2nd Quarter, 2015

Your companies achieved good second quarter sales and earnings growth despite slow rates of economic growth around the world and the persistent strength of the dollar. Collectively, the earnings for your companies rose 9% during the quarter on a 3% sales increase. The comparable figures for the S&P 500 companies are minus 1% and minus 9%.

The good results achieved by your companies result from their managers knowing how to continue to grow their businesses by developing or acquiring the capabilities to exploit product or service opportunities within or adjacent to their existing markets. In some instances, your companies, after careful planning, successfully changed how their sales or service organizations operate and then realized accelerated growth while opening more opportunities. They know what to do and the teams they lead know how to do it! Achieving their success under the current business conditions where not just competitors, but also governments, suppliers and customers are more demanding, requires determined, dedicated, realistic leaders who characterize the men and women running the operations of the businesses you have invested in. We think that your companies can easily adjust to an increase in short-term interest rates when the Fed finally decides to raise rates. Confirmation of a manufacturing contraction in China by the government, which alarmed many commentators, has not surprised the managers of your companies with operations in China. They have been making adjustments to cope with this eventuality for many months.

IDEXX Laboratories Corp.

Investor enthusiasm for IDEXX Laboratories’ good second quarter results and management’s compelling description of how its pipeline of new diagnostic tests and instruments will accelerate revenue and earnings growth erased the stock price decline of 11% for the year that we reported on June 5, 2015. IDEXX Laboratories’ stock price is up 4% year-to-date. Second quarter sales of $413 million were up 6% over the same period last year. The strong U.S. dollar reduced the quarter’s revenue growth by 7%. Global recurring diagnostics sales of $300 million grew 14% organically and placements of premium chemistry and hematology instruments each grew 44% over the same period last year. Earnings per share rose 9% to 60¢.

The July launch of two diagnostic tests in the U.S. and their quick uptake by companion animal vets demonstrates both the quality of IDEXX’s innovations and the ability of the direct sales force to explain the benefits of the new products. The company began shipping a rapid assay test for Leptospirosis, a highly contagious and dangerous disease for both pets and humans. Vets and technicians dread taking a urine sample from a sick pet exhibiting the disease’s flu-like symptoms and then waiting at least 24 hours to get a result back from the reference lab. Clinics using the new SNAP test receive results in eight minutes. IDEXX expects this test to add $1 million to $2 million to rapid assay revenue this year alone.

The more significant launch is that of IDEXX’s SDMA test, its unique diagnostic test for chronic kidney disease. The U.S. launch has been flawless. As of August 6, the second day of the company’s annual investor meeting, 300,000 pets have been tested, nearly 11,000 of the 25,000 clinics in the U.S. are using the test and over 1,300 non-IDEXX reference lab customers have requested it. With 27 peer-reviewed papers and the integration of the test into the International Renal Interest Society’s staging guidelines, the test is rapidly becoming part of the standard of care. Vets that do not use IDEXX’s reference labs are either paying $19.95 for the SDMA test alone or running a full chemistry panel for $30 or $40. Management expects the availability of the SDMA test to increase the growth rate of recurring diagnostic revenue. Reference lab customer retention may increase by 2% from 96% to 98%; overall chemistry testing may rise as vets use this test to explain the value of preventive testing to pet owners; more vets will purchase IDEXX’s diagnostic instruments and services to have access to the test; and the company receives $19.95 for each stand-alone test.

Express Scripts

Express Scripts delivered good second quarter results with gross profit of $2.2 billion growing 2% and adjusted earnings per share of $1.44 up 17% over the second quarter of 2014. These results exclude transaction costs associated with the Medco merger and amortization of intangible assets. On April 29, 2015, the company repurchased 55.1 million shares at an average price of $84.79 per share. The remaining 15% of this accelerated share repurchase plan will be completed in the first half of 2016. Thus, profit growth and a lower share count each contributed equally to earnings per share growth during the quarter. Efficient operations and excellent management of drug costs helped deliver operating earnings per claim of $5.59, an increase of 4%. The 2015-16 selling season is going well. Express Scripts expects to retain 95% to 97% of its existing clients, a significant improvement from the 92% retention rate in 2014. Exceptional execution of the January 1 transition generated good references that will help win new business.

