2nd Quarter, 2016

David Malpass, an economist whose analysis of economic data has proven useful and illuminating for us, directed our attention to the fact that over the past five years, bond issuance has provided 72% of the U.S. economy’s credit growth. All this credit financed by bonds was raised by governments and large corporations. Government borrowers, for the most part, used the funds raised to pay operating expenses, while corporate borrowing was used to finance acquisitions or stock repurchases designed to increase earnings per share for the forthcoming quarter. We emphasize the short-term thinking motivating this debt issuance because it is increasingly prevalent among managements of public companies. Many companies without the reduction in share count facilitated by debt funding would have reported a decline in their quarterly earnings. The quarterly dividends paid plus stock repurchases now exceed the earnings reported by U.S. public companies. Second quarter earnings for the S&P companies were 3.5% below last year’s second quarter. Your companies’ earnings for the quarter were 6.4% higher than last year. The foregoing means that it’s more important than ever for companies to generate free cash flow from their operations and that means we are more reliant than ever on the good character and experience of the managers running the companies we own in your and our portfolios. The total return on these stocks is 9.5% year-to-date compared to the comparable return for the S&P 500 of 6.2%.


Mettler-Toledo’s second quarter sales of $608.3 million grew 6% in local currencies and 5% in U.S. dollars over the second quarter of 2015. A combination of lower material costs, product mix and on-going cost efficiency programs contributed to earnings per share growth of 15% to $3.18 from $2.77 a year ago. Revenue grew in all regions with 6% growth in the Americas, 4% growth in Europe and 8% growth in Asia-Pacific. The quarter’s Laboratory sales rose 10% to $298 million. Strong demand from biopharma companies delivered excellent growth for pipettes and analytical instruments such as pH meters and titrators. Lab revenue growth in China was over 10% with growth in all product lines. Purchases by multinational biopharma companies in China were strong, which after three years of weak sales indicate that these companies have returned to the normal replacement cycle for their lab instruments.

Mettler-Toledo also announced the acquisition of Troemner, a private company in the Philadelphia area that leads the U.S. market in sales of weights and weight calibration services. This company, with about $27 million in annual sales, is a natural fit for Mettler who has 14 calibration labs worldwide, but has little business in the U.S. because of the quality of Troemner’s products and calibration services. Troemner also sells laboratory equipment such as heaters and stirrers which will enhance the Ohaus product offering. Ohaus is Mettler’s second and lower cost brand that is sold through distributors.

Customers must calibrate weights on a regular basis and only Mettler and Troemner have achieved the top accreditation level for accuracy. Troemner’s calibration service, which accounts for 20% of its sales, fits well with Mettler’s strategy to increase its contract-based, value-added services business. Service revenue accounted for 23% of sales in the second quarter and grew 5% over the same period a year ago. The increasing quality of Mettler’s products reduces the opportunity to fix them when they break. Maintenance contracts ensure that the instruments work reliably and improve customer satisfaction and retention. They also improve technician productivity because they can plan their visits. Mettler-Toledo’s stock price is up 18% since January 1.

IDEXX Laboratories Corp.

IDEXX Laboratories delivered exceptional second quarter results with sales of $467 million up 13% organically and earnings of 74¢ per share up 23% over the second quarter of 2015. The company’s share price rose 13% on August 2, 2016 the day they announced these results. IDEXX’s stock price is up 53% since the beginning of the year. Global companion animal diagnostic recurring revenues of $338 million rose 12% organically with 14% growth in both in-clinic instrument consumables and reference lab services, while sales of rapid assay tests for infectious diseases rose 7% to $55.8 million. With the placement of 1,334 Catalyst chemistry analyzers, 934 premium hematology analyzers and 467 SediVues, global instrument revenues grew 35% to $33 million. SediVue automates and simplifies the laborious manual process of preparing and identifying sediment in urine samples. It produces clear digital images along with a description of each substance in the sediment within three minutes of loading the sample. Its speed adds urinalysis to the chemistry and hematology results that vets can present to pet owners during a patient visit. It pays for itself with one or two tests per day which makes it affordable for most clinics.

