4th Quarter, 2013

Your companies’ managers have steadily honed their operating and financial discipline since the downturn. That enabled them to grow their revenues and profits during the past year despite intensely competitive and unforgiving markets for their products and services. The growth realized by recognizing product or service opportunities within or adjacent to served markets has been rigorously executed whether the solutions required adapting existing services and products or acquiring the capability. Realized profits for most of your companies are modest but repeatable gains. They result from execution capabilities that surpass the best of what might have been achieved within these companies a few years ago. They were well managed then. Their ability to do it better and better strengthens your companies which collectively have achieved 6% revenue and 12% earnings growth during the last quarter. The comparable figures for the S&P 500 companies are 1% and 8%. Your companies stocks have fared better than the 1% increase in the S&P since the start of the year.

Express Scripts

Express Scripts delivered excellent results for the fourth quarter and for all of 2013. The company successfully transferred all of its clients to one information platform, profitably moved 10 million UnitedHealth Group members off its platform and prepared to add more than 100 new clients (with tens of thousands of members) on January 1, 2014 with minimal disruptions to its clients and plan members. Express Scripts processed 1.5 billion prescription claims in 2013, of which 890,000 were UnitedHealth Group claims. Operating earnings per claim were $4.63 for the quarter and $4.51 for the year, increases of 15% and 17% respectively. Strong growth in this metric demonstrates the company’s ability to sell new services to its clients and to control operating costs, both of which are critical in a high-volume, low-margin business. Fourth quarter earnings per share rose 7% to $1.12 from $1.05. Earnings per share for the year rose 15% to $4.33 from $3.75. Express Scripts generated $4.8 billion in cash flow from operations while spending $413 million on capital improvements which results in free cash flow of $4.4 billion! The company used its cash to retire $1.9 billion in debt and repurchased 60.8 million shares for $3.9 billion, an average cost of $64.27 per share. On March 5, 2014, Express Scripts announced its plan to repurchase an additional 65 million shares of stock, bringing its total authorization to 140 million shares. Its stock price is up 12% since January 1 and rose 30% in 2013.

Express Scripts is the only pharmacy benefit manager (PBM) with all of its clients on one information platform. Although the task of moving 3,500 clients and 100 million members to one system after the Medco acquisition was daunting, having to update only one system allows the company to respond quickly and cost effectively to stay compliant with Medicare rules and regulations, to respond to changes from healthcare reform and to offer new services to its clients. The cost of regulatory compliance has increased. In late 2013, for example, the Center for Medicare and Medicaid Services issued a 700-page release on the new rules for 2014. Having one system also makes it easier to analyze the vast amounts of data the company receives daily. Express Scripts uses this data to purchase generic drugs for its five automated pharmacies at the lowest cost. Since most of the drugs that Express Scripts sells treat chronic conditions, they know what volumes are likely to be throughout the year. The company’s supply chain experts work with generic manufacturers to get the lowest costs. Express Scripts can reduce the variability in vendors’ manufacturing processes by either providing baseload capacity or by stabilizing a manufacturing process by purchasing excess volume. They will consider holding 90 days of inventory of a generic drug, versus two days of inventory for a branded drug, if the price is low enough to offset the warehousing cost.

Express Scripts strengthened its senior management team with the promotion of Timothy Wentworth to President with responsibility for all aspects of the company’s core business. Tim led the employer and key accounts organizations for nearly 14 years at Medco and was also CEO of Accredo, the company’s specialty pharmacy. We saw Tim two months after the closing of the Medco acquisition where he expressed unbounded enthusiasm for having the opportunity to join the Express Scripts team to help make the deal work. Cathy Smith joined the company on February 10 as Chief Financial Officer. Before joining Express Scripts, she was the CFO of Walmart International. She brings her experience working for a large public company in a high-volume low-margin business.


