2nd Quarter, 2014

Your companies’ good second quarter earnings, in many instances, directly benefitted from skillful teamwork their managements purposefully have rewarded over the past five years. Their concentration on performance and responsibility has enabled division managers throughout their companies to reduce unit costs while managing profitable expansions through careful investment in new sources of recurring revenues from providing existing or similar products or services to new customers. Sustained internally generated growth is never easy, but it’s steady. Unsurprisingly, many of our nation’s largest companies are looking elsewhere for growth while everyone is reminded regularly by the Federal Reserve that interest rates must be kept low to stimulate economic growth. Merger and acquisition activity, led by GE and the largest telecom, healthcare and technology companies, so far this year has reached $1.75 trillion surpassing 2007’s takeover volume. The size of these larger companies often makes it difficult for them to generate meaningful internal growth when their markets are growing slowly, so with large cash balances earning meager returns and financing readily available the merger boom has arrived. It will continue until it stops. It usually is not good for the shareholders of the buyers. The S&P is up 8.5% since the beginning of the year.

Automatic Data Processing

ADP’s fiscal fourth quarter and full year revenues rose 10% and 8% respectively to $3.1 billion and $12.2 billion, while earnings of 63¢ and $3.14 per share rose 15% and 9% from the prior year quarter and fiscal year respectively. The average number of employees on each employer’s payroll rose 2.9% during the quarter and 2.8% for the full year. New business bookings of $1.4 billion during the year were up 7% from the prior year, while client revenue retention improved to 91.4%, an all-time high. The company now has 90% of its more than 400,000 small business clients on RUN powered by ADP and 50,000 mid-sized businesses on ADP Workforce Now. The adoption of these new cloud-based solutions generates more revenue and profit for ADP because customers tend to buy additional integrated add-on services when they upgrade to the new platforms. ADP’s stock price is up 5% year-to-date.

ADP plans to spin-off its Dealer Services business into an independent publicly traded company named CDK Global, Inc. It will begin trading under the ticker symbol CDK on October 1. The new company will be the largest global provider of integrated information technology and digital advertising and marketing solutions to automobile dealerships and manufacturers. During its fiscal fourth quarter CDK’s revenues rose 8% to $499.4 million and operating profit of $113 million rose 19%. During the fiscal year, revenue and operating profit of $1.95 billion and $428 million rose 7% and 14% respectively. Nearly all of the growth was organic. CDK is benefitting from new business sales and an increase in digital advertising spending from its customers who comprise 26,000 car dealerships and most auto manufacturers in the U.S. and in over 100 additional countries.  Customers include seven of the ten largest auto retailer groups by total new vehicle units sold. The dealer management system is at the core of a dealership. Its solutions automate and integrate critical workflow processes from pre-sale advertising and marketing campaigns to sales, financing, insurance, parts supply, repair and maintenance of vehicles. CDK’s digital marketing business maintains websites and manages the rapidly growing digital advertising spending of dealerships and auto manufacturers. We have watched management methodically build this business over many years and intend to hold and possibly add to the shares of CDK that we receive in the spin-off. Index funds which own ADP stock may sell CDK when it begins trading which would provide an attractive opportunity to buy more.

IDEXX Laboratories Corp.

IDEXX Laboratories’ integrated diagnostic strategy, where Veterinary Diagnostic Consultants (VDCs) sell both in-clinic instruments and reference lab services, continues to deliver strong sales and earnings growth. Second quarter sales of $390 million grew 9% organically over the second quarter of 2013. Earnings increased 11% to $1.10 per share. The new sales strategy delivered 12% organic growth in recurring diagnostics revenues with 13% growth in in-clinic instrument consumables and 12% growth in reference lab services. Placements of Catalyst Dx, IDEXX’s in-clinic chemistry instrument that generates the bulk of instrument consumable sales, rose 34% to 800 units. Of the 500 units placed in North America during the quarter, 60% went to customers new to IDEXX. In the 12 months since the start of the new sales program, the company’s 125 VDCs called on 16,000 of its 22,000 U.S. animal hospital customers. Year-over-year revenue growth for clinics that received VDC visits was 11.9% versus 2.9% for clinics that did not. Sales grew because VDCs spent more time explaining the value of the company’s diagnostic tests and services to vets. IDEXX’s sales grew despite slow growth in vet clinic visits during the quarter, which rose 0.6% while practice revenue grew 4.3%.

