 24, 2013 appears to have delayed some equipment purchases as radiation oncologists and surgeons evaluate EDGE’s ability to treat lung cancer. Service revenues and orders both grew more than 10% during the quarter. Service, which has 50% gross margins, now represents more than 35% of Oncology Systems revenues. Varian’s stock price is up 5% since January 1.

IDEXX Laboratories Corp.

Revenues from the consumable products used in IDEXX Laboratories’ in-house instruments were $72.4 million during the fourth quarter, an increase of 16% organically. Consumables sales rose 10% for the year to $279 million based entirely on higher unit volumes. Vets who use IDEXX’s high-throughput instruments, on-line services and protocol-based discounts perform more diagnostic tests. Vet clinics that upgraded their in-house chemistry and hematology instruments to Catalyst and ProCyte in 2012 increased their testing volumes by 20% to 25% compared to an increase in testing of 15% to 20% when clinics upgraded their instruments in previous years. IDEXX launched a reagent rental program for its chemistry instruments for vet practices with large testing volumes. In a reagent rental agreement, a clinic commits to purchase a high volume of consumables, usually for five years. Instead of paying for the instrument up-front, it pays for the instrument over the life of the five year contract. The company increased its Catalyst placements in new vet clinics outside of North America by offering them this option. Clinics with Catalysts account for 80% of total chemistry consumables revenues and are very loyal. IDEXX’s fourth quarter and full year sales were $319.5 million and $1.3 billion respectively, up 4% and 6% over the comparable periods a year ago. Earnings for the quarter rose 16% to 74¢ per share, and full year earnings were $3.13, an increase of 14%. IDEXX’ stock price is unchanged since January 1 after rising 22% in 2012.


Wabtec’s fourth quarter sales and earnings were 14% and 29% higher than the results for the comparable period a year ago. The strong fourth quarter earnings of $1.34 per share helped lift the company’s 2012 earnings to $5.19 per share, 48% above the $3.57 per share earned in 2011. These exceptional results are attributable to excellent quality and cost control in all the company’s divisions. A timely upturn in fourth quarter transit sales helped sustain profit growth when tank car deliveries to railroads and leasing companies for transporting oil slowed slightly. This year Wabtec expects that freight car deliveries, including cars for container transport and tank cars, will number between 50,000 and 55,000 compared to 59,000 this past year. Transit car sales currently are benefitting from enactment of a two-year extension of federal funding at past levels. This year Wabtec is poised to secure over half its transit sales from providing replacement parts and overhaul services to non-U.S. transit systems where funding is steadier. The rising percentage of sales outside the U.S. results from Wabtec’s successful management of four acquisitions, costing $170 million. The initial acquisitions in 2011 were two U.K. companies followed by another in 2012 after the mid-year purchase for $90 million of a Netherlands-based manufacturer of electronic components for rail and industrial markets. That company also has operations in the U.K., the U.S. and China. The growth of Wabtec’s Positive Train Control System continues unabated. Management expects sales will rise 15% to 20% above the record $215 million achieved last year. Wabtec’s stock price has risen 15% since the beginning of the year. Last year the company repurchased 607,000 shares at an average price of $77 per share.

C.H. Robinson Worldwide Inc.

CH Robinson’s adjusted earnings during the fourth quarter of 68¢ were up only 1.5% from the same period a year ago even as total revenues of nearly $3.0 billion rose 15.7% and net revenues of $444 million rose 10.8% from the same period a year ago. The results exclude a $280 million gain on the sale of the T-Chek payment services business and one-time costs from the sale as well as transaction costs related to its November 1 purchase of Phoenix International which more than doubles the size of Robinson’s global forwarding business. For the full year 2012, total revenues, net revenues and earnings of $11.4 billion, $1.7 billion and $2.76 rose 9.9%, 5.2% and 5.3% respectively. Robinson’s shares have fallen 6% since January 1 with all of the decline occurring after its disappointing earnings report on February 5.