The strong placements of SediVue in its first quarter of sales demonstrate the success of IDEXX’s commercial transformation. All of IDEXX’s veterinary diagnostic consultants hired since 2013 when the company began to move from two sales forces that sold either in-clinic instruments or reference lab services to specialists with deep knowledge about diagnostics who sell diagnostic information have experience in either animal health or human health. Some of the reps with animal health sales experience brought vet relationships with them. Before 2013, only 40% of sales force hires had clinical or medical knowledge. In addition, the sales force has at least 11 years of sales experience in health care. IDEXX also offers extensive training to its direct sales force through the IDEXX Learning Academy to ensure that they have the depth of knowledge required to sell high tech life science products. The Academy deploys a full range of training tools including online, self-study, classroom learning and role-playing with the professional service vets. Members of the U.S. sales team underwent 30 to 50 hours of training on SediVue, urinalysis, and other workflow issues six months ahead of the SediVue launch. During the quarter, the U.S. team placed 502 Catalyst chemistry analyzers with 300 or 60% at competitive accounts. Many of the competitive placements resulted from initial discussions of the SediVue. Catalyst placements grew 14% over the second quarter of 2015 because of these gains and increased retention as vets spend 20 to 60 minutes with the IDEXX sales rep during each visit.

Express Scripts

Express Scripts’ second quarter gross profit of $2.16 billion increased 1.7% over the gross profit of $2.13 billion reported a year ago. Adjusted earnings per share of $1.57 rose 9% with higher net income accounting for 2% of the growth and a lower share count accounting for the rest. Express Scripts’ Safeguard Rx programs that use its cost control tools to guarantee limited cost increases and specialist pharmacists to ensure better drug adherence address their clients’ focus on these issues. Express Scripts announced its Diabetes Care Value program on August 31, 2016. This program features a cap on drug price increases at one-half of the anticipated increase of 17.7% in 2017 and a network of 10,000 Walgreens and independent pharmacies that are committed to improving patients’ drug adherence by 5%. All patients that use retail pharmacies will have access to the specialist pharmacists in Diabetes therapeutic resource center. They also can obtain prescriptions via home delivery. Strong interest in these innovative condition-based programs has contributed to a strong selling season. Express Scripts’ expects to retain 96% to 98% of their existing clients whose three-year contracts expire this year. This is the highest retention level forecast since Express Scripts acquired Medco in 2012.

The company released its 2017 National Preferred Formulary on August 1, 2016. It provides clinically equivalent options to 85 drugs excluded from the formulary. There are 3,900 drugs currently on the market. Express Scripts determined through extensive analysis of its prescription data that only 0.12% of the 25 million patients covered by the formulary will have to switch medications, while excluding these drugs will save approximately $1.8 billion in 2017. Plan sponsors who have used the National Preferred Formulary since its launch in 2014 have saved $3.1 billion to date. Express Scripts’ stock price has declined 21% since the beginning of the year because its relationship with Anthem continues to worry investors. The tension between the companies remains primarily at the CEO level. Express Scripts is now working well with Anthem’s health plans to adopt programs that control costs and help them grow their membership.


