1st Quarter, 2014

Your companies’ first quarter earnings were good and in many instances better than managements’ forecasts. That served to keep their stock prices up while the stocks of the few companies whose results fell below forecast dropped sharply on the news. That occurred even if earnings were above last year’s quarterly results. Although some of the stocks that went down have started back up, all are now what traders once called “show-me” stocks, which means they must meet or surpass their managements’ revised forecasts for revenue and earnings growth. Predictable growth, as you know, is what we as long-term investors seek to find in the companies we choose for investments. A good investment for us is a company that can generate rising revenue growth without diminishing its overall margin. They accomplish this by entrusting promising managers with responsibility to expand the business by offering new products or services to existing customers or by expanding sales of existing products into new markets. For us, maintaining the operating margin during growth is crucial because managers’ concentration on cost control yields economies of scale and develops managerial skills for further profitable growth. The average revenue growth achieved by your companies in the first quarter was 6% which produced average earning per share growth of 10%. The comparable figures for the S&P 500 were 1.9% and 2.3%. The S&P 500 index is up 5.5% this year.

The risk we see in the financial markets once again appears to be in the bond market where avid pursuit of yield has resulted in a resurgence of institutional demand for collateralized leveraged loans. These debt instruments are supposedly better than the $89 billion of CLOs issued in 2007. They are currently selling at a pace that may lift issuance this year above $100 billion. The illiquidity inherent in these complex debt instruments poses no immediate risk of a market sell-off as long as the Fed, the European Central Bank and the Bank of Japan keep interest rates down.

Express Scripts

Express Scripts’ first quarter earnings grew 8% over the same period a year ago to 99¢ per share but were 1¢ below the $1.00 midpoint of its forecast. The company lowered its forecast for full-year earnings by 6¢ to $4.88 per share from $4.94 per share and its estimate for the number of prescriptions it will process by 30 million to 1.30 billion claims from 1.33 billion claims. About two-thirds of the decline in the claims estimate resulted from the decision of several large health plans to delay the implementation of Express Scripts’ services from July 1, 2014 to January 1, 2015 because of the uncertainty created by health care reform, new regulations for Medicare and Medicaid expansion. Inclement weather contributed to the 9% reduction in processed claims during the quarter. Members did not refill their prescriptions at the pharmacy nor did they go to the doctor to renew their mail prescriptions. Express Scripts also did not gain as many new members on the public health exchanges as they expected. People signed up late, and although Express Scripts’ health plan clients exceeded their new membership goals, 40% of these new members were already served by Express Scripts in other plans. Express Scripts’ stock price fell 6% on April 30 after the company reported its first quarter results. Express Scripts’ stock price at $71 is up 2% since January 2.

Operating earnings rose 8% to $4.60 per claim as the company reduced some of the costs associated with the January 1 implementation of 100 new clients. During the quarter, Express Scripts repurchased eight million shares of stock for $618 million, an average price of $77.25 per share. With all its clients on one platform, Express Scripts is now working on its back office integration. Chief Financial Officer Cathy Smith, who joined Express Scripts in February from WalMart International, commented during our meeting with her on May 28, 2014, that the company will move from fourteen IT systems to one. This system will make information for decision-making rapidly available to its finance and client service teams.

Tim Wentworth, President of Express Scripts, described the new client service organization, which consists of four client groups such as health plans and employers. Each group has a dedicated sales team to help client service teams sell new services to their existing clients. Express Scripts now works as a partner with its health plan clients to win new commercial business. Health plans account for about 50% of its book of business and are an important source of new member growth. In addition to developing specific tools to help them navigate the Medicare drug plan rating process, Express Scripts encourages health plans to bring clients to the company’s Innovation Lab to see how their pharmacy claims will be managed. These visits helped two large plans win new clients. The company renewed the contract of its largest customer, the Department of Defense, for seven years. The new contract expands the home delivery program and adds claims processing for pharmacies on military bases. Express Scripts reduced the prescription adjudication time to one to two minutes from one to two hours when the government processed the claims. The expanded scope of the contract reflects the quality of service Express Scripts provides to its largest client.


