1st Quarter, 2016

The 2016 first quarter revenues and earnings were good for all your companies other than the one dependent upon selling directly to oil and gas producers. Excluding that company’s results, first quarter earnings rose 8.6% compared to a 1.6% decline for the S&P companies without the oils. Revenue growth for your companies was 5%. Achieving this growth has become increasingly difficult which means these well run businesses must pay even more attention to cost control. They know that many of their customers are affected by the current worldwide slowing of economic growth caused in part by the collapse in commodity prices and an ensuing increase in bankruptcies. The financial repercussions so far have been slight because the actions and carefully worded guidance from the Fed and other major central banks around the world have persuaded debt and stock market participants to expect mammoth infusions of central bank liquidity at the first sign of financial stress. This suppresses the price volatility of bonds and stocks. The intent of this assured intervention is to sustain the current policy until economic growth revives. This policy, however, encourages companies to engage in financial engineering including large stock buybacks or acquisition of competitors to gain revenues with costs that can be readily cut. It also undermines companies’ appetite for new productivity-enhancing investments. Evidently, no other policy is being considered. Accordingly, the Fed is on the way to ‘the loosest tightening in the history of modern central banking.’ The foregoing comments on the central banks’ dominant influence on the financial markets are drawn upon the insights in Mohamed El-Erian’s latest book The Only Game in Town. He is a good thinker and capable bond investor.

Your cash reserves are invested in a BlackRock ETF that owns $11.4 billion of U.S. Treasury securities maturing in less than two years. It provides a yield of .65% which is better than nothing. We hold these reserves so your portfolio is ready to buy at a good price the shares of companies we think are as well-managed as those you own if, as is not improbable, further slowing of the economy or an alarming geopolitical event gives us a buying opportunity. A characteristic shared by the best companies owned in your portfolio and those under consideration as additions are well-learned habits of continual cost cutting along with well-practiced abilities to modify existing products or services to grow by exploiting new market opportunities.

Mettler-Toledo International Inc.

Sales growth in the U.S. and in China of 5% and 6% respectively compared with the first quarter of 2015 contributed to Mettler-Toledo’s first quarter sales growth of 4% in local currencies, one percentage point higher than the company’s forecast. Sales of $539.4 million grew 1% in U.S. dollars. Laboratory sales grew 5% during the quarter with strong sales of pipettes and autochem systems. Mettler’s pipettes, sold under the Rainin brand, are used to measure quantities of liquid precisely and are the second most widely used equipment in a chemistry or life sciences research lab after the balance. Rainin’s pipettes employ a unique technology that reduces the force required to eject used tips, and thus makes them easier to use in repetitive lab procedures. The proprietary tips provide Mettler with a profitable stream of recurring consumable product sales. The autochem business offers automated reaction vessels, accessories, sensors and computer software that control and analyze reaction processes in real time. These systems improve R&D productivity by speeding up the translation of bench scale to larger scale production processes which results in manufacturing processes that produce higher yields of high quality products at lower cost.

Continued investment in life sciences research and production in China contributed to the sales growth there, the first since the fourth quarter of 2014. Mettler won large government life science contracts for its Rainin pipettes and for its intelligent sensors in process analytics. The company also won a large contract at a pharmaceutical facility to integrate its formulation software with the facility’s bench and production floor scales. Although Mettler is winning industrial business, the core industrial business in China remains weak. Overcapacity in factories still exists, but sales did not decline as much as they did last year. The company’s earnings of $2.42 per share rose 9% over the earnings of $2.21 reported a year ago. Mettler’s stock price has risen 11% since January 1.

Express Scripts

According to Express Scripts’ 2015 Drug Trend Report, specialty drugs accounted for 38% of the cost of drugs for its plan sponsors’ 85 million members in 2015 and will account for half of all U.S. drug spending by 2018. Express Scripts is addressing this huge concern for its clients with unique programs such as its Hepatitis Cure Value (HCV) program. Launched in January 2015, HCV exclusively offers AbbVie’s Viekira Pak, a twice-daily oral drug that cures Hepatitis C, to all members of health plans in the program regardless of the severity of their illness. The program includes an adherence guarantee that refunds the cost of the drug if patients do not complete the twelve week treatment and an inflation cap that requires the drug manufacturer to increase its rebate to the plan sponsor if the list price rises above a negotiated price during the course of the year. Plan sponsors must use Accredo, Express Scripts’ specialty pharmacy, to dispense the drugs. HCV was extremely successful. Over 95% of patients were adherent; 96% of those patients were cured of Hepatitis C, and plan sponsors saved $1 billion on drug costs. All plan sponsors who use the National Preferred Formulary, which now covers 28 million patients, signed up for the program in 2016.

