1st Quarter, 2015

The positive first quarter sales and earnings gains achieved by almost all of your companies by successfully competing for sales here and abroad in markets buffeted by unusually wide currency and commodity price movements, attest to their managers’ skills in coping with changing circumstances. We reduced your ownership in companies harmed by steep declines in commodity prices, while continuing to pay attention to how their managements adapt to profit from the adversity that severely affects their competitors. Even with these included, your companies combined first quarter sales and earnings, which rose 3% and 8% respectively, were much stronger than the comparable results for the S&P 500 companies. They collectively experienced a sales decline of 2% and earnings growth of less than 4%. The total return of the S&P 500 is 3.7% since the beginning of the year.

We think slowing sales growth for most publicly-owned companies, including those listed on non-U.S. markets, has kindled interest in cash takeovers financed through issuance of bonds at low rates to make acquisitions that boost the buyers’ near-term earnings. This phenomenon regularly recurs after the stock market rises for several years and companies find it difficult to continue to post earnings gains. Unsurprisingly we noted early this week that U.S. corporate bond issuance during the first quarter rose 5.9% to a record high. The issuance in May rose to a record of $543 billion, although U.S. acquisitions in the month amounted to only a record $243 billion! The takeover phase of a rising market usually lasts for a while. We have learned that as this sort of buying frenzy builds, long-term investors’ best protection is the character strength of good managers. This is why we invest in companies run by managements determined to leave their company stronger than it was when they assumed command.

Express Scripts

Express Scripts delivered good first quarter results with gross profit increasing 1% to $1.91 billion. SG&A fell 1% to $498 million and interest expense declined 6% to $116 million, contributing to earnings growth of 11% to $1.10 per share which the company achieved without the benefit of any share repurchases. Earnings exclude amortization associated with the Medco acquisition and other non-recurring expenses. The 7% increase in operating earnings per prescription to $4.92 based on a 4% reduction in prescriptions filled also demonstrates Express Scripts strong operational performance and the growing profitability of its specialty drug business. The company’s Hepatitis Cure Value Program, which began at the beginning of the year, already shows patients achieving better adherence than at retail while clients realize significantly greater savings.

Express Scripts’ ability to increase patient access and to improve outcomes for the 26 million members on its National Preferred Formulary has gotten the attention of pharmaceutical companies. On May 26, 2015, an article in The Wall Street Journal described Express Scripts’ commitment to setting the price of cancer drugs based on how well they work in different types of cancers. Genentech, for example, is open to such plans because Roche, its parent company, already has a similar program in Italy. The challenge is how to make pay-for-performance pricing work in the more fragmented U.S. market. Amgen and Express Scripts began discussions earlier this year to determine pricing and the appropriate patient population for Amgen’s new biologic cholesterol-lowering drug which should receive FDA approval this summer. Express Scripts’ stock price is up 2% since January 1st.

IDEXX Laboratories Corp.

IDEXX Laboratories had a busy first quarter with the addition of 50 new vet diagnostic consultants (VDCs), an increase from 125 to 175 smaller sales territories and the move to all-direct sales in the U.S. As a result of remapping the sales territories, 9,000 of the 23,000 current vet customers have a different VDC than they did at the end of 2014. Despite all these changes, first quarter revenue of $385 million rose 6% organically over the first quarter of 2014. The strong dollar cut revenue growth by 6% during the quarter. Earnings per share of 98¢ increased 10%, despite an 8% currency penalty. U.S revenues of $235 million rose 13% organically, with sales of instrument consumables and reference lab services helping lift U.S. recurring diagnostic revenues 15%. Rapid assay sales fell 3%, however, excluding the gain from the move to all-direct sales. While sales of IDEXX’s proprietary Canine 4Dx test, which tests for heartworm and six tick-borne diseases, posted solid volume gains, sales of older tests for feline leukemia, feline HIV and canine heartworm declined during the quarter. These tests, which lost patent protection in 2009, were sold mainly by distributors to vets who bought only these products from IDEXX. With the VDCs focused on larger customers, distributors successfully sold a competitor’s assay to many of these vets. As a result of this temporary gap in its sales coverage, IDEXX cut its 2015 sales forecast for these first generation assays by $15 million to $50 million, or 3% of total sales. It also lowered its 2015 organic sales growth estimate from 14.5% to 12.5% and earnings per share growth to 5%. IDEXX’s stock price plunged 17% on April 28, 2015, the day the company announced its first quarter results and reduced forecast. Over the next two days, it fell another 6%. Although it has recovered some since then, IDEXX’s stock price is 11% lower since the beginning of the year.