As a result of the success of its new model, IDEXX announced on July 25 that it is expanding its sales force. It will shrink the size and increase the number of sales territories from 125 to 174 to provide direct representation to over 1,100 vet clinics which are currently served by telesales. Each VDC will call on 120 clinics per month instead of 160 clinics, which increases the number of calls each VDC can make by 15%. The addition of new VDCs increases the number of calls to vet practices by 60%. The company is also increasing the number of field service representatives from 25 to 48. Field service representatives, most of whom were vet technicians, know vet practices intimately and work with three or four VDCs. They install instruments, provide customer support and help clinics to activate and use VetConnect Plus, a cloud-based service which provides a single source for each patient’s diagnostic history and pushes test results to a cell phone or tablet as soon as they are ready. Active users of VetConnect Plus are IDEXX’s most loyal customers with 99% retention rates for instrument consumables.

IDEXX is also adding 12 professional service veterinarians to provide peer-to-peer clinical support for its growing portfolio of specialized tests, which currently account for less than 10% of reference lab sales because they have not been detailed. In the first quarter of 2013, 50 laboratory diagnostic consultants and inside salespeople sold IDEXX’s reference lab services to vets. With the implementation of the new sales force strategy in April 2013, the total number of sales people rose to 227. It will rise to 412 in 2015 with the expanded sales force which will accelerate the growth of reference lab services sales. IDEXX Laboratories’ stock price has risen 15% since January 2.

Express Scripts

Express Scripts’ second quarter adjusted earnings of $1.23 per share were up 9% over the same period a year ago. Adjusted earnings exclude amortization and restructuring costs associated with the Medco acquisition. A 7.5% reduction in share count from 828 million to 766 million diluted shares outstanding accounts for all of this growth. The company purchased 29.9 million shares of stock for $2.2 billion, at an average price of $73.29, during the quarter. While net income did not change, Express Scripts successfully offset the decline in gross profit from the loss of the claims of UnitedHealth members with productivity increases from the decommissioning of the legacy Express Scripts IT platform and from optimizing the number of call centers and large automated pharmacies that fill prescriptions for home delivery. These operating efficiencies and better management of drug costs with the National Preferred Formulary, which was selected by over 90% of its commercial clients, contributed to 13% growth in operating earnings per prescription to $5.37. CEO George Paz’s crisp description of the company’s success selling its unique money-saving services to new customers and increasing its business with existing customers encouraged investors to envision profitable growth for Express Scripts once the back office integration is complete. Express Scripts’ stock price is up 5% year-to-date.


Wabtec’s second quarter sales and earnings of $731 million and 91¢ per share were 15% and 18% higher than the comparable quarter last year. Freight sales, which contributed 56% of total sales rose 16% above sales in the year ago quarter. Transit sales were 13% higher, although unlike freight sales where the margin widened 2.2% to 24.4%, the transit margin contracted 1.2% to 11.5%. Orders during the quarter lifted the freight backlog up to a record $1.25 billion while transit orders for cars and locomotives brought the transit backlog up to a record $1.25 billion. Wabtec is the only US manufacturer offering a commuter locomotive compliant with the new EPA Tier 4 emission regulations that become effective in 2015. The company’s Positive Train Control System (PTC) is the only Electronic Train Management System approved by the Federal Railroad Administration. Rail safety legislation enacted in 2008 requires US railroads and commuter authorities to install and implement this technology, or a comparable approved solution, by the end of 2015. Wabtec and all the affected government and industry organizations expect the deadline will be extended. Wabtec’s second quarter PTC revenues were $74 million, 14% above a year ago.

On June 6, Wabtec completed the acquisition of Fandstan for a cash payment of $199.4 million provided equally from cash held overseas and borrowings. The acquisition adds annual sales of $240 million of which 60% are obtained from transit systems. The other 40% of sales are sold to industrial users of equipment such as cable management control devices for seaport cranes, offshore oil installations and wind farms. Importantly, 30% of Fandstan’s sales are replacements of worn equipment. Amortization of acquisition costs will result in little earnings contribution during the initial year of ownership. Wabtec’s stock is up 11% since the beginning of the year.

Donaldson Inc.

