3rd Quarter, 2013

Throughout the past year, we have come to understand the exceptional ability of your companies to control costs while improving their overall profitability by carefully investing in new products, services, facilities and employees. In implementing these business strengthening initiatives, the managers of your companies carefully retain the option to revise their commitments as conditions change. The searing experience of the economic downturn has made them value financial flexibility more than ever. Many of your companies this year have entered new markets with products or services and established new facilities to support expansions. Their caution also is evident when they have made acquisitions to expand their businesses. Negotiations now involve detailed plans for adoption of common business practices to avoid disruption. Operating considerations are as important as financial terms. None of your managers have been tempted to consider taking gobs of low-priced debt to fund large “synergistic” acquisitions. We know your companies are not operationally or financially vulnerable if the Federal Reserve decides to rein in its bond purchases and allow interest rates to rise. If these changes push stock prices down, we think your companies would decline less than most and thereafter rise more.

Automatic Data Processing

ADP’s fiscal first quarter revenues and earnings rose 8% and 10% respectively to $2.8 billion and 68¢ per share. The company achieved strong earnings growth despite the 16% decline in interest earned on client funds held for clients which reduced EPS growth by 5%. An 8% increase in average client funds balances to $17.4 billion, partially offset the impact of the decline in portfolio yield from 2.6% to 2.0%. During the quarter, ADP repurchased nearly 1% of its shares outstanding for $303 million at an average price per share of $72. Shortly after the quarter, ADP raised its quarterly dividend 10% to an annual rate of $1.92 per share providing a 2.4% yield. ADP shares have risen 38% since the beginning of the year.

The average number of employees on each existing client payroll in the U.S. rose 2.6% from the same period a year ago. In addition, ADP added new clients and sold add-on services to existing clients to generate 8% organic revenue growth. New services introduced recently include data-driven analytics, document management in the cloud and ADP Recruiting Management, a unified platform that includes social and mobile tools to attract job candidates, an important part of the recruitment process. ADP TotalSource PEO (Professional Employer Organization) revenues increased 12% organically in the quarter with the addition of 31,000 worksite employees bringing the total to 300,000. In addition to human resources management and benefits administration, the inclusion of healthcare coverage makes TotalSource a strong value proposition for customers who benefit from ADP’s scale and ability to sort through a myriad of new regulations.

CME Group Inc.

CME shares are benefitting from greater volatility in medium and long-term interest rates which helps drive transaction volumes in its interest rate products. CME’s stock price is up 57% since the beginning of year. During the quarter, average daily futures and options transaction volume of 12.0 million rose 11% from the prior year quarter. All of the growth came from the 29% surge in interest rate average daily volumes to 5.8 million during the quarter. Transactions in North America, which comprise 77% of electronic volume, rose 8% while Europe, Middle East and Africa rose 15%, Asia-Pacific was up 22% and Latin America increased 23%. CME total revenues of $714.6 million rose 5% while earnings of 71¢ per share were up 8% from the same period a year ago.

CME’s management has done an excellent job developing innovative products to market to new and existing customers. This is especially true of its interest rate products. Its Eurodollar contract, launched by CME in 1981, has become the benchmark interest rate contract traded throughout the world. In 2007, Eurodollar futures volumes were concentrated in the first two years’ quarterly contracts (the front 10) which generated 93% of Eurodollar futures volume while Eurodollar contracts between years 2 and 10 (the back 32) accounted for just 7% of trading volume. Trading volumes in the front 8 have been constrained by the Fed’s zero interest rate policy which has kept short-term rates near zero with little volatility. This year futures and options contracts derived from the back 32 comprise 42% of Eurodollar volume reaching 865,000 contracts per day, up from 162,000 per day in 2007. In addition to its thriving listed futures and options contracts, CME has secured a dominant role in the fledgling OTC (over-the-counter) interest rate swap market. CME has boosted its market share in the dealer-to-client business from 5% in the first quarter of this year to 31% in the third quarter. Its share of open interest exceeds 45% and at $7.4 trillion is 10 times above the level at the start of the year.