The European launch of Catalyst One is a great success, with 291 analyzers placed during the quarter, with 81 in Italy alone! IDEXX has placed 1,200 Catalyst Ones in vet clinics since its launch in November 2014. Catalyst One is IDEXX’s second generation advanced chemistry analyzer that offers the ease-of use, broad test menu and fast time to results of the premium Catalyst Dx at half the price. With strong vet interest in IDEXX’s new kidney and infectious disease diagnostic tests and its deep pipeline of new products coming to the market in the next 12 months, IDEXX is well-positioned to grow profitably in the near future. The stock will split two-for-one on June 15th.

CDK Global

CDK Global’s stock price has leapt 32% since the beginning of the year and 75% since the company was spun-off from ADP on October 1, 2014. It generated strong revenue and earnings growth during the quarter. On a constant currency basis, revenues of $526 million rose 7.5% and adjusted earnings of 35¢ rose 15% from the same period a year ago. CDK operates three business segments: Automotive Retail North America (ARNA) which generates 64% of revenues and 80% of profit; Automotive Retail International (ARI) which generates 16% of revenue and 12% of profit; and Digital Marketing which accounts for 20% of revenue and 8% of profit. ARNA revenues rose 8% during the quarter driven by a 4.5% increase in client sites and 3.5% more revenue than a year ago from each site. ARNA operating profit rose 12% from a year ago. ARI revenue rose 3% during the quarter, despite a 2% decline in client sites, as a result of a 5% increase in revenue from each site. An increase in dealer sites in Asia-Pacific and the U.K. was offset by a decline in sites in Continental Europe. ARI operating profit rose 4% from a year ago. Revenue growth of 11% in Digital Marketing was driven by strong spending per client website which increased 13% from the same period a year ago. This is higher margin revenue than auto manufacturer advertising-related revenue, which has a large pass through component. This welcome shift is the result of management focusing on selling more of its marketing services to its auto dealer customers in addition to digital advertising placement for auto manufacturers. Its early success with the dealers has resulted in a near doubling of Digital Marketing’s operating profit from a year ago.

CDK is holding its inaugural Investor Day meeting in Chicago on June 16 when it plans to share the results of a major comprehensive review of its cost structure. It plans to provide its execution roadmap and financial goals for both revenue growth and margin expansion. We think the able managers of CDK can maintain consistent revenue growth and deliver improving margins, but acknowledge that the stock is no longer cheap.

Automatic Data Processing

ADP’s fiscal third quarter revenues of $3.0 billion were up 7% despite a 2% negative impact from foreign currency translation. Earnings of $1.04 per share from continuing operations rose 16% from the same period a year earlier and were reduced by 2¢ per share from foreign currency translation. The company’s new business bookings rose 6% during the quarter while the number of employees on each existing client’s payroll was up 3.1%. Average worksite employees at ADP’s TotalSource professional employer organization increased 13% to 369,000 as TotalSource revenues rose 15% to $745 million during the quarter. ADP’s pre-tax margin reached 24.5% during the quarter from 23.3% a year ago as the company successfully controls costs while investing in innovative solutions which help its clients comply with an increasingly complex regulatory environment. The company is seeing strong demand for its Health Compliance solution which helps companies manage the Affordable Care Act (ObamaCare). During the quarter, ADP completed the migration of all its small business customers to its RUN cloud-based payroll and HR management platform allowing it to shut down maintenance and support for the legacy EasyPay platform during the quarter. The transition to RUN exceeded expectations with better client retention and greater adoption of additional human capital management modules.

ADP purchased 13 million shares, representing 2.7% of the total outstanding for $1.1 billion or about $84½ per share this fiscal year to date. $825 million came from CDK prior to its spin-off on October 1, 2014. The total return on ADP shares is 3% since the beginning of the year and 18% since it spun off CDK.

CME Group Inc.