Express Scripts made two important announcements regarding senior management on September 9, 2015. First, Tim Wentworth, who became President and Chief Operating Officer in 2014, will succeed George Paz as CEO after the company’s annual meeting in May 2016. Paz will become non-executive chairman. He became president of the company in 2003 and CEO in 2005. Second, Eric Slusser joined Express Scripts as Chief Financial Officer. He served as CFO of Gentiva Health Services, a privately-held provider of home health, hospice and community care services, for six years prior to joining the company. He also served as CFO of Centene Corp., a specialized health insurance company, from 2007 to 2009. A certified public accountant, Slusser has 22 years of experience in finance outside of healthcare. Express Scripts’ stock price is unchanged since the beginning of the year.


Wabtec’s stock is up 10% since the beginning of the year. The company’s second quarter earnings of $1.04 per share, 14% higher than the year ago quarter were the highest for any quarter in the company’s history. Sales rose to a record $847 million, 16% higher than the year ago quarter, as a result of a 30% increase in sales to freight railroad customers. An additional $25 million for rebuilding locomotives as well as $69 million of incremental electronics sales for Positive Train Control Systems and a new dispatch system for the Florida East Coast Railway brought freight revenues up to $543.7 million during the quarter. Wabtec managed to increase its operating margin slightly to 18.4% despite a year-to-year increase of only 2% in transit profits due to translation into dollars of profits from sales denominated in foreign currencies. That, for example, eliminated recognition in the financials of a 2% improvement in the operating margin on Fandstan’s sales from its plant in Germany. It was acquired a year ago in June.

Four days after reporting its strong second quarter earnings, Wabtec announced it had agreed to buy the 51% ownership held by the family controlling Faiveley Transport, Europe’s second largest railroad equipment manufacturer. It’s located in France. Wabtec agreed to issue preferred stock, paying a 1% dividend convertible into 1.125 Wabtec common shares after three years to pay for 75% of the purchase cost. The balance will be paid in cash available from deposits held overseas. After conversion, the Faiveley family will own 6% of Wabtec. Before offering the same terms to public shareholders, Wabtec must receive approval for the acquisition from an employee council. Thereafter, public shareholders would be offered similar terms, although Wabtec might buy a greater percentage of publically owned shares for cash. The acquisition may not close until mid-2016. Importantly, Wabtec’s management resisted the temptation to borrow heavily to make this strategic acquisition. Ray Betler, Wabtec’s President and CEO and Stéphane Rambaud-Measson, the current CEO of Faiveley, who will become President and CEO of Wabtec’s Faiveley Transport business after the acquisition, previously worked together at Bombardier and welcome the prospect of working with one another again.

Although Faiveley’s sales are less than half Wabec’s, and its margins are less than half the 18.4% operating margin earned by Wabtec, its position in transit markets in Europe and Asia offer access for Wabtec’s products and bring stable recurring revenues as well as growth from expanding transit systems. Faiveley’s products complement Wabtec’s with little overlap, even in brakes, which is surprising since it owns the European operations of Westinghouse Airbrake that Wabtec’s previous management could not acquire in 1990 when they bought the U.S. business from American Standard. The issuance of preferred stock postpones dilution of shareholder equity for three years, providing time for Wabtec to bring Faiveley’s operating margin up toward the 12% margin earned on Wabtec’s transit revenues. After the acquisition, transit revenues will constitute 54% of Wabtec’s revenues. They are less cyclical than freight revenues, but nowhere near as profitable when freight demand is strong, as it is now.