Donaldson Inc.

Improving engine aftermarket sales contributed to Donaldson’s fiscal first quarter 2014 sales of $599 million, up from $589 million a year ago. Earnings of 41¢ per share, a 14% increase over last year, resulted from the company’s continued focus on margin improvement and cost containment. Replacement parts as a percent of sales increased to a record of 54% versus 51% in the fiscal first quarter of 2013. Power Core sales increased 16% during the quarter. Power Core, a patented filter technology introduced in 2001, is used in air filtration for heavy duty trucks and off-road equipment. It is currently in its second generation with the third generation in development. This best-of-class technology has a 90% win rate for new original equipment manufacturer programs, and gives Donaldson the entire replacement market for these filters. This product’s small size gives truck and off-road equipment makers flexibility in how they configure their filtration systems. Free cash flow was a record $78 million for the quarter, up 83% from the same period a year ago. In addition, Donaldson increased its quarterly dividend 56% to 14¢ per share. Year to date, Donaldson’s stock is up 28%.


Wabtec’s third quarter sales of $631.4 million and earnings of $73.9 million equal to 76¢ per share were 8% and 17% higher than the results in the comparable quarter a year ago. Seven acquisitions over the past fifteen months, which together cost $288 million, accounted for 80% of the quarterly sales increase. Importantly, earnings grew more rapidly than sales in the quarter because planned and effective implementation of Wabtec’s proven manufacturing cost control methods improved productivity in the acquired businesses and helped lift the company’s operating margin 2% to 24%. This improvement was achieved even though sales to more profitable freight customers declined 4% while sales to transit systems rose 25%. The quarter, however, included a sales increase of $8.3 million to transit systems to replace and rebuild worn brakes. This is the company’s core competency and hence quite profitable. Rebuilding brakes and providing replacement parts now constituters 57% of Wabtec’s sales. These recurring sales are more profitable than original equipment sales. Sales to transit systems also included $10.8 million for electronic products used in Wabtec’s Positive Train Control System (PTC) which is the only Federal Rail Administration approved system for use of a locomotive on-board computer with a GPS locator and a dedicated radio frequency connection for a central station to control train speed and activate brakes to prevent train collisions and derailments. The Rail Safety Improvement Act of 2008 requires U.S. railroad and transit rail systems to have working PTC systems on their lines by the end of 2015. All are applying for delay. Several freight railroads, for example, are impeded from deploying systems because existing laws restrict the availability of antennae sites. Total PTC sales during the quarter were $60 million. Only three of the 21 U.S. rail transit systems; Denver, Los Angeles and San Diego have begun to install PTC systems.

At its November 12 meeting for investors, Al Neupaver, Wabtec’s Chairman and CEO, stated that the company continued to talk with the owners and managers of many small profitable manufacturers of railroad and industrial equipment that would prosper if they were part of Wabtec. He found investment bankers’ suggestions that Wabtec contemplate a large debt-financed acquisition eminently resistible. During the quarter, Wabtec bought $5 million of its shares at an average price of $53.76. Wabtec’s stock is up 52% since the start of the year.

Precision Castparts

Precision Castparts (PCP) sales for its fiscal second quarter ending September 29, rose to $2.36 billion which is 23% higher than its sales in the year ago quarter. Over 75% of this sales increase comes directly from the acquisition consummated this past January of Timet. It is the largest titanium manufacturer in the U.S. Sales growth in the quarter, excluding Timet’s contribution, was 6%. Earnings for the quarter rose to $649 million or $2.90 per share, 28% higher than earnings for last year’s comparable quarter. The improved efficiencies PCP’s management sought to achieve through its purchase of Timet are just beginning to be realized. The drop in metal prices has not lessened PCP’s determination to instill habitual attention to the value derived by saving and reworking metal that others often discard. Management, in reviewing the quarter, cited the near-term gain realizable from reducing Timet’s inventories by $100 million. Too much inventory not only wastefully ties up money, it encumbers efficiency by its looming presence in every production decision.