CME’s strong revenue growth of 8% to $843 million and its renewed focus on cost control resulted in an 18% increase in adjusted earnings to 98¢ per share. Operating leverage pushed its operating margin up to 62% from 58% a year ago. Total average daily volume of 15 million contracts rose 10% from a year ago and was the second highest volume quarter ever. Energy volume of 2.1 million contracts per day rose 26% from a year ago reaching a new record. Foreign exchange volume of nearly 1.0 million contracts per day rose 17% as volatility returned to the F/X markets. Interest rate volume rose 12% in the quarter to 7.6 million contracts per day, while agricultural commodities and metals rose 2% and 4% respectively. Equity index contracts fell 4% to 2.8 million during the quarter.

CME continues to build its international volumes at a rapid pace. Its European based volume rose 14% to 2.3 million contracts while volume from Asia jumped 22% to 570,000 contracts per day. CME also continues to build its OTC interest rate swap clearing business which reported a 57% year-over-year revenue increase to $20 million from over 500 customers. Increasingly these customers are also utilizing more of CME’s futures and options contracts which, according to a report by Greenwich Associates, have lower transaction costs than swaps. Its top OTC Clearing customers have generated twice the growth CME experienced in the marketplace overall. The total return on CME shares is 7% year-to-date.


Wabtec’s first quarter sales of $819 million and earnings per share of 99¢ were both 18% above last year’s comparable results. This strong growth is notable considering the Company’s success in increasing its foreign sales from a third of its total five years ago to just under half now. The translation of overseas sales into dollars cut reported first quarter sales 5%, but this drag was more than offset by a 33% year-to-year increase in sales to U.S. freight railroads. The strength in freight sales was augmented by a 12% increase to $94 million in Positive Train Control (PTC) revenues which include sales from Texas-based Railroad Controls which the company acquired for $76 million in February. This acquisition helps lift PTC 2015 revenues, which carry the company’s highest margin, to nearly 20% above the $320 million of sales obtained last year.

The deadly Amtrak May 13 derailment, like its predecessors, has impelled politicians and journalists to call for rapid installation of PTC on passenger rail lines, without reporting that Amtrak and our commuter railways lag far behind U.S. freight railroads in installing this proven safety system on locomotives and alongside the tracks. In the U.S., 60% of freight locomotives are equipped with onboard computers, half of the wayside signaling units are installed and only a third of the antennas and radios for the system are deployed despite The Rail Safety Improvement Act enacted in 2008 specifying that PTC must be installed on most U.S. railroads by the end of 2015. Litigation over whether railroad rights of way permit placement of signaling devices has delayed deployment. Among the many issues that needed resolution were Indian burial rights. Legislation extending the deadline for deploying PTC is winding its way through Congress with no indication of increased funding for equipping Amtrak or Commuter Rail Systems. As of this writing, only five of the twenty-one U.S. transit systems have contracts with Wabtec to install PTC systems, the only Federal Rail Administration approved system.

Transit sales during the quarter were 1% less than a year ago due to booking a $50 million order secured through GE in the year ago quarter and the foreign exchange drag on European sales including Fandstan’s acquired last year. During the quarter, Wabtec’s U.K. division secured a $90 million three-year contract to overhaul transit cars. Sales of Wabtec’s new composite brake shoes manufactured in Germany to replace cast iron shoes have reached $10 million a quarter. Over 63% of Wabtec’s sales are to replace or rebuild worn equipment. When announcing its earnings, Wabtec’s management raised its earnings forecast for the year a nickel to $4.10 per share. Wabtec’s stock price is up 15% since the beginning of the year.

Mettler-Toledo International Inc.

Strong sales growth in the U.S. and Europe contributed to Mettler-Toledo’s first quarter sales growth of 5% in local currencies. Sales in U.S. dollars fell 3% to $535.7 million from $550.6 million in the first quarter of 2014 because the rise in the dollar reduced sales growth by 8%. The sales force successfully used the company’s tools to realize price increases of 1.9 percentage points during the quarter. Manufacturing plants using Blue Ocean, Mettler’s company-wide enterprise resource planning system based on common global data, reduced material costs by 1.4 percentage points. Both efforts contributed to the increase in gross margin to 55.8% from 53.1% a year ago. First quarter earnings of $2.21 per share rose 12% over the first quarter of 2014, excluding restructuring charges in both periods.