Wabtec’s first quarter revenues of $695.2 million were 13% higher than revenues in the year ago quarter. Earnings rose 15% to 83¢ per share compared to 72¢ last year. This year during the quarter, the company’s skill in continuously applying lean manufacturing processes to reduce cost, lifted the operating margin to 17.5% from 16.9% a year ago. During the first quarter, freight sales rose 23% above sales last year and amounted to 56% of total sales. Transit sales increased 3%. Sales of new or rebuilt equipment, such as brakes or brake shoes to replace worn equipment or components, constitute 60% of Wabtec’s sales and are the company’s second highest margin products. The units manufacturing these products have become increasingly adept at removing cost. Sales of Positive Train Control (PTC) equipment, Wabtec’s highest margin product, reached $70 million during the first quarter. They included $41.2 million sold to freight customers who, unlike transit and Wabtec’s Brazilian railroad customers, pay promptly. The only flaw evident in Wabtec’s good quarterly results is an $80 million increase in accounts receivable during the quarter which is largely attributable to contractual terms of sales to transit systems and Wabtec’s Brazilian PTC customer where extensive testing is permitted before acceptance and hence payment is required. During the quarter, Wabtec secured a $16.6 million contract from Alaska Railroad Corp for a PTC system. Need for multiple regulatory approvals of Wabtec’s $220 million purchase of Fandstan delayed completion of the acquisition until June 6. Fandstan has manufacturing facilities in the U.K., Germany, Poland, China, Australia and the U.S. Its German factory near Dusseldorf generates sales of $90 million, almost 40% of Fandstan’s 2013 sales of $235 million. This formerly privately-owned company complements and strengthens Wabtec’s existing businesses. Accounting charges will prevent the acquisition from adding to reported earnings this year. Wabtec’s stock price is up 8% since the beginning of the year.

Donaldson Inc.

Donaldson’s fiscal third quarter sales of $624 million were 1% above the comparable figure a year ago while earnings per share of 46¢ were unchanged. Sales growth, excluding gas turbine filters, rose 6% driven by continued double-digit growth of replacement engine filters which generated a year-over-year revenue increase of $24.1 million. Gas turbine filter sales surged a year ago on a large $25 million delivery to Saudi Arabia and now reflect a more normalized revenue run rate of $42 million a quarter. Industrial filtration filter sales were up $12 million from a year ago. Solid manufacturing activity drove strong demand for Torit dust collector replacement filters which more than offset weaker sales of new systems. Excluding gas turbine, sales in Europe rose 7%, the U.S. rose 2%, Asia-Pacific was up 10% and Latin America rose 23%.

Donaldson continues to invest in organic growth opportunities, adding distribution capabilities in emerging markets and in sales and technical resources worldwide to win additional platforms for its newest filtration technologies from original equipment manufacturers who need to meet ever more stringent environmental regulations. In addition to these expenditures that will increase revenues, management continues to fund the rollout of its global enterprise resource planning system which will provide greater control over the company’s business. Continuing to spend to increase revenue and to improve expense control is sound business practice. During the quarter, Donaldson repurchased 2.4 million of its shares representing 1.7% of shares outstanding for $99.5 million or $41.46 per share. It intends to reach its target for the fiscal year of repurchasing 4% of its shares outstanding. The company also raised its dividend payment 18% to 66¢ annually, providing a dividend yield of 1.7%. Donaldson’s stock price at $41.50 is down 4% since the beginning of the year.