During the quarter, PCP’s aerospace revenues rose 26% as sales of engine castings rose 10% to keep pace with the rise in Boeing 787 Dreamliner production. Manufacturing of engine housings for the Boeing 737-Max is underway but not yet ready to ramp. During the quarter, airframe sales reached $613 million over 25% higher than sales during the year ago quarter, despite sales running behind Dreamliner’s production pace due to destocking by a customer. The income from airframe sales on a Dreamliner are $10 million, almost equal to the income earned from castings for the engines. PCP’s stock price is up 34% since the beginning of the year.

Express Scripts

Express Scripts delivered adjusted operating earnings per claim of $4.63, an increase of 13% over the third quarter of 2012, as their corporate and health plan clients use more of the company’s tools to reduce the cost of health insurance that includes Obamacare’s ten essential benefits. For the first time, health plans have expressed interest in Express Script’s tools, including narrow retail pharmacy networks and Select Home Delivery, which requires members to opt out of mail delivery of their chronic medications. Over 40% of its health plan customers who are participating in the public exchanges have implemented more aggressive mail programs. These customers count on Express Scripts’ proven success in introducing new programs that control costs without upsetting plan members.

The transfer of legacy Express Scripts’ clients to the new (Medco) platform is 80% complete and will be finished by the end of the year. With all 100 million members on one platform, Express Scripts will focus on selling additional clinical programs to its clients and on the roll-out of its new National Preferred Formulary which covers 30 million members. Formularies, the list of drugs available to patients, are an important tool to improve health outcomes cost effectively. Express Scripts’ Pharmacy and Therapeutics (P&T) committee evaluates every new drug when it is launched and all drugs in the formulary once a year. This independent committee consists of 18 physicians in academic and private practice from all over the country and one pharmacist. Committee members are paid a stipend, but are not Express Scripts’ employees. They, not the company, choose the committee’s members. Once the P&T Committee has made its clinical determination, a second committee evaluates the drugs for net cost and market share to determine their place on the formulary. The P&T Committee then reviews the final formulary design to ensure its clinical appropriateness.

The National Preferred Formulary is the largest formulary in the U.S. Express Scripts uses its scale to negotiate larger volume discounts from drug manufacturers on behalf of its clients. The formulary will maintain its three-tier structure with generic drugs on the first tier, preferred branded drugs on the second tier and non-preferred branded drugs on the third tier. Express Scripts excluded 48 drugs from the formulary entirely. The formulary contains lower-cost alternatives for each excluded drug. About 2.6% of members currently take these drugs, and removing them will reduce their clients’ costs by 3% or $700 million annually. As with its decision to remove Lipitor from its formularies in 2005 and the decision to remove Walgreen from its pharmacy networks in 2011, Express Scripts’ consultants worked with thousands of clients this fall to explain the change and to help them manage the impact on their members. The company’s call centers set up for this purpose have been quiet. Members have presented letters from Express Scripts explaining the coming change to their doctors and have received prescriptions for the alternatives. Express Scripts’ earnings per share rose 5% to $1.08 over the $1.03 earned in the same period a year ago. The company deployed $751.1 million of the
$1 billion of cash flow from operations generated during the quarter to repurchase 11.6 million shares of stock. The company has repurchased 23.7 million shares of the 75 million authorized in April. Express Scripts stock price is up 25% since January 2.

Varian Medical Systems

Varian Medical Systems’ fourth quarter and fiscal year revenues were $770 million and $2.9 billion, up 2% and 5% respectively over the same periods a year ago. Lower radiation therapy system installation and warranty costs along with a 10% reduction in the cost to build the high-end TrueBeam radiation systems contributed to 6% growth in full year earnings to $3.98 per share. Fourth quarter earnings of $1.08 per share were unchanged from the fourth quarter of 2012. Oncology Systems’ fourth quarter revenues declined 1% to $585.3 million from $590.1 million a year ago with revenues split evenly between North America and the rest of the global markets. Gross orders were up 3%, while orders were down 6% in North America. This decline was offset by a 13% increase in orders from Europe/Middle East/Africa and 2% order growth from Asia. Scandinavian countries, Switzerland and Africa contributed to the growth in Europe while orders in China rose 30%. Of the 19 equipment deals signed in Japan in the fourth quarter, 13 were for state-of-the-art TrueBeams. Uncertainty in the U.S. related to the implementation of health care reform, declining reimbursements to free-standing clinics, which account for 5% of Oncology Systems’ sales, and consolidation of oncology centers have slowed purchasing decisions as hospitals and large free-standing clinics evaluate their operating models.