Wabtec’s fourth quarter revenues of $681.5 million were 11.6% higher than revenues in the year ago quarter. They lifted 2013 revenues to $2.57 billion, 7% above 2012 revenues. After a 3¢ per share restructuring charge to move a plant from California to Mexico, 2013 earnings were $3.01 per share, 15.7% higher than the $2.60 earned in 2012. Half the revenue increase last year came from acquisitions made during the year, while the margin improvement of just under 1% was achieved from material sourcing and manufacturing cost savings in businesses acquired in 2012 as well. During the quarter, the final $15 million payment on Wabtec’s initial $165 million contract to provide a Positive Train Control System (PTC) for MRS Logisitica in Brazil was not booked because the system is still undergoing tests and a contract covering additional rail lines is being negotiated. Early in December, Sound Transit, which serves Seattle, signed a $34 million contract for a PTC System which is the company’s highest margin product.

Wabtec closed its largest single acquisition since the end of 2008 with the purchase, at the end of last September of Longwood Industries, a North Carolina manufacturer of specialty molded rubber products. Many of these products are designed to perform essential functions in locomotive, railcar and truck airbrake systems. Application of Wabtec’s lean manufacturing performance system, which reduces production cycle times and defects, cuts material waste and emphasizes sourcing savings, increased margins slightly in the fourth quarter and offers the probability of further improvements. Wabtec’s managers are remarkably skilled at gaining enthusiastic adoption of their manufacturing practices. Proficiency is recognized, acclaimed and rewarded throughout the company. Approximately 15% of Wabtec’s existing workforce is covered by collective bargaining agreements which have not kept workers from enthusiastically embracing the company’s lean manufacturing regimen.

On February 12, Lincoln’s birthday, Wabtec closed its $215 million purchase of Fandstan Electric Group Ltd, its largest overseas acquisition ever. This company, owned by a British couple in their eighties, generates 60% of its sales from products for transit systems, notably pantographs, a framework for conveying electric current to a vehicle from overhead wires or from third rails to shoe gears. Non-transit sales are primarily to industrial power customers, which includes energy producers and users. Aftermarket sales constitute 30% of Fandstan’s total sales and no products compete with any Wabtec products sold to transit systems. Almost 50% of Fandstan’s sales are to customers on the European continent, 20% are in the UK, another 20% are in Asia and 10% are in the US. Fandstan’s operating margin is slightly lower than Wabtec’s and management cautions that any improvement this year, which probably would come from improved sourcing, will be offset by purchase price accounting amortization resulting from the acquisition. Fandstan appears well-suited to realize steady profit margin improvement through rigorous application of Wabtec’s lean manufacturing practices. Wabtec management’s disciplined approach to acquisitions resulted in regular contact with Fandstan’s management and owners over the past four years, which made them the preferred buyer. Wabtec’s stock price is up 8% since the start of the year. It rose 70% in 2013.

Donaldson Inc.

Donaldson continues to execute effectively in a slow growth environment. In spite of a 2.4% sales decline this quarter, the company reported an impressive 14% increase in earnings, reaching 39¢ per share. Earnings outpaced the sales decline as gross margins reached 34.7%, an improvement of 130 basis points versus the prior year’s quarter through favorable product mix, productivity initiatives and increased equipment utilization. Engine Products, 52% of sales, increased 7% in the quarter. The impressive 11% increase in Engine Aftermarket sales was attributable largely to the absence of significant inventory reductions, equipment utilization improvement and the company’s commitment to its market growth initiatives. Original equipment manufacturer (OEM) sales in the Americas were down 7%, while sales to European OEMs increased by 7% because of strength in the agricultural equipment market and truck purchases due to upcoming Euro IV emission standard implementations.

The Industrial Segment, 38% of sales, remained under pressure as the Gas Turbine business declined 50%, as expected. Gas turbine sales are variable, and management believes they are at the bottom of the cycle. Order growth this quarter should result in stronger sales in FY 2015. Industrial filtration sales increased 1% as manufacturing activity drove record demand for replacement filters. The combination of the stabilization of many of Donaldson’s first fit equipment end markets and the increasing demand for their replacement filters across both Engine and Industrial segments gives management confidence that their businesses will gradually improve during the second half of this year. Total aftermarket sales continued to exceed 50% of total sales, a testament to Donaldson’s skilled execution.