Precision Castparts

Precision Castparts quarterly earnings for its 2014 fiscal fourth quarter ending March 30, were $3.21 per share, 16% higher than the $2.82 per share earned in the year ago quarter. These results were achieved even though reported revenues rose only 4% in the quarter because lower metal prices for nickel and titanium alloys contractually must be passed through to customers. That reduced sales by $73 million. Intercompany sales of $56 million to Timet also cut reported sales for the quarter. Remarkably, costs in the 2014 fiscal fourth quarter were one million dollars less than last year’s comparable quarter. The importance of that achievement may have prompted Mark Donegan, the Company’s CEO, to state in response to a question about Boeing’s Partnering for Success initiative that “we are a company that’s constantly in a deflationary mode.” Success in the aerospace business requires cutting costs in half every time production doubles.

Sales for all of fiscal 2014 rose to $9.6 billion, 15% higher than fiscal 2013, while earnings per share rose to $12.12, 24% higher than the $9.72 earned in fiscal 2013. Cash flow from operations in fiscal 2014 rose to $1.6 billion, equal to 90% of reported net income. Aerospace sales in fiscal 2014 were 6% higher than the prior year and constituted 68% of total sales. Sales, mostly to Boeing for large commercial jets, amounted to 79% of the total while military sales, which are primarily spares, accounted for 15%. Regional jet manufacturers constituted the balance. Precision Castparts’ Airframe Products division currently supplies eight fastener shipsets to Boeing for production of its 787 Dreamliner. It is poised to begin delivering ten shipsets a month to match Boeing’s production rate for the innovative plane. In March, Precision Castparts agreed to acquire for $625 million, Aerospace Dynamics International, which operates a single facility in Valencia, California. It is a supplier of fasteners and latches to Airbus. Mark Donegan has stated for some time that he would like to increase Precision Castparts’ sales to Airbus, but would not operate a production plant in Europe to achieve that goal. Since January 1, Precision Castparts’ stock price at $273 is up 1% after rising 37.5% last year. During the quarter, the company paid an average price of $255 to repurchase 763,500 shares.

Air Lease Corporation

Air Lease produced strong first quarter results with revenues up 28% to $246 million and earnings up 50% to 57¢ per share from the comparable period a year ago. During the quarter the company delivered five new aircraft from its order pipeline bringing its total operating lease portfolio to 196 aircraft leased to 79 airlines in 47 countries. Air Lease sold four aircraft during the quarter for a gain which contributed 8¢ to earnings per share. The company seeks to sell aircraft when they are seven to eight years old, which is about one-third of their 25-year useful life. Its fleet has a book value of $7.7 billion and an average age of 3.8 years. Air Lease ended the quarter with $5.9 billion of debt, 2.3 times the book value of its equity. Its debt has an average maturity of seven years which equals the remaining average lease term of its leased aircraft portfolio. Its funding cost is 3.75%. Air Lease is the only aircraft leasing company with contracted future lease payments from its customers that exceed its debt outstanding.

Air Lease is seeing strong demand from its diverse customer base for the newer, more fuel-efficient aircraft in its order book. Passenger traffic growth of 5.6% in the first quarter remains strong. Boeing and Airbus have sold out their planned production of modern and more fuel efficient new aircraft years in advance. With fuel accounting for 30% or more of airline operating costs, Air Lease can obtain attractive and profitable lease rates with its customers for the aircraft in its order book. Air Lease targets the replacement cycle for its customers’ aging aircraft, so it is not dependent upon airlines expanding their existing fleets. It has placed all deliveries for 2014 and 2015 totaling 67 mostly single-aisle fuel efficient aircraft from Boeing and Airbus. It is now focusing on placing 265 aircraft it has in its order book for 2016 and beyond. Air Lease shares have risen 33% since mid-January.