Varian won the tender from the Brazilian Ministry of Health for 80 radiation systems to be installed in the country’s public hospitals over the next five years. The company has over 70 employees in Brazil, has installed 185 radiation therapy systems and also has a strong software base. This infrastructure allowed the local team to develop a strategy that won the bid without hitting their floor price. These systems include a basic radiation source without any imaging as well as basic treatment planning and information management software. Less than 24 hours after the contract was awarded, Varian received several calls from hospitals requesting pricing on upgrades.

On September 22 at the annual conference for radiation oncologists and therapists, Varian launched RapidPlan, an add-on module to its market-leading Eclipse treatment planning software. RapidPlan dramatically improves the quality of all treatment plans by using a clinic’s best existing plan as the starting point for the next plan. Currently, a radiation oncologist initiates the treatment planning process by mapping out the tumor and all the structures that should not receive much radiation. For head and neck cancers, she has to map 15 structures which takes at least an hour per structure. The medical physics team then spend a day or two finding the best beam arrangement that minimizes the dose to these structures. They start from scratch every time. The doctor then reviews the plan and makes any final adjustments. RapidPlan uses the best plan for that anatomy in the clinic’s database and adapts it to the anatomic features of each patient. The software eliminates the work of the oncologist and generates a plan in three minutes, instead of two days. The best plans are then added to the database so clinics continually improve their baseline plans. Memorial Sloan-Kettering’s plan for prostate tumors comes with the software so clinics can either use it or develop their own plans and see how they compare. RapidPlan improves the quality and efficiency of treatment planning which is critical to the growth of radiosurgery where treatments are delivered in five to seven days instead of four to six weeks, and to the training of professionals who develop treatment plans in emerging markets. Varian forecasts revenues of $200 million if all 3,300 sites that use Eclipse install RapidPlan. Varian’s stock price has risen 12% since January 2.


Roche’s third quarter sales rose 6% in constant currency to CHF 11.6 billion, excluding a CHF 184 million release from reserves related to provisions of Obamacare. Sales of both the Pharmaceutical and Diagnostics Divisions rose 7% to CHF 8.9 billion and CHF 2.5 billion respectively. Strong growth in sales of assays for tumor markers, including one recently launched to detect lung cancer, that run on Roche’s large automated instruments in clinical labs contributed to the revenue growth of the Diagnostics Division.

Roche reported good progress on the expansion of its HER2-positive drug franchise during the quarter with sales growing 5% worldwide to CHF 1.8 billion. While Herceptin accounted for 81% of the quarter’s sales, Perjeta and Kadcyla, Roche’s new drugs which had almost all their sales in the U.S., contributed CHF 186 million and CHF 156 million to sales. Sales of Perjeta grew 11% over the second quarter as more patients received the drug as part of chemotherapy after surgery. On October 1, 2013, the FDA approved Perjeta as a component of treatment before surgery in patients with high-risk HER2-positive early stage breast cancer. This accelerated approval was based on data from a Phase II study that showed that 40% of patients who received Perjeta with Herceptin and chemotherapy had no evidence of the tumor detectable at surgery. Roche forecasts the market size for this use of Perjeta to be CHF 150 million in the U.S.