Donaldson continues to be an excellent steward of cash. Free cash flow for the quarter was $30 million and more than doubled from the prior year’s $14.7 million. The company continues to spend 6% to 7% of sales combined on research and development and on capital improvements to maintain its technological leadership in filtration systems. Year-to-date, Donaldson’s share price is down 1%. It rose 34% in 2013.

Precision Castparts

Precision Castparts’ (PCP) results for its fiscal third quarter ending December 29 were good despite aerospace customers’ decisions to defer delivery and hence bookings of almost $50 million of finished products until after the start of 2014 to reduce their calendar year-end inventories. All these products now accepted by customers will add to reported sales for the current quarter. Fiscal third quarter sales also were reduced by a $48 million drop in pass-through metal prices for PCP’s manufactured parts. Nonetheless, sales for the past quarter rose 16% to $2.36 billion with much of the gain coming from a 27% increase in sales to industrial customers of TIMET, the nation’s largest titanium manufacturer acquired a year ago. Quarterly earnings, although reduced by the absence of profit on the deferred sales, were $2.95 per share, 27.7% higher than the $2.31 per share earned in the year ago quarter. Importantly, PCP has realized cost savings of $30 million at TIMET and is set to achieve another $50 million in the current quarter with even more obtainable throughout the rest of 2014. The successful achievement of crucial cost savings with more to come, while integrating TIMET, confirms that PCP’s management continues to sharpen its manufacturing skills. They will prove capable of taking out costs as manufacturing volumes rise for the essential parts the company has contracted to provide to Boeing for the new 787 Dreamliner and the new fuel efficient 737-MAX. The company currently provides engine housings, aerostructures and fasteners in quantities sufficient for production of seven 787s a month. Boeing currently is making 10. PCP has proven itself a reliable supplier that meets its contractual commitments to customers’ aircraft delivery schedules, and particularly Boeing’s, while bringing down unit production costs as it increases volumes. This capability ensures the company’s growth. PCP’s price is down 4% since the start of the year after rising 42% last year.

Core Laboratories

Core Laboratories produced, as expected, strong year-over-year increases in fourth quarter revenue, net income and earnings per share. Revenue growth of 8.6% during the quarter produced a 16% increase in operating earnings and as a result of share repurchases a 21% increase in earnings per share to $1.42. During the year, Core increased its revenue 9.5% to $1.1 billion, its net income 9.5% to $243.2 million and lifted its earnings per share 16% to $5.28 helped by share repurchases. Core’s management has regularly repurchased the company’s stock as an integral part of its disciplined capital management. Since activating its share repurchase program in October 2002 through the end of last year, Core has bought 36,186,389 shares for a total purchase price of $1.2 billion. The average price per share was $32.41. Last year the company bought 1,482,198 shares for $227.2 million which is an average price of $153.30. The principal source of funding for last year’s share repurchase was the free cash flow of $262.7 million generated by Core’s businesses, although dividend payments of $58.6 million during the year required the company to borrow $23.1 million to fully fund the purchases. The quarterly dividend rate now is 50¢ per share. A measure of Core’s capital efficiency is its success in producing, over the past 10 years, an average of $3.35 in incremental revenues for every dollar spent on capital investment in the prior year. Another important measure, especially for us, is Core’s ability during the past decade to generate free cash flow averaging $1.13 for every dollar of net income reported. Its lowest conversion of net income into free cash flow occurred in 2007 when free cash flow equaled only 92% of reported net income or $2.24 per share of the reported earnings of $2.44 for that year. Core has 45.5 million shares outstanding. Its long-term debt and lease obligations amount to $267 million. Core’s stock price is up 1% since the beginning of the year after rising 75% last year.