Automatic Data Processing

ADP’s fiscal fourth quarter revenues of $2.7 billion rose 7% excluding a 3% negative impact from currency translation. Earnings of 55¢ per share from continuing operations rose 15% from the same period a year ago. Its fiscal 2015 full year revenues of $10.9 billion rose 9% excluding a 2% negative currency impact, while earnings of $2.89 rose 12% from the prior year. Its pre-tax margin of 18.9% rose 60 basis points from the prior year. During the fiscal year, ADP returned $2.5 billion to shareholders through dividends and share repurchases.

During the quarter, ADP posted a huge 18% increase in worldwide new business bookings on strong demand for its cloud-based human capital management solutions especially for products which help businesses comply with the Affordable Care Act. The number of employees on existing client payrolls increased 2.9% in the fiscal fourth quarter and 3.0% for the fiscal year. Average worksite employees for ADP’s TotalSource PEO increased 13% to 384,000 driving revenues from this comprehensive outsourced HR solution up 16% to $678 million during the quarter. ADP continues to invest in and introduce additional products and services which it can sell to existing customers. ADP DataCloud, introduced last quarter, leverages data that ADP maintains to provide customers with insights into their workforce through reporting and analytics. The tools help predict employee turnover and also provide benchmarking analysis utilizing data from ADP’s 600,000 customers with 24 million employees. We are surprised that ADP’s total return is minus 3.6% since the beginning of the year.

CME Group Inc.

CME delivered another quarter of strong operating results. Revenues of $820 million rose 12%, expenses rose just 2% to $325 million and adjusted earnings of 95¢ per share surged 23%. Revenue growth, which was all organic, came primarily from an increase in clearing and transaction fees as the overall volume of futures and option contracts traded increased 6% to 13.3 million. The average rate per contract rose 4% to 77.7¢ as its highest priced contracts recorded the strongest growth. Contract volume during the quarter declined 1% and 4% in interest rates and equities respectively but surged 20%, 30% and 42% respectively in energy, agricultural commodities and foreign exchange products. During the quarter, 2.6 million options contracts traded overall, an increase of 13% from a year ago, while those trading electronically rose 29%. CME’s investments in electronic trading system enhancements, new products and investor education for the options market are working. Investments made during the past five years to develop trading in its products around the world are also paying off with volumes up 22% in Asia, to 548,000 per day and up 10% in Europe to 2.2 million contracts a day. CME has reduced expenses by closing most of its trading pits where activity has been replaced by electronic trading. In addition they have reduced overall headcount and consolidated data centers. The total return on CME is 9% since the beginning of the year.

Mettler-Toledo International Inc.

Mettler-Toledo’s second quarter sales of $582 million grew 3% in local currencies over the same period a year ago. The strong Swiss franc reduced reported sales growth by 7%. While sales were strong in the U.S. and in Western Europe, weak sales in China, Russia and Brazil reduced revenue growth by 4%. Good execution of its sales and marketing programs, including the investments in new sales personnel, allowed the company to leverage its product portfolio to increase market share. Mettler delivered earnings growth of 9% to $2.77 per share over the same period a year ago excluding restructuring charges. Earnings per share grew 14% in local currencies.

Mettler is investing in new products and salespeople for its Product Inspection business where revenues grew 9% during the second quarter. This business, with sales primarily to food, beverage and pharmaceutical companies in developed countries, accounts for 40% of the Industrial business and for 18% of total revenues. Product Inspection instruments, which include checkweighers, metal detectors, X-ray, vision and serialization solutions, ensure the integrity and quality of packaged goods. The company has the broadest product offering on the market and is the clear global market leader outside of Japan where local competitors dominate. The company’s large, well-trained global service force provides high uptime and, thus, manufacturing productivity. This service capability is a key selling point. If the packaging line is down, manufacturing stops. Mettler is considered the innovation leader and anticipates that 80% of orders for its core X-ray instrument will be for its newest instrument. It offers the highest sensitivity as well as comprehensive diagnostic tools that ensure uptime. Major food companies use more Mettler instruments to detect contaminants that can lead to product recalls. They also are beginning to use these instruments to track item-level serialization to provide traceability to the point of sale. The company already sells these sophisticated systems to pharmaceutical companies where label information is regulated and label mixups or errors can lead to product recalls by the FDA. Mettler-Toledo’s stock price dropped 12% in August amid investor concerns about economic growth in China. It is down 2% year-to-date.