Results from a Phase III study presented at the American Society of Hematology meeting on December 7, 2013 demonstrated that Roche’s Gazyva is more efficacious than its Rituxan in elderly, less healthy patients with chronic lymphocytic leukemia (CLL). Gazyva and chemotherapy reduced the risk of the disease worsening or death by 61% compared to Rituxan and chemotherapy. The median time before the disease returned for patients taking Gazyva was 27 months compared to 15 months for patients taking Rituxan. This patient group represents 55% of the patients with CLL who are currently treated with Rituxan. These results suggest that Gazyva, may successfully replace Rituxan as the standard of care in CLL. Several trials are underway to see whether Gazyva is as effective in non-Hodgkins lymphoma. On November 1, 2013 the FDA approved Gazyva for the treatment of CLL. It is the first drug to be approved with the FDA’s Breakthrough Therapy designation and is the fifth cancer drug approved by the FDA in the past three years. The price of Roche’s ADRs has risen 21% since mid-February.

IDEXX Laboratories Corp.

IDEXX Laboratories successfully transitioned the remaining 80% of the sales territories of its North American diagnostics sales force to its new sales model during the third quarter. The existing sales reps made 40% more calls, and along with 13% more sales reps increased total customer calls by 58%. Sales reps in the 20% of the territories that began operating under the new model on April 1 achieved instrument placements 20% higher than a year ago. While revenue from instrument placements declined from $21.7 million in the third quarter of 2012 to $19.1 this quarter, sales of instrument consumables were $75.8 million, up $8.1 million or 12.4% over the same period a year ago. Placements of high-throughput chemistry and hematology analyzers to new customers reached a new record this quarter with 57% of chemistry placements going to new clinics in North America and with 49% placed in new clinics worldwide, while 45% of the hematology analyzers were placed in new accounts as well. Competitive placements take longer to achieve, but they offer a 100% increase in consumable revenue from very loyal customers. IDEXX reports 98% loyalty for instrument consumables and about 95% loyalty for Rapid Assays and Reference Lab services.

In addition to helping the 10,200 vet practices that have activated their VetConnectPlus accounts to access diagnostic information for their practices, sales reps have a string of new products that create opportunities to have productive conversations with their customers. In the first quarter of 2014, IDEXX will launch SNAP Pro, a portable device which looks like an iPhone. It initiates, reads and records the results of the SNAP rapid assay tests used by 90% of vets in North America. It also automatically uploads the results to a patient’s diagnostic information in VetConnectPlus and sends the charge for the test to a clinic’s practice management system. While SNAP tests are easy to use and interpret, technicians must watch the tests because they cannot read the results after about 30 minutes. Clinics often miss charges for these tests because they have to be entered manually. SNAP Pro provides sales reps from IDEXX and its distributors an opportunity to present the benefits of the company’s diagnostic offerings to many vets that do not currently use them. IDEXX’s third quarter sales of $338.3 million were up 7.4% organically and earnings rose 13% to 86¢ per share. IDEXX’s stock price has risen 12% since January 2.

Core Laboratories

Core Laboratories’ third quarter revenues of $273 million and earnings of $1.36 per share were respectively 11% and 20% higher than the comparable results for the quarter a year ago. During the quarter, the company bought 363,000 shares at an average price of $154 per share. These purchases reduced the weighted average number of shares outstanding by 3.5% which lifted reported earnings per share by nearly 5¢. The company’s quarterly revenues and earnings were the highest ever for the fourth consecutive quarter. Core’s free cash flow from operations during the quarter exceeded $65 million which provided 92% of the funds used in the quarter to repurchase shares and to pay the dividend of 32¢ per share to shareholders. When the company reported its earnings, management said that it expected fourth quarter revenues would rise to $280 million. That lifted the stock price. It would make revenues for 2013 over $100 million higher than 2012 revenue of $975 million. The expected revenues would produce fourth quarter earnings of close to $1.40 per share and free cash flow of approximately $70 million. In commenting on 2014, Core’s management stated that they thought growth from operations in the oil shale basins in the U.S. and in the deepwater offshore would increase and enable the company’s revenues and profit to grow more rapidly. Currently 40% of Core’s revenues come from services provided to customers producing from offshore wells. An increasing number of these wells extended 10,000 feet or more below the sea floor. No numerical forecast about next year’s financial results has been mentioned other than to state more than once that free cash flow from operations next year would approach $300 million.