Like Wabtec’s first quarter sales and earnings which were below the comparable year ago quarter’s results, Wabtec’s second quarter sales and earnings were less than last year’s results. Sales at $724 million were 14.5% less than last year’s second quarter primarily due to a decline in freight revenues resulting from fewer railcar and locomotive deliveries and most importantly a 20% decrease in Positive Train Control (PTC) and electronic signaling revenues. This downturn in Wabtec’s most promising and profitable business is directly attributable to the two year extension until 2018 of the Federal Railroad Administration’s deadline for full implementation of PTC. The current decline in railroad profitability deepened railroad cuts for PTC expenditures and resulted in a $145 million drop in PTC sales, freight car deliveries and aftermarket sales. Despite this sudden deep drop in profitability, Wabtec’s management and its railroad customers continue to support electronification of train control which improves railroad safety and profitability. Rigorous application of the Wabtec Performance System enabled the company during the quarter to limit the decline in gross profit to 11% and to report earnings per share of $1.00 for a difficult quarter. The earnings per share figure benefitted from acquisition of 1.95 million shares at a cost of $69 per share which should prove accretive for us as shareholders when the Faiveley acquisition is consummated soon after the expected approval is obtained from the EU. Importantly, Faiveley which is run by Stéphane Rambaud-Measson, a former colleague of Ray Betler, Wabtec’s CEO, has successfully adopted elements of the Wabtec Performance System. It lifted Faiveley’s FY2016 operating margin to 9.8% for its fiscal year ending March 31, 2016. An increase in the operating margin of almost 1% last year augurs well for realizing the efficiencies and growth sought through the merger. Wabtec’s stock is up 5% since the start of the year.

CME Group Inc.

CME delivered another quarter of strong growth as revenues of $906.4 million rose 11% from the prior year. Four of its six product lines, equity, energy, agricultural commodities and metals, generated revenue growth of more than 20% from the same period a year ago. Revenue from the other two product lines, interest rate and foreign exchange futures and options, rose 3% and declined 7% respectively. CME continues to expand its customer base outside of the U.S. with electronic transaction volume from Europe and Asia up 12% and 21% respectively. Outside U.S. volumes now account for 24% of the total. Adjusted earnings of $1.14 per share rose 15% from a year ago. CME’s total return since the beginning of the year is 22%. The company continues to work with its customers to develop sought after add-on products and services. More than 14 new products have been launched this year. Earlier this year, CME launched the Ultra 10-Year U.S. Treasury Note future and companion options to address a gap in the marketplace that the existing 10-Year Treasury Note and the Treasury Bond futures do not cover. During the first three weeks after launch, 400,000 contracts traded, surpassing the previous all-time new product volume record for the first three weeks of trading established by Dow index futures. Over 7 million Ultra 10-Year U.S. Treasury Note contracts have traded since. The Ultra 10-year is succeeding because customers seek 10-year hedges on Treasuries, and in practice, the standard 10-year Treasury future tracks the yield for seven years. During the quarter, CME became the first exchange to offer interest rate swaptions clearing which will provide clients with capital efficiencies and reduced counter-party risk. A swaption is the option to enter into a swap. Continuous product innovation and international expansion has occurred while CME management has tightly controlled costs. During the first half of 2016, organic revenue is $332 million above the same period two years ago while operating expenses (excluding license fees and amortization) are down $14 million!

Automatic Data Processing

ADP’s fiscal fourth quarter and full year revenues of $2.9 billion and $11.7 billion rose 8% and 7% respectively from the same periods a year ago. Adjusted earnings of 69¢ and $3.26 per share rose 25% and 13% respectively. ADP’s full year operating margin rose 60 basis points to 19.5%. The number of employees on existing client payrolls rose 2.5% during the quarter and full year, reflecting stable hiring within ADP’s customer base. The company booked a 12% increase in worldwide new business sales representing annualized recurring revenue of $1.75 billion. This organic growth will be partially offset by a 1% decline in revenue retention during the year to 90.5%. As the company continues to upgrade its clients to its newer cloud-based solutions, client losses on older platforms have increased. During the quarter, ADP added resources to increase the pace of its mid-market client migrations to the latest version of Workforce Now, which is two-thirds complete. All of ADP’s small business clients have upgraded to its modern RUN small business platform. To better serve its customers on its integrated cloud-based platforms ADP is reorganizing its service organization to simplify and align service operations to its strategic platforms. The upfront investment required will contribute to operating efficiencies over the long term. During its fiscal year, ADP returned $2.1 billion to shareholders through share repurchases and dividends. The 8% dividend increase during the year raised the dividend yield to 2.4% and marked its 41st consecutive year of increase. ADP’s total return is 6% since the beginning of the year.


