EARNINGS LETTER

4th Quarter, 2016

The 6.2% rise in our stock market, as measured by the S&P, is greater than we expected but most welcome because over two-thirds of our stocks rose even more than the market in response to their good results! In commenting on the quarterly results, several managements cited encouragement of initiatives advocated by managers and workers in divisions within their company that improved sales and profits not for just the quarter, but for years to come. These added variants to existing products or services are victories for everyone involved, including customers.

Your gains during the quarter depended upon the percentage of your assets invested in stocks and the amount we kept in treasuries because of our apprehensions. We have been hesitant to invest the reserves kept in treasuries because the stocks of the companies we have examined and visited for possible investment are as expensively priced as those we own. Sometimes the price-to-earnings multiple is higher. We hold reserves now because stock prices have become expensive and short and long-term interest rates remain low even though the Fed has raised rates and is guiding investor expectations to prepare for more increases. We believe it’s sensible to hold reserves after four months of an uninterrupted rise in stock prices which has lifted the price-to-earnings multiple for the S&P to over twenty times.

We know some smart investors who enthusiastically endorse the policies of the Trump administration and think those policies have propelled stocks higher. We also know equally smart investors who adamantly oppose the administration. All of them know that every new administration is tested by adversaries, domestic and foreign. In the past, most administrations have handled some challenges well and botched others badly. The legislative initiatives undertaken with the urging of the Trump administration reminds us of the remark attributed to Bismarck, “No one should see how laws or sausages are made.”

Mettler-Toledo

Stable customer instrument replacement cycles in the fourth quarter and in 2016 allowed Mettler-Toledo to use its sales and marketing and productivity tools to deliver excellent operating results in both periods. The addition of 200 sales representatives for specific product lines and geographies in both telesales and in the field along with its Big Data initiatives, which include identifying opportunities to replace instruments more than 10 years old at client facilities, contributed to sales of $710 million for the quarter and $2.5 billion for the year, growth of 8% and 7% in local currencies over the same periods a year ago. The strong U.S. dollar reduced reported sales by 3% in the quarter and 2% during the year.

Mettler’s targeted marketing programs enable the direct sales force to demonstrate the value of the company’s solutions to a specific customer problem. This selling method reduces price discounting and allowed Mettler to realize price increases of two percentage points in both periods. Successful supply chain management and improved productivity from shared back office services and simpler order processing contributed to 10% growth in operating profit during both periods to $200 million and $583 million for the quarter and for the year. Operating margin for the fourth quarter increased one percentage point to 28.2% from 27.1% a year ago. 2016 operating margin also rose one percentage point to 23.2% over the operating margin in 2015. Earnings rose 14% in the fourth quarter to $5.28 per share and 15% to $14.80 for the year. The company’s stock price rose 7% on February 3, 2017 the day after it announced its strong financial results. Mettler’s ability to deliver steady profitable growth in a slowly growing world economy by focusing on the factors they can control has lifted its stock price 15% since the beginning of the year.

IDEXX Laboratories

IDEXX Laboratories’ stock price jumped 13% on February 2, 2017 after the announcement of excellent fourth quarter and full year results. Its stock price is up 30% year-to-date. Fourth quarter revenue of $443 million grew 12% organically over the same period a year ago. 2016 revenue grew 11% organically to $1.77 billion. The strong U.S. dollar reduced revenue growth in the fourth quarter by 1% and had no effect on full year growth. Earnings per share for the fourth quarter and the full year of 58¢ and $2.44 grew 21% and 19% over the same periods a year ago, and earnings per share grew 33% and 25% for the quarter and the year in constant currency.

IDEXX achieved these results with 12% organic growth in recurring diagnostic revenue which reached $1.3 billion in 2016. It includes sales of in-clinic instrument consumables, reference lab services and rapid assay tests. With about 10 visits to each veterinary practice in the U.S. last year, IDEXX’s direct sales force convinced more vets of the value of using more diagnostic testing in their practices. Their success increased testing volumes in-clinic and at the reference labs. It also reduced price discounts so that the company realized price increases of 2% to 3% on its tests. IDEXX achieved operating margin growth of 1.7 percentage points in constant currency to 19.7% while adding 40 people to its U.S. sales force. Gross margins increased 0.4% while increased revenue per sales person accounted for the rest of the growth in operating margin. IDEXX’s combination of unique products and its direct sales force lifted IDEXX’s customer retention rate to 98% in 2016.