Express Scripts used its predictive analytic tools, which incorporate prescription data with 400 other variables, to determine those patients who needed help staying on the drug and those who would take the drug as prescribed and thus did not pay any adherence guarantees in 2015. Express Scripts has added similar programs for the high cost biologic cholesterol-lowering drugs approved last year and a program that offers indication-based pricing for oncology drugs. In this program, plan sponsors pay for a drug based on its efficacy in different types of cancer. All of these programs use Accredo as the dispensing pharmacy. They reduce the cost of expensive specialty drugs by moving share to the lowest cost specialty drug, improve access and health outcomes for patients. They also are very profitable for Express Scripts because it receives a dispensing fee, which can be as high as 6% of the cost of the drug, in addition to the standard fees for its formulary management programs. Dr. Steven Miller, Express Scripts’ Chief Medical Officer, commented that as long as drug companies develop new drugs, Express Scripts will make money by moving patients to the lowest cost drug with equivalent efficacy.

Express Scripts’ first quarter gross profit of $1.88 billion was 1.7% less than its gross profit of $1.91 billion in the first quarter of 2015. Adjusted claims volume of 324 million, where each three-month home delivery prescription counts as three one-month prescriptions, rose 5% from 308 million prescriptions a year ago. Operating earnings and net income of $1.46 billion and $791.4 million fell 3.5% and 2.5% respectively. Extra first quarter costs associated with implementing millions of health plan changes on January 1 and lower margins associated with the first year of the renewed Department of Defense contract accounted for the expected decline. Earnings per share rose 11% to $1.22 from $1.10 a year ago with a 13% decline in share count accounting for the increase. The company repurchased 45.7 million shares for $3.4 billion in the first quarter at an average price of $73.74. Express Scripts’ stock price is selling at $75.84, down 13% since the beginning of the year because investors are worried about the status of its outsourcing contract with Anthem, its largest customer. While each company has sued the other for breach of contract and negotiating in bad faith, on its first quarter conference call Anthem’s CEO indicated that they have no plans to evaluate alternatives to their relationship with Express Scripts for at least two years.

IDEXX Laboratories Corp.

IDEXX Laboratories’ first quarter revenue and earnings of $418 million and 51¢ per share grew 11% and 14% respectively in constant currency over the first quarter of 2015. The strong dollar reduced reported revenue growth by 2%. IDEXX generated 5¢ per share in foreign exchange hedging gains in the first quarter of 2015 that did not recur this quarter which reduced earnings growth in U.S. dollars to 4%. The first quarter results demonstrate the success of the company’s direct sales strategy and its innovative tests and instruments. Global recurring diagnostic revenue of $305 million rose 11% over the same period a year ago. Global placements of premium chemistry and hematology instruments increased 28% to 1,980, while the U.S. sales team placed 1,080 premium instruments including orders for 250 SediVue digital urinalysis instruments, an increase of 36%. SediVue placements increase future recurring diagnostic revenue as much as the placement of a Catalyst chemistry analyzer at a new account. The Catalyst is IDEXX’s most widely-used in-clinic instrument.

IDEXX’s 180 U.S. veterinary diagnostic consultants increased their calls to the vet practices in their territories by 23% during the first quarter for an annual rate of 10 visits per practice per year. Their increased presence along with visits from the company’s service veterinarians who explain the value of IDEXX’s advanced test menu lifted U.S. reference lab revenue by more than 15% over the first quarter of 2015. IDEXX’s proprietary SDMA test that detects early kidney disease continues to build the reference lab business. The number of practices sending chemistry panels to IDEXX because they include the proprietary SDMA test for early-stage chemistry disease in March increased by 15% over March 2015 before the launch of the assay in July 2015. The company’s labs have run 3.5 million SDMA tests since its launch in July. It is now available throughout the company’s global lab network. IDEXX’s stock price is up 21% since the beginning of the year.