SGS’ second half revenues of CHF 2.98 billion and adjusted net income of CHF 365 million rose 5.9% and 9.3% in constant currency respectively. For the year on the same basis revenues of CHF 5.83 billion rose 6.5% and earnings per ADR of CHF 0.78 rose 10% from the prior year. SGS declared a regular cash dividend of CHF 0.65 per ADR which will be paid in April. This is a 12% increase above the prior year dividend payments. Organic revenue growth for the year was 4.4% with acquisitions adding another 2.1%. During 2013, SGS acquired 12 businesses for CHF 108 million which generate CHF 107 million in annual revenues and CHF 18 million in operating income. These small tuck-in acquisitions include an industrial services business in South America, a minerals business in Africa and a vehicle inspection business in China.

The cyclical downturn in the global mining industry continued to reduce the profitability of the Minerals business which experienced a 7.8% organic revenue decline. One-half of the 1,700 headcount reductions across the company during 2013 were job cuts from Minerals. Its weak performance was more than offset by continued strength in Consumer Testing, Oil, Gas & Chemicals, Automotive and Government & Institutions Services, all of which achieved high single digit or low double digit organic growth. Consumer Testing, SGS’ largest profit contributor, accounting for 26.4% of operating income, was also its fastest growing. The company has invested in expanding its mobile device testing capability and is winning share for conformance testing for 2G, 3G, 4G and now 4.5G and 5G technologies. This has also positioned the company well for GPS testing of mobile devices. SGS also utilizes GPS technology to provide sophisticated services to its customers. These include electronic cargo tracking systems for trucks and containers in transit, precision farming and forestry monitoring. SGS’ ADRs are up 9% since the beginning of the year.

Mettler-Toledo International Inc.

Mettler-Toledo’s fourth quarter sales of $684.2 million grew 3% in local currencies with increases of 2% in North America and 8% in Europe. Growth in Asia, outside of China, offset the 7% sales decline there. Sales for the year were $2.38 billion, a 1% increase over sales of $2.34 billion in 2012. Mettler’s operating margins expanded 80 basis points to 24.1% for the quarter and 90 basis points to 19.9% for the year. The company’s cost reduction programs, which include opening a shared services center in Poland to provide back-office services for its European business, contributed to the margin expansion. Mettler also hired 30 people in Poland with master’s degrees and PhDs to provide technical support to customers who purchase its $25,000 to $100,000 instruments. These employees, along with 50 people in India, replaced higher cost, less academically qualified people in Switzerland. Earnings per share rose 10% to $3.79 for the quarter and $10.46 for the year. Mettler generated $284.6 million in free cash flow in 2013, an increase of 12% from $254.5 million in 2012. The company spent $295 million to repurchase 1.3 million shares of stock at an average price of $223.18.

Management believes that markets in the developed world have stabilized and will grow in 2014. They are developing sales and marketing programs and adding sales people to capture new sales as customer demand strengthens. Mettler must convince customers to replace existing instruments in these markets. The company initiated 45 projects to pursue sales in specific applications and geographies. Over 75% of them target developed markets. These programs lead to the steady development of new products based on this detailed work. About 25% of sales come from products introduced in the last 24 months. Mettler’s stock price is unchanged since January 1. It rose 26% in 2013.

Automatic Data Processing

Revenues of $3.0 billion and earnings of 78¢ per share in ADP’s fiscal second quarter rose 9% and 8% respectively from the same period a year ago. Lower interest earned on rising client funds balances reduced earnings by 2¢ per share or 3% during the quarter. The number of employees on existing client payrolls in the US increased 2.9%. Combined worldwide new business bookings for Employer and Professional Employer Organization (PEO) Services rose 7%. During the quarter customers of ADP’s PEO added 32,000 worksite employees, bringing the total to 311,000 as it generated a 14% increase in revenues. The Affordable Care Act’s regulatory compliance challenges have led more small businesses to ADP’s integrated payroll, HR, healthcare and benefits administration solutions.