Visa’s fiscal third quarter revenues of $3.6 billion rose 6% in constant currencies over the same period a year ago. Payments volume of $1.3 trillion grew 10%, with 10% growth in the U.S. and 11% internationally. Earnings per share exclude one-time expenses related to closing the acquisition of Visa Europe on June 21, 2016. Visa’s managers reduced personnel and marketing spending by $100 million or 7% to deliver an operating margin of 68% for the quarter. This margin will decline with the addition of Visa Europe, but Visa has experience improving its operating efficiency. In 2007, a year before Visa’s IPO, the company’s operating margin was 34%, the same as Visa Europe’s margin year-to-date. Visa Europe becomes the second largest geographical segment after the U.S. with 28% of total payments volume. The 38 countries of Visa Europe give Visa access to thousands of additional cross-border combinations, pairs of countries where cardholders make purchases in a country other than where the card was issued. These transactions generate higher transaction fees than domestic payments. Visa’s total return is 7% since January 1.

Ecolab, Inc.

Ecolab focuses on new account gains and the uptake of new products and programs to drive revenue growth. The company continues to introduce better cleaning and sanitizing products, dispensing systems, core equipment such as a warewasher in a restaurant, training and auditing services. The service provided by the company’s 25,000 sales associates continues to improve as Ecolab invests in its information technology systems to collect more data remotely. It takes about five years for a new product to reach peak sales. Ecolab expects the products introduced in 2015 to have sales of $1.15 billion in 2020. Sales of new products introduced within the last five years account for 30% of the company’s total sales.

Ecolab touches 42% of the fresh milk produced around the world, and its products and processes have been crucial to extending milk’s shelf life over the decades. Synergex, its newest EPA-registered sanitizer and disinfectant, can be used throughout a plant on all surfaces and within the processing equipment. In addition to being safer to handle than other disinfectants, a large Australian milk producer reduced sanitizer use by 35% while increasing its milk’s shelf-life from 18 to 21 days. The longer shelf-life added approximately $1 million in additional annual sales. Ecolab will introduce this product to all of its customers as it identifies new uses.

Ecolab’s sales rose 1% organically in constant currencies to $3.25 billion over the same period a year ago. A 13% decline in revenue in the Energy Business to $755 million offset most of the revenue growth in Ecolab’s Industrial and Institutional businesses which grew 2% and 5% to $1.14 and $1.15 billion respectively. Ecolab took a one-time pre-tax charge of $64 million in the Energy business which includes inventory write-downs and a reduction of 1,000 employees, 4% to 5% of the division’s total. Earnings per share of $1.08 were unchanged from the second quarter of 2015. The total return on Ecolab’s stock is 4% since the beginning of the year.

Core Laboratories

Core Laboratories’ second quarter sales and earnings of $148.1 million and 35¢ per share were respectively 3.5% and 3¢ per share below the comparable figures for the first quarter. These results were better than other oil services companies who were more adversely affected by the 24% decline in the number of rigs operating in the US during the quarter. In discussing the quarterly results, Core’s management bluntly stated with no caveats that its “second quarter 2016 results should mark the bottom of its anticipated V-shaped . . . recovery, followed by increased crude oil prices and expanded industry activity levels worldwide.” Core’s forecast reflects its intimate knowledge of onshore North American Production where its customers reliant on its Production Enhancement technology are among the leading producers acquiring acreage and increasing their drilling now. The company’s expertise in analyzing reservoir fluids for deepwater wells makes it a participant in production decisions in the Gulf of Mexico and offshore Guyana and West Africa. Although Core is confident an upturn is occurring, the pace remains uncertain. Core’s total return is down less than 1% since the beginning of the year.