Wabtec’s first quarter sales of $772 million were 6% below the sales achieved in last year’s first quarter. Although foreign exchange translation losses accounted for $18 million or 22% of the sales decline, the preponderance of the decline came from a 13.5% drop in sales of components, including specialty products and electronics for U.S. railroad freight customers who have cut capital expenditures by 35% this year. These cuts are offset slightly by a 7.4% increase in deliveries of components for new transit cars. Remarkably during the quarter, the gross profit margin rose 1.9% from 31.2% to 33.1% because cost reduction initiatives cut the cost of sales to freight customers 3.9%. Effective implementation of the Wabtec Performance System resulted in lower material costs and better operating performance which raised the operating margin to 18.4% from 18.1% a year ago. The company managed to improve its efficiency as sales declined by reducing employment 7% over the past two quarters. This is an extremely difficult accomplishment which adds to the credibility of management’s forecast of an earnings increase of at least 6% to $4.40 per share for 2016 from the $4.14 earned last year. During the first quarter, Wabtec’s sales of Positive Train Control Systems (PTC), its most profitable product, were only $85 million, down from $108 million during last year’s fourth quarter. Wabtec is the only provider of PTC systems approved by the Federal Railroad Administration. All U.S. freight and passenger railroads, including transit systems, must have PTC systems installed and operable by the end of 2018. Wabtec expects that PTC systems sales along with train control and signaling products, which amounted to $30 million in the past quarter, will increase in each successive quarter during the year. Unsurprisingly, the European Commission’s regulatory approval of Wabtec’s $1.8 billion acquisition of Faiveley is delayed, pending “further investigation (Phase 2) commencing on May 12 of a few product areas.” Wabtec’s stock price is up 10% since the beginning of the year.

Automatic Data Processing

ADP’s fiscal third quarter revenues of $3.2 billion and earnings of $1.17 per share rose 7% and 14% respectively from the same period a year ago. Foreign currency translation reduced revenue growth by 2% during the quarter. New business bookings growth of 13% reflects continued strong demand for its new products including modules which assist with Affordable Care Act compliance. To comply with the ACA, employers with more than 50 employees must send Form 1095-C to each employee describing the health insurance available to them. More than 25,000 businesses engaged ADP to deliver nearly 10 million Form 1095-C’s. This was the largest new employee tax filing form mandated by the U.S. government since the W-2 was first introduced more than 70 years ago. This past year, ADP processed nearly 60 million W-2’s, but the 1095-C is more complex because it requires the inclusion of health plan coverage details in addition to data from the payroll system. The penalty for failure to file a Form 1095-C is generally $260 per employee or a maximum of $3,178,500 per company.

During the quarter, the number of employees on each of ADP’s existing client payrolls rose 2.5% from a year ago. Once again, the TotalSource professional employer organization business which provides the most comprehensive set of outsourced human capital management solutions including payroll, healthcare and other benefits generated the strongest growth with revenues of $866.3 million up 16% and operating profit of $97.9 million up 22% from a year ago. Average TotalSource employees increased 14% to 422,000. Interest earned on client funds of $102.8 million was up just 1.5% as client funds balances of $26.7 billion rose 1.9% and the average interest yield remained stable at 1.5% compared to a year ago. ADP’s total return is 5% since the beginning of the year.

CME Group Inc.

CME’s first quarter sales of $934.2 million and adjusted earnings of $1.15 per share rose 11% and 17% respectively from the same period a year ago. CME achieved record average daily volume of 16.9 million contracts, up 13% from a year ago. Fee revenue from its financial contracts (interest rates, equity index and foreign exchange) rose 16% while commodities contracts (agricultural commodities, energy and metals) increased 10% from the same period a year ago. Strong global participation in CME markets lifted volume growth. Average daily volume traded from outside the U.S. rose 24% to 3.7 million contracts representing 22% of total volume. In Europe average daily volume rose 28% to 2.9 million contracts led by equities which surged 70%. Open interest, which quantifies future demand for contracts, measures the size of the market. It reached a record daily level of 116 million contracts in the quarter, up 27% from 91 million at year-end.

CME’s energy contract average daily volume rose 18% to 2.5 million contracts. This included record West Texas Intermediate oil futures and options contract volumes of 1.4 million contracts per day. In Europe and Asia average daily energy volume leapt nearly 60% and 75% respectively. CME has increased its volume share of its WTI product relative to its competitor’s ICE Brent contracts to 60% in March, up from a 51% share three years ago. The number of large open interest holders reported by the CFTC rose 6.9% from the prior year as of April. In April and May, average daily volume of energy contracts rose 36% from the same period the prior year.