CME Group Inc.

CME’s fourth quarter average daily volume, revenue and earnings of 16.3 million contracts, $913 million and $1.14 per share surged 24%, 12% and 18% respectively. Quarterly average daily volume records in interest rates, energy and metals were achieved and volume during European and Asian trading hours rose more than 50% during the quarter. CME’s continued focus on its customers’ needs has led it to develop new capital efficient solutions such as its ability to clear interest rate swaps and interest rate futures in a single clearinghouse which provides $3 billion in margin savings for customers. This unique capability helped drive record volume growth in the company’s interest rate franchise.

During the full-year, average daily volume, revenue and earnings of 15.6 million, $3.6 billion and $4.53 per share rose 12%, 8% and 12% respectively. Annual volume records were reached in interest rates, energy, agricultural commodities, metals and options. Continued expense control enabled 92% of the $268 million increase in year-over-year revenue to fall to operating income, lifting CME’s already impressive 64% operating margin to 66% during the year. It was 61% in 2014. CME declared $1.9 billion of dividends for shareholders during 2016, up from $1.6 billion during 2015 and $1.3 billion in 2014. The quarterly dividend plus the year-end special dividend amounted to $5.65 per share! CME’s stock price is up 8% since the beginning of the year.

Automatic Data Processing

ADP’s fiscal second quarter revenues of $3.0 billion and adjusted earnings of 87¢ per share rose 6% and 20% respectively from the same period a year ago. A pre-tax gain of $205 million from the sale of its Consumer Health Savings Account and COBRA businesses are excluded from these figures. During the quarter, ADP repurchased 4.6 million shares, 1% of the total outstanding for $422 million or $92 per share. The company’s PEO (professional employer organization) which provides outsourced human resources management, benefits, health care and payroll, continues to deliver double-digit growth. Revenues of $818 million and worksite employees paid of 452,000 each rose 12% from a year ago. Attainment of operating efficiencies and slower growth in selling expenses led to a 22% increase in operating profit. Employer Services revenues increased 4% to $2.3 billion and operating profit rose 10%. The number of employees on each existing client payroll rose 2.3%. Investors overreacted to a 5% decline in new business bookings which sent ADP’s stock price down 5.7% from $101 to $95.25 on February 1, 2017, the day the company announced its second quarter results. During the quarter, ADP sold fewer services related to the Affordable Care Act (ACA) and signed up fewer new customers after the election because of uncertainty about potential changes to the law. ADP’s stock price recovered from the drop on February 1 and is up 2% since the beginning of the year and up 15% since November 8.

Visa

Visa’s fiscal first quarter revenue grew 25% to $4.5 billion and earnings per share of 86¢ rose 23%, excluding a one-time charge in the year ago period, driven by acceleration in U.S. payment volumes and cross-border transaction growth with the inclusion of Visa Europe. The strong U.S. dollar reduced revenues and earnings per share by 3% each. U.S. payments volume growth increased 1.5 percentage points to 12.4%, and U.S. credit payments volume surged 20.2% with new volume from Costco and USAA during the quarter. Visa’s decision to partner with Costco and fast-growing issuers such as JP Morgan with its popular Chase Sapphire Reserve credit card enabled Visa to gain market share for the seventh year in a row. Visa now processes 50% of U.S. credit card spending on its network. International transaction revenues rose 44% to $1.5 billion with the addition of Visa Europe. If Visa had owned Visa Europe last year, normalized cross-border growth would have risen by two percentage points to 12%. European payments volume rose from 7.2% to 9.1% despite Brexit and other economic concerns. The depressed British Pound and lower Euro encouraged travel to the UK and Europe from all parts of the globe, while the strong dollar encouraged U.S. residents to visit Canada, Mexico and the UK. Visa’s year-to-date total return is 16%.

