4th Quarter, 2014

Your companies produced good fourth quarter earnings despite dollar appreciation against the euro which cut reported sales growth to 5% or less in many instances. The appreciation of the Swiss franc likewise reduced reported sales and earnings for your Swiss companies. The oil price collapse along with declines in metal and grain prices hurt sales and profits for a few of your companies. Nonetheless, the average increase in sales and earnings for your companies was 7% and over 11%. The comparable figures for the S&P were 1% and 2%. The European Central Bank’s determination to try to emulate our Federal Reserves’ massive bond buying program, despite the dissimilarities in its structure and the financial markets it has jurisdiction over, has lifted European stock prices, while the prospect of the Fed raising U.S. interest rates later this year has kept our stock market from continuing its rise. These decisions reverberate through currency, commodity, bond and equity markets throughout the world. The swings are wider than in times past caused in part by government regulations here and abroad curtailing the amount of money dealers can deploy which leaves markets less liquid. We know from conversations with the able managers of your well-run companies that sales growth is harder to achieve despite successful investments made recently to augment sales and realize operating efficiencies. We always look for flaws in our perception of the companies we own and know to be apprehensive when the Fed is implementing economic changes which may result in an inadvertent increase in risk. We are wary and shall work to improve the quality of your portfolio when opportunities arise.

IDEXX Laboratories Corp.

IDEXX Laboratories completed the transition to all-direct sales in the U.S. by the end of the year, a month earlier than planned. The company’s e-commerce site, which was launched in December, already receives 30% of customer order volume. The 125 veterinarian diagnostic consultants (VDCs) increased quarterly visits to the 20,000 to 25,000 U.S. vets, seeing each practice at least four times during the year. These sales calls generated strong growth in placements of instruments used in clinics and in reference lab services. In 2014, IDEXX placed 1,600 Catalyst Dx chemistry analyzers in U.S. vet clinics, a 20% increase over 2013, lifting the installed base to 10,000 analyzers. Hematology placements rose 23% for the full year. Of the clinics that have a Catalyst Dx, 96% also have a premium ProCyte or LaserCyte hematology analyzer to deliver a complete blood and chemistry analysis during the pet visit. IDEXX placed over 3,100 Catalysts and 3,200 premium hematology analyzers in vet clinics around the world during the year, increases of 29% and 22% respectively. These placements were well ahead of the company’s goals and contributed to 14% organic growth in instrument consumables to $341 million in 2014.

U.S. reference lab sales rose 13% during the fourth quarter with higher prices contributing less than 1% to the growth. Volumes from customers who already use IDEXX reference labs grew 8% as these vets used more proprietary advanced tests recommended by their VDCs. Before IDEXX launched its new sales model, the company saw no growth in sales of these tests. With 174 VDCs making 45,000 visits to vet practices each quarter starting in 2015, the company expects the use of reference lab services to grow more than 10% per year in the future. IDEXX is launching two new tests that should increase preventive care diagnostic testing by vet practices. Chronic kidney disease affects one in three cats and one in ten dogs. Preventing this fatal illness is one of the top reasons vets encourage wellness testing. By the time standard chemistry tests show reduced kidney function, there are few available treatment options. IDEXX has developed a test for a biomarker that identifies the onset of kidney disease months or years earlier, while the pet is still healthy and when progression of the disease can be slowed with therapeutic diets or drugs. This test replaces a complex, expensive test with one that uses low cost reagents and runs on the high-throughput chemistry analyzers in the reference lab. IDEXX will include this test as part of the standard chemistry panel at no extra charge, which should accelerate its acceptance as the new standard of care. IDEXX has also developed a test for intestinal hookworms and roundworms that can be run on a chemistry analyzer. Today, 80% of the 40 million annual fecal sample tests are manually prepared and analyzed under a microscope. Converting 25% of the 40 million tests to IDEXX’s assay would grow the company’s fecal testing business over 400% to over $100 million annually. 2014 reference lab sales were $493 million.

IDEXX’s fourth quarter sales of $377 million and full year sales of $1.5 billion delivered organic growth of 9% and 10% over the same periods a year ago. Earnings per share of 95 cents for the quarter and $3.99 for the year grew 16% and 15% respectively. None of these results include the one-time costs associated with moving to the all-direct sales during the fourth quarter. IDEXX generated free cash flow of $191 million in 2014, 105% of net income. The company reduced its diluted share count by over 9% with the repurchase of 4.925 million shares for $618 million, an average price of $126.69 per share. IDEXX’s stock price has risen 1% since January 1. It rose 39% in 2014.