CME’s investment in system enhancements to its Globex electronic trading platform, new products and client education are driving options usage and the electronification of options trading. During the first quarter 3.5 million options traded daily, up 22%. Of these, a record 1.8 million contracts traded electronically on Globex, an increase of 26%. In Europe and Asia, options volume rose 36% and 25% respectively. CME’s total return is 9% since the beginning of the year.


Visa delivered consistent revenue and earnings growth in its fiscal second quarter. Net revenue of $3.6 billion grew 9% in constant currency over the same period last year, with the relatively strong U.S. dollar reducing reported revenue growth by 3%. Earnings per share, excluding a one-time benefit related to the Visa Europe acquisition, increased 7% to 68¢. Earnings per share growth was reduced 10% by the strong U.S. dollar and the absorption of the first full quarter of permanent interest expense from Visa’s December 2015 issuance of $16 billion in long-term debt. Visa financed this debt at an average rate of 3.1% in advance of the Visa Europe purchase. The slow global economy did not prevent Visa from achieving double digit payment volume growth, with U.S. and international constant currency payment volumes increasing 11% and 14%, respectively, as the worldwide shift to electronic payments continues. U.S. consumers drove domestic payment volume to $694 billion from $628 billion despite a one percentage point drag from gas prices. Cross border payment volumes grew 5% this quarter as they did in the previous quarter. Travel from China and commodity-based economies in Latin America, the Middle East and Africa remains depressed. Sustained strength in inbound European commerce will benefit Visa when the company closes the acquisition of Visa Europe.

Visa strengthens its position as the backbone of global payments by opening its network to emerging payment technologies while maintaining network security. In February, Visa’s global product and technology teams launched Visa Developer, a platform that provides tools to software developers to create novel applications that run on Visa’s payment network. Using Visa Developer’s tools, a client created a working prototype of a mobile application in three days and a marketable product in a few weeks, substantially improving the typical months-long development and configuration process. The total return for Visa is 3% since the beginning of the year.

Ecolab, Inc.

Ecolab’s first quarter revenue of $3.1 billion was 2% lower in constant currency than revenue from the first quarter of 2015. Unfavorable foreign exchange translation reduced sales growth in U.S. dollars by an additional 4%. Earnings per share of 77¢ fell 4% from 80¢ posted a year ago after adjusting for one-time charges in both periods. Foreign currency effects also reduced the quarter’s earnings by 11¢ per share or 14%. While the company’s Institutional and Industrial businesses delivered moderate revenue growth of 4% and 2% to about $1.1 billion in revenue each, both businesses achieved double-digit operating profit growth. Institutional’s operating profit rose 18% to $196 million and Industrial’s operating profit grew 25% to $129 million. Volume gains and cost reduction initiatives accounted for most of the two percentage point increase in Industrial’s operating margin to 11.9% and for the 2.6 percentage point increase in Institutional’s operating profit to 18.7%. Institutional continues to deliver strong revenue and profit growth as its field service associates bring new products and services to over 600,000 foodservice, lodging and long-term care facilities in 132 countries. Institutional continues to win new accounts as it standardizes its business operations and employs local talent in the 12 countries that account for 87% of its sales. These countries are the U.S., Canada, France, Germany, the U.K., Italy, Spain, China, Japan, Australia, Mexico and Brazil.

The first quarter results for Ecolab’s Energy business were worse than expected. Sales declined 15% in constant currency to $767.3 million with declining volumes sending operating profit down 42% to $60 million. Management expects its upstream business, which primarily services North American shale oil wells, to decline from 10% of Energy’s sales to 8% by year-end. Sales of oilfield chemicals to customers with producing oil wells is down a bit more than expected because customers have temporarily stopped some programs and services. The downstream business that services refineries continues to grow and will account for 30% of Energy’s revenue this year, up from 25% last year. Ecolab does not expect a recovery in Energy until 2017. The total return on Ecolab’s stock is 4% since the beginning of the year.