Wabtec

Wabtec’s fourth quarter sales of $760 million were $20 million lower than the company’s forecast which meant earnings of 81¢ per share, before Faiveley merger costs, fell below the estimates given by Wabtec’s management. Earnings for the year were $3.85, 7% below the earnings achieved in 2015. Until the fourth quarter shortfall, management had been extraordinarily successful in achieving the goals it announced for sales and earnings. The reason the company missed its forecast was the reluctance of U.S. freight railroads and transit systems to purchase and accept delivery of any Positive Train Control (PTC) equipment or signaling equipment. Management attributes the reluctance to deploy additional PTC equipment last year on locomotives or along rail lines that must be using PTC by year-end 2018 to the decline in freight revenues that persisted throughout last year until December when shipments rose. That growth continues, lifting freight revenues almost 5%.

Wabtec is good at adapting its business to changing circumstances and maximizing the opportunities occurring in its businesses and those it finds where its operating skills, notably its manufacturing capabilities, can accelerate the growth of the company. The transformative event that occurred during the quarter was the acquisition of the Faiveley family’s controlling ownership of Faiveley Transport which enabled Wabtec to consummate its merger with Faiveley as of November 30, 2016. The cost was $1.7 billion. The final tender offer giving 98.53% ownership of Faiveley was not certified until March 10, 2017. Faiveley obtains 60% of its sales from Europe, 28% from Asia and 12% from the Americas where Canadian and Brazilian customers are prominent, although it has won a contract from the Chinese contractor to provide the HVAC systems for Boston’s new transit cars. Faiveley’s two newest manufacturing plants are a 50,000 sq. ft. plant in the Czech Republic and an expansion of its plant in Hosur near Bangalore in India which manufactures the full range of Faiveley’s products from brakes and couplers to HVAC systems, doors and pantographs. Faiveley has 56 manufacturing and maintenance sites worldwide. Importantly, 45% of Faiveley’s revenues come from maintenance contracts with transit systems throughout Europe and Asia. This is Faiveley’s most profitable and steadily growing business. Its acquisition changes Wabtec’s revenues from 55% freight customers to 55% transit at a time when transit systems are expanding worldwide to transport growing urban populations throughout the world. Wabtec management’s preliminary estimate for 2017 earnings for the New Wabtec is $3.95-$4.15 per share. This is the low end of what might be achieved from a difficult task of combing two successful businesses where the managers and workers seem to be enthusiastic about working with one another. Wabtec’s stock is down 7% since the start of the year.

Ecolab, Inc.

Ecolab’s fourth quarter sales of $3.3 billion declined 1% in local currencies from sales in the same period a year ago. Full year 2016 sales of $12.9 billion were unchanged from sales in 2015. Ecolab produces and sells its products and services locally so the translation of sales in foreign currencies into U.S. dollars reduced revenue by $198 million in 2016 or 1.5%. Adjusted earnings, which exclude one-time gains, charges and taxes, of $1.25 per share for the quarter and $4.37 for the year were unchanged from earnings in the same periods a year ago. One time charges in 2015 were 53¢ for the quarter and $1.24 for the year because of charges related to the decline in Ecolab’s Venezuelan business. One-time charges in 2016 were much smaller, 1¢ in the fourth quarter and 22¢ for the year. Ecolab took a $50 million after-tax charge to write down the value of inventory in the Energy business and to reduce the size of the business by 1,000 people.

Fourth quarter revenue for the Institutional, Industrial, Pest Control and Equipment Repair businesses grew 4% to $2.5 billion with 7% growth in the light industrial water business which serves food and beverage manufacturers, hotels and commercial buildings, and 8% revenue growth in the quick serve restaurant and pest control businesses. The combination of Ecolab’s solid chemistry technology, which replaces 30-gallon drums of chemicals on building floors, and 3D TRASAR has made this technology more suitable for Ecolab’s Institutional customers. 3D TRASAR is Nalco’s proprietary system of chemicals, sensors and services managed by a staff of chemical engineers in Pune, India who continuously monitor water quality and adjust the chemical levels needed to maintain consistent water quality. Tang Plaza and its adjoining 392 room Singapore Marriott reduced water use by 38% per year after the installation of one of these systems. It increases the number of times the hotel can reuse the water in its cooling towers.