Ecolab, Inc.

Growth in corporate account sales and new product introductions in all of Ecolab’s businesses contributed to second quarter revenue growth of 5% in constant currency over the second quarter of 2014. A $250 million year-over-year impact of foreign currency translation reduced reported sales by 2% to $3.4 billion. Ecolab expects sales to corporate accounts to be about $1 billion this year, as much as the cumulative sales from 2009-2014. The company develops and designs programs for a customer, such as Coca-Cola’s Bottling Investment Group which runs 1,100 bottling plants worldwide, and then puts them in place in each plant. Ecolab employs 25,000 field service associates, more than half of whom have more than five years’ experience, to ensure that the programs, systems and processes work as designed and that employees are trained at each unit. Ecolab’s new product pipeline grows 12% to 15% per year, at twice the overall corporate sales growth rate of 6% to 8%. Since it takes time for new products to be installed at customer facilities, Ecolab measures innovation by peak sales at 5 years. The company delivered $1 billion in sales from innovation in 2014 and expects sales of $1.15 billion this year.

Food & Beverage, Global Institutional and the service businesses, Pest Elimination and Equipment Care, each delivered 6% revenue growth during the quarter. Strong growth in these businesses more than offset the 5% sales decline in the Energy business. Sales in the upstream Energy business declined 37% during the quarter. This business sells private label chemicals to service companies that drill and complete shale oil wells in North America. Revenues fell 2% in the downstream oil field chemical and refinery businesses. Double-digit growth in international business offset some of the weakness in North America. Ecolab continues to generate operating leverage by controlling costs and increasing product volumes. Adjusted operating income, which excludes special gains and charges, was $438 million, an increase of 8%. Operating margins increased 0.8 percentage points to 15.1%. Adjusted earnings rose 5% over the same period a year ago to $1.08 per share from $1.03. The total return on Ecolab stock is 6% since January 1.


Hexcel delivered solid second quarter results with sales rising 5.4% in constant currency over the second quarter of 2014 to $476 million. The strong dollar reduced reported sales growth by 4.2%. Earnings per share of 63¢ rose 14.5% over earnings per share of 51¢ reported a year ago. Commercial aerospace revenues grew 7.7% to $325 million with revenues from new Boeing and Airbus programs rising more than 30%. Sales to these programs more than offset declines in revenues from lower production rates of older planes. Space and Defense sales of $88 million were unchanged from those a year ago. Revenues from the top 15 programs, which account for 70% of the division’s sales, grew almost 10% in the first half of the year. Decreased production of the C17 transport plane reduced quarterly sales by $13 million. Lower demand for commercial helicopters for oil and gas exploration trimmed sales by $1.7 million.

Hexcel continues to implement a broad array of productivity programs to increase throughput, reduce product changeover times and to minimize or reuse scrap material. These programs and a focus on increasing inventory turns and supply chain efficiency contributed 0.5 percentage points to the 1.7 percentage point improvement in Hexcel’s operating margin to 19% from 17.3% a year ago. The company also continues to introduce improved versions of its existing products. At the Paris Airshow in June, Hexcel introduced a new honeycomb core material which increased its heat resistance from 500°F to 2,000°F by inserting heat resistant material into the honeycomb cells. Hexcel can combine these inserts with other materials that reduce aircraft engine noise to tailor this material used in the nacelle, the internal engine cover, to meet the specific needs of each customer. Hexcel’s stock price is down 6% since its initial purchase in late April.