Core Laboratories

Core Laboratories’ first quarter revenues and earnings of $153.6 million and 35¢ per share were 28% and 51% below the results for the first quarter of last year, when revenues and earnings were down 19% and 41% respectively. The results in early 2015 reflected the contractionary effect of a drop in the oil price from over $100 to the mid-$50’s per barrel. In this year’s first quarter, Core’s Production Enhancement division, which sells perforating charges and water soluble tracers to shale oil producers to make fracking more precise, intelligible and productive, experienced a disproportionately large earnings shrinkage as the completion of shale oil wells ground to a halt. The number of active land rigs in the U.S. fell 39% to 437, while over 4,000 of the horizontal wells drilled have not yet been completed. Production Enhancement sales fell 41% and its operating margin dropped below 10%. In 2014, it exceeded 30%. We expect new products in use by drillers adept at using new technology will increase Production Enhancement’s sales and profit, but no resumption of the past growth nor realization of past margins is probable. The reason for owning Core is the specialized capability it has developed to analyze the changing composition of oil and gas reservoir fluids as production changes the mix. For example, after years of producing oil from reservoirs beneath the North Sea, several Core customers now find that analyzing the reservoir fluids every two weeks to then modify the liquids or gases injected increases production and prolongs the life of the fields. The analysis of these fluids and their behavior under intense heat and pressure, as high as 400° Fahrenheit and 20,000 psi, in these reservoirs requires specialized instruments developed by Core to replicate the reservoir conditions thousands of feet below the earth’s crust. Many of the fields treated are large offshore deep-water fields operated by national or major oil companies. These services now contribute more than 50% of Core’s revenues and a higher percentage of profits. No company currently offers competitive fluid analysis services. The experience of many of the 1,300 scientists Core employs makes these crucial analyses more useful. Core wisely has decided to offer furloughs and opportunities for multi-skill training to retain its scientists while profits are depressed. On May 11, Core sold 1,475,000 shares of stock at $118.65 per share to raise $175 million to strengthen the company’s balance sheet. Core’s stock price at $121 has been pulled up 12% since the beginning of the year by the 32% rise in the price of oil.

Red Hat

Red Hat continues to benefit from companies’ interest in maximizing the flexibility of their hardware and software choices by using its supported open source software in their datacenters and in the cloud. Fourth quarter sales rose 17% to $544 million and fiscal year 2016 sales of $2.05 billion grew 15% over the same periods a year ago. Subscription revenue, which accounted for 88% of full year sales grew 16% to $1.8 billion. Infrastructure sales rose 12% to $1.5 billion and consist primarily of Red Hat Enterprise Linux (RHEL), the company’s supported version of the open source operating system Linux. Revenue from its new products, Application Development and Emerging Technologies, grew 37% over last year to $323 million from $237 million. Many customers modernizing their software development processes lower their costs by using Red Hat’s middleware software in addition to RHEL. Middleware connects applications to the operating system and provides a consistent platform to build applications that are easy to deploy. Red Hat’s version is much less expensive to use than proprietary software from IBM or Oracle.

Of the 30 largest deals closed during the quarter, 14 deals were in excess of $5 million and five were over $10 million. In addition to renewing at 120% of the value of the previous contract, 75% of these deals included subscriptions for middleware. Red Hat generated over $100 million in revenue from the public cloud in fiscal 2016 with half of the revenue coming from customers who spent less than $5,000 in the cloud. These users probably include small and medium-sized businesses, a new market for Red Hat, as well as engineers testing and developing new software applications and start-ups. The other half of the public cloud revenue came from customers who increased their datacenter RHEL subscription purchases while using the public cloud for additional RHEL workloads. These purchases support Red Hat’s thesis that companies will use hybrid clouds, combinations of on-premise and public cloud-based computing, depending on the requirements of their software applications.

As Red Hat closes more deals of $1 million or more, total backlog becomes a better metric of the company’s potential revenue growth because more customers sign multi-year contracts. The company’s backlog, which grew 15% year-over-year to $2.13 billion includes deferred revenue of $1.72 billion along with future billings of $410 million which do not appear on the balance sheet because they represent the later years of these contracts. The portion to be billed in the next 12 months is $275 million. Earnings per share for the fourth quarter of 52¢ rose 21% from the 43¢ earned in the fourth quarter of fiscal 2015. Earnings per share for the year rose 19% to $1.91 from $1.60 a year ago. Red Hat also maintained good cost discipline during the year. Operating margins increased 0.3 percentage points to 23.6% from 23.3% while the company added 1,500 employees in sales, customer support and research and development. Red Hat had 8,800 employees at the end of fiscal 2015. All of these results exclude share-based compensation, amortization of purchased intangible assets, transaction costs and the non-cash interest costs of Red Hat’s convertible debt. Red Hat’s stock price is down 7% since the beginning of the year.