A 14% decline in fourth quarter Energy business revenue and a 30% decline in operating profit offset the revenue growth and the 9.5% operating profit growth in the other businesses. Product volumes remained at the same levels as last year, but the business made pricing concessions to meet its customers’ reduced cash flow. Ecolab reported that prices hit their low on July 1, 2016 and have begun to recover slowly. Management forecasts that the Energy business will be slightly accretive to both revenue and operating profit in 2017. The total return on Ecolab’s stock is 7% since January 1.

Core Laboratories

Core Laboratories’ fourth quarter revenue and pre-tax operating earnings were up 5% and less than 1% above the comparable year ago numbers. These results, which barely met management’s prior expectations, are just enough to make their forecast of an imminent upturn in Core’s deepwater and international business credible. The only significant improvement during the past quarter in Core’s business occurred in its Production Enhancement division which makes the most advanced perforating charges used to make the deepest and most debris free penetration of horizontally drilled shale formations. Core also provides chemical tracers that allow drillers to identify the oil flow from each perforation along a horizontal drill pipe as long as a mile.

Increased activity in the Permian Basin in West Texas accounted for most of the quarterly revenue increase for Production Enhancement. This drilling upturn seems to be a precursor for more activity. ExxonMobil, a Core customer, has just acquired the Bass Family acreage in the Permian which abuts its existing acreage. Apache, another customer, has announced plans to drill extensively on acreage adjacent to the Permian that heretofore was deemed unpromising. These improving prospects for Production Enhancement, though welcome, are not enough to lift Core’s stock out of its listless trading range. For that to happen, Core needs renewed revenue and profit growth from its Reservoir Description business which now produces 80% of its operating profits, although the operating margin is only 17.5%. In the years before the oil price drop in 2014, the operating margin for Reservoir Description was over 30%, with its newly launched Reservoir Fluid Analysis service earning higher margins on measurements made on newly designed equipment that precisely measure and analyze the composition of reservoir fluids under intense heat and pressure. When oil prices were higher, the operators of fields, especially old offshore fields such as those in the North Sea, were using Core’s fluid analyses to maximize production over the remaining life of the field. Renewed deepwater exploration such as BP’s Mad Dog expansion in the Gulf of Mexico and Exxon’s major discovery offshore Guyana should accelerate the recovery of Core’s most profitable business. We wish to see what the incremental margin is on rising revenues before adding to the stock. Core’s stock price has declined 8% since the beginning of the year.

Red Hat

Red Hat’s fiscal third quarter total revenues of $615 million rose 18% from the same period a year ago as subscription revenue, which accounts 88% of the total, was up 19% to $543 million. Training and service revenue increased 9% during the period to $72 million. Red Hat further segments its subscription revenue between its core infrastructure products, primarily Red Hat Enterprise Linux (RHEL) which generated revenue of $431 million, up 16% and its Application development and other emerging technologies, including Red Hat’s cloud-enabling technologies, which generated revenue of $112 million, an increase of 33% from a year ago. GAAP earnings of 34¢ per share, excluding a 3¢ benefit from the adoption of a new accounting standard, rose 36% from the same quarter a year ago. Non-GAAP earnings of 61¢ per share, which adjusts for non-cash share-based compensation expense, amortization of intangible assets and other one-time non-operating costs, rose 22% from a year ago.

During the quarter, the top 25 customer subscription renewals all renewed at an average 20% increase in the value of the commitment. Many of these customers are adopting cloud computing as part of their IT strategy and have chosen Red Hat as a partner to deploy its technologies both on-premise and in the public cloud. Two customer renewals were valued at $20 million each, eight were above $5 million and all 25 were valued above $2 million. Financial services, technology, media and government were the top verticals. During the quarter, Red Hat repurchased 1.6 million shares, nearly 1% of the total outstanding, for $125 million or $78 per share. Red Hat’s stock price has risen 20% since January 1.

Johnson & Johnson

Johnson & Johnson’s fourth quarter sales of $18.1 billion rose 2.3% operationally over revenues of $17.8 billion in the fourth quarter of 2015. The strong U.S. dollar reduced reported sales by 0.6%. Excluding acquisitions, divestitures, an additional week of sales in 2015 and special items such as the rapid sales decline in Venezuela and in their Hepatitis C franchise, adjusted sales grew 7.6% worldwide. Full year sales of $71.9 billion increased 3.9% operationally with foreign currency reducing growth by 1.3%. Adjusted worldwide sales rose 7.5% over the same period a year ago. The extra week of sales in 2015 reduced revenue growth for the quarter and for the year by 4.8% and 1.3% respectively. Adjusted earnings per share for the quarter and the year were $1.58 and $6.37, increases of 9.7% and 8.5%.