Donaldson’s fiscal fourth quarter sales growth accelerated from the pace achieved in recent quarters, rising 6%. Revenue reached $668 million, while earnings during the period of 50¢ per share rose 4%. During its fiscal year ending July 31, sales of $2.47 billion rose 2% and earnings of $1.76 rose 7% from the prior year. During the past year, sales of filters to original equipment manufacturers of on-road vehicles rose 5% and sales of off-road vehicles declined 4% in constant currency. Aftermarket sales were particularly strong, rising 12% to more than $1 billion and represented 64% of engine filter sales. Build rates for new trucks have picked up while agricultural equipment sales have slowed. New mining equipment volumes remain at low levels but construction equipment demand is improving. Donaldson’s Industrial Filtration Solutions, comprised primarily of its Torit dust collection systems, rose 4% driven by strong demand for replacement filters as a result of solid levels of manufacturing activity. Weak capital spending on new manufacturing facilities, however, slowed demand for new industrial dust collector systems. During the fiscal year, liquid filtration sales rose 13% and accounted for over $500 million of revenues. Liquids filtration growth is boosted by market share gains from platform wins for Donaldson’s Select diesel fuel filters which use the company’s proprietary Synteq XP Media. This novel filtration material provides enhanced engine protection from contaminants and water which are more prevalent in today’s ultra-low sulfur and bio-diesel fuels.

In addition to strong utilization of equipment in the field, and more proprietary systems requiring Donaldson made replacement filters, the strong growth in replacement filter sales is the result of Donaldson management’s decision to expand distribution of replacement filters in underpenetrated markets. During the quarter, Donaldson added 58 new distributors in Latin America, Southeast Asia, India, China and Eastern Europe. Last month it opened its newest distribution center in Peru, and work is underway on a new distribution center in Slovakia. More filter demand means Donaldson needs to add manufacturing capacity to meet growth. Its new plant in Poland will be completed in the spring. Donaldson’s stock price is down 4% since the start of the year.

Precision Castparts

Precision Castparts’ stock price is down 10% since the beginning of the year with much of the decline occurring after the company reported on July 24 earnings of $3.32 per share, 15% higher than earnings for the quarter a year ago. The earnings were 3¢ below the analysts’ consensus estimate. Some investors were disappointed that the year-to-year increase in revenues was only 7% after reductions for contractual metal price pass-throughs and intercompany sales. Absent these required adjustments, sales would have risen 11%. The probable causes for the selloff, however, are doubts about the company’s ability to reach its 2016 earnings goal. They were voiced by some analysts on the scheduled call where management comments on the quarterly results. The questions included a statement that management had missed meeting analysts earning expectations in nine of the last fourteen quarters. That was followed by asserting that an extrapolation of last year’s earnings at a low teen growth rate would result in a number below the low-end of the per share earnings goal of $15.50 – $16.50 set by management for the fiscal year ending March 31, 2016. Precision’s management never provides quarterly or even annual earnings estimates. We think that scheduled production increases by Boeing and to a lesser extent Airbus, assure that Precision will experience accelerated sales growth after the current quarter sufficient to meet the company’s goal. During the current quarter, sales will be crimped by annual maintenance of Timet, the company’s titanium producer, and its forges. Throughout the quarter, the pace of casting and airframe components production will accelerate to meet Boeing’s production rate of ten 787s a month. Precision’s content on each 787 is $10 million. During the quarter, the company bought 637,000 shares at an average price of $249.

Air Lease Corporation

Air Lease delivered strong second quarter results with revenues of $256.3 million up 23% and earnings of 58¢ up 42%. The company delivered thirteen new aircraft to eight customers from its order book bringing the number of owned aircraft to 207 which are leased to 77 airlines in 47 countries. During the quarter the company sold two aircraft from its operating lease portfolio generating a gain of 8¢ per share. Excluding the two aircraft sales, revenues rose 18% and earnings per share rose 22% from the same period a year ago. The young and valuable Air Lease aircraft portfolio has an average age of 3.6 years, an average remaining lease term of 7.2 years and an aggregate fleet net book value of $8.3 billion. More than 95% of its aircraft are operated outside of the U.S. with 46% in Asia/Pacific.