Laboratory sales rose 8% with growth in all product lines and regions. This growth follows 7% revenue growth a year ago, demonstrating the strength of this business. Industrial sales increased 1% over the same period a year ago. Industrial sales in the U.S. and Europe rose in the mid-single digits during the quarter as a result of a strong U.S. economy and excellent sales force execution in both regions. China’s Core Industrial sales, which now account for about 7% of the company’s total sales, fell 22% during the quarter with sales declines in all customer and product segments. Continued overcapacity resulted in declines in large orders from state-owned companies, the government, multinationals and Chinese national companies. Small orders declined as well, which indicates that existing customers are delaying the replacement of their instruments. Deferred sales may return when credit becomes more available, but it is the first time management has seen deferred instrument sales in China in over 10 years. Mettler-Toledo’s stock price is up 11% since the beginning of the year.

Ecolab, Inc.

Ecolab’s first quarter sales of $3.3 billion grew 4% organically over the same period a year ago. Reported sales fell 1% as foreign exchange rates reduced sales in U.S. dollars by 5%. Sales growth in Ecolab’s Industrial and Institutional businesses, which benefitted from lower oil prices, grew 3% and 7% respectively, while the Energy business delivered 1% organic growth during the quarter. Energy’s margins remained steady as raw material cost savings offset lower pricing and investments in the business. Earnings of 80¢ per share, net of non-recurring items, rose 8% as a result of gaining new business and higher prices from sales of new products.

Ecolab’s Food & Beverage (F&B) business had the best performance in the Industrial group with organic sales growth of 3% over the first quarter of 2014. With annual sales of $1.7 billion, F&B is the global leader in the $8 billion market of providing cleaning and sanitizing and water and waste treatment solutions to beverage, dairy, food and protein processors. F&B serves 25,000 customer locations, which provide many opportunities to add value and to obtain new ideas that R&D develops into new products and services. Innovation is key to Ecolab’s success because it helps customers produce more with less water and energy. It also differentiates Ecolab from its local or price-driven competitors. F&B, along with the Water and Pest Elimination groups, has performed total plant assessments in 140 plants in 50 countries. Ecolab brings its experts from these groups to a plant for two weeks and searches for opportunities to increase throughput while saving water and energy. On average, they find more than $1 million in productivity opportunities and ways to reduce water use by 30%. These teams have identified over 3,000 modifications, which approach $150 million in savings from productivity improvements and reduced water use by over 10 billion gallons. Customers track these savings in their utility bills. Ecolab identifies these improvements while maintaining high levels of food safety and brand protection. The total return on Ecolab’s stock is 12% since January 1.

Air Lease Corporation

Air Lease delivered another solid quarter with revenues up 13% to $278 million from the same period a year ago. Adjusted earnings of 61¢ per share, which included 5¢ of gains on the sale of two aircraft, rose 7% from the 57¢ reported a year ago when the gain recorded on aircraft sales was 8¢. Excluding the aircraft sale gains in each period, earnings rose 14%. Air Lease’s stock price has risen 12% since the beginning of the year. During the quarter, the company took delivery of and leased 10 aircraft increasing its owned aircraft to 223 while adding two aircraft to its managed fleet portfolio bringing the total to 19. It ordered an additional 57 Airbus aircraft during the quarter bringing its total order book to 411 aircraft. Air Lease typically places these planes with its 82 airline customers 18 to 24 months in advance of aircraft delivery from the manufacturer. The order backlog of Boeing and Airbus for new aircraft ranges from 5.7 years for 777’s to 9.3 years for A320’s, increasing the value of Air Lease’s order book which has more than 180 deliveries scheduled over the next five years.

At its Investor Day presentation on May 19, Air Lease highlighted the long-term growth drivers for the industry while emphasizing its key differences from its peers. Global passenger traffic growth of 6% remains healthy and the benefit from replacing aircraft to reduce operating costs and improve fleet performance is considerable. New aircraft produce a 15 to 20% improvement in fuel efficiency, providing airlines with the best long-term fuel hedge. In addition to being quieter, which reduces landing fees, the new aircraft have longer ranges. This allows an airline to fly to more distant cities and carry more cargo which boosts revenue per aircraft. Air Lease, which has an investment grade credit rating, is the only aircraft lessor with contracted cash flows which exceed its total debt outstanding. Over 95% of its aircraft are leased to customers outside of the United States where market growth is stronger. China, for example, is a growing market for Air Lease, and accounts for 22% of lease revenue last year. The country has three times the U.S. population but only one-third of its passenger aircraft. Four different Chinese airlines will be amongst Air Lease’s top 10 customers in the years ahead based on currently scheduled aircraft deliveries, up from three in the top 10 today.