All three divisions contributed to revenue and earnings growth during the year. Adjusted Pharmaceutical sales of $33.5 billion rose 11.5% with greater than 30% revenue growth for its new cancer drugs, Darzalex for multiple myeloma and Imbruvica for a common form of leukemia, and for Stelara and Simponi, two drugs that treat autoimmune diseases. Pharmaceutical sales accounted for 46.5% of the company’s sales with a pre-tax margin of 39.1%. Adjusted Medical Device sales of $25.1 billion rose 0.9% as strong sales in instruments that treat atrial fibrillation and surgical tools for minimally invasive surgery were offset by the loss of revenue associated with the sale of the Cordis stent business and a 5.9% decline in Diabetes Care revenues. Pre-tax margin for this division was 32.1%. J&J is exploring strategic alternatives for its consumer diabetes business because of continued price pressure on blood glucose monitors and insulin pumps. Strong revenue growth of Neutrogena products which included the initial sales of a home-use light therapy acne treatment contributed to adjusted sales of $13.3 billion for the Consumer division which grew 4.3% over the same period a year ago. Strong focus on productivity over the last two years has freed up $1 billion to invest in e-commerce and other marketing initiatives. Pre-tax margin of 19.9% rose 5.6 percentage points over the pre-tax margin of 14.3% in 2015.

On January 27, 2017, J&J announced the $30 billion acquisition of Actelion, a Swiss drug company with three marketed drugs that treat pulmonary arterial hypertension, a condition that constricts the arteries that carry blood from the heart to the lungs. It puts increasing pressure on the right side of the heart which eventually leads to heart failure. J&J will acquire these drugs with their sales force and clinical development team as well as co-development rights to three promising drugs in late-stage development. Actelion’s early stage R&D organization, which is led by the company’s founders Jean-Paul and Marie Clouzel, will be spun-off into a new publicly-held company so that it can continue to work on more than 10 drugs in early development. J&J will own 32% of this company and will be the natural commercialization partner for any new drug that treats a disease with more than 100,000 patients worldwide. The acquisition is accretive to J&J’s top- and bottom-lines, increasing annual revenue growth by about 0.5% per year and earnings per share by 1.5 – 2.0% per year. The unusual structure of this deal demonstrates the sagacity and flexibility of J&J’s Pharmaceutical division leadership. They are acquiring marketed drugs that meet an unmet medical need and have strong clinical data supporting their efficacy, which their global commercial organization will use to treat more patients. They avoid adding over 60% of Actelion’s R&D costs and preserve a small, effective R&D organization as a separate organization. The total return on J&J’s stock is 11% since the beginning of the year.

Varian Medical Systems

Varian Medical Systems’ fiscal first quarter revenues of $763 million increased 1% over the same period a year ago. Earnings per share of $1.09 rose 10% over earnings per share of 99¢ reported a year ago. Net income accounted for 6% of the growth and a lower share count accounted for the rest. Earnings in both periods exclude amortization of purchased intangible assets and other one-time charges. These charges in 2016 include about 20¢ per share of duplicated operating costs associated with operating two publicly-traded companies as Varian prepared for the spin-off Varex Imaging Corporation on January 28, 2017. Oncology Systems’ fiscal first quarter revenue fell 1% to $581 million, but achieved 7% growth in revenue from North America which accounted for 48% of sales. Good software and service sales along with lower product, installation and warranty costs lifted gross margin four percentage points to 46.4%.

First quarter orders of $586 million grew 10% with contributions from all geographies. Orders in North America rose 7% during the quarter, leading to a 6% trailing 12-month order rate which is at the high end of the company’s forecast. Orders in Asia and in Europe, the Middle East and Africa rose 25% and 18% respectively. In India, Varian received an $18 million order from a single customer for several radiation systems as part of a $35 million 10-year contract. Orders in China rose 25% because the need for additional radiation systems remains acute. A hospital in Beijing has four radiation systems which each perform treatments 21 hours each day, leaving three hours to perform quality assurance and prepare for the next day’s patients. Varian Medical Systems’ stock price is up 15% since the beginning of the year. Varex Imaging (VREX) began trading as a public company on January 30, 2017. We sold your shares after its inclusion in the S&P SmallCap 600 index lifted its stock price 12%.