Air Lease’s customers continue to lease more new aircraft to replace their aging fleets. The improved fuel efficiency of new aircraft reduces the airlines operating costs making them more profitable. In addition, passenger traffic continues to grow. The International Air Transport Association recently reported that revenue passenger-kilometers have risen 5.9% globally during the first half of 2014 and load factors remain healthy at 79.3%. Air Lease’s stock price is up 16% since mid-January.

Varian Medical Systems

Varian Medical Systems’ fiscal third quarter revenue of $748 million was up 3% from the same period a year ago. Earnings rose 5% to $1.08 per share, excluding a one-time charge taken this quarter. Oncology Systems’ sales also rose 3% to $578 million. Orders fell 1% with orders in North America unchanged from last year and orders from markets outside North America down 2%. Strong growth in emerging markets including Latin America, China and Eastern Europe did not offset a 30% decline in orders in Japan. Japan is Varian’s second largest market after the U.S. and orders were up 50% a year ago. Orders in Latin America rose more than 30% while orders in China rose 20% during the quarter. Orders in emerging markets now account for 15% of Varian’s total orders.

The proposed Center for Medicare and Medicaid Services reimbursement rates and two clinical studies strengthen the case for hospitals to purchase Varian’s radiation systems. The new bundled rate for radiosurgery is the same whether treatment is performed on a Varian system or on competitive systems that use a cobalt radiation source. A study conducted at the University of Alabama, Birmingham, showed that using Varian’s system to treat multiple brain metastases is both more efficient and comparable in plan quality to the cobalt systems. Another study demonstrated that the all-digital sub-systems including patient positioning, image guidance and real-time tumor tracking, of TrueBeam and EDGE, Varian’s systems designed to perform radiosurgery, together deliver treatments that are accurate to less than one millimeter. Earlier state-of-the-art systems had overall accuracy of 2 millimeters. This improvement increases radiation oncologists’ confidence that they can safely deliver high doses of radiation to tumors near critical organs. Varian’s stock price has risen 8% since January 2.

Core Laboratories

Core’s second quarter sales and earnings met the lowered forecast management provided to investors in mid-May. Consolidated revenues for the quarter were less than 2% higher than those earned in the year ago quarter while earnings after subtracting a 7¢ per share benefit from foreign exchange translation gains and a lower tax rate were $1.35 per share compared to $1.32 earned in last year’s second quarter. Revenues from Core’s two largest divisions Reservoir Description and Production Enhancement, which together produce 90% of the company’s revenues, were no higher than a year ago. The slight revenue and earnings gain achieved in the quarter came from Reservoir Management which is a good business but not the reason we nor other investors own the stock. We own Core because it provides oil companies, including majors, independents and national oil companies, with analytic services that enable them to produce oil and gas with minimal damage to the reservoir which helps maximize the recovery of more of the oil originally in place. That is crucial because even with the advanced technology utilized by the oil industry onshore and offshore, rarely more than 40% of the oil in place is recoverable today. In some of the new discoveries in the deep-water wells offshore in the Gulf of Mexico and offshore Brazil and Angola the estimated recovery is as little as 10% unless laboratory fluid analyses conducted by Core yield a solution. A 1% increase in the ultimate recovery from the deep-water discoveries in the lower tertiary formation over 30,000 feet beneath the Gulf of Mexico seafloor is worth $6 billion to the participating companies. The least expensive oil to produce is the incremental barrel from an existing field where all the extractive infrastructure exists. That is particularly true of the wells beneath an offshore platform.

Core’s business is improving despite two quarters of disappointing earnings caused by the deferral of analyses of cores taken from deep-water wells in the lower tertiary formation beneath the Gulf of Mexico. Revenues from these services are tied to exploration and are not recurring like revenues from analyses of the fluids in producing reservoirs where the composition of the liquids changes as gas and oil is produced. Water increases as the oil is extracted and the percentage of asphaltenes, waxes, hydrates and other contaminants such as scale changes. If untreated, the flow in the reservoir is impeded. All these contaminants must be dynamically analyzed before the operator decides which fluids or gases might be injected to enhance recovery. Over half Core’s Reservoir Description revenues, which constitute 48% of Core’s total revenues, come from reservoir fluid analyses. These laboratory services using customer supplied cores are growing faster than any of the other services provided by this division. The value of these analyses is confirmed by customers’ contracting with Core for more of these analyses at more frequent intervals. Core’s stock price is down 19% since the beginning of the year. During the quarter, the company paid an average price of $172.41 to purchase 455,219 shares of its stock.