Red Hat

Red Hat’s first fiscal quarter revenues of $568 million rose 18% over the same period a year ago. Adjusted earnings per share of 50¢ grew 14%, and exclude transaction costs from acquisitions, amortization of intangible assets, non-cash employee compensation and interest expense associated with Red Hat’s convertible debt. Subscription revenue for its enterprise versions of open source software was $502 million, an increase of 18%. Subscription revenue for Red Hat’s version of the Linux operating system grew 14% to $403 million. Sales of application development and emerging technologies software subscriptions rose 39% to $98 million from $70.8 million a year ago. Sales of these new products now account for 17% of total sales, an increase of 2.6 percentage points over last year. Most of the growth comes from additional subscriptions to the company’s JBoss middleware software, which standardizes the development, deployment and management of applications by securely connecting applications used on a web browser with applications, databases and other systems that are maintained in a company’s data centers. Because it is based on Red Hat Enterprise Linux, users can deploy applications built with JBoss in the datacenter or in the public cloud. It offers the same performance to develop applications as do proprietary products from IBM and Oracle, but at 20% of their annual cost. Red Hat closed 45 deals over $1 million during the first quarter, an increase of 50% over the first quarter of fiscal 2016, and 83% of the top 30 deals included at least one component of its new software offering. Red Hat’s stock price is down 9% since the beginning of the year.

Varian Medical Systems

Varian Medical Systems’ stock price rose 6% on August 28, 2016, the day after the company reported good fiscal third quarter results. Its stock price has risen 19% since January 1. Fiscal third quarter sales of $789 million rose 1% over the same period last year. Revenue growth of 8% to $605 million in Oncology Systems and 9% growth in Imaging Components was partially offset by a $53 million decline in Varian’s “Other” business segment. Adjusted earnings per share, which exclude amortization of intangible assets from purchases and non-recurring charges, were $1.22, a 6% increase over the fiscal third quarter of 2015. A lower share count accounted for all of the gain. Oncology Systems’ orders rose 6% with orders in North America up 15%. Orders are up 7% over the past 12 months, a better measure of Oncology Systems’ order growth. In the U.S., Varian won several multi-system orders from large hospital networks and replaced some competitive radiation sources and software. Orders for RapidPlan, software that uses machine learning to incorporate best practices from existing treatment plans into new ones, and Insightive Analytics, which allows clinics to track the progress of each patient’s cancer treatment in addition to the workflow in the clinic, are growing over 10%. These software products allow clinics to improve the quality and the value of the treatments they provide patients. These measures become more important as Medicare shifts from fee-for-service to value-based reimbursements. Orders in China, Varian’s second largest market, rose 13% with very strong demand for the EDGE radiosurgery suite, the company’s highest-end and most profitable system. Almost 90% of the orders in China are going into new facilities, expanding the long-term opportunity for service and software upgrades.

Air Lease Corporation

Air Lease’s revenues rose 15% from last year’s second quarter to $350 million and earnings increased 20% to 84¢ per share. Net income margin expanded 1.8 percentage points to 40.6% as Air Lease’s interest expense grew 7% during the quarter, less than half the rate of its revenue growth. In the first six months of 2016 the company reduced its average interest rate from 3.59% to 3.33%, yielding annualized interest expense savings of $22 million. During the quarter, Air Lease sold ten aircraft from its operating lease portfolio for a gain of $17 million and spent $897 million to acquire sixteen new planes, thirteen from its order book and three from a large Latin American airline that had ordered too many planes from Airbus. Air Lease placed all three planes on long-term leases with airlines in Western Europe during the quarter. The company has now placed 91% of its orders through 2018 on long-term leases, up from 85% last quarter, and has placed 80% of its orders through 2019. Air Lease locks in current lease rates for planes with longer delivery dates as airlines make long-term plans to replace their aging aircraft. On June 30, Air Lease owned 245 aircraft with an average age of 3.7 years, and received fees for managing an additional 33 aircraft. Air Lease’s planes comprise about 1.2% of the global fleet in service. The company promoted President and Chief Operating Officer John Plueger to CEO on July 1. Steven Udvar-Házy became Executive Chairman of the Board. Competition to lease older planes and for sales/leasebacks of new planes to airlines has lowered lease rates for certain aircraft. Investors are concerned that Air Lease might not be able to maintain its rates in the future. Air Lease’s total return is minus 18% year-to-date.