Roche

On March 2, 2017, Roche announced successful results from a large clinical trial which evaluated Perjeta, its second generation HER2-positive breast cancer drug, as an adjuvant therapy. Adjuvant therapies kill any remaining cancer cells after surgery to prolong remission. Patients adding Perjeta to Herceptin and chemotherapy after surgery remained disease-free longer than patients who took just Herceptin and chemotherapy, the current standard of care for early stage breast cancer. The 4,800 person trial, which took five years to complete, makes a strong case for using Perjeta as an adjuvant in early breast cancer. In 2015, 70% of Herceptin sales came from its use in this setting, so this positive result protects Roche’s largest drug franchise from competition with Herceptin biosimilars. Roche’s stock price rose 6% that day. The total return on Roche ADRs is 11% year-to-date.

Roche’s 2016 revenue of CHF 50.6 billion rose 4% in constant currencies over 2015 revenue. The strong U.S. dollar actually added 1% to reported revenue growth in Swiss francs. Pharmaceutical and Diagnostics Divisions’ revenue of CHF 39.1 billion and CHF 11.5 billion grew 3% and 7% respectively. Revenue for the three drugs that comprise the breast cancer franchise rose 8% to CHF 9.5 billion or 24% of total Pharmaceutical sales. Roche’s two targeted cancer drugs and Tecentriq, its cancer immunotherapy, had strong first year sales of CHF 384 million based on strong clinical data. As a result of the good efficacy data in patients whose bladder cancer has returned after chemotherapy, Tecentriq has achieved a 60% market share of the drugs used to treat this cancer since its launch in May.

The Diagnostics Division placed 190 of its high-speed immunochemistry analyzers in Europe since its launch in 2016 and expects to receive FDA approval to sell the instrument in the U.S. this year. Roche’s new high-speed hematology instrument uses a small sample volume automates slide preparation and the identification of abnormal blood cells so labs at cancer centers receive this information at the same time. Operating margin for the company was 36.4% with a 43.2% operating margin for the Pharmaceutical Division and a 16.7% operating margin for the Diagnostics Division. Core earnings per share of CHF 14.53 rose 5% over earnings last year.

Express Scripts

Express Scripts’ earnings of $1.88 per share for the quarter and $6.39 per share for the year grew 20% and 16% respectively. Growth in net income accounted for 8% of the growth in fourth quarter and for 5% during the full year. A lower share count accounted for the rest of the growth. The company generated $4.6 billion in free cash flow and repurchased 65.3 million shares for $4.7 billion, at an average price of $72.69. Operating earnings for the fourth quarter and for the year rose 6% to $2.0 billion and $7.2 billion respectively over the same periods a year ago. Growth in 2016 operating earnings offset an estimated loss of about $380 million from the loss of the Coventry and Catamaran business. The loss of the Coventry business reduced prescriptions filled by 5%.

Increased use of Express Scripts’ well-received Safeguard Rx plans and its narrow retail pharmacy networks enabled the company to reduce the cost of drugs and prescriptions filled for its clients. In 2016, drug prices increased 3.8% for clients compared with an 11% increase in the price of branded drugs. Express Scripts also continues to improve the efficiency of its operations. At a minimum, the company plans to offset annual cost increases of 6% to 7% that result from increases in wages, leasing costs, consultant fees and general business growth. SG&A expense declined 10% in 2016. SG&A expenses were $65 million lower than forecast because weak third quarter operating earnings reduced incentive pay for the fourth quarter and several IT projects were deferred. Increased member use of Express Scripts’ on-line tools allows the company to close a customer service center in Pueblo, CO in April.