ADP continues to execute its plan of migrating existing customers to its most advanced cloud-based product offerings. During the quarter, 25,000 small businesses migrated to ADP RUN bringing the total to 315,000. During the next year and a half, the company will complete its mid-sized customer migration to ADP Workforce Now which already has 45,000 customers onboard. Half of the customers who have migrated from a stand-alone solution also sign up for additional services such as time and attendance, HR and benefits administration. ADP produced more than 50 million year-end tax statements for its 360,000 customers’ employees and enabled 15 million employees and their dependents to enroll in medical benefits for 2014. ADP’s stock price inexplicably is down 4% since the start of the year, although its price went up 41% last year.

CME Group Inc.

CME’s revenues of $687 million and adjusted earnings of 61¢ per share rose 4% and 2% respectively from the same quarter a year ago. Average daily volume of futures and options contracts was 11.3 million, up 11% from the same period a year ago as interest rate volume surged 29%. Growth outside of the US, which contributed 22% of transaction volume, was strong during the quarter with Latin American volumes up 36% and volumes in Asia and Europe each up 12%. The increase in interest rate contract volume was broad-based with Eurodollars up 48% and Treasuries up 15%. New interest rate products launched in the last three years contributed 4% of total interest rate volume. Interest rate contract volume growth was accompanied by an increase in open interest of 44% from the beginning of the year. This is an important precursor for future transaction volume growth. In addition to successful new product introductions and expanded geographic coverage, CME has improved its execution efficiency. In 2013, 45% of its options trades were executed on its electronic Globex system up from 35% the prior year. Furthermore, CME has become the global leader in dealer-to-customer OTC interest rate swap open interest, holding 52% of the global outstanding client-cleared swap open interest. These transactions involve real money customers such as insurance companies and asset managers, not dealers.

In mid-January, CME paid its annual variable dividend of $2.60 per share, twice the amount of last year’s payment. CME also raised its quarterly dividend to an annual rate of $1.88 per share. Contract volumes continue to rise during the current quarter with average daily volume in January of 12.9 million contracts up 13% from the same period a year ago. During February, volume averaged 14.0 million contracts. Despite this, CME’s stock price is 3% lower since January 1, after rising 54% last year.

IDEXX Laboratories Corp.

IDEXX Laboratories’ fourth quarter results demonstrate the effectiveness of the transformation of the North American diagnostics salesforce. Both recurring diagnostic revenue and placement of the company’s high-throughput instruments grew more than 10% over the fourth quarter of 2012. Recurring diagnostic revenue, which consists of instrument consumables, rapid assay tests, test kits and reference lab services, grew 11% organically during the quarter and accounted for $1 billion of the company’s 2013 sales of $1.4 billion. Worldwide placements of Catalyst Dx chemistry analyzers increased 10% during the quarter with half of them going to new customers. IDEXX placed 2,400 of these instruments in vet clinics in 2013 and has placed 12,000 Catalysts since its launch in 2008. Placements of ProCyte Dx, IDEXX’s high-throughput hematology analyzer, rose more than 25% during the quarter, almost twice the number placed during the prior three quarters of the year. Sales representatives increased the commitment of their customers to IDEXX’s diagnostics tools by teaching vets how to access historical diagnostic data for each pet using VetConnect Plus, the company’s unique cloud service that combines all of a pet’s diagnostic data from in-clinic instruments and reference labs. Since July 2013, 5,500 of the 11,600 clinics that have activated VetConnect Plus have become active users, accessing the data at least once or twice a month.