Automatic Data Processing

ADP reported solid fiscal second quarter results with revenues of $2.7 billion up 7% and earnings from continuing operations of 70¢ per share up 8%. Revenue growth, nearly all organic, was reduced 1% by foreign currency translation. During the quarter, worldwide new business bookings grew 15% as clients continue to engage ADP to help manage workers and the associated regulatory complexities. This strong growth demonstrates the success ADP is having in the marketplace with their cloud-based human capital management solutions. These software-as-a- service solutions help companies manage workers from recruitment to retirement. During the quarter, existing U.S. clients added 3.0% more employees on average to their payrolls, while ADP’s comprehensive professional employer organization generated 15% growth in average worksite employees from the same period a year ago. Interest earned on client funds balances rose 2% above a year ago to $91 million as the increase in average client funds balances to $19.8 billion more than offset the 10 basis point decline in the interest yield to 1.8%.

At its March 3 Investor Day, ADP emphasized the importance of its improved cloud-based software platforms for small, mid-size and large employer customers to manage regulatory complexity and ensure compliance. Each year, ADP updates thousands of rule changes to ensure clients’ tax compliance as well as health care eligibility including Affordable Care Act compliance. More than 500,000 small and mid-size customers have upgraded to the new cloud-based solutions which are easier to use and result in lower service costs for ADP. In addition, these clients purchase more add-on products and services from the company, boosting revenues and profitability. The total return on ADP’s shares, which includes dividends and changes in stock price, is 3% since January 1. It was 20% in 2014.


Visa’s fiscal first quarter revenues of $3.4 billion and earnings per share of $2.53, rose 9% in constant currencies and 15%, respectively over the same period last year. The strong U.S. dollar reduced revenue growth in the quarter by 2%. Visa had a good quarter converting cash to electronic payments. Credit and debit card transactions processed over Visa’s network rose 10% to 17.6 billion, while global consumer expenditures remained flat. Visa-branded global payments volume during the quarter grew 11%. U.S. payments volume grew 10%, driven by a 14% increase in credit card payments, and international volume grew 13%, propelled by a 16% increase in debit card payments. Visa receives service revenue for the global payments volume achieved in the previous quarter; thus, the company generated service revenue of $1.5 billion, up 8% over the same period a year ago, based on September 30, 2014 global payments volume of $1.2 trillion. International transaction revenue rose 9%. The strong U.S. dollar reduced travel into the U.S. from Europe, Canada and Latin America, while higher revenues from foreign exchange conversions offset most of the decline in transaction volume.

Use of Visa’s token services, which create secure 16-digit numbers that are linked to the account number on a credit or debit card and a specific device or web site, remains strong. Forty-three card issuers, who account for 75% of Visa’s U.S. payments volume, have adopted this service to facilitate their customers’ use of Apple Pay. Of the 750 banks and credit unions who have signed up to offer Apple Pay, over 500 are Visa customers. Visa announced that a four-for-one stock split will occur on March 19, 2015 and repurchased 3.1 million shares for $803 million at an average price of $258 per share during the quarter. The total return on Visa’s shares is 1% since the beginning of the year.

CDK Global

CDK Global’s innovative solutions optimize customer work flows to improve customer service and car dealer profitability. CDK delivered strong fiscal second quarter results. Revenues rose 7% to $521 million after a 1.5% reduction from foreign currency translation. Adjusted earnings of 37¢ per share rose 37% from the prior year with adjusted operating margin rising more than 300 basis points to 18.1%. CDK’s North American Automotive Retail business generated 7% revenue growth to $335 million. Operating profit rose 13% to $91 million. The International Automotive Retail business had revenue growth of 3% to $88 million and operating profit of $16 million, up 20% after management reduced operating costs. The company increased the total number of dealership locations using its dealer management system 4.5% to nearly 14,000 while increasing the average revenue per dealer site by 4.7%. Digital Marketing revenues of $105 million and operating profit of $11 million rose 17% and 138% respectively. Increased spending by auto manufacturers contributed over half the growth which boosted average revenue per website 9%. CDK’s stock price is up 14% since January 1 after rising 32% last year.