Varian Medical Systems

Varian Medical Systems’ fiscal second quarter revenues of $759 million grew 2% in constant currency. Revenue growth in U.S. dollars was unchanged from a year ago because of unfavorable foreign exchange losses. Earnings of $1.09 per share were unchanged from the earnings reported a year ago. Earnings from both periods exclude amortization of purchased intangibles and non-recurring expenses. Oncology Systems’ revenue of $584 million grew 1% while gross profit rose 73 basis points (0.73%) to 43.7% as a result of more software and service sales, lower manufacturing costs and the suspension of the medical device excise tax. Orders of $618 million posted strong growth of 8% with 7% growth in North America and 23% growth in Europe, the Middle East and Africa. Double digit order growth in China offset a decline in orders in Japan to deliver 3% order growth in Asia. Varian received large orders in all three geographies during the quarter. The M.D. Anderson Cancer Center in Houston ordered six $2 – $3 million TrueBeam systems. The Apollo Hospital Group, the largest hospital chain in India, which is part of Varian’s European business, ordered 11 TrueBeams, one EDGE radiosurgery system and five brachytherapy systems. Brachytherapy systems implant radioactive seeds directly into a solid tumor and are often used to treat prostate and breast cancers. Over 75% of the orders in China were for new locations which will generate revenue from future sales of software, service and accessories as these clinics upgrade their systems to treat more patients.

In October 2015, Varian began selling VitalBeam, a fully digital system that allows clinics to offer advanced radiotherapy treatments for $1 million to $2 million depending on the accessories and software products purchased with the radiation source. It offers all the benefits of the TrueBeam system but cannot perform radiosurgery. While VitalBeam was developed as a mid-tier system for emerging markets, orders in the U.S. have been surprisingly strong. It is an excellent option for clinics that have fully depreciated radiotherapy systems and want to replace them with a new system capable of performing advanced treatments such as image-guided radiotherapy. Orders from these clinics contributed to the quarter’s strong order growth in North America.

Imaging Component sales remained weak during the quarter, down 8% over the same period a year ago because Toshiba Imaging Systems, which accounts for about one-third of Varian’s annual x-ray tube sales, has taken advantage of product improvements in tube life to reduce its supply of spare tubes. Varian reduced its 2016 sales growth forecast to 3%, a reduction of 1% or $35 million, to account for lower sales from Toshiba. On May 23, Varian announced that it will spin-off this business into a new publicly-traded company. Varian’s effective cost reduction programs will offset the impact of lower sales on the earnings growth forecast which remains unchanged at 4% to 5% for the year. Varian’s stock price has risen 2% since January 1.

Air Lease Corporation

Air Lease reported strong first quarter results. Revenues of $343.3 million rose 23% and adjusted earnings of $1.38 rose 34%. During the quarter, Air Lease generated a $21 million gain from the sale of its portfolio of twelve turbo prop aircraft. Air Lease typically sells aircraft from its portfolio when they are eight years old which provides capital for the purchase of new aircraft from its order books with Boeing and Airbus. During the quarter, Air Lease purchased 11 new aircraft for $731.6 million. The purchase of new aircraft and sale of mid-life aircraft keeps its fleet young, with an average age of 3.6 years and average remaining lease term of 7.2 years on its 239 owned aircraft. This also reduces the risk of impairment of the residual value of its aircraft. Excluding the gains on aircraft sales from each period and the current quarter receipt of $3.25 million of insurance proceeds reduces first quarter revenue growth and earnings growth to 18% and 27% respectively.

Global passenger traffic demand rose 7% during the first three months of 2016. Demand for new and used aircraft remains strong globally, with the exceptions of Russia and Brazil. Airlines can reduce operating and fuel costs by replacing their aging aircraft. Air Lease’s 239 aircraft are leased to 88 airlines in 50 countries. It has placed on long-term lease 85% of its 103 aircraft slated for delivery through 2018. Its deliveries for this year and next are 100% placed. Management confirmed that lease yields remain steady at 11.5% annually and buyer demand for used aircraft remains solid. Airlines based in Asia represent 43.6% of leased aircraft with China representing one-half of that. European airlines represent 30.7%. Seventy-five percent of Air Lease’s $8 billion of debt outstanding is fixed rate and 90% is unsecured. The composite interest rate on the debt is 3.34% a decline from a year ago when it was 3.59%. Air Lease’s stock price has declined 11% year-to-date, in line with its largest publicly traded peer company AerCap Holdings NV. AerCap reported 2% revenue growth and 8% adjusted earnings per share growth. We think the weakness in Air Lease stock price is caused by investor worry about the weakening global economy and the financial strength of airlines globally. An index of publicly traded U.S. airlines is down 15% since the beginning of the year.