On January 6, 2014, IDEXX announced the launch of Catalyst One, a chemistry analyzer with all the functionality and test menu of the Catalyst Dx, but designed for practices that run one to five samples a day. IDEXX’s engineers reduced the cost to manufacture this instrument by 40%, with a 70% reduction in part count and an 83% reduction in assembly time. The instrument will retail for $12,000 compared to $18,000 for the Catalyst Dx. The Catalyst One also will run a thyroid test that can be added with other chemistry slides in the same sample run. It thus streamlines the workflow for this test in the clinic. Over half the panels that vets send to the reference lab include this test because thyroid disease affects many dogs and cats, especially older cats. IDEXX currently offers this test, but it has to be run on a separate analyzer. With the sales reps compensated for recurring diagnostic revenue and instrument placements, IDEXX has given them a great opportunity to win new business in 2014. Fourth quarter sales were $354.1 million, an increase of 10.6% organically, while sales for the year rose 6.7% organically to $1.4 billion. Earnings for the quarter and the year were 82¢ and $3.48, increases of 11% and 12% respectively, excluding a one-time gain in 2012. The company spent $368 million to repurchase 4.0 million shares during 2013 which reduced its share count by 7%. IDEXX achieved good earnings growth in 2013 despite a 12% increase in sales and marketing costs and a 7% increase in R&D spending to $88 million. The company spends more on R&D than all of its competitors combined. IDEXX’s stock price is up 20% since January 1.

Varian Medical Systems

Varian Medical Systems’ fiscal first quarter revenues and earnings rose 6% to $712 million and 91¢ per share respectively over the same period a year ago. The earnings growth includes the impact of the 2.3% excise tax from Obamacare on the US sales of radiation equipment as well as a planned increase in research and development expenses to strengthen the company’s products and services for the mid-market. As the technology leader in radiation oncology, Varian has traditionally best served the clinics that want the most advanced equipment and service available. Over 80% of the radiation therapy systems purchased in the US, for example, are the most technologically advanced TrueBeam. Oncology Systems revenue, which accounted for 77% of total sales during the quarter, rose 3% over the same period a year ago to $541 million. Service sales grew 9% as Varian’s sales representatives convinced more customers to purchase a service agreement with their equipment. They also purchase Varian’s software-as-a-service agreements which entitle customers to unlimited technical support and free software upgrades. Service, with its recurring revenues, now accounts for 40% of Oncology System’s revenues.

Oncology Systems’ first quarter orders rose 5% to $533 million with North American orders up 13% over the same period a year ago. Varian booked $19 million of a $50 million multi-year agreement for equipment and services with two large US health systems that are consolidating their networks. Varian also received orders for radiosurgery upgrades to the TrueBeam and for EDGE, its dedicated radiosurgery system. In December 2013, the US Preventive Services Task Force issued guidelines for lung cancer screening for people considered to be at high risk for the disease but who are currently symptom-free. With radiosurgery already approved to treat early stage lung cancer, Varian expects more clinics to replace their ten year-old radiation therapy equipment with the versatile TrueBeam which performs both radiation therapy and radiosurgery. Varian’s stock price is up 9% since January 1.

FEI Company

FEI Company had a terrific fourth quarter and a good full year 2013. Its stock price is up 14% year-to-date. Revenues rose 15% to $265.3 million from $230.9 million in the fourth quarter of 2012. Earnings rose 35% to 97¢ per share from 72¢ per share. Bookings, the best measure of future sales growth, were $256.8 million, up 11% from the same period a year ago. Fourth quarter Industry sales rose 34% organically to $121.3 million as the four largest semiconductor manufacturers purchased FEI’s recently launched instruments for their manufacturing lines. These tools automate the inspection of defects on wafers that contain integrated circuits made with the smallest geometries and complex 3D structures. Science sales for the quarter rose 3% to $144 million. For the year, FEI’s bookings rose 10% to $976.2 million. Revenues rose 4% to $927.5 million while earnings rose 7% to $3.01 per share from $2.80. Full year Science sales and bookings grew organically 7% and 10% to $500 million and $553 million, respectively. In December, scientists from The Scripps Institute published a paper in the prestigious journal Science where they used FEI’s tools to elucidate the structure of the HIV virus as it infects a cell. This new structure, which provides a blueprint for vaccine design, could not be characterized with existing techniques.