Express Scripts’ stock price is down 5% since the beginning of the year. The termination of the Anthem-Cigna merger leaves Anthem’s current management in charge of Express Scripts’ second largest customer. Anthem has initiated the process to identify a pharmacy benefit manager for the years after the contract with Express Scripts’ expires in 2019. We have little confidence that Anthem’s management will make a rational decision. New management, however, can radically alter Express Scripts’ relationships with its clients and suppliers. After several years of pricing disagreements, Express Scripts’ removed Walgreens from its pharmacy networks in 2012 and shifted business to CVS, Rite-Aid and independent pharmacies. In 2014, Walgreens installed new Co-Chief Operating Officers who understood the value of pharmacy benefit managers’ ability to increase visits to their stores. Walgreens is now Express Scripts’ preferred pharmacy network. The companies worked together to create a cost-effective plan that enables patients to purchase a 90-day supply of drugs at retail pharmacies. Express Scripts’ clients benefit from the cost savings and improved drug adherence that comes with fewer refills and Walgreens provided discounts to Express Scripts that make this program as profitable as its home delivery program.

Air Lease Corporation

Air Lease generated $370 million and $1.42 billion in revenues for the fourth quarter and full year, respectively, representing growth of 13.4% and 16.0%. A continued decline in Air Lease’s average interest rate on its debt in addition to tight cost control helped earnings per share grow 20.3% and 24.6% in the quarter and the year, respectively, to 89¢ and $3.44. During the year, Air Lease signed lease agreements for 122 aircraft with 39 customers in 33 countries and sold 46 aircraft from its portfolio, including its entire ATR turboprop fleet and 80% of its Embraer jet fleet, for a gain of $61.5 million. Proceeds from these sales of $1.2 billion are being used to acquire new aircraft.

Air Lease continues to produce attractive and growing returns on equity. The adjusted return on equity has increased steadily from 11.2% in 2012 to 19.5% in 2016. Air Lease has signed long term contracts for 92% of the 141 aircraft it expects to receive from Boeing and Airbus through 2019, including all 77 aircraft to be delivered in 2017 and 2018. Ninety percent of their lease agreements include an interest rate adjustment provision which helps offset the cost of an increase in interest rates prior to delivery of the aircraft. Minimum future lease payments for Air Lease’s current and committed fleet rentals rose 14% in 2016 to $23.8 billion. As launch partner for Boeing’s 787-10 Dreamliner program, Air Lease has already leased to airline customers all 10 of the aircraft it will receive in 2019. Air Lease has 30 787-10’s on order. This aircraft offers the lowest operating cost per seat of any widebody aircraft on flights up to 6500 nautical miles and is in demand by airlines. The total return on Air Lease shares year to date is 14%.

SGS

SGS’ 2016 revenues of CHF 5.98 billion and earnings of CHF 0.71 per ADR rose 6.0% and 3.4% respectively in constant currency from the prior year. Organic revenue growth of 2.5% was supplemented by acquisitions which contributed 3.5% to revenue growth. SGS’ non-energy businesses, which generated 72% of total revenue, delivered strong 6.2% organic revenue growth. The company’s energy related markets were weak with low oil prices and soft demand for minerals leading to lower volumes and prices. Management has responded to these weaker markets by reducing headcount and writing down CHF 26 million of assets. The 0.5% decline in operating margin from 15.6% to 15.1% was also the result of lower margins of two of the acquisitions and investments being made to improve IT systems for laboratory operations and HR management in addition to the development and implementation of its shared services infrastructure. These investments will improve operating efficiency and provide higher margins in the years ahead. The company made nineteen acquisitions during the year which added CHF 203 million in revenue and CHF 20 million in operating income. These small to mid-sized companies provide access to new markets and additional service offerings. During 2016 free cash flow increased CHF 80 million to CHF 738 million as working capital, a key initiative, continues to improve. Management’s consistent improvement in free cash flow generation to fund organic growth and accretive acquisitions benefits shareholders, while its significant annual dividend pays us to wait for them to rekindle stronger growth. The total return of SGS ADR’s is 6% since January 1.

Nestlé

Nestlé’s 2016 sales of CHF 89.5 billion grew 3.2% organically over 2015 sales. Organic growth excludes the impacts of acquisitions and divestments which reduced revenue growth by 0.8% and the impact of a strong Swiss franc which reduced growth by an additional 1.6%; thus, reported revenue growth in Swiss francs was 0.8%. While Nestlé reported strong volume and mix growth of 2.4% for the year, management noted that the first half of the year with growth of 2.8% was stronger than the second half. Pricing contributed a meager 0.8% to