Visa reported fiscal second quarter constant currency revenue growth of 10% to $3.4 billion. Earnings per share of $0.63 were 15% higher than last year’s second quarter, excluding a one-time $201 million tax benefit a year ago. Aided by the absence of the Sochi Olympics and FIFA World Cup marketing expense last year, Visa achieved an operating margin of 67%, its highest ever as a public company. Total credit and debit card transaction volume grew 11%, driven by the conversion from paper-based to electronic payments. In the U.S., credit card volume of $316 billion rose 12%, an acceleration of 2% over the growth rate a year ago. The additional payment volume that Visa gained from its long term partnership with Chase, the country’s largest card issuer, added 3% to credit card growth this quarter, offsetting the reduced payment volume from low gas prices. Debit card volume increased 6% in the U.S. and 12% internationally.

On March 2, 2015, Visa announced a new exclusive co-brand relationship with Costco, the third largest retailer in the U.S., replacing American Express as the sole credit card network provider effective April 1, 2016. This marks the first time in 16 years that Visa credit cards will be accepted at the retailer which has annual sales of more than $115 billion. Visa returned $1.4 billion to shareholders during the quarter in the form of dividends and share repurchases. The total return on Visa shares is 6% since the beginning of the year.

Varian Medical Systems

Varian Medical Systems’ fiscal second quarter revenue of $759 million was 2% lower than revenue of $779 million a year ago. The strong U.S. Dollar reduced revenue growth by 4% during the quarter. Earnings per share of $1.07 rose 3% from $1.04 a year ago. Excellent cost control helped Varian maintain operating margins. These cost savings will offset almost all of the impact of the stronger dollar on earnings this year. Oncology Systems’ orders of $581 million declined 5% from orders of $613 million a year ago with foreign currency accounting for the entire decline. Good order growth in Western Europe, along with order growth of 15% in North America and 10% in China was offset by weakness in Africa, India and Japan. Varian booked large orders in Algeria and in India last year. Orders in emerging markets are often government tenders and tend to be lumpy. Orders in Japan, Varian’s second largest market after the U.S., were down in dollars, but flat in constant currency. The market is sluggish, but Varian believes that new marketing programs have helped it regain some share.

Varian won a contract to upgrade the radiotherapy and radiosurgery programs of the Sarah Cannon Cancer Network of Excellence, the global cancer network of Hospital Corporation of America. Sarah Cannon, a network of 75 hospitals in the U.S. and U.K., offers cutting edge services to more than 100,000 cancer patients each year. In addition to buying 6 TrueBeam radiation systems, information management and treatment planning software that will be installed over the next 18 months, Sarah Cannon will use Varian’s newest data analytic tools, RapidPlan and InSightive software. RapidPlan, a knowledge-based treatment planning tool, uses the best treatment plans in the entire system as the starting point for new individual plans so that each patient receives state-of-the-art treatment. InSightive captures, organizes and visualizes clinical and administrative data from the entire network, which facilitates the dissemination of best practices across every hospital. Varian’s integrated offering of efficient, versatile radiation systems with data analytics that capture the clinical knowledge gained from treating patients provides tools to continuously improve treatment methods and ultimately patient outcomes. Varian’s stock price is up 1% since January 1st. The stock price jumped 9% after Varian reported strong first quarter earnings on January 28, 2015 and gave back that gain in early May, when the company reduced its 2015 earnings forecast during its second quarter earnings call because of a delay of three large orders in its $80 million Security and Inspection Products business.