Roche’s first half sales of CHF 25.0 billion grew 4.8% in constant currencies and 6% in Swiss francs over the first half of 2015. Pharmaceutical sales rose 4% to CHF 19.5 billion over the same period. Revenue from the company’s key drugs grew 10% to CHF 10.1 billion. Sales for the three drugs that treat metastatic breast cancer rose 10% to CHF 4.75 billion as increased use of Perjeta, whose sales rose 34% to CHF 906 million, strengthened sales of Herceptin because the combination lengthens the time patients remain free of cancer. Sales of Avastin rose 4% during the half, with strong growth in China for treating lung and colorectal cancers. Sales of Roche’s key immunology drugs, Actemra (rheumatoid arthritis), Xolair (moderate to severe allergic asthma and hives) and Esbriet (idiopathic pulmonary fibrosis) grew 26% to CHF 1.9 billion. Declining revenue from increased competition to Tarceva (lung cancer) and Lucentis (age-related macular degeneration) offset some of the growth of these key drugs. Diagnostics’ sales rose 6% to CHF 5.6 billion with Professional Diagnostics growing 9% to CHF 3.2 billion. Revenues from immunoassays, tests that use monoclonal antibodies to measure the level of proteins, drugs, hormones and other substances in a blood sample, grew 14% to CHF 938 million. Tissue and Molecular Diagnostics revenues grew 12% and 8% respectively.

Roche’s first half core earnings of CHF 7.74 per share rose 5% over earnings of CHF 7.22 per share a year ago. Core earnings exclude the amortization of intangible assets, asset impairments and restructuring charges. Roche included a CHF 426 million gain from a change to its Swiss pension plans and a CHF 94 million charge for the early redemption of $857 million of U.S. debt with a 6.25% interest rate. Earnings per share grew 1% excluding these items. Roche expects to launch five new drugs in 2016 and is investing in manufacturing capacity and marketing programs to ensure successful launches. The May launch of Tecentriq, the company’s first cancer immunotherapy drug for the treatment of advanced metastatic bladder cancer, exceeded expectations with sales of CHF 19 million in its first six weeks on the market. The FDA granted Roche an October 19, 2016 priority review date for Tecentriq in non-small cell lung cancer based on results from a Phase III trial with 1,125 patients with advanced cancer which demonstrated that patients who took Roche’s drug lived longer than patients who received chemotherapy. The company is also preparing for the launch of its multiple sclerosis drug at the end of the year. In addition to increased manufacturing costs that result from low utilization of its new biologic manufacturing facility in Vacaville, CA, Roche is using higher cost contract manufacturers to ensure sufficient supplies of these new drugs. The company’s R&D costs increased 10% or CHF 400 million over the first half of 2015 to CHF 4.8 billion. Roche has eight Phase III trials in lung cancer underway that evaluate Tecentriq alone or in combination with other drugs. It has 46 clinical trials in cancer immunotherapy with combinations of Tecentriq and nine other drugs that increase the immune system’s sensitivity to both solid and hematologic tumors. The total return on Roche ADRs since the beginning of the year is minus 7%.