Wabtec’s fourth quarter sales of $821 million were 20.5% above the sales generated in 2013’s fourth quarter and brought sales up 18.5% to over $3 billion for all of 2014. Earnings for the quarter rose 25% to 95¢ per share while earnings for the year of $3.62 per share were 20% higher than 2013’s. Importantly, cash flow of $472 million from operations, which is equal to $4.87 per share exceeded net income from operations for the first time in three years and fulfilled a commitment management had made publically to investors. The cash flow upturn enabled Wabtec to acquire Fandstan in June of last year for a cash payment of $199.4 million and Dia-Frag, a Brazilian manufacturer of brakes, in August for $70.5 million in cash while increasing Wabtec’s outstanding debt by only $70.5 million to $520 million. The acquisition cost of the mid-year purchase of the family-owned Fandstan, Wabtec’s largest acquisition to date, prevented this profitable business from contributing toward last year’s earnings increase. Just over 30% of Fandstan’s sales are replacement parts for transit equipment and cables used on harbor cranes, offshore production platforms and rigs and in windmill farms. Transit systems account for 60% of Fandstan’s sales.

In conjunction with announcing earnings, Wabtec’s management forecast sales growth of 10% for 2015 and earnings per share of $4.05, 12% higher than last year. The earnings estimate contains a 10¢ provision for probable foreign exchange losses. The company now obtains 51% of its sales from outside the U.S. compared to 33% as recently as five years ago. Wabtec’s backlog scheduled for delivery in 2015 is $1.5 billion, $840 million to freight railroad customers and $660 million to transit systems. Management, in discussing the outlook, said that revenues for PTC (Positive Train Control) systems, the company’s most profitable product line, would rise 10% to $320 million this year. Over 60% of Wabtec’s total sales come from orders to replace or rebuild worn equipment. The lead time for these orders is typically less than 30 days. The company’s Becorit division, based in Germany, was selected before year-end, as one of two companies in Europe whose composite brake shoes are approved to replace iron brake shoes on European transit cars. The development of this innovative noise-reducing material is illustrative of Wabtec’s focus on research and development to make prosaic products better. This allows the company to derive 38% of its sales from new products introduced in the past five years for its very risk averse customers. Another promising new product is a heat exchanger that allows customers’ locomotives to comply with the new Tier 4 U.S. emission standards. During the quarter, Wabtec bought 346,800 shares at an average price of $77.85 per share. Wabtec’s stock price has risen 7% since the start of the year after rising 17% last year.

Express Scripts

Express Scripts’ fourth quarter earnings per share, excluding the loss of 10 million UnitedHealth Group members in 2013, rose 26% to $1.39. Full year earnings of $4.88 rose 18%. Claims processed during the quarter and the year met the high end of the company’s forecast at 337 million and 1.31 billion respectively. Operating profit per claim was $5.51 for the quarter and $5.19 for the year, increases of 19% and 13% respectively. On December 22, 2014, the first business day after AbbVie’s treatment for Hepatitis C received approval from the FDA, Express Scripts announced that the 26 million members of its National Preferred Formulary (NPF) would have access to this drug exclusively. Gilead’s drugs Sovaldi and Harvoni were excluded from the formulary. In addition to obtaining access for all of its members to a drug that offers a 95% cure rate with few side effects, 2,200 of the 2,600 clients who use the NPF agreed to have Accredo, Express Scripts’ specialty pharmacy, serve as the sole distributor of the drug for their members. In return, they received guaranteed inflation caps on the price of the drug, a cap on the total cost of the drug if a patient takes it for more than 12 weeks, and a full refund if a patient stops taking the drug before completing the 12 week treatment. Express Scripts also negotiated price discounts with Gilead for its other clients. On its fourth quarter conference call, Gilead announced that the average discount from list price on its Hepatitis C drugs was 46%. Express Scripts receives a larger discount from AbbVie, and their contract stipulates that Express Scripts will always receive the lowest price for this drug.