Roche’s first quarter sales of CHF 12.4 billion grew 4% in constant currencies over the first quarter of 2015. Sales in Swiss francs grew 5%. The Pharmaceuticals Division’s sales of CHF 9.8 billion and the Diagnostics Division’s sales of CHF 2.6 billion grew 4% and 5% in constant currencies over the same period a year ago. Revenue of Perjeta, one of Roche’s second generation drugs for HER2-positive breast cancer grew 33% to CHF 332 million. Perjeta, in combination with Herceptin, is approved in 95 countries as a treatment for metastatic breast cancer after surgery and in 60 countries to reduce tumor size before surgery in non-metastatic breast cancer. The total return on Roche’s ADR is minus 1% since January 1 as investors anxiously await the results of a large clinical trial that studies the efficacy of Perjeta and Herceptin as an adjuvant, where a year of treatment after surgery prevents or significantly delays a relapse. Investors are also waiting for the results of a large clinical study that tests the efficacy of Gazyva, Roche’s improved version of Rituxan, in non-Hodgkins lymphoma. Successful outcomes will significantly boost revenue growth for these two important drugs for Roche.

In the meantime, Roche launched three targeted medicines in the U.S. this quarter, for lung cancer, melanoma and relapsed chronic lymphocytic leukemia, the most common adult leukemia. While sales of the first two drugs are small, they are growing quickly as additional clinical data and patient response supports the efficacy of these drugs. Roche co-developed the leukemia drug with AbbVie and will split the profits 50 – 50. AbbVie reports all sales of the drug. Roche’s diagnostics business continues to introduce innovative tests, such as an assay that predicts which pregnant women are at high risk for developing preeclampsia, one of the leading causes of death for mothers and their babies. Roche’s three laboratory-based businesses, Professional, Molecular Diagnostics and Tissue Diagnostics delivered 7%, 11% and 13% revenue growth over the same period a year ago. This growth was partially offset by an 11% decline in sales of the company’s diabetes low-end glucose meters and test strips.


Nestlé’s first quarter sales of CHF 20.9 billion grew 3.9% organically with volume growth of 3.0% and pricing growth of 0.9%. Reported revenue growth in Swiss francs was unchanged from the first quarter of 2015. Volume growth accelerated in Powdered and Liquid Beverages (mostly coffee), Water and PetCare to 5.2%, 6.2% and 3.6% respectively. Prices, however, have fallen 4% over the past four years in the U.S., Western Europe and China which account for more than two-thirds of Nestlé’s revenue. The company’s ability to develop new products or update existing ones drives increased sales in products such as CoffeeMate in the U.S. where the introduction of new flavors, packaging and Natural Bliss, its creamer in the natural category, deliver mid-single-digit revenue growth year after year. Nestlé successfully repositioned Hsu Fu Chi, its Chinese confectionary business, so it now contributes to revenue growth. The introduction of new machines, limited edition “grand cru” coffees and new boutiques for Nespresso helped its growth in all regions, even in Western Europe where Nespresso has a 50% share of single-serve coffee systems. This format, which now accounts for 18% of the $77 billion coffee market, is growing the fastest.

Nestlé still faces challenges in Asia with the reintroduction of Maggi noodles in India and the repositioning of its Yin Lu products in China. Maggi noodles returned to stores in India in November 2015, five months after the product was banned, and are steadily recapturing market share. Fixing Yin Lu has been more challenging, but Nestlé is moving from peanut milk into faster growing walnut milks and other plant-based milks. It is applying the same mix of product innovation and marketing that successfully relaunched frozen food in the U.S. and other brands with promise but need to be fixed. The total return on Nestlé’s ADRs since January 1 is 3%.


SGS will report its first half financial results on July 18. The company has completed six tuck-in acquisitions this year with combined annual revenues of $130 million. The acquired companies have operations in Hong Kong, South Africa, Netherlands and the U.S. The most significant company SGS acquired is Accutest Laboratories, the fifth largest full service environmental testing company in the U.S. Founded in 1956, privately owned and headquartered in Dayton, Ohio, Accutest’s network of labs and customer service centers in 14 states helps customers enhance their environmental reputations, manage risk, and increase business efficiency. The total return on SGS ADR’s since the beginning of the year is 18%.

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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.