Air Lease Corporation

Operating results at Air Lease remain strong, although its stock price has fallen 7% this year amidst investor worries about China and the impact of lower fuel costs on new aircraft demand. Chinese airlines generate 22% of the company’s lease revenues. Its three largest customers, China Southern, China Eastern and Air China are among the strongest airline credits in the world. Air Lease reported second quarter revenues of $304.7 million and earnings of 70¢ per share, increases of 19% and 21% respectively from a year ago. This strong growth along with its 39% pre-tax profit margin indicates that lease yields and thus demand for modern fuel-efficient jets remain strong. During the quarter, Air Lease took delivery of and leased 18 new aircraft from its order book and sold 14 aircraft from its operating lease portfolio bringing its owned fleet to 223 jets. They are leased to 84 different airline customers in 47 countries. Its remaining 22 aircraft deliveries in 2015 are 100% placed with airlines, while 94% of deliveries scheduled for 2016 are already placed with airline customers. Global passenger demand is up 6.3% in the first half of the year according to the International Air Transportation Association which highlights the need for airlines to continue to invest in their fleets. Lower jet fuel costs improve airline profitability and enable them to continue to upgrade their existing fleets. A good hedge against higher future jet fuel prices in the years ahead is reducing fuel usage by retiring older planes and upgrading to the newest generation aircraft being delivered by Boeing and Airbus.


Visa delivered strong revenue and earnings growth despite little growth in the global economy. Fiscal third quarter revenue of $3.5 billion rose 14% in constant currencies over the same period a year ago. The strong dollar reduced reported revenue growth by 3%. Adjusted earnings of 62¢ per share rose 15% over 54¢ achieved during the fiscal third quarter of 2014. This quarter’s earnings exclude a one-time tax benefit of $280 million or 12¢ per share and a 4¢ per share charge for a one-time expense. Service revenues of $1.6 billion increased 9% as payment volumes rose 11% to $1.2 trillion. Service revenue growth benefitted from a fee increase on U.S credit transactions. Transactions processed by Visa’s network during the quarter rose 8% to 18 billion, with U.S. transactions growing 8% and international transactions up 7%. The associated data processing revenues rose 6% to $1.4 billion. Russia began processing domestic transactions on its own network in April which reduced international transaction growth by 2% during the quarter. Visa will continue to process cross-border transactions in Russia.

Visa continues to invest in its electronic payment platforms that facilitate e-commerce. Visa Checkout, the company’s payment platform that offers the secure transfer of payment information with a username and password, continues to expand with 270 financial institutions and 160,000 merchants participating worldwide. The potential payment volume has grown to $50 billion. Over five million registered users in 16 countries now use Visa Checkout for on-line payments including consumers in China, Hong Kong, New Zealand, Brazil, Colombia and South Africa. Visa also announced a partnership with FireEye, a leading provider of network security, which will combine cyber attack data from both companies to help merchants, acquiring and card-issuing banks quickly detect and respond to these attacks. The total return on Visa’s stock is 8% since the beginning of the year.

Varian Medical Systems

Varian Medical Systems’ third fiscal quarter revenues of $784 million increased 5% over the same period a year ago. The strong U.S. dollar reduced reported sales growth by $42.9 million or 6% during the quarter. Earnings of $1.13 per share rose 4% excluding a non-recurring charge taken last year. Oncology Systems revenues were $559 million, down 3% from a year ago while orders of $635 million rose 2%. Order growth in constant currencies rose 10% as strong growth in international orders offset a 2% decline in orders in North America. Orders rose 13% in Europe and the Middle East, 21% in Asia and 62% in Latin America. Varian achieved almost $30 million in competitive replacements in North America by replacing seven Siemens radiation treatment machines and 20 software systems. Every clinic that needs to replace a competitor’s radiosurgery system is evaluating Varian’s EDGE system. The competitor’s system treats only brain and head and neck tumors, while EDGE provides treatments of the same quality for these tumors and treats liver and lung cancers as well. Varian is not seeing a decline in demand for its systems and services in China. Orders remained strong, growing more than 10% over the same period last year. The company’s recent Users Group meeting in Beijing that focused on radiosurgery had 550 attendees. The company also received orders for two EDGE systems during the quarter. Excellent supply chain management helped hold gross margins steady at 43.5% year-to-date despite the foreign exchange headwinds. Growing volumes of radiation treatment purchases based on the TrueBeam platform allow the company to obtain volume discounts from its suppliers. These discounts and increased sourcing in lower cost countries have enabled the company to reduce variable costs for these systems by 4% to 6% each year over the past two years. Investor concern about the long-term profitability of the business has contributed to an 9% decline in Varian’s stock since January 1.