During the quarter, Core’s Production Enhancement division generated 50% of the company’s operating income from revenues of $119.5 million, 44% of total company quarterly revenues. Its operating margin rose to 35.4% in the quarter and was significantly higher than the margins of just under 30% realized by the company’s two other divisions, Reservoir Description, its original business, and Reservoir Management. Two-thirds of Production Enhancement sales are from products or services provided to oil companies in North America, most of whom are drilling horizontal wells in oil bearing shale formations. Approximately one-third of division revenues come from diagnostic services while two-thirds are derived from well completion products. The diagnostic tools importantly include patented oil soluble chemical tracers injected along with the proppant inserted into the oil-bearing formation by operators using Core’s Reservoir Description technologies to precisely place each frac. Amazingly, precise control is possible miles below the drill floor at distances of over a mile away. The traceable chemicals allow the operators to identify and measure the success or failure of each fracked stage, even when they are tightly spaced, by analyzing the fluids flowing from the well after the well has been brought onto production. Multiple instruments, some designed by Core, permit analysis to occur while the fluids are downhole or at the surface. Often when part of the formation needs to be refracked, the fluids are sent to one of Core’s labs for analysis. The downhole analytical tool is custom manufactured to meet exacting specifications by Core’s engineers in Houston. These rugged instruments are built to function at temperatures as high as 400 degrees Fahrenheit and pressures up to 30,000 pounds per square inch which are encountered more frequently in onshore or offshore wells extending to depths of 30,000 feet or more. Core’s stock price is up 71% since the beginning of the year.

Cenovus Energy Inc.

Cenovus Energy’s third quarter cash flow and operating earnings were lower than last year’s results because a 40% increase in operating cash flow of C$915 million from its upstream operations did not offset the 75% decline in refining cash flow from C$532 million in the third quarter of 2012 to C$133 this quarter. Cash flow and operating earnings were C$1.23 and C$0.41 per share, compared with C$1.47 and C$0.57, declines of 17% and 28% respectively. A swing from a C$218 million unrealized loss from Cenovus’ hedging program in the third quarter last year to a C$5 million gain this year reduced operating earnings for the quarter by C$0.29 per share.

Production from Cenovus’ oil sands rose 6% during the quarter to 101,824 barrels per day (bbls/d) with increased volumes at Christina Lake and a decline in daily production from Foster Creek. Christina Lake produced 52,732 bbls/d up from 32,380 bbls/d a year ago as Phase D achieved full production in the first quarter of 2013 and Phase E began producing bitumen in mid-July. Foster Creek’s production of 49,020 bbls/d declined from a record 63,245 bbls/d a year ago, a record daily volume that exceeded its design capacity of 60,000 bbls/d. A major turnaround that shut down Foster Creek for six days along with the completion of deferred well maintenance reduced daily volumes by about 4,000 bbls/d during the quarter. Production has averaged 54,000 bbls/d since completing the turnaround. It will remain at this level during 2014 while Cenovus optimizes the operations of this mature field that first produced bitumen in 2002. The 45,000 bbl/d Phase F at Foster Creek is on budget and on schedule to begin producing bitumen in 2014. The company has approvals to add 40,000 to 50,000 bbl/d of production at Christina Lake, Foster Creek and Narrows Lake, where Cenovus began construction this summer, every 12 to 18 months through 2019.

Cenovus’ stock price is down 12% since January 2. We believe it will remain depressed until the company demonstrates that it intends to manage Pelican Lake for free cash flow instead of investing to grow production. In its October 23 updated guidance, the company reduced its planned investment in this reservoir from C$590 million to C$490 million which lowered Pelican Lake’s forecast use of cash from C$170 million to C$80 million in 2013. Confirmation in Cenovus’ 2014 budget announcement on December 12 that the company plans to manage this asset to generate free cash flow would strengthen the business and help the stock.

Mettler-Toledo International Inc.