Core Laboratories

Core’s first quarter revenues of $262.9 million, surprisingly, were only $2 million higher than revenues in the quarter a year ago. Although net income rose 7.8% and earnings per share increased over 10% to $1.35 per share, the results were disappointing. Core’s Production Enhancement Division, which over the past two years has accelerated the company’s revenue and earnings growth, achieved less than a 3% increase in revenues during the quarter and only an 8.6% increase in operating earnings. The slower growth reflects the effect of the harsh winter in North America on completion of wells in the oil-bearing shales. The division’s sales and earnings were up despite adverse conditions because it continues to introduce more effective tools for penetrating these formations along with oil-soluble chemical tracers to determine precisely where the stimulation has worked and where it needs to be repeated. Less than 20% of Production Enhancement’s revenues are from older products exposed to lower-priced competitive products which impinge upon overall growth. Revenue growth in Core’s original business Reservoir Description, which generates almost half the company’s revenues, surprisingly slowed almost to a halt during the first quarter. Higher margins lifted operating earnings 2% above last year’s quarter. The harsh weather in North America and Europe caused a decline in the number of cores cut and analyzed from established North Sea projects and North American shale oil fields other than those in the Permian Basin.

The earnings release and management’s comments on April 23 knocked the price of Core’s stock down 14% to $185 where it stabilized until May 12, when management reduced its earnings forecast for the current quarter to a range of $1.32 to $1.35 per share. That compares to first quarter earnings per share of $1.35 and $1.32 in last year’s second quarter. The lower forecast cut the stock price. Core repurchased 254,340 shares at an average price of $184 during the first quarter. Before the forecast was revised on May 12 it purchased 168,000 additional shares at an average price of $190. Core’s stock price now at $160 is down 16% since the start of the year. It was up 70% last year.

The rare occurrence of negligible Reservoir Description revenue growth coupled with management citing less sampling and analysis of reservoir fluids in established shale oil fields along with reductions in scheduled cutting of cores in these fields contributed to the selloff in the stock. Furthermore, after two successive steep price drops in the stock, the confidence of investors, including us, was shaken when management stated while discussing their reduced forecast, that three of the nine major core projects for deep water Gulf of Mexico wells scheduled for this year by operators were deferred into the second half. A few may be delayed into next year. The depths of all these wells are almost 30,000 feet beneath the sea floor. They each cost almost $200 million to drill, so a $3 million core analysis is an inconsequential expense. The analysis is crucial for determining how to initiate production to avoid damage to the reservoir and to help ensure maximum production over the life of the field. Many of the delayed core analyses were caused by oil company managements pausing to carefully scrutinize the cost of developing these deep water fields. After evaluations, all are proceeding. Two years ago, no cores were taken in the Gulf of Mexico. Last year, five were taken. Core analyses resemble business capital expenditures and are tied to exploration and development while fluid analyses are recurring operating expenses because the fluid composition changes as oil and gas are produced from the reservoir. Notably, Core continues to provide fluid analytics for Petrobras’ deep water wells in the pre-salt formation offshore Brazil. The oil in the formation, subject to intense pressure and heat, is undersaturated with natural gas which lessens the oil flow, making continual fluid analysis essential. Operators’ recognition of the importance of the understanding of fluids in maximizing production of the oil in place continues to generate rising recurring revenue for Core. As production depletes the oil in the reservoir, water increases, which necessitates even more frequent fluid analyses, especially in older fields such as those in the North Sea or the older producing wells in the Gulf of Mexico. Over 40% of Core’s revenues come from core analysis and fluid analytics for offshore operators. These operators store their cores for fluid analysis in Core’s laboratories where the conditions in producing wells or exploratory appraisal wells can be simulated to replicate intense pressures of up to 30,000 psi and heat of 500ºF at the well bore of deep water wells. Core’s revenues from fluid analysis are rising more rapidly than those from any of Reservoir Description’s other services. Including revenues from onshore operators it already is almost 50% of the division’s revenues. These revenues, which rise as reservoirs depleted by production require injection of fluids or gases such as CO2, help ensure a resumption of steady growth.


SGS, the world’s leading provider of inspection, verification, testing and certification services through its network of 1,650 offices and labs, reports its first half revenues and earnings in July. Its ADR price has risen 11% since the beginning of the year.