Roche’s six month sales of CHF 23.6 billion grew 5.7% at constant exchange rates over the first six months of 2014. The strengthening of the Swiss franc against all major currencies except the U.S. dollar reduced the period’s reported revenue growth in Swiss francs by 3%. Core earnings per share of CHF 7.22 rose 2%. Core earnings exclude amortization of intangible assets, restructuring charges and other non-recurring expenses. Earnings per share rose 7% excluding the impact of the sale of Neupogen rights to Amgen in 2014.

Revenue from the Pharmaceutical Division rose 5% to CHF 18.4 billion. Roche’s trio of breast cancer drugs posted revenue of CHF 4.3 billion, up 21% over the first six months of 2014. Increased use of Avastin in cervical and ovarian cancers contributed to revenue of CHF 3.4 billion, an increase of 9%. Sales of immunology drugs Actemra for rheumatoid arthritis and Xolair for severe asthma and hives rose 25% and 28% to CHF 675 million and CHF 593 million respectively. Loss of sales from Xeloda, an oral cancer drug and Pegasys, an interferon used in older Hepatitis C treatments, reduced revenue by 2%. Roche’s cancer immunotherapy drug continues to deliver good results treating patients with lung cancer who have failed at least one treatment and patients with metastatic bladder cancer. While most investors focus on the development of this drug, the company is successfully developing drugs outside oncology. On June 30, 2015, Roche reported the results from two late-stage studies of its novel multiple sclerosis drug in 1,676 patients with the relapsing form of the disease. Ocrelizumab, a biologic drug that targets the immune cells that are thought to be a key contributor to myelin and nerve cell damage that cause MS, reduced the relapse rate, the progression of disability and the number of brain lesions compared to the standard of care. Roche will use the results of these trials to file with the FDA and the EU regulatory authorities early next year.

The Diagnostics Group delivered strong first half results with revenues of CHF 5.2 billion up 7% over the first six months of last year. Operating margin rose 0.3 percentage points to 19.5%. Roche Diagnostics is the largest global supplier of in-vitro diagnostics instruments and consumables with 20% of a $55 billion market. It has leading market share in all of its businesses. Roche is developing companion diagnostics for 60 new drugs in late-stage trials. It has mastered the complex regulatory process of working with the drug and diagnostic groups at the regulatory agencies at the same time. Scientists begin developing the tests in early stages of drug development to ensure that the diagnostics are ready at the right time to enable late-stage drug trials. Roche ADRs have returned 2% since January 1.


Nestlé’s first half revenues of CHF 42.8 billion grew 4.5% organically over the first six months of 2014. Volume and pricing growth accounted for 1.7% and 2.8% of revenue growth respectively. The strong Swiss franc reduced revenue growth by 5.8%. Earnings of CHF 1.43 per share were down 1% as reported, but rose 7.3% in constant currency. While the trade operating profit margin of 15% was unchanged from a year ago, gross margin increased 1.6 percentage points with increased operating efficiency and lower cost of goods in Nestlé’s skin care business contributing equally to the gain. Nestlé used the savings to increase consumer marketing and research and development spending by 17% and 9% respectively. Working capital utilization was good during the period. It declined CHF 2.4 billion over the same period a year ago. Improvements in global procurement reduced accounts payable by CHF 2.0 billion. François-Xavier Roger became Chief Financial Officer on July 1, 2015. He joined Nestlé from Takeda Pharmaceuticals in Japan where he was chief financial officer. He also held senior finance positions at Aventis and Danone. Roger plans to continue Wan-Ling Martello’s focus on return on invested capital and to use her model to determine whether to invest, fix or divest the company’s diverse businesses.