Good management of operating expenses resulted in a 9% increase in Mettler-Toledo’s earnings to $2.57 per share over the same period a year ago. Sales grew 1% in local currencies to $591.7 million. Realized price increases of 2.4% offset the drop in volume that resulted from a 12% decline in sales in China, which currently accounts for 17% of the company’s annual revenues. Sales in the Americas and Europe were strong, rising 5% and 7% in local currencies respectively. Strong demand for Mettler’s balances and process analytics tools that monitor water quality contributed to 3% growth in the Laboratory business during the quarter. Industrial sales declined 3% with weak performance in industrial weighing applications in Asia, particularly China, and in the Americas.

Industrial weighing applications account for 46% of Mettler’s business in China because the company supplied many large government-sponsored infrastructure projects. The slow-down in provincial and local infrastructure projects since Xi Jinping became General Secretary of the Communist Party in November 2012, reduced demand for steel, cement and other commodities. In addition to supplying fewer scales for specific projects, the decline in manufacturing left Mettler’s customers with excess capacity. The company exited the businesses that serve these customers because it could be years before they invest in new equipment or plants. Mettler will add engineering and marketing resources in Western China where infrastructure investment continues to grow and in applications associated with consumption such as food quality, pharmaceutical production and testing labs, areas where Mettler expects to see sustained growth. The company is also strengthening its sales and service presence in Indonesia, Vietnam, the Philippines, Turkey, Brazil and other emerging markets with growing middle class consumers. Mettler’s stock price is up 26% since January 2.


In October, SGS hosted its investor day meetings in Houston. The company’s management commented that third quarter results were similar to the first half of the year when organic revenue rose 5% and total revenue rose 7% in constant currency. The continued decline in its Minerals business during the quarter, which generates 14% of company revenue and profit, reduced organic revenue growth from 7% to 5%. Worldwide exploration spending this year is down 32% from $21 billion to $14 billion as the major minerals exploration and production companies are conserving cash. Business conditions remain weak in Europe as well but are offset by organic growth of 12% in the rest of the world.

In Houston, we heard from management about the opportunities available to SGS from the U.S. energy market transformation. Shale gas and oil production has already created two million jobs and management noted that the infrastructure needed requires $180 billion of investment in the next decade. SGS is well positioned to adapt to and profit from these changes. SGS provides pipeline integrity services and intends to become a leader in this growing market. Pipeline integrity testing involves external as well as internal inspection, utilizing specialized instruments which are run inside the pipe. We visited the company’s Applied Technology and Innovation Center and heard from its leaders and scientists how it was solving problems for its customers with innovative technology-based services such as Fluid ProPAL, a portable lab which provides on-site oil composition analysis for offshore production. The company has also developed drilling fluids supervision as well as lab services and fluid analytics capabilities at the well head. Waterpro, an automated instrument which provides continuous monitoring of water flow from a well analyzes the composition of water. Other instruments determine pressure, volume and temperature of fluids in a small, rugged and portable unit. Many of these technology-based services provided by SGS are driven in part by new regulations which are being promulgated continuously. The price of SGS ADRs is unchanged since the beginning of the year.

FEI Company

FEI Company’s record third quarter orders of $251 million grew 12.4% over the third quarter of 2012 with 10% organic growth, 1.8% from the acquisition of its Australian distributor and the rest from favorable foreign exchange rates. Revenues for the quarter of $218.7 million were down from $221.8 million, in line with management’s forecast. Net income for the quarter was $28.6 million compared with $29.2 million reported a year ago. These results translate into earnings of 67¢ and 71¢ per share for the respective periods. The decline in net income resulted from increased investments in R&D and marketing associated with the launch of seven new products since the beginning of the year. Orders booked during the quarter are the best indicator of the growth in FEI’s business. The company recognizes revenues once its instruments are installed and operating at customer sites. While very few orders are cancelled, deliveries are sometimes delayed because the laboratory or location in the wafer fab is not ready. FEI’s backlog, which is currently $482 million and is up $57.2 million since the beginning of the year, also provides visibility into the next twelve months of sales. Semiconductor manufacturers typically take delivery of their systems three months after placing an order. FEI usually delivers the high-end transmission electron microscopes (TEMs) ordered by its Science customers within nine months of receiving an order.