Express Scripts’ success in using the purchasing clout of the NPF to control drug costs has become more important as great new specialty drugs come to market. The decision to exclude Gilead’s drugs from the NPF will save clients more than $1 billion in 2015. According to Express Scripts’ 2014 Drug Trends Report published on March 10, 2015, specialty drugs accounted for 1% of U.S. prescriptions and 32% of spending on drugs in 2014. Spending on specialty drugs grew 31% with a 6% increase in utilization and a 25% increase in price. Hepatitis C drugs accounted for 46% of this growth despite having the second lowest prescription volume of the top 10 specialty conditions. The company is already working with Amgen and Regeneron on pricing and access for their injectable cholesterol-lowering drugs which should receive FDA approval this summer. Unlike orphan drugs with high costs, as many as 10 million Americans might benefit from these drugs which have an annual cost of $10,000 per patient. Express Scripts’ stock price is down 4% since the beginning of the year, after rising 20% last year. The company is off to a good start in 2015 with a smooth January 1 implementation of plans for new clients and plan changes for existing clients. They also won some health plan renewals earlier than they expected. Investors, however, are disappointed with the 2015 forecast of 10% to 13% earnings per share growth and the company’s withdrawal of its five-year earnings forecast.

Mettler-Toledo International Inc.

Mettler-Toledo’s fourth quarter sales of $697.4 million and full year sales of $2.5 billion rose 6% and 5% respectively in local currencies over the same periods last year. Earnings per share in both periods rose 11% to $4.24 for the quarter and to $11.72 for the year. All of Mettler’s regions and businesses contributed to sales growth during the fourth quarter with sales in Europe and the Americas up 6% and sales in Asia up 5%. Laboratory sales increased 6% while Industrial sales rose 4%. Good price realizations, lower material costs and the successful implementation of cost control initiatives lifted fourth quarter operating margin 1.2 percentage points to 25.3%. Better management of accounts receivable and inventory contributed to a 21% increase in free cash flow in 2014 to $343.5 million, up from $284.6 million a year ago. Mettler converted 100% of its net income to free cash flow.

The company’s latest marketing initiative focuses on building a centralized group that nurtures cold leads. This group designs automated email marketing campaigns by applying sophisticated tools to its customer database to create personal email content. Sales people follow-up once a lead moves from “cold” to “warm”. Mettler piloted this program for a year and learned that the sales force can convert many warm leads into sales. This program improves the effectiveness of the sales force by shifting their focus to higher value leads and adds new contacts to the Spinnaker database. Mettler’s stock price has risen 2% since the beginning of the year, after rising 25% last year.

Ecolab, Inc.

Ecolab’s fourth quarter sales of $2.7 billion and full year sales of $14.2 billion rose 6% and 9% in constant currencies over the same periods last year. Acquisitions accounted for 4% of sales growth in 2014. Record new business wins and new product introductions offset weak economic growth and declining oil prices. Earnings per share, excluding non-recurring items, increased 15% during the fourth quarter to $1.20 and 18% to $4.18 for the year. Fourth quarter sales of Global Industrial grew 2% organically. Water delivered the strongest organic sales growth at 5% with the strong uptake of cooling water treatment that incorporates Ecolab’s proprietary solid dispensing systems for hotels and other small institutions. Increased hotel lodging rates and foot traffic in restaurants in the U.S. contributed to 6% organic sales growth for Global Institutional, the company’s oldest and most profitable business. Ecolab continues to standardize and execute global sales initiatives and to transfer core competencies around the globe. These initiatives and the introduction of new premium products like Sanitizing Wash ‘N Walk increased Institutional’s fourth quarter operating margin to 20.4%, up 1.3 percentage points from the same period a year ago. Ecolab added its proprietary antimicrobial technology to its best-selling rinse-free kitchen floor cleaning product. The product is dispensed as a foam that disperses grease to leave a non-slippery, clean floor once it dries. Adding the antimicrobial product reduces salmonella, listeria and E. coli levels by 99%.

Fourth quarter sales of Ecolab’s Energy business, its newest and largest business, grew 11% with operating margins up 0.2 percentage points to 15.1%. The company forecasts that current oil prices of $50 per barrel will reduce 2015 Upstream sales by as much as 40% and that 2015 Energy sales growth will be flat. Market share gains and lower material costs in Production and Downstream which account for 83% of Energy’s revenue will offset the revenue decline in the Upstream business. Operating income will increase slightly because of lower material costs and operating efficiencies. Ecolab also expects oil prices to stay at current levels through 2016, but once prices lap last year’s decline, companies will start drilling new wells. Prices will then remain steady and, thus, more predictable. Sales and profits of Energy grow because more water is produced and must be treated with its products as oil is extracted from the reservoirs. Injection of gases such as CO2 or water to stimulate oil flow also requires more of Ecolab’s profitable services. The total return on Ecolab’s stock is 10% since January 1.