Roche’s first quarter sales of CHF 11.8 billion grew 5% in constant currency over the same period a year ago. The Pharmaceutical Division posted 4% growth with sales of CHF 9.3 billion. Sales in the U.S. rose 6% as continued growth in the use of Perjeta lifted its revenue 60% to CHF 187 million. Actemra, a first-in-class treatment for rheumatoid arthritis and related auto-immune diseases, posted U.S. revenue growth of 35% to CHF 124 million. Global sales from Roche’s three breast cancer drugs grew 23% to CHF 2.2 billion, as longer Perjeta use before surgery in newly diagnosed breast cancer patients increased the use of Herceptin as well. Global sales of Avastin rose 6% to CHF 1.6 billion with more use in ovarian and cervical cancer in the U.S. and in estrogen receptor positive breast cancer in Europe. Positive results from a clinical study for patients with this form of breast cancer increased Avastin sales in Europe by 3%. Roche initiated Phase I trials of combinations of its cancer therapies in 3,500 untreated lung cancer patients following positive clinical results of the company’s cancer immunotherapy drug Atezolizumab in lung cancer, especially in combination with Avastin or chemotherapy. The Diagnostics Division’s first quarter revenue of CHF 2.5 billion grew 6%, including 10% growth in its Molecular Diagnostics business. With the launch of a new Hepatitis B assay which quantifies the amount of virus present in a blood sample, Roche completed its market-leading menu of viral load tests on its medium and high volume instruments. The company has placed more than 100 of them in the field. The total return on Roche ADRs is 12% since January 1st.


Nestlé’s first quarter sales of CHF 20.9 billion grew 4.4% organically over the first quarter of 2014 with higher volumes and prices contributing 1.9% and 2.5% respectively to the growth. All geographies contributed to this growth with revenue growing 5.6% in the Americas, 4.5% in Europe, Middle East and North Africa and 2.2% in Asia, Oceania and sub-Saharan Africa. On January 1, 2015, Nestlé moved North Africa, the Middle East, Turkey and Israel into Zone Europe to provide a better balance of developed and emerging markets in its European (now EMENA) and Asian (AOA) regions. On May 1, 2015, Wan Ling Martello, who joined Nestlé as Chief Financial Officer in 2011 from Wal-Mart International, became head of Nestlé’s Zone AOA. Before joining Wal-Mart, Martello had extensive food and retail management experience at Kraft Foods. CEO Paul Bulcke will assume the CFO’s responsibilities until Nestlé appoints a new CFO.

Nestlé’s Global Water business is its smallest, at 8% of total revenue, but fastest growing business. First quarter sales of CHF 1.7 billion grew 7.3% organically over the same period a year ago. The U.S. is Global Water’s largest market, accounting for 50% of its annual sales. Growing demand for both sparkling and still bottled water placed Nestlé ahead of Dr. Pepper Snapple as the third largest U.S. soft-drink company behind Coca-Cola and PepsiCo in 2014. Nestlé has transformed its delivery business to 1.5 million homes and small businesses with a revamped web site and new bottle sizes. Sales to these customers are growing two to three times faster than sales to retail stores. Customers can now make one-time on-line orders of combinations of Nestlé’s still and sparkling waters. Nestlé receives $6 to $7 per 24 half-liter bottle case with orders that average $35 and include about 20% for shipping. Consumers pay $5 or less to buy the water at retail, but many prefer the convenience of not carrying the water home. With 2,000 delivery trucks that reach 60% of the U.S. population, Nestlé makes these deliveries within 24 hours. With home delivery sales approaching 20% if its U.S. water sales, Nestlé should be able to steadily move the business’ operating margin from 9.7% toward the 15.3% company average.

While consumers opt for bottled water over carbonated soda and other sugary drinks, activists in California have picketed Nestlé Water’s offices in Los Angeles and Sacramento, demanding that the company stop extracting water from drought-stricken areas. Nestlé notes that its five bottled water plants, out of the 108 in California, use 725 million gallons of water out of the 13 trillion gallons of water used in annually in the state, or less than 0.006% of the total. Even if Nestlé closed its plants, the resulting annual savings would be 0.3% of the total that residents and public users need to save. The total return on Nestlé ADRs is 8% since the beginning of the year.

Core Laboratories

Core Laboratories’ first quarter revenues and earnings both declined more steeply than management expected at the end of January, when they commented on Core’s year-end results. Then they thought that first quarter revenues and earnings would fall 12% and 20% below 2014’s first quarter. The results announced at the end of April were worse. Quarterly revenues of $213.6 million were 19% below the year ago quarter’s and earnings per share of 72¢ were down 47%! The decline in the use of Core’s products and services was faster and steeper than management expected based upon their experience during the 2008-9 decline. Declines of 3% and 18% in the revenue and profits for Core’s largest business Reservoir Description which derives 85% of its revenues from services that help sustain production from existing fields fell within the forecast. Revenues remained strong because recurring laboratory analysis of the changing composition of the fluids in producing reservoirs under conditions replicating the temperatures and pressures found there is crucial for determining the additives needed to maintain production at the optimum rate to ensure maximum recovery. Recurring revenue from these fluid analyses, which is a unique capability of Core, exceeds 55% of Reservoir Description revenues and continues to grow. This division generated 57% of Core’s revenues during this year’s first quarter compared to 47% in the fourth quarter.