Robinson’s core trucking volumes and net revenues rose 12% and 7.1% during the quarter and 10% and 3.9% for the full year from the same periods a year ago. The acquisition of Polish trucking firm Apreo contributed 4% to the volume growth during the fourth quarter. The current slow pace of economic growth makes Robinson’s shipping customers extremely cost-focused, which hurts Robinson’s profits. The freight marketplace has been stagnant for a sustained period. This reduces Robinson’s ability to add more value to shipments by securing scarce trucks at favorable rates in a tighter more variable marketplace. Robinson’s average truckload rate per mile charged to customers increased 1% excluding fuel while its truckload transportation costs increased 2% on the same basis during the fourth quarter and for the full year. This trend has continued into 2013.

Last year the number of Robinson’s active customers rose 14% to 42,000 while its active carrier base increased 6% to 56,000. Robinson’s largest customers, using its industry leading transportation management information system, are booking Robinson for more of their transportation requirements when Robinson holds its pricing constant. Robinson is automating more of these shipments in order to improve its efficiency as it battles higher costs for transportation from its carrier network. If Robinson can get greater volumes across its system while holding down operating costs it will be able to generate profitable growth. Robinson’s $100 million investment in its transportation management information system needs to begin producing a tangible improvement in operating results. We have reduced our position in Robinson while we wait for its improved operating efficiency to become evident to investors. In the meantime, Robinson has increased its dividend which now provides a 2.5% yield and it is buying in more stock. In 2012 Robinson repurchased 4.2 million shares for $245 million or $58 per share, reducing its outstanding shares by 2.5%.

Automatic Data Processing

ADP’s fiscal second quarter revenues of $2.7 billion and continuing operating earnings of 72¢ each rose 7% from the same period a year ago. ADP shares are up 14% since the beginning of the year reflecting the companies’ consistently good results in a difficult economy. New business sales rose 5% during the quarter and 9% for the past two quarters combined as its customers continue to upgrade to new integrated cloud-based products which generate more revenues per employee for ADP at the same cost. ADP’s Employer Services revenues rose 7% to $1.9 billion during the quarter driven by a 2.6% increase in the number of employees on existing client payrolls, new clients and the sale of add-on products and services such as benefits administration to existing clients. The company’s comprehensive TotalSource solution which provides fully outsourced payroll, HR and healthcare benefits generated 13% revenue growth to $466 million as the number of employees rose 10% during the quarter to 276,000. CEO Carlos Rodriguez recently noted at a small lunch meeting that customers are continuing to spend money to implement ADP’s new product platforms which will result in better employee satisfaction and improved efficiency. ADP increased its dividend again this year by 10% to $1.74 per share.

Teradata Corp.

Teradata’s fourth quarter and full year revenues rose 10% and 13% respectively from the same periods a year ago. Earnings of 68¢ and $2.53 rose 13% and 20% respectively for the quarter and full year. Teradata’s software and hardware product sales slowed in the second half of 2012 to a 9% gain from the first half surge of 25% from the same period the prior year. This will make comparisons during the first half of 2013 difficult as U.S. customers are spending more cautiously. Services revenue growth of 11% was consistent throughout the year as customers depend upon Teradata’s consulting staff to derive value from their enterprise data warehouse, integrated marketing and big data analytics systems. During the quarter the Americas region generated $449 million in revenues, up 8%, while Europe rose 21% to $176 million and Asia Pacific was up 2% to $115 million.

During the year, Teradata added 49 new sales territories up from the 45 added during 2011 bringing the total to 569. This year the company plans to add an additional 20 to 30 new sales territories as well as additional sales and consulting specialists for its Aster big data analytics and integrated marketing solutions. During the quarter, Teradata added two Fortune 100 customers in the U.S. who plan to build large-scale enterprise data warehouses. Other new customers in the U.S. include O’Reilly’s Auto Parts, USDA Food Safety and Inspection Service and the State of Ohio which will use Teradata for health and Medicaid spending analytics. New customers in Europe included the Dutch Tax Authority and HSBC Turkey and in Japan Sumitomo Mitsui Card, a leading credit card issuer. Existing customers, such as Comcast and Dell are adding Teradata’s new Aster big data analytics appliance to their existing enterprise data warehouse solution.

Continuing economic uncertainty in the U.S. is causing customers to delay new purchases, and add capacity expansions in smaller increments. This will result in a decline in revenues from the Americas in the first quarter. Management is not forecasting any large deals to close, resulting in flat overall company revenues and a decline in earnings from the same period a year ago. The growth of data storage and analysis needs will ultimately drive demand for Teradata, the market leader, but this can be delayed for a few quarters. As a result of the reduced near-term visibility, Teradata’s stock price has declined 5% since January 1. It rose 28% last year.