Mettler-Toledo International Inc.

Mettler-Toledo’s first quarter revenues of $550.6 million rose 4% in local currencies over the same period last year. Sales in the developed world grew nicely, rising 9% in Europe and 3% in the Americas. Sales in Asia grew 1% with sales in China unchanged from a year ago, excluding a 2% loss from the industrial businesses that the company exited last year. Industrial sales grew 1% while laboratory sales rose 7% with growth in all regions including China. Laboratory sales in China grew 6% with 16% growth in sales to life science and research labs. This strong growth more than offset a decline in sales of process analytics instruments to industrial customers. Reduced state funding for new chemical and power plants that use these instruments to monitor water quality, along with the loss of the local sales manager accounted for most of the decline.

Service accounted for 23% of the quarter’s revenues. With almost 2,800 service personnel, Mettler has a larger and more global service force than any of its competitors. The company provides extensive training and tools that make service technicians experts in specific product areas. An installed base of several million instruments and the detailed database that classifies each instrument by application and industry facilitates the development of service marketing campaigns. Mettler is developing standard service products to make it easier for the sales force to convince customers to purchase a service plan when they purchase an instrument. The company expects to increase this attachment rate from less than 20% as its sales force becomes more comfortable using the resources available in Blue Ocean, its new global information platform.

Earnings per share rose 9% to $1.97 over the first quarter of 2013, excluding restructuring charges. Unfavorable foreign exchange rates reduced earnings growth by 5%. The actions Mettler took in China last year to avoid projects with poor payment terms contributed to free cash flow growth to $34.5 million this quarter from $9.6 million in the first quarter of 2013. Mettler-Toledo’s stock price is up 3% since January 2.

Automatic Data Processing

ADP reported good fiscal third quarter results with revenues of $3.3 billion and earnings of $1.08 per share each increasing 7% from the comparable period a year ago. ADP is benefitting from the greater complexity companies face managing employee benefits as a result of the Affordable Care Act (“ObamaCare”). ADP’s TotalSource professional employer organization accelerated its revenue growth to 15%, all organic, as average worksite employees serviced rose 18% to 328,000 during the quarter. Through TotalSource, ADP provides health and dental coverage at attractive rates from third-parties in addition to payroll, HR and other employee benefits. New business bookings across ADP’s Employer Services business rose 14%. The company has implemented several product upgrades which simplify regulatory compliance and leverage analytics to assist their customers. The number of employees on existing client payrolls increased 2.8% for the quarter. The decline in interest earned on client funds reduced earnings growth by 2% during the quarter. ADP announced that it will spin off its Dealer Services business in October. This well-managed, profitable segment of the company generates nearly $2 billion of ADP’s $12 billion annual revenue. ADP’s stock price is down 1% year-to-date. It rose 45% last year.

CME Group Inc.

CME Group’s revenues of $777 million and operating earnings of 83¢ per share rose 8% and 14% respectively from the comparable period a year ago. Futures and options transaction volume rose 9% to 13.6 million contracts per day. This solid growth was fuelled by its interest rate franchise, which surged 19% on expectations for an improving economy and less government intervention leading to market determined interest rates. Equity and agricultural contracts rose 11% and 8% respectively while foreign exchange, metals and energy contracts fell 23%, 20% and 1% respectively. OTC swaps revenue, totaled $12.8 million, up 19% from last quarter. CME captures $128 per OTC trade and averages 1,500 trades per day. CME has a 49% share of this fledgling market. In January, CME made its special annual dividend related to the free cash flow generated during 2013 bringing the total 2013 related dividends to $1.5 billion representing a yield of 6.5%.