Most of the substantial drop in Core’s revenue and profits occurred in the company’s heretofore highly profitable Production Enhancement division which provides perforation and tracers soluble in water and oil to more effectively complete horizontal shale oil wells. These tools allow drillers to use less pressure and water to frack a formation more precisely and to quickly diagnose the effects so the formation can be promptly refracked. Although Core anticipated a drop in drilling, it did not anticipate that it would be as abrupt as it was and result in a vast deferral of completions. Over 4000 wells in the U.S. have been drilled and remain uncompleted, which constitutes an inventory of work yet to be done by the Core’s service company customers. The downturn in U.S. land drilling, evidenced by a 35% drop in active rigs, drove Production Enhancement revenues down 32% and caused a 73% or $27.2 million drop in pre-tax operating income. On top of that, Canadian oil sands producers ruined the results of Core’s relatively small Reservoir Management division by ending a contract that had provided quarterly revenues of $8 million. That drove this small divisions’ revenues and operating profit down 39% and 63% respectively, which reduced the contribution to overall profit to 9% from 12%. The reason to continue owning Core, which is the most consistently profitable oil service company, is the strength of its fluid analytics business and its skill in devising ever more precise tools for safer and more productive development of oil bearing shales. During the quarter, Core bought 683,290 shares at an average price of $106 per share. Its stock price is down 1% since the beginning of the year.

Donaldson Inc.

Donaldson’s fiscal third quarter sales of $568 million declined 9% from the same period a year ago largely as a result of the 7% or $44 million negative impact of foreign currency translation. It’s earnings of 33¢ per share, which includes 5¢ per share of restructuring charges declined 28% from the same period a year ago. In constant currency, its off-road engine filter sales experienced the biggest decline during the quarter, dropping 17%. The decline in sales of agriculture and mining equipment continued as original equipment manufacturers cut production and reduced inventory. Even Donaldson’s after-market replacement filter sales slowed during the quarter to just less than a 2% increase as manufacturers cut inventory levels and independent distributors became more cautious and ordered less. The bright spot in Engine Filter sales continues to be for on-highway trucks which rose 12% during the quarter. Donaldson’s industrial filter sales fell 2% as strong replacement filter sales were offset by a drop in new system installations. The gas turbine filter business declined 11% from a year ago as a large $10 million order was delayed by the customer to a future period. This can be a lumpy business. Revenue had doubled during the previous quarter and will increase at a mid-teens rate for the full fiscal year.

Donaldson’s cost reduction actions, which included $5.2 million of restructuring charges during the quarter, will generate $20 million in cost savings beginning next fiscal year. Further expense reduction in its Chinese operations will generate an additional $15 to $20 million of savings. Revenues from Donaldson’s China operations, which represent about 7% of company revenue, declined 15% during the quarter. Donaldson has returned 170% of its net income to shareholders this fiscal year-to-date including $201 million of share repurchases, reducing shares outstanding by 3.6%, and $68 million of dividends paid, which is a 14% increase from the prior year. Donaldson’s total return this year is minus 6%.


SGS will report its first half financial results in July. Thus far during 2015, the global leader in inspection, verification, testing and certification services has announced the acquisition of seven businesses, broadening its capabilities in the U.S., U.K., France, Australia and Brazil and adding over $35 million in annual revenues. The total return on SGS ADR’s since the beginning of the year is minus 1%.

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

Client portfolio holdings may change, and stocks of companies noted may or may not be held by one or more client portfolios from time to time. Investors should not consider references to individual securities as an endorsement or recommendation to purchase or sell such securities. Transactions in such securities may be made which seemingly contradict the references to them for a variety of reasons, including but not limited to, liquidity to meet redemptions or overall client portfolio rebalancing. Investing in the stock market involves gains and losses and may not be suitable for all investors. Investment return and principal value of an investment will fluctuate.