Precision Castparts

Precision Castparts’ (PCP) fiscal third quarter sales of $2 billion and earnings per share of $2.32 rose 13% and 9% respectively above the comparable results reported for last year’s third quarter. Expenses directly related to the December acquisition of Timet, the largest titanium manufacturer in the U.S., reduced earnings by 8¢ per share during the quarter. Timet, with annual sales of $1.2 billion, operates four melting mills in the U.S., two more in the U.K. and one in France. The acquisition, at a cost of $2.9 billion, is PCP’s largest ever. Last year, 16% of Timet’s sales went to PCP which has appointed its senior vice president, Steve Hackett, to manage the integration of Timet. When accomplished, it will become part of PCP’s Forged Products division. Steve, in 2003, was given responsibility for integrating SPS Fasteners which has become the core of PCP’s rapidly growing and highly profitable Airframe Products division. A key determinant of success will be the cost savings realized by collecting and reusing titanium cutoffs and chips. An equally important cost control practice is encouraging workers to recommend ways of making workflow more efficient within their group, a practice which PCP’s managers have learned to implement based upon the enthusiasm and unanimity of the workers directly involved.

On January 24, when PCP announced its earnings, its stock price rose to an all-time high, within a nickel of $195. The cause for the rise was management clearly stating publicly in its fiscal third quarter conference call, its goals for the next three years. The reason not explicitly stated is the size of the Timet acquisition coming after the company spent $1.6 billion on seven smaller but additive acquisitions since last April 2, just after the fiscal year began. The headline number given by management is earnings of $15.50 to $16.50 per share by the end of fiscal 2016. The company also announced a $750 million stock buyback, its first ever. Its stock price is up 1% since the start of the year.

Cenovus Energy Inc.

Large price discounts for Canadian heavy oil along with longer and more expensive scheduled maintenance at Cenovus Energy’s refineries cut fourth quarter cash flow to C$0.92 per share. Cash flow during the fourth quarter of 2011 was C$1.12. Operating earnings of C$0.27 per share exclude a C$0.52 per share goodwill impairment of the Suffield gas field in Southern Alberta. Low gas prices reduced the value of the asset and enabled the company to write off the goodwill. Operating earnings were C$0.44 per share in the fourth quarter of 2011. With Christina Lake phases C and D operating at full capacity during the fourth quarter, oil produced from the oil sands rose 35% during the quarter and the year to 100,867 barrels per day and 89,736 barrels per day respectively. Cash flow for 2012 rose 11% to C$4.80. Operating earnings were C$1.66 excluding the goodwill impairment compared with C$1.64 in 2011.

The price of Cenovus’ oil in the fourth quarter was C$60.13, a 25% decline from C$80.50 in the fourth quarter a year ago. The company’s oil hedges offset C$6.24 per barrel or 30% of the difference. The Wood River and Borger refineries benefited from a glut of Canadian heavy oil in the Mid-Continent because supply exceeded refinery capacity and pipeline capacity to the west coast of Canada and to the Gulf Coast of the United States. The company’s refineries processed 84,000 barrels of oil per day from Christina Lake during the quarter because it was C$10 cheaper per barrel than other heavy oils. In the future, Cenovus Energy expects the discount for Christina Diluent Blend to range from C$3 to C$5 because its viscosity and acidity are slightly higher. Cenovus has locked in a C$20 – C$21 discount to WTI crude for 90% of its 2013 oil production which will stabilize cash flows for the year. The company also expects cash flow from its refineries to return to C$300 – C$400 million in the first quarter of 2013. Cenovus’ stock price is down 5% since the beginning of the year because investors’ outlook has shifted from optimism about the availability of large volumes of oil from our Northern neighbor to fear that the environmental impact of extracting bitumen from the oil sands will prevent the building of pipelines to transport the oil safely and at low cost. The United States imports 8.5% of its oil from Venezuela’s vast Orinoco oil sands where the bitumen is mined. We know that Venezuela’s environmental regulations are more lax than Canada’s.