Despite these good results, CME shares have declined 10% since the beginning of the year with most of the drop coming after the publication of Michael Lewis’ book Flash Boys, which asserts that the cash equity markets are “rigged”. It does not opine about the futures markets in which CME operates, but the stocks of all publicly-traded exchanges fell. The futures industry’s vertical market structure is vastly different from the highly distributed structure of the equities market. About a dozen different equities exchanges compete for trading volume where orders are segmented into 80 different types. Liquidity for CME’s most widely traded benchmark products is concentrated at CME where it can identify who is doing what for whom down to the millisecond. High frequency traders who utilize CME exchanges are not afforded any special access or information that is not available to all other market participants. Many studies and analyses point to the liquidity benefit provided by high frequency traders which tightens the bid/ask spreads and reduces trading costs. High frequency traders account for approximately 15% of CME’s revenues. We think CME should be looked to as a model of market efficiency.

IDEXX Laboratories Corp.

IDEXX Laboratories had a great first quarter. Good execution of the new sales model delivered strong growth in new instrument placements and in diagnostic consumables and services. First quarter revenues of $360.2 million grew 8% organically over the same period a year ago. Earnings rose 10% to 89¢ per share. Recurring diagnostic revenues, which include instrument consumables and service, rapid assay tests and lab services, grew 10% organically over the first quarter of 2013 to $259 million, accounting for 72% of total sales. Worldwide placements of Catalyst chemistry analyzers grew 36% with more than 50% going to customers new to IDEXX. Overall hematology instrument placements rose 22% as well. The company placed 1,200 SNAP Pro mobile devices during the first quarter of its launch. These portable instruments read and record the results of SNAP rapid assay tests. The SNAP Pro improves technicians’ workflow by eliminating the need to monitor the assays to read results which fade about 30 minutes after the test is run. Clinics also capture more charges because they are recorded automatically in the practice management software. Initial interest in the SNAP Pro was strong: IDEXX placed 2,400 Catalyst Dx instruments during all of last year.

International diagnostics sales grew 15% organically during the quarter. Organic growth exceeded 30% in the Nordic countries, Austria, South Africa, Australia and China, and was above 15% in Japan, Germany, Holland and Switzerland. This growth results from investment in regional and country leadership as well as the introduction of innovative products. IDEXX plans to invest in its commercial organization worldwide as it scales its sales model. IDEXX Laboratories’ stock price has risen 23% year-to-date.

Varian Medical Systems

Varian Medical Systems’ second fiscal quarter revenues rose 1% to $779 million. Unfavorable exchange rates, especially the Japanese Yen, reduced sales growth by 2% over the second fiscal quarter of 2013. Earnings of $1.04 per share were 2¢ higher than last year’s second fiscal quarter earnings, excluding a 16¢ per share charge to settle long-standing intellectual property litigation. Oncology Systems’ quarterly revenues of $603 million rose 4%, while gross orders rose 6% to $613 million with North American and international markets growing 3% and 9% respectively.

During the second quarter, the company booked several large contracts with large hospital systems in the U.S., as well as in Algeria and Australia, that include the installation of several machines and long-term service and software agreements. Varian signed a $20 million agreement with UnityPoint Health, a health system with 290 physician clinics and 32 hospitals in metropolitan and rural Iowa, western Illinois and southern Wisconsin. It includes the purchase of at least four TrueBeam machines over the next three to five years to add radiosurgery capability throughout the system and a seven-year Enterprise Software Agreement to support Varian’s data management and treatment planning software. UnityPoint has centralized Varian’s software so that a patient’s diagnostic images can be taken at one site, medical physicists plan the treatment at another site, and treatment is then delivered at a third site closest to the patient’s home. The $51 million agreement with the Algerian Ministry of Health will equip six centers over the next five years with TrueBeam machines and software that will allow these centers to perform radiosurgery. The GenesisCare Health Network in Australia ordered 10 TrueBeams and software that will be delivered over the next three years.