Third quarter orders for FEI’s Science customers jumped 33% to $152.2 million with orders of high-end TEM systems more than doubling in Life Sciences. Structural biology labs ordered a record number of FEI’s $5 million Titan Krios TEMs to add cryo-electron microscopy to the existing tools they use to characterize proteins. Krios TEMs freeze proteins and then image them at very high resolution. This technique complements x-ray crystallography, the technique that Watson and Crick used to characterize DNA, which requires researchers to make crystals of proteins, a tricky process that can take weeks to yield a good sample. Orders from the U.S., Eastern and Western Europe, the Middle East, China and Australia demonstrate that when respected biologists publish papers that show both the capabilities of TEMs and provide the methods for using them, researchers find the funds to buy them. FEI’s stock price is up 14% since our initial purchase in August.

Sigma Aldrich Corp.

Sigma-Aldrich delivered the highest quarterly organic sales growth in two years during the third quarter of 2013. Sales of $668 million grew 5% organically with all regions and businesses contributing to the growth. Adjusted earnings of $1.05 per share, which exclude one-time items, rose 12% over the same period a year ago. Strong collection of receivables and a global supply chain initiative with excellent inventory management helped generate free cash flow of $411 million for the first nine months of the year, 109% of adjusted net income and a 42% increase over the free cash flow generated during the same period a year ago. Sales to pharmaceutical companies of all sizes are growing, with research sales up mid-single digits and life science products and services from SAFC Commercial up more than 10% each during the third quarter. Sigma’s unique ability to provide a seamless transition from R&D through scale-up on the commercial side without having to revalidate suppliers has become more important to its pharma customers. Sigma’s stock price has risen 21% since January 2.


Nestlé reported nine-month sales of CHF 68.4 billion, organic growth of 4.4% over the same period last year. Sales in developed markets, which account for 50% of the company’s total revenues, rose 1.1% while sales in emerging markets rose 8.8%. All regions and product categories contributed to volume growth of 3.0% for the period, up from 2.7% for the first six months of the year. Price increases accounted for 1.4% of the period’s organic growth. Nestlé posted 1.9% volume growth in Europe despite no economic growth and price deflation by focusing on opportunities to serve cash-strapped families with popularly priced products and with premium systems including Dolce Gusto and Nespresso, its premium single cup coffee systems. Powdered and Liquid Beverage Products, Nestlé’s largest product category with sales of CHF 15 billion, delivered volume growth of 5.0%, followed by Confectionary, mostly chocolate candy, at 3.9% and PetCare at 3.5%. New flavors and an 11% reduction in saturated fat content from 7.2 to 6.4 grams contributed to strong global sales of KitKat bars. The new KitKat Android operating system created significant brand awareness through digital media with mentions of KitKat in over one billion tweets since its launch in October. The price of Nestlé’s ADRs is up 2% since the initial purchase in March. The stock yields 3%.

C.H. Robinson Worldwide Inc.

CH Robinson is struggling to generate profitable growth in a competitive slow growth freight environment. Its customers place less value upon Robinson’s unique network of transportation services to manage complex supply chains. With little need to quickly add shipments to meet unexpected demand, customers have focused on reducing costs to achieve operating efficiencies. In order to retain business and gain market share, Robinson is accepting lower margins. During the quarter, Robinson’s total revenues rose 15% to $3.3 billion, and its net revenues, after the cost of purchasing third party transportation, increased 7% to $463 million. Total operating expenses rose much faster to $287 million, up 17%. Earnings of 69¢ per share fell 4% even after a 3% reduction in shares outstanding from stepped-up share repurchases.

On November 6, Robinson held an investor day in New York. Reflecting the slower growth achieved the past two years, management reduced their long-term net revenue growth targets to 5% to 10%, down from 15%, the growth rate achieved since it went public in 1997. In the near-term, even these reduced targets will be difficult to achieve. We continue to use Robinson’s stock, which yields 2.4%, as a source of funds. Robinson’s stock price is down 9% since the start of the year.

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