Core Laboratories

Core Laboratories’ revenues for the fourth quarter of 2012 rose to $254 million, 4.4% above those for the year ago quarter. Growth for the full year was better. Revenues rose to $981 million, 8% above 2011’s while earnings per share grew 19% to $4.54. The free cash flow generated from operations last year was $206 million, 85% of which Core used to repurchase 1,581,000 shares at an average price of $111 per share. The repurchase increased fourth quarter earnings per share by 2¢.

Core derives half of its revenues and operating profits from Reservoir Description Services which customers rely on to increase daily production and ultimate recovery from reservoirs, 80% of which primarily produce oil. Offshore production constitutes 40% of the total and half of these reservoirs lie beneath deep water. Core’s analyses provide vital information for prudent reservoir management as the removal of oil changes the composition of the fluid remaining in the reservoir making it wetter. In addition to continuing analyses of producing reservoirs, Core helps plan the development drilling after discovery wells identify promising structures. Thousands of feet of core samples from the discovery wells are required for these analyses. The company has received samples from multiple companies’ discoveries in the lower-tertiary formation beneath the deep-water in the Gulf of Mexico as well as core samples from discovery wells offshore Brazil and West Africa. An inflow of business has impelled Core to begin construction of a 100,000 square ft. expansion of its laboratory facilities in Houston. The company surprised some traders by reporting a 3.3% year-over-year increase in revenue from its Production Enhancement business that generates 41% of company revenues. It provides well casing perforation equipment and tracing and diagnostic chemicals to enable well operators precisely assess the penetration of the producing formation achieved by well completion or fracturing processes. Core’s HTD blast perforating system is widely used in the Bakken where Core’s analysis of identifying trace chemicals enables operators to optimize the spacing of frac stages along the horizontal wells. Core is currently testing a perforating gun designed to operate under high pressure conditions found at the bottom of 20,000 foot wells drilled in deep water. Covering by short sellers who may have expected Production Enhancement revenues to drop in tandem with a decline in the North American rig count helped propel the stock up 14% right after Core reported its earnings. The stock price is up 26% since the start of the year.

National Oilwell Varco

When, On February 1, National Oilwell Varco (NOV) announced its results for the fourth quarter of 2012 and the year, its stock price fell 8% which has left it up less than 1% from the beginning of the year. The cause for this reaction to satisfactory results was lower than expected margins earned on the revenues of the company’s Rig Technology division which generates over half of NOV’s revenues and two-thirds of its operating profits. The division’s fourth quarter operating margin was 22.4%, a decline of 1.6% from the prior quarter and 3.6% below the margin earned in the year ago quarter. NOV’s management, in commenting on the results, stated that the lower margins result from prices for the equipment supplied for deep-water drillships or semisubmersible rigs remaining 8% to 10% below those obtained in 2008. The absence of improved pricing occurs while shorter construction times at unfilled Asian shipyards building most offshore rigs requires NOV to manufacture the equipment it supplies for the rigs faster. That affects efficiencies especially when, for example, all the sensors recording and transmitting temperature and pressure measurements on all the interconnected equipment must be tested to ensure they function flawlessly.

The good news accompanying the earnings is that Rig Technology booked orders for $2.4 billion of drilling equipment, raising its backlog to a record $11.9 billion. The orders received were to equip four drillships and three semisubmersibles with blowout preventers for six of them. NOV has orders to equip 57 of the 80 deep-water rigs on order from shipyards worldwide. Over 90% of NOV’s backlog is for offshore rigs destined for international waters. In commenting on the fourth quarter, NOV’s President, Clay Williams, who came to the company with Varco in 2004, emphatically disputed assertions emanating from Wall Street that orders for deep-water rigs would slow. NOV’s onshore business, which is concentrated in the U.S. and Canada, has experienced a slowdown commensurate with the 11% decline in the active rig count. The pace of orders for automated land rigs to replace antiquated rigs unsuited for horizontal drilling as well as demand for drilling mud downhole tools, coiled tubing and drill pipe, casing and tube inspection services has slowed. Revenues are up because the company has countercyclically bought distribution businesses in Canada and the U.S.