Mettler-Toledo International Inc.

Consistent execution of its targeted marketing programs and new product introductions contributed to Mettler-Toledo’s second quarter sales of $609 million, sales growth of 4% in local currencies over the second quarter of 2013. Earnings rose 8% to $2.54 per share, excluding restructuring charges in both periods. Sales in the Americas rose 5%, while sales in Europe and Asia grew 3% each. Good growth in laboratory instruments and product inspection systems contributed to 2% sales growth in China, the first reported growth in several quarters. Laboratory sales grew 6% during the quarter with strength in balances, pipettes, analytical instruments and process analytics, an extension of the company’s pH sensors to monitor water quality in manufacturing processes and in power plants that need clean water.

Mettler plans to increase its market share in pH meters with the addition of a hand-held meter and a basic bench top meter to complement the high-end bench top instrument introduced last year. The hand-held instrument’s ergonomic design makes it easy to hold and a graphic display makes it easy to read in low light. In addition to having a light that indicates when the measurement is good, customers can purchase kits with a meter, sensor and accessories designed for their industry segment. The new bench top pH meter has fewer features than the high-end model, but is priced to be sold by distributors and telesales in emerging markets. To further reduce cost, its ease-of-use allows marketing and product training to take place primarily on the web. Mettler-Toledo’s stock price has risen 10% since January 2.

FEI Company

FEI Company posted second quarter revenue of $237 million up 6.5% from $223 million in the second quarter of 2013. Earnings per share of 70¢, excluding one-time items, were 2¢ lower than earnings per share of 72¢ a year ago. With orders for new products accounting for more than 50% of orders so far this year, FEI decided to write-off $755,000 of parts from old products and sold two older systems at a discount. The company also incurred one-time charges associated with the move to its new factory in Brno, Czech Republic, which was completed on time and under budget. This well-executed move enabled FEI to ship instruments assembled at the new facility in August.

Orders booked during the second quarter rose 9% to $259 million compared with orders of $237 million a year ago. Science orders rose 14% with Materials Science orders up 10% over the second quarter of last year and up 50% over the first quarter of 2014. Several universities and research institutes in the U.S. and Europe ordered the new $5 million Titan Themis transmission electron microscopes (TEMs) for materials analysis and Krios TEMs for structural biology. Demonstrations of FEI’s newest instruments at a customer event in Brno on September 6, highlighted the improvements in ease-of-use the company has incorporated into its newest instruments. Its new electron microscopes use the company’s proprietary software that aligns optical images and high resolution electron microscope images in the viewfinder to create a Google Earth effect. The user locates an area of interest, selects it and then turns a dial to increase the resolution of the area to the micro- or nano-scale. This intuitive approach makes it much easier to find objects of interest or to create samples for a TEM using a dualbeam instrument.

Orders for the Industry business were $110 million, up 3% from $107 million for the same period a year ago. While all of FEI’s major Electronics customers have acquired a near-line system, a TEM designed to measure small features and a dual-beam that automatically takes samples from 12-inch wafers, customer issues related to the timing of investments in specific semiconductor manufacturing facilities delayed a couple of these $10 million orders. Initial customer feedback indicates that FEI’s system provides critical analyses for semiconductor manufacturers producing chips with geometries below 20 nanometers. The first customer with a working system commented that they had never seen such good results with so little labor, thus getting better data at a lower cost. The order delays, however, pushed some revenue for these systems into 2015 and forced FEI to reduce its 2014 revenue estimate by $30 million to $983 million from $1.01 billion, 6% growth over 2013. This revision sent the stock price down 12% on July 31, the day after FEI announced its second quarter results. FEI’s stock price recovered most of the loss in August and is down 7% since the beginning of the year.

Sigma Aldrich Corp.

Sigma-Aldrich’s second quarter sales of $701 million rose 2% organically over the same period a year ago. Higher volumes, a 1% price increase and good expense control contributed to 6% growth in earnings to $1.11 per share. Growth in U.S. Research sales strengthened during the quarter. They were up slightly compared with the second quarter of 2013, but were up 4% compared to the first quarter of 2014. Sigma initiated several collaborations with leading academic labs and research hospitals to develop new gene-editing tools that are less expensive and easier to use for exploratory studies. The company introduced its second technology for chemical synthesis developed by chemists at The Scripps Institute. It is safer to use and delivers higher product yields. These collaborations strengthen Sigma’s scientific dialogue with leading scientists and expand the market with innovative new products. Global research sales of $357 million were unchanged from a year ago because funding restraints in Europe offset the growth in the U.S.

Revenues from Sigma’s Applied business of $172 million grew 6% organically as the business expands its offering of products with its Enhanced Quality profile. These products address the more stringent regulatory scrutiny of supply chains and risk management issues faced by diagnostics and testing labs. Sigma is also manufacturing more assays for these customers in its dedicated state-of-the art manufacturing facilities for in vitro diagnostics that meet ISO and FDA good manufacturing practices. SAFC Commercial’s sales rose 1% during the quarter to $172 million. $6 million in contract manufacturing sales were delayed to the fourth quarter of 2014 and the first quarter of 2015. Contract manufacturing, which accounts for 15% of SAFC Commercial’s sales, receives multi-million dollar orders that can be delayed a month or two because of delays in the FDA approval process. Order cancellations are rare, however, because almost all of the drugs are approved. Once a drug receives FDA approval, sales of Sigma’s products continue for the life of the drug. Sigma-Aldrich’s stock price is up 10% since the beginning of the year.


Revenue from Roche’s drugs that treat metastatic breast cancer and rheumatoid arthritis grew more than 20% during the first half of 2014 to CHF 3.7 billion and CHF 568 million respectively. They accounted for 19% of the company’s first half revenues of CHF 23.0 billion. Sales grew 5% at constant exchange rates over the first six months of 2013. Core earnings per share, which exclude amortization of intangible assets, restructuring charges and other non-recurring expenses, rose 7% to CHF 7.57 per share. Roche generated free cash flow of CHF 6.3 billion during this period, 95% of net income.

Roche presented clinical results for 27 different drugs at the American Society of Clinical Oncology in early June. The most compelling results came from a Phase I study of its anti-PD-L1 immunotherapy drug for metastatic bladder cancer. This cancer is the ninth most common cancer globally and the fourth most common in men. It also has a grim prognosis with 5% survival at 5 years. After six weeks of treatment, the drug shrank 43% of the tumors in patients whose tumors tested positive for the presence of PD-L1. At 12 weeks, 52% of the patients responded to the treatment with complete elimination of the tumor in 7% of the patients. As the first potential new treatment for this cancer in 30 years, on May 30, 2014, it received FDA breakthrough therapy designation which expedites the development and review of drugs that treat life-threatening illnesses and have preliminary clinical evidence which indicates that the drug may demonstrate substantial improvement over existing therapies.

On August 24, Roche announced the acquisition of InterMune for $8.3 billion in cash. InterMune, a biotech company based in Brisbane, CA, has commercialized pirfenidone in Japan, Canada and 15 European countries. Pirfenidone is an oral drug that delays the progression of idiopathic pulmonary fibrosis (IPF), a progressive, irreversible and ultimately fatal disease characterized by loss of lung function due to fibrosis (scarring). Results from a Phase III clinical study published in May demonstrated the effectiveness of the drug in delaying the loss of lung function. When the data from this study were combined with those from two other Phase III studies, pirfenidone reduced the risk of death at one year by 48%, making it one of the first drugs that may prevent the onset of IPF if patients are treated before the disease progresses. InterMune received breakthrough therapy designation for pirfenidone in July and expects the FDA to approve it in late November. Roche estimates that 200,000 people suffer from IPF in the U.S. and in Europe. These patients will benefit from Roche’s patient access programs and its experience in educating physicians about the benefits of early treatment of irreversible diseases. Genentech has an established R&D and commercial organization in pulmonology. It currently markets Pulmozyme for cystic fibrosis and Xolair for moderate to severe asthma. Adding InterMune’s expertise in fibrosis to Roche’s expertise in inflammation and immunology will strengthen the company’s R&D programs in pulmonology. Roche’s ADRs are up 9% since January 2.


SGS’ first half 2014 revenues of 2.8 billion Swiss Francs and earnings of CHF 0.33 per ADR rose 5.3% and 6.5% respectively from the same period a year ago on a constant currency basis. Three-quarters of revenue growth was organic while one-quarter came from acquisitions. Excluding its Minerals Services business which experienced a 7.6% organic revenue decline, the remaining businesses generated solid organic growth of 5.8%. Reduced exploration spending by mining operators cut geochemistry and metallurgy sample volumes at SGS’ large Minerals facilities in Canada, Australia and South America. SGS is further reducing headcount and capacity by closing under-utilized locations. The decline in Minerals was more than offset by strength in Consumer Testing Services which delivered 7.3% revenue and 8.7% profit growth with an operating margin of 22.7%. Strong growth in East Asia and the Americas came from restricted substance testing (there are European Community regulations prohibiting more than 1,000 substances from a variety of products) in its electronics segment and in additional testing of cosmetics, personal care and household hygiene products after additional capacity was added.

Frankie Ng, who built Consumer Testing Services into one of SGS’ most consistently profitable businesses, is now running Industrial Services. After six acquisitions and the completion of a major restructuring in Europe, Industrial Services generated 8.3% revenue growth and a 19% jump in profits during the first half of 2014. The business delivered double-digit organic revenue growth outside of Europe with strong U.S. growth coming from pipeline integrity testing. SGS’ ADRs are down 3% year-to-date.

CME Group Inc.

CME’s revenues of $731.6 million and adjusted earnings of 77¢ per share declined from the same period a year ago by 10% and 17% respectively. Average daily volumes transacted at CME exchanges were 12% below the strong level of a year ago when interest rate volumes surged 70% in June 2013 after Fed Chairman Bernanke began discussing the need to begin tapering its purchases of Treasury and mortgage backed securities. Historically low levels of volatility across foreign exchange, equity and energy markets reduced average daily trading volumes of futures and options contracts to 12.6 million. CME’s high fixed expense operating structure hurts profitability during periods of lower trading activity. During the quarter, CME offered a voluntary retirement program and received about 2.5% participation amongst its employees helping to reduce the fixed expense base modestly. To be eligible, employees needed to have a combination of age and years of employment at CME of 70 or more. CME’s shares are up 4% since the beginning of the year. Volumes have picked up since the end of the quarter. Quarter-to-date volumes are up 9% year-over-year, lifted by an increase in interest rate volume of 21%. Open interest of 106 million contracts has reached an all-time high.


Nestlé delivered solid first half revenues of CHF 43 billion in difficult market conditions. Organic sales growth was 4.7% over the first half of 2013 and up from 4.2% in the first quarter of 2014. Revenue rose 0.6% in developed markets to CHF 23.9 billion and 9.7% in emerging markets to CHF 19.1 billion. Product volumes, what Nestlé calls real internal growth, rose 2.4%, 2.3% and 4.2% in the Americas, Europe and Asia/Oceania/Africa respectively. Europe, which accounted for 28% of sales, continues to be the most difficult market. Prices fell 0.9% as supermarkets cut prices to appeal to cash-poor consumers. The company’s operating margins increased 0.3 percentage points to 15.4% despite a 5% increase in consumer-facing marketing expenses. Strong sales of premium and super premium infant formula in developing markets contributed to organic sales growth of 7.9% for the Nutrition and Health business with 3.9% coming from volume growth. Operating margins for this business increased 1.3 percentage points to 19.9%.

Nestlé’s premium coffee businesses continue to thrive on innovation and global expansion. Nespresso’s annual revenue, the company’s super-premium coffee system, is over CHF 4.25 billion and Nespresso CEO Jean-Marc Duvoisin, expects revenue to increase CHF 500 million this year. The successful launch of new grand cru coffees, the Nespresso Cube, a store with fully automated capsule delivery, and the VertuoLine, a machine developed specifically to suit the tastes of North Americans for a large cup of coffee contribute to double-digit revenue growth. On August 27, Nestlé announced a new initiative to source all of its permanent grand cru coffees sustainably through the AAA Program the company established with the Rain Forest Alliance in 2003. Nestlé will invest over CHF 15 million over the next five years to improve the cultivation of coffee plants by small farmers in Ethiopia, Kenya and South Sudan. Earnings per share for the half were CHF 1.57, an increase of 3.6% in constant currencies. On August 7, Nestlé announced a CHF 8 billion share repurchase program that it expects to complete by the end of 2015. Nestlé’s ADRs are up 6% year-to-date.

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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.