CME Group Inc.

Volatility has returned to many markets and CME’s benchmark products benefit. During the fourth quarter average daily volume of nearly 15 million contracts, the second highest quarterly volume in the company’s history, rose 31% over the same period a year ago. Interest rate contract volume increased 41%, foreign exchange rose 36%, equity index contracts rose 26%, agricultural commodities increased 18%, energy rose 14% and metals rose 14%. Revenues during the quarter rose 22% and adjusted earnings of 95¢ per share rose 48% from a year ago. Product innovation continues to add to CME’s growth. Contracts introduced during the past five years generated $378 million in cumulative revenue from 452 million contracts traded. The recent reorganization of its leadership structure has improved customer responsiveness while reducing costs. This improves the company’s operating leverage. During the quarter total expenses rose just 2% from the same period a year ago. Its strategy to increase electronic trading volumes from outside the U.S. is paying off as well and reached 24% of total electronic trading during the quarter. January and February year-over-year average daily volume growth of 21% and 13% respectively to 15.6 million and 15.8 million contracts per day marks a strong start to their first quarter of 2015. CME’s total return since the beginning of the year is 9%. Last year it was 15%. CME paid its annual special dividend in the amount of $2.00 per share on January 13th. It also raised its quarterly dividend 6.4% to a $2.00 annual rate.

Air Lease Corporation

Air Lease posted strong fourth quarter results with revenues of $286 million and earnings of 65¢ per share, each up 18% from the same period a year ago. For the full year, revenues rose 22% to $1.05 billion while earnings of $2.38 per share rose 32% from the previous year. Its pre-tax operating margin rose to 37.6% from 34.2%. Demand for new aircraft with the latest technology remains strong. The drop in jet fuel prices improves the profitability of airlines that need to upgrade and expand their aging fleets to accommodate the growth in global passenger traffic which was 5.9% in 2014. It has risen 5% annually over the past 30 years. During the fourth quarter, Air Lease delivered nine aircraft from its new order pipeline and sold eight older aircraft from its operating lease portfolio generating a $20 million gain, up from $17 million in gains booked on aircraft sales during the same quarter a year ago. During 2014, Air Lease took delivery of 36 new aircraft and sold 16, leaving it with 213 aircraft at year-end leased to 77 airlines in 46 countries. Airlines in Asia lease 43% of Air Lease’s planes, and those in Europe lease 33%. Airlines from the U.S. and Canada comprise only 4.6% of leased aircraft. Its aircraft fleet had a weighted average age of 3.5 years, down from 3.7 a year ago, with an average remaining lease term of 7.3 years, up from 7.1 a year ago. The aggregate net book value of the fleet at year-end was $9.0 billion up 18% from a year ago, while total debt outstanding of $6.7 billion was 13% higher than a year ago. The percentage of fixed rate debt rose to 82% from 73% a year ago, yet its composite interest rate rose only four basis points to 3.64%. Air Lease will take delivery of 40 new aircraft in 2015 which are all leased, ensuring continued growth. Air Lease’s stock price is up 8% year-to-date.

Precision Castparts

Precision Castparts (PCP) reported disappointing third quarter sales of $2.46 billion, up only 5% from $2.34 billion during the year ago quarter. Operating income was only 2% above last year’s comparable quarter even though large commercial airline sales were 7% higher. Earnings per share of $3.09 were up 5% year to year, helped by a buyback during the quarter of 836,000 shares at an average price of $232 per share. Operating earnings of Investment Cast, the company’s most profitable business segment rose 5% as it achieved a margin of 36.2% on a 3% sales increase. Airframe sales rose 11% with margins above 30%. These two operating divisions produced 70% of the company’s operating profit during the quarter compared to 66% a year ago. Forged Product sales in the quarter were only 2% above last year’s, while operating income dropped 7% below last year as the margin fell 2.3% to just over 23%. The principal cause for these poor results was longer than planned annual maintenance on its 35,000 ton vertical extrusion press in Houston. That meant replacing scheduled high margin aerospace and oil and gas customers’ work with low margin industrial jobs to avoid idling even more equipment. The forge became fully operational near the end of November. Management’s newly revised earnings forecast of $12.80 to $12.90 per share for the fiscal year ending March 2015 means earnings for the current quarter will be only pennies above last year’s earnings. The need to make up production shortfalls to align with current production rates for Boeing and Airbus planes coupled with falling demand from oil and gas customers evidently will postpone margin improvement for another quarter. Forged Products is the division that performed superbly after the acquisition of Timet in December 2012.