Nestlé’s first half sales of CHF 43.2 billion grew 3.5% organically over the first half of 2015. Foreign exchange translation and divestitures reduced reported sales growth by 2% and 0.8% respectively. The company achieved volume growth of 2.8% across all geographies and businesses during the half. Pricing contributed only 0.7% to organic revenue growth with deflation continuing in Western Europe and low milk and coffee prices making it hard to raise prices in emerging markets. Innovation and premium products contributed to increased market share in 49% of the company’s categories and geographies and stable market share in 8 others. Consumers respond to Nestlé’s innovation in natural and organic foods and to its science-based products. Sales of new Lean Cuisine meals with higher protein, lower sugar and salt content rose 19% organically during the first half of the year. Sales of Purina Beyond, a natural cat food increased 42% over the same period. Nestlé’s science-based Boost nutritional drinks, which have 10 grams of protein, 3 grams of fiber and 26 vitamins and minerals, have grown 15% in the U.S. since their launch. Nestlé has introduced them in Korea and is preparing to launch them in Europe as well. Nestlé’s successful marketing of its premium sparkling water brands San Pelligrino and Perrier resulted in high-single digit revenue growth and contributed to the strong 4.7% volume growth for the company’s water business. Nestlé Waters’ first half sales of CHF 3.9 billion grew 4.2% organically with greater than 10% growth in emerging markets which was partially offset by some price deflation in Western Europe and China. Operating margin increased 1.4 percentage points to 12.4% as a result of higher premium product sales, cost efficiencies and lower plastic raw material costs.

Nestlé’s commitment to cost efficiency and portfolio management has lifted gross margins from 47.0% for the first six months of 2012 to 50.8% this year. The company invested the 1.3 percentage point improvement in operating profit in marketing and in R&D, but still increased operating margin 0.3% percentage points to 15.3% from 15% a year ago. Earnings per share excluding one-time items rose 5.7% to CHF 1.33. On June 27, 2016 Nestlé’s Board of Directors announced that Paul Bulcke, the current CEO, would replace Peter Brabeck as Chairman of the Board of the company. Mark Schneider, the CEO of Fresenius since 2003, will become CEO on January 1, 2017. In addition to having a strong record of portfolio management and capital allocation at Fresenius, he will add his experience in clinical nutrition and R&D to the senior management team. Fresenius is a global healthcare company with a leading kidney dialysis business and a €6 billion hospital supply business that includes clinical nutrition and systems to deliver it to patients. Fresenius acquired Nestlé’s medical nutrition business in 2007. The total return on Nestlé ADRs is 10% since January 1.


SGS’ first half 2016 revenue of 2.9 billion Swiss Francs rose 7% on a constant currency basis comprised of 3.4% organic growth and 3.6% from acquisitions. Its adjusted profit of 274 million Swiss Francs rose 3.3% as the operating margin declined 60 basis points to 14.2%. SGS incurred higher costs from investments in IT systems for its lab operations and human resource management. It also commenced building a shared services infrastructure to streamline support functions covering major finance and technical back-office processes from 35 countries. This multi-year undertaking should boost operating efficiency and margins once completed. The ten acquisitions made during the first half of 2016 added CHF 48 million of revenue and just CHF 1 million of operating income. They are focused primarily in the U.S. and China and have lower margins until their integration is complete. On-going reductions and delays in expenditures by energy and mining customers continued to impact growth from its Oil, Gas & Chemicals, Industrial and Minerals businesses.

Driven by increasing concern over food safety by consumers and regulators, the company’s food safety services delivered strong growth and helped the Agriculture, Food and Life business achieve CHF 444 million revenue and CHF 62.7 million operating income, increases of 8.6% and 14.4% respectively from the same period a year ago. SGS is uniquely positioned to provide full supply chain solutions from farm to table. SGS food quality and safety services involves extensive testing for pesticide residues, pathogens, heavy metals and various allergens in addition to pre- and post-production inspection and verification to ensure quality, quantity, traceability and cleanliness. Consumer and Retail revenue rose 5.7% as softlines rebounded from a year ago as the company won business from medium and large size global brands and retailers and garnered new business from new sourcing countries including Vietnam and Turkey. The total return on SGS ADRs is 20% since the beginning of the year.

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Capital Counsel’s investment strategy combines disciplined fundamental analysis with patient execution. We hope this letter helps you understand that stock selection is at the core of our investment strategy. We 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.