All regions contributed to revenue growth during the period. Organic growth was 6.6% in the Americas, 3.4% in Europe, Middle East and North Africa and 2.2% in Asia, Oceania, sub Saharan Africa (AOA). Management sees positive early signs from the U.S. launches of Lean Cuisine Market Place and Stouffers Fit Kitchen lines of frozen foods that reposition both of these products in the healthy eating category. China delivered mid-single digit revenue growth with ambient dairy showing some signs of improvement. Nescafé ready-to-drink beverages delivered more than 10% growth. The voluntary recall of Maggi noodles in India on June 5, 2015 reduced revenue growth in AOA by one percentage point. The company incurred an additional CHF 66 million in one-time costs to remove hundreds of millions of packages of the most popular snack product in India from shelves in every store. In addition, food safety labs in Singapore, the U.K. and Canada tested the product and deemed it safe for export. In August, tests at the Central Food Technological Research Institute in Mysore, India determined that the product meets all food safety regulations. Nestlé is working with local authorities to reintroduce the product in India. The total return on Nestlé ADRs is 6% since January 1.

Core Laboratories

Core’s second quarter revenues of $204 million and earnings per share of 81¢ were 24% and 45% below the comparable results reported for last year’s second quarter when oil prices were trading above $100 a barrel. The price has been cut by more than half. These second quarter results are slightly better than the comparable results for companies comprising the S&P oil service composite, although Schlumberger’s earnings declined less on a similar drop in revenues. During the quarter, Core’s revenues were only 4.5% less than those booked in the first quarter while net income rose 10% to $34.6 million. That indicates that the 600 person or 12% reduction in Core’s workforce made during the first quarter at a cost of $7.1 million may be sufficient to regain the mid 20% net income margin earned during the pre-boom years. No employees are any longer on furlough. If these modest cuts coming after Core management incurred costs of $6.3 million in last year’s third quarter to phase out Production Enhancement products that were becoming commoditized is all that’s needed to bring Core’s costs back in line, management has done well.

Recurring analyses of the composition of reservoir fluids in producing oil fields, particularly those offshore, have proven to improve oil recovery and have become Core’s fastest growing service. It is growing at nearly 20% and now provides 35% of total revenues. Some customers have increased the frequency of their analyses to twice monthly, although that is not the norm. The analyses are performed in Core’s laboratories on proprietary instruments that replicate the reservoir temperatures and pressures. Core’s Production Enhancement division also is beginning to obtain new business from customers, notably in the Bakken, to provide perforating charges and tracers to refracture oil fields for five companies. Core’s business has stabilized and is prepared for revenue growth that is yet to be realized. Core’s total return is minus 10% since the beginning of the year. During the past quarter, Core paid an average price of $119.24 to buy 359,732 shares.

Donaldson Inc.

Donaldson’s fiscal fourth quarter and full year sales of $609.7 million and $2.4 billion declined 1.1% and rose 1.3% in constant currency respectively. Foreign currency reduced reported sales by 7.7% and 5.4% during the quarter and full year period. Earnings of 45¢ per share and $1.58 per share during the quarter and year declined 10% and 9% and exclude 4¢ per share and 7¢ per share of restructuring charges to reduce the size of its workforce, close a production facility in Grinnell, Iowa, and write-off a partially completed facility in Xuzhou, China which is being mothballed. While these cost reductions are expected to generate 15¢ per share in annual cost savings, Donaldson continues to invest for growth by expanding liquid filtration production in Europe with a new plant in Poland and expanding aftermarket distribution in Latin America and Eastern Europe. During the full year, Donaldson repurchased 6.68 million shares at an average cost of $38.39 for $256.3 million, representing 4.7% of total diluted shares outstanding.