NOV’s fourth quarter earnings were $1.49 per share up 9% after excluding the benefit of a foreign tax credit. Revenues during the quarter rose 33% above the year ago quarter to $5.7 billion. Earnings for the full year were $5.91 per share, 24% higher than the $4.77 earned in 2011.

Sigma Aldrich Corp.

Sigma-Aldrich’s sales for the fourth quarter and the year grew 7% and 5% respectively to $655 million and $2.6 billion over the same periods in 2011. Organic sales rose 3% in the quarter and the year with Research growing 2% and Sigma Aldrich Fine Chemicals (SAFC) growing 5%. Fourth quarter earnings rose 5.5% to 96¢ per share, and earnings for 2012 excluding one-time charges rose 2.4% to $3.85. Unfavorable foreign exchange rates reduced earnings growth by 6.5% for the quarter and 5.5% for the year.

The company continues to invest in the faster growing parts of its business. It has reorganized into three business units to offer solutions tailored to specific customer groups instead of broadly selling products to its 1.4 million individual customers in 100,000 accounts. Research will continue to offer Sigma’s broad range of products to academic, government and pharma company scientists in developed and emerging markets through its web site, dealers and catalogues. The company will add to the 215,000 products it currently sells to meet the needs of scientists working at the frontiers of their fields. This division accounted for 53% of sales in 2012. SAFC Commercial sells critical raw materials, active drug ingredients, cell media and BioReliance testing services to life science companies that are scaling up the manufacture of new drugs. This division also will sell precursor chemicals used in LED and semiconductor manufacturing. Sales from this division accounted for 24% of the company’s 2012 sales. The Applied business, which accounted for 23% of 2012 sales, sells products to manufacturers of diagnostic tests and sophisticated clinical labs that run their own diagnostic tests. It also sells larger quantities of research chemicals to industrial laboratories that perform food safety and environmental testing. These customers benefit from Sigma’s solutions because they perform routine tests. Rather than sell a clinical lab the products it would need to develop a screening test for lung cancer, Sigma developed the test for them and now has a two year supply agreement worth $1 million. Sigma-Aldrich’s stock price is up 7% since the beginning of the year.

CME Group Inc.

CME’s fourth quarter revenues and adjusted earnings of $661 million and 63¢ per share declined 10% and 11% respectively from the same period a year ago. The volume of futures and options traded during the quarter declined as uncommonly low levels of volatility were evident in its key interest rate, equity and energy markets. CME has made the investments necessary to be a beneficiary of regulatory reform by expanding its OTC clearing services in the U.S. and Europe for interest rate, credit default and foreign exchange swaps in advance of the March 11 mandate for dealers and large hedge funds. No other exchange or clearinghouse is in a position to provide customers with capital efficiencies of up to 90% as a result of margin offsets within its existing clearinghouse. During 2012 more than 60 clients cleared over $1.6 trillion in notional value through its new OTC clearing facilities.

The dearth of trading activity seen in the fourth quarter has abated and volumes year-to-date are recovering. During January and February, average daily volume of 12.5 million contracts was up 19% from the average trading volume registered during the second half of 2012 and open interest is up 15% from the low reached in the fourth quarter. Reflecting the improving outlook, CME shares have surged 24% since the beginning of the year.


We decided to cut your Intel position following the company’s February 13 announcement that it hired executive search firm Spencer Stuart to find candidates to succeed CEO Paul Otellini who plans to retire in May. When Paul made his decision in November, we learned that he chose to depart because he believed Intel’s CEO’s decisions ought to be made with a five year time horizon in mind. He felt that was no longer appropriate for him. We think he has done a good job. Far better than his predecessor. The Intel Board’s decision to prolong the search for Paul’s successor made their decision committing Intel to a $13 billion capital spending program, the largest ever seem discordant. The capital spending plans were announced in conjunction with the fourth quarter earnings release and the metrics for the company’s 2013 financial forecast. Intel’s fourth quarter earnings of $2.6 billion or 51¢ per share were $900 million or 26% lower than the amount earned in 2011’s fourth quarter. Moreover, the 2013 forecast envisions lower earnings for next year with percentage declines similar to the past quarter in each of the next three. We cannot recall a company in the midst of an unresolved management succession embarking on a massive capital spending program that turned out to be a success.

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.