After two successive quarters of disappointing results, which preclude the possibility of PCP meeting management’s earlier earnings forecast for fiscal 2016, management has resolved to issue a full sales and earnings forecast for fiscal 2016 in early May when the 2015 results are released. The forecast will be discussed in detail then. This process for communicating with shareholders is vastly preferable to a multi-year target which the company had issued and then not met. The reason for owning PCP is the company’s strong position as a supplier for Boeing and Airbus which it earned by being a reliable cost-efficient supplier. It is scheduled to benefit soon from an increase in 787 production from 10 aircraft a month to 12 and then 14. PCP’s revenues currently are $10 million on each 787. It’s less than $2 million on each 737, but rises on the new fuel efficient 737-MAX which is starting to go into high volume production. Precision Castparts’ stock price has dropped 13% since the beginning of the year.

Varian Medical Systems

Investors lifted Varian Medical Systems’ stock price almost 9% on January 29, 2015, the day after the company announced good fiscal first quarter results. Varian’s stock price is up 8% since the beginning of the year. Revenues of $738 million grew 4% over the same period a year ago with the strong U.S. Dollar reducing growth by 2%. Earnings per share of 99¢, excluding a one-time restructuring charge, rose 9% from 91¢ a year ago. Oncology Systems’ revenue of $563 million rose 4% over the same period a year ago and accounted for 76% of the quarter’s revenues. Service revenues of $254 million increased 14% as Varian’s installed base of radiotherapy systems grows and more customers purchase software subscriptions which include updates and maintenance. Service, with its high-margins and recurring revenue, now accounts for 45% of Oncology Systems’ business.

Varian’s international business delivered strong order growth during the quarter, up 13% to $311 million. The company saw 30% order growth in its emerging markets which accounted for 15% of orders during the quarter. Orders grew 17% in Asia/Pacific with 42% order growth in China. Varian won a tender offer from the People’s Liberation Army and received approval from Chinese’s FDA for the EDGE radiosurgery system. The opportunity in China is large. The lung cancer burden is very high and only 20% of cancer patients receive radiation therapy compared with 50% to 60% in the U.S. and Europe. Orders in Africa have grown dramatically since fiscal year 2013 when they were about $7 million. Varian had over $50 million in orders in FY 2014 and received orders of more than $20 million from Algeria, Egypt and South Africa during the quarter. These orders, along with strong orders in France, Turkey and Hungary contributed to 12% order growth in Europe, the Middle East and Africa. North American orders declined 3% during the quarter following exceptionally strong order growth of 13% in the first quarter last year. North American order growth over the last 12 months was 4% and is consistent with the company’s expectations.


Roche’s 2014 revenues of CHF 47.5 billion rose 5% at constant exchange rates over 2013. Core earnings per share, which exclude amortization of intangible assets, restructuring charges and other non-recurring expenses, grew 7% to CHF 14.29 per share. Pharmaceutical Division sales of CHF 36.7 billion and Diagnostics Division sales of CHF 10.8 billion increased 4% and 6% respectively. Roche’s fast-growing HER2-positive breast cancer and immunology drugs delivered more than 20% revenue growth. In just over two years since its U.S. launch, Perjeta achieved 2014 sales of CHF 912 million, having become part of the standard of care for women with untreated HER2-positive breast cancer. Roche believes that the launch of the first Herceptin biosimilar in Europe may be delayed until 2017 because of challenges enrolling patients in clinical trials. Sales of Actemra, Roche’s drug for rheumatoid arthritis grew 23% to CHF 1.2 billion in 2014, while U.S. sales of Xolair rose 25% to CHF 975 million as a result of FDA approval to treat chronic hives. Professional Diagnostics’ revenues of CHF 6.0 billion increased 8% over 2013 with immunoassay revenue up 13% to CHF 2.7 billion. Immunoassay revenue has grown more than 10% per year for the last 16 years as Roche adds medically relevant tests to the menu and introduces modular instruments that enable labs of all sizes to improve their efficiency with custom configurations and automated processes.