FEI has refocused its oil and gas business from the well-site to reservoir characterization under the leadership of a new and experienced manager of the Natural Resources business. The company used $68 million of cash from its European operations to strengthen the workflow for its oil and gas customers with the acquisition of Trondheim, Norway-based Lithicon, a leading provider of digital characterizations of oil well cores to ExxonMobil, Shell and Statoil along with Petrobras and other national oil companies. Lithicon has unique software that models how oil and water flow through pores that are characterized by non-destructive micro-CT scans of the cores. FEI also acquired a product license from Australia National University for the instrument that performs the micro-CT scans, and the software that produces 3D images on the micron scale. This technology complements FEI’s existing technologies that produce images at the nanometer scale.

Sigma Aldrich Corp.

Sigma-Aldrich’s fourth quarter and full year 2013 results reflect the success of its salesforce realignment from a product-focused to a customer-facing organization. Fourth quarter sales of $684 million grew 6% organically over the fourth quarter of 2012, and full year sales rose 4% organically to $2.7 billion. Unfavorable foreign exchange rates reduced revenue growth by 1% in both periods. Earnings for the fourth quarter rose 6% to $1.02 per share and rose 7% to $4.12 per share for the year. Sigma generated a record $541 million in free cash flow as a result of its initiatives to manage its supply chain and working capital.

Sigma’s Research business reported sales of $1.4 billion and accounted for 52% of the company’s sales in 2013. Sales grew 2% organically, with sales to academic and government research laboratories, which account for 50% of revenues, unchanged from 2012. Sales to pharmaceutical and biotech companies continued to strengthen as these customers implement Sigma’s workflow solutions which include managing their purchases, stockrooms and inventories of chemicals and biologic reagents used by scientists doing drug discovery research. The Applied business had sales of $629 million and grew 5% organically in 2013. Revenues for Cerilliant, Sigma’s certified standards and reference materials business, grew more than 10% during the year with increased sales in Europe and Asia-Pacific. In response to growing sales and specific requests from its customers, Sigma expanded its ISO-certified manufacturing capabilities for critical components of diagnostics kits. Strong demand for SAFC Commercial’s biologic products and services resulted in 6% organic revenue growth for the year to $673 million. BioReliance delivered 7% organic growth as more customers used their services to test the products that Sigma manufactured. Revenues of the Hitech business, which accounts for 15% of sales of this division, declined more than 10% during the year as price declines in LED precursors more than offset the growth in the profitable and larger semiconductor chemicals business. Sigma-Aldrich’s stock price is unchanged since the beginning of the year. It rose 27% in 2013.


Roche’s 2013 revenues of CHF 46.2 billion rose 6% in constant currencies over 2012. Core earnings, which exclude amortization of intangible assets, restructuring charges and other non-recurring expenses, rose 7% to CHF 13.89 per ADR. Operating income increased 5% to CHF 17.4 billion. Roche expanded its operating margin by 60 basis points to 38.3% from 37.7% in 2012 while research and development expenses rose 5% to CHF 8.7 billion. The company generated free cash flow of CHF 13 billion and reduced its net debt to CHF 6.7 billion from CHF 10.6 billion in 2012. Roche’s ADR has risen 9% since the beginning of the year.

The Pharmaceutical Division’s R&D expense of CHF 7.7 billion supported 66 novel drugs in its pipeline with 15 drugs in Phase III clinical trials. It includes the development of production processes for Roche’s complex biologic drugs. The company currently has nine antibody-drug conjugates (ADCs) in development to treat eleven types of cancer. ADCs link an antibody to a very toxic small molecule drug and deliver the drug only to cells targeted by the antibody. Kadcyla, the first ADC approved for metastatic breast cancer, had sales of CHF 234 million since its U.S. launch in February 2013. Roche estimates that more than 50% of women whose breast cancer returned after treatment with Herceptin used the drug. Sales of oncology drugs rose 10% to CHF 22.5 billion and accounted for 62% of the CHF 36.3 billion revenues of the Pharmaceuticals Division.