Varian won these contracts because they worked with radiation oncologists and clinic administrators to create multi-year plans to build capabilities at a sustainable pace for these health care systems. The partnerships ensure that the clinics install and manage their radiation systems and software to deliver treatments cost-effectively. Knowing how many machines to deliver over a three to five-year period allows Varian to improve its operating efficiency by planning when to purchase materials and to manufacture the systems. The exclusive arrangements also eliminate the expense and distraction of competing for every machine and software installation. These long-term relationships also give Varian earlier insight into what its customers need, and thus enable it to develop the products and services its customers value most. Varian’s stock price has risen 6% since the beginning of the year.

FEI Company

For the first time since Don Kania became CEO in 2006, FEI Company’s quarterly revenues and earnings were below the company’s forecast. First quarter revenues of $226.3 million were up 2% from those of a year ago, but were $1.7 million below the $228 million low-end of the forecast that management provided in February. Earnings were 59¢ per share, down 9% and 1¢ below the low-end of the company’s forecast of 60¢ per share. FEI also reduced its forecast for second quarter revenues and earnings because five large orders to non-U.S. material science customers that FEI expected to book in the first quarter will be booked during the second or third quarter this year. Some customers decided to acquire FEI’s new products instead of those they had planned to order. This change can delay orders by several months because researchers often have to write new grants to fund the purchase. Over 50% of the product orders during the quarter were for new products, and management expects orders from materials science customers to be higher this year than last. FEI’s stock price dropped 10% on April 30, 2014, the day after it reported these lackluster results and is down 2% since the beginning of the year.

The rest of FEI’s businesses performed well during the quarter and demonstrate that working with leading scientists and engineers to incorporate their workflow improvements into the company’s products is a sound strategy for growth. Orders from the Industry business rose 18% to $123.2 million with acquisitions and favorable foreign exchange rates accounting for 11% of the growth. FEI’s Asian customers, Samsung, TSMC and Micron are investing heavily to develop robust sub-20 nanometer processes and to manufacture microprocessors with three dimensional features. Engineers use FEI’s high-end transmission electron microscopes (TEMs) in the lab to analyze defects and the chemical composition of the chips.

Science orders of $124.1 million were only 2% lower than orders from the first quarter of 2013, despite the decline in materials science orders. Orders from structural biology customers were more than twice those of a year ago as cryo-electron microscopy, a technique where biologists take thousands of images of frozen proteins in rapid succession before they are damaged by the electron beam, provides high-resolution structures of proteins that cannot be acquired with existing techniques. Scientists at Cambridge University and the Max Planck Society developed a new detector for the Krios TEM, FEI’s instrument designed specifically for structural biology, based on the sensor of digital cameras. It takes bursts of photos which coupled with new image processing software produces a clear, detailed image of the protein. In the March 28, 2014 issue of Science, an article titled “The Resolution Revolution” summarizes how scientists used FEI’s microscope to determine the structure of a large protein. The author stated that “…this achievement heralds the beginning of a new era in molecular biology.”

Sigma Aldrich Corp.

Solid performance of Sigma-Aldrich’s Applied and Commercial businesses lifted first quarter revenue to $689 million, 3% organic growth over the first quarter of 2013. Divestitures reduced reported sales by 1%. Earnings per share rose 5% to $1.06 excluding one-time restructuring charges. The Research division’s sales of $359 million (52% of total sales) grew 1% as sales to research labs in Europe and Latin America offset a small decline in U.S. sales. Inclement weather and weak government research funding impacted the U.S. business during the quarter. Management noted that more National Institutes of Health funding is going to actual research rather than to payroll and infrastructure and thus expects some growth in the U.S. market during the second half of the year. The Applied division’s sales rose 7% to $171 million with Diagnostics and Testing revenue growing more than 10% in Asia and Europe. Sigma continues to launch its Cerilliant analytical chemistry products in these regions.