The total return on Roche’s ADRs is -2% since the beginning of the year as investors respond to positive news about competitive oncology products. Roche expects to report results from its comprehensive immuno-oncology program at medical meetings in April and late May. The company is running 11 Phase III trials for its anti-PD-L1 immunotherapy drug in four types of cancer. In addition, 26 early stage trials include six new biologic drugs that enhance the immune system’s recognition of cancer cells to increase the ability of its anti-PD-L1 drug to kill them. Thirteen of these trials involve combinations of Roche’s targeted therapies, such as Tarceva or Avastin, or combinations of immunotherapies. Roche continues to invest in diagnostic tools to determine the most effective immunotherapy drug combinations. On January 12, 2015, Roche announced an expanded collaboration with Foundation Medicine that will use their highly accurate and comprehensive genomic screening tests to standardize genomic information generated during research and clinical trials. Oncologists have ordered comprehensive genomic screening of over 35,000 tumors since Foundation Medicine’s inception in 2010. The company compares the test results with the latest scientific and clinical data to determine which currently available targeted therapies will best treat a patient’s cancer. Over 25 drug companies currently use their testing and data services for drug development.


Nestlé’s 2014 revenues of CHF 91.6 billion grew 4.5% organically, a respectable result when growth in its markets was 1% to 2%. Nestlé achieved its plan with earnings per share of CHF 3.44 growing 4.4% in constant currencies and with its operating margin up 30 basis points from 15.2% to 15.5%. Sales in developed markets of CHF 51.4 billion accounted for 56% of sales and grew 1.1% organically, while sales in developing markets rose 8.9% organically to CHF 40.2 billion. The company achieved volume growth of 2.3% in the Americas and 2.4% in Europe and in Asia/Oceania/Africa (AOA). Prices increased 3.1% and 3.3% in the Americas and AOA and fell 0.5% in Europe. Sales in Europe remained soft for the entire year while sales in North America only began to improve in the fourth quarter. China, Nestlé’s second largest market after the U.S., had weak performance because Nestlé decided to reduce stock levels in stores of Yinlu peanut milk to ensure freshness. This destocking reduced sales in ambient dairy, an intensely competitive category and Nestlé’s largest category in China. The company is investing in new products, trade and consumer marketing programs and distribution channels to address the growing interest in products with better nutrition and health characteristics. Chinese consumers outside of the country’s largest cities are heavy users of e-commerce to buy packaged food.

Nestlé’s pet care business, the global leader, delivered strong results, posting sales of CHF 11.3 billion with organic growth of 5.6%. It is also one of Nestlé’s most profitable businesses with operating margins of 19.8%. Pet care is an ideal category for Nestlé because pet owners are very engaged with the products and care about the product innovations company delivers. Nestlé can test which ingredient changes improve the nutritional value and taste of the food. In addition, the company employs nutrition science to develop foods that treat specific ailments. Nestlé developed a dog food that improves the cognitive functioning of older dogs. The application of nutrition science is more visible in this category because one can control a pet’s diet. The total return on Nestlé’s ADRs is 2% since the beginning of the year.

Donaldson Inc.

Donaldson’s sales of $597 million during its fiscal second quarter rose 3% while adjusted earnings of 37¢ per share rose 6% from the same period a year ago. Foreign currency translation reduced reported sales growth by 4% and earnings by 6%. Diluted shares outstanding declined 6% year-over-year as a result of the company’s share repurchase program. Donaldson’s Engine filter sales rose 1% in constant currency to $357 million. An 18% drop in sales of off-road filters to manufacturers of agricultural, construction and mining equipment were offset by increases of 12% to on-highway truck manufacturers, 16% in aerospace and defense and 4.5% in replacement filter sales which account for two-thirds of Engine filter sales. This is half the growth rate replacement filters experienced last quarter. Donaldson’s Industrial filter sales rose 7% in constant currency with nearly all the growth coming from its gas turbine filter segment which doubled sales to $64 million during the quarter on strong deliveries to the Middle East.