Roche’s Immunology and Ophthalmology franchises posted revenues of CHF 6 billion and grew 12% in 2013. Sales of Actemra, a drug that reduces inflammation caused by rheumatoid arthritis, rose 30% to CHF 1 billion. Approval in the US, Europe and Japan of a formulation that can be given as an injection should boost future sales. Sales of Lucentis, an antibody designed for use in eyes that slows the progression of wet age-related macular degeneration, rose 15% to CHF 1.7 billion. Sales growth began to accelerate during the second quarter when Roche introduced a reformulated injection that extended the time between doses from one to two months. Lucentis also benefits from approvals to treat two other eye conditions that result from excess blood vessel growth. Both Lucentis and its competitor Eylea are taking share from the off-label use of Avastin.

In 2013, the Diagnostic Division’s sales were CHF 10.5 billion, up 4% in constant currencies. Demand for immunoassays and instruments sold to clinical laboratories by Professional Diagnostics contributed to this business’ 8% revenue growth to CHF 5.7 billion. In addition to introducing four new assays that identify specific gene mutations in cancers, the Diagnostics Division is developing companion diagnostics for seven of the 15 drugs in late-stage development. Roche also strengthened its offering in Women’s Health with the introduction of a molecular diagnostic test for human papilloma virus, the major cause of cervical cancer, and a tissue-based diagnostic test to identify precancerous lesions that are missed by PAP smears.


Nestlé delivered good full year 2013 results despite weak economic growth in the US and Europe and slowing growth in emerging markets. Sales of CHF 92.2 billion rose 4.6% organically with increased volumes contributing 3.1% to growth and increased pricing adding 1.5%. Sales in developed markets rose 1% organically to CHF 51.4 billion, while sales in developing markets rose 9.3% to CHF 40.8 billion or 44% of total 2013 sales. Europe was the most difficult market for the company in 2013. Sales were CHF 25.5 billion with volumes growing 1.9% and prices declining 0.9%. Pet Care performed well throughout Europe. New product introductions such as Maggi Tender Papyrus, a special cooking paper that adds flavor to cooked food without adding fat or oil, contributed to volume growth. Nestlé reduced operating costs by CHF 1.5 billion again this year through the Nestlé Continuing Excellence program. Savings from this program, which reduced the cost of goods sold by 70 basis points and distribution costs by 10 basis points, enabled the company to increase the marketing spending on its brands and to increase its operating margin from 15% to 15.2%.

On February 11, 2014, Nestlé announced the sale of 48 million L’Oréal shares back to L’Oréal in exchange for its 50% share of Galderma, the skincare joint venture the companies formed in 1981, and 3.4 billion euros in cash. The €6 billion deal reduces Nestlé’s stake in L’Oréal from 29.4% to 23.3% with the retirement of the shares. With 2012 sales of €1.6 billion, Galderma is the largest global pharmaceutical company that specializes in dermatology and skincare products. The company has five R&D centers, five manufacturing centers and 5,000 employees in 80 countries. It will become the core of Nestlé Skin Health, a new company which will be managed as an independent subsidiary as is Nestlé Health Science. It extends Nestlé’s science-driven innovations to skin health, a key component of wellness. It also provides entry to the fast-growing and profitable $60 billion global skincare market. The price of Nestlé’s ADRs has risen 2% since January 1.

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Capital Counsel’s investment strategy combines disciplined fundamental analysis with patient execution. We hope this letter helps you understand that stock selection is at the core of our investment strategy. We invest in profitable well-managed companies that generate recurring free cash flow. These companies possess strong balance sheets and earn attractive rates of return on shareholders’ capital. We know the companies and their proven execution focused managers well. They deal with problems openly and effectively, and have incentives aligned with shareholders. We evaluate the company, as an informed private buyer might, to determine the value of the business based upon its ability to generate free cash flow. We manage concentrated portfolios which provide our clients with good long-term results. The financial strength of the companies held in client portfolio lessens the drop experienced when markets decline.

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.