Commercial sales rose 3% to $159 million during the quarter. Life Science product sales, which account for about 60% of the division’s sales, grew in low single digits because several large contract manufacturing projects ended during the fourth quarter instead of during the first quarter as expected. This sales decline offset double digit sales growth in both the cell culture media and Life Science services businesses. Sigma’s cell culture media sales have grown almost 10% per year for the past several years. The company is building a new plant in Scotland to provide an added source of supply for its U.S. and European customers. Sigma provides cell culture media to all major pharmaceutical and biotech companies and is winning more early-stage drug development business. Cell culture media contain 60 to 100 products that nourish the cells that produce biologic drugs. Sigma makes most of the components of its media in addition to combining it and grinding it to a uniform size and composition. A portion of a bag of dry medium must produce the same results when mixed with water as does the entire bag. Once a company uses a cell culture medium to manufacture a drug, regulatory agencies specify its use for the drug’s entire product life. The ability to provide consistent batches of the product, to qualify the source of each component and to manufacture according to Good Manufacturing Practices (GMP) required by regulatory agencies around the world, makes Sigma an ideal vendor of this critical material. The company prices many of its products based on its quality level with GMP or PharmaGrade brand products commanding the highest prices. Sigma-Aldrich’s stock price is up 7% since January 2.


Roche’s first quarter sales of CHF 11.5 billion rose 5% in constant currencies over the same period a year ago. The Pharmaceuticals Division’s sales were CHF 9.0 billion, an increase of 4%. Oncology drugs’ sales were CHF 5.6 billion. Sales of its breast cancer drugs of CHF 1.8 billion, grew 17% worldwide and 27% in the U.S. Perjeta and Kadcyla, Roche’s new breast cancer treatments, accounted for 31% of the CHF 580 million U.S. sales of the Herceptin drug family during the quarter. Both drugs are seeing strong market share gains in their labelled indications. Kadcyla, launched in February 2013, is used in 43% of treatments when metastatic cancer returns after treatment. Perjeta has 65% share in the neo-adjuvant setting where patients with early stage cancer receive the drug 9 to 18 weeks before surgery to shrink the tumor and has 55% share for the initial treatment of metastatic breast cancer. The company’s broad offering of immunoassays for clinical labs contributed to the quarter’s 7% revenue growth of Roche’s Diagnostics Division to CHF 2.46 billion. Strong sales of the human papillomavirus (HPV) test lifted sales of the Molecular Diagnostics group by 7%, not including reagents sold to life sciences researchers. The test received FDA approval for primary screening for cervical cancer on April 25, 2014, which allows doctors to use this test instead of a Pap smear in women over 25 years old. Roche’s ADR price is up 10% since the beginning of the year.


Nestlé’s first quarter sales of CHF 20.8 billion grew 4.2% organically over the same period a year ago with volume growth outpacing price growth. Sales of CHF 11.4 billion in developed markets grew 0.6%, while sales of CHF 9.4 billion in developing markets rose 8.5%. Sales in the Americas rose 4.1% organically to CHF 6.0 billion with volume contributing 2.0% to the growth. New product launches in frozen pizza, in beverages with CoffeeMate Scout Flavors (thin mint and coconut caramel) and in confectionery with Butterfinger cups offset reduced sales from severe weather in North America and the impact of the late Easter holiday on confectionery sales in Brazil. Severe weather in the U.S. affected factory, transport and retail operations in addition to consumer behavior. Confectionery is Nestlé’s largest category in Brazil with annual sales of more than CHF 1.0 billion. Most of these sales occur at Easter! In fact, confectionery sales for the company declined 3% during the quarter because of the lack of Easter sales in the U.K., Germany and France, Nestlé’s largest confectionery markets. Nestlé Waters’ first quarter sales of CHF 1.6 billion grew 6.2% over the same period a year ago with volume growth of 8.1% offsetting some price deflation. A warm winter in Europe, a switch to “healthier hydration” in the U.S. and strong growth in Nestlé Pure Life and branded waters in China, Turkey and Egypt contributed to growth in this highly competitive market. Nestlé’s ADR price has risen 8% since the beginning of the year.

* * *

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.