During the quarter, off-road filter products and aftermarket filter product sales fell 24% and 5% respectively on weakness in mining and agricultural markets which lessens demand for new equipment and replacement filters. On-road products, by contrast, rose 8% on strong production of heavy duty trucks. Industrial filter sales rose 5% on good demand for dust collection filters and gas turbine sales rose 30%. Donaldson’s total return is minus 20% since the beginning of the year. Three-quarters of the decline came since June 30 after we reduced our position because of management’s comments regarding the need to make more acquisitions.


SGS Group’s first half revenue growth of 3.4% to CHF 2.66 billion on a constant currency basis was generated equally from organic growth and acquisitions. In Swiss Francs, revenue declined 1.9% compared to the same period a year ago principally because the Swiss Franc strengthened 13.2% against the Euro. Sales in Euros comprise 26.3% of revenues. During the first half, SGS completed seven acquisitions for total consideration of CHF 41 million. These seven companies generate annualized revenue of CHF 33 million and operating income of CHF 8 million. SGS’ adjusted net profit rose 5.8% during the first half to CHF 260 million excluding CHF 47 million of one-off restructuring expenses. Forty percent of the restructuring costs are in the Minerals business to reduce headcount and close facilities with additional restructuring in its Industrial and Oil, Gas and Chemicals businesses. SGS’ most rapid organic revenue growth of 8.4% came from Government and Institutions services which had solid growth in its inspection businesses in Europe, Middle East, Africa and Asia. Its important Consumer Testing business generated mixed results with revenues up 5.7% but operating income up just 0.7%. SGS achieved double-digit revenue growth in the Electrical and Electronics segment stemming from recent investments in LTE testing capacity for wireless and mobile devices and equipment in the U.S. and Asia. Its Automotive parts testing recorded double-digit growth in China, India and Germany. The margin decline in the Consumer Testing business, however, came as a result of lost volume in softlines as some competitors moved more quickly to shift testing to lower cost locations in Northern China, Turkey and Vietnam. The total return on SGS ADRs is minus 10% since the beginning of the year despite its free cash flow doubling from the same period a year ago as a result of significant improvements in working capital, a priority of the new CFO.

CDK Global

CDK held its inaugural Investor Day meeting in Chicago on June 16 and provided a summary of its business transformation plan which it developed with a leading consulting firm. Though there are multiple elements to the plan, essentially CDK management intends to eliminate costs, raise prices and take on more debt to increase dividend payments and share repurchases. Under this ambitious three year plan, CDK expects to deliver 4 to 5% annual revenue growth and greater than 25% annual pre-tax profit growth annually while bringing its 2018 cash flow margin to 35% from 22% today. It expects to incur charges of $150 million during the next three years to reduce costs and streamline the organization. The plan will be difficult to execute, but could make the company attractive to buy-out firms. According to Bloomberg, CDK is meeting with private-equity firms to gauge their interest. Our additional purchases made after the spin-off in October last year become eligible for long-term capital gains treatment next month.

During CDK’s fiscal fourth quarter, adjusted revenues of $497 million and adjusted earnings of 28¢ per share rose 2% and declined 10% respectively from a year ago when its automotive retail business in the U.S. had a higher mix of more profitable upgrade installations. For the full fiscal year, on an adjusted basis, revenues of $2.5 billion rose 6% and earnings of $1.38 per share rose 15% from the same period a year ago. Certain costs, such as $1.9 million during the fourth quarter for consulting and other fees associated with the transformation program are not included in the adjusted calculations provided by the company It is up 68% from its October 1 spin-off from ADP.

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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 seek to invest in profitable well-managed companies that generate recurring free cash flow. These companies should 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 have provided our clients with good long-term results. The financial strength of the companies held in client portfolios has lessened 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.