On January 30 Donaldson announced that Tod Carpenter will replace the highly capable and long-tenured CEO Bill Cook, who will remain Chairman. We have met with Tod and of course Bill before and met with them both again on February 26. We were surprised to hear the sense of urgency expressed concerning the need to acquire a filtration business outside of Donaldson’s current areas of proven expertise. To accomplish this task in a manner that increases shareholder value will be difficult since private equity firms and weaker competitors may have much lower ROI hurdle rates. Heretofore, Donaldson has been a disciplined allocator of its free cash flow. We reduced our position in this successful investment given the change in management in conjunction with the perceived strategic necessity to expand its acquisition criteria. The total return on Donaldson’s shares is -2% since January 1.


SGS’ second half 2014 revenue of CHF 3.1 billion rose 5.5% while net income of CHF 359 million rose 1.1% on an adjusted basis. For the full year, revenue of CHF 5.9 billion rose 5.4%, with 4.0% organic growth and 1.4% of growth from acquisitions. Adjusted earnings of CHF 0.82 per ADR rose 10.9%. Revenues from Asia/Pacific rose the most, up 6.9% with revenues from the Americas increasing 6.3% and Europe, Africa and the Middle East up 4.1% in constant currency. Total headcount rose 2.8%. During the year Minerals testing remained the company’s weakest business, as lower commodity prices reduced demand for mineral testing. During the year Minerals revenues declined 4% and margins fell 150 basis points to 14.1% as the company took further actions to reduce costs. Oil, Gas and Chemicals, Consumer Testing and Agriculture were the company’s fastest growing business units with sales up 8.6%, 6.9% and 6.6% respectively. The company’s free cash flow remained strong and exceeded CHF 600 million. This supported a 4.6% increase in the annual dividend to CHF 0.68 per ADR, representing a dividend yield of 3.5%. On January 21, SGS announced that Frankie Ng would become CEO and Chris Kirk would step down. Frankie Ng, whom we have talked about in the past, joined SGS in 1994 and doubled the company’s Consumer Testing business revenues from 2005 to 2011 while expanding its scope worldwide. It is the largest contributor to SGS’ profits and has an operating margin exceeding 24%. Since 2011 Frankie has managed the Industrial business which needed to be fixed. It has since grown by one-quarter and last year reported a 130 basis point margin improvement. Chris Kirk will remain a director of the company while Sergio Marchionne remains Chairman. The total return on SGS’ ADRs is -8% since January 1.

Core Laboratories

Core Laboratories’ record fourth quarter revenues of $278 million and earnings of $1.54 per share had little impact on its share price. Revenues for the year rose 1.1% to almost $1.1 billion while earnings per share increased 9.4% to $5.27. Investors who look at the company are focusing on where oil prices might bottom, what the company’s oil price forecast is and perhaps what effect lower prices might have on the company’s business. That means management’s forecast for Core’s 2015 first quarter revenues and earnings is a better indicator of future developments than most because its management experienced the 2008-9 price decline and strengthened the company while bringing it through that difficult time. They forecast that Core’s first quarter revenue will drop 12% below last year’s while earnings per share will fall 20%. This forecast was accompanied by a clear statement that the declines in subsequent quarters could result in Core’s second and third quarter revenues and earnings being lower than the first quarter. That would occur because Core’s most profitable business, Production Enhancement, provides tools that significantly lower production costs while improving the effectiveness of the completion of onshore North American shale oil wells as well as deep-water vertical wells, notably in the Gulf of Mexico. Management pointed out that currently there are 875 wells in the Bakken that have been drilled but not completed because the oil price has dropped. Completion costs are approximately 60% of the total cost of an onshore horizontal well, so waiting before completing a well amid the current crude glut makes sense. Core’s new enhanced oil recovery techniques can improve the recovery rate in the Bakken and Eagle Ford by as much as 50% from the high single digit rates obtainable now. When oil prices stabilize, this business should thrive. The company’s revenues from its shale oil customers are still declining which means it’s too soon to accurately gauge where or when the oil price decline will end. Core’s management thinks the price may stabilize sometime in the fall or during the first part of next year, but definitely in 2016. The stock price already has fallen 60% from its 2014 high which is comparable to the 64% drop from its 2008 high to its low in 2009. Although Core’s revenues are contracting, it remains one of the most profitable oil service companies with nearly 30% of its revenues from recurring offshore reservoir fluid analysis services. The total return on Core’s stock is -10% since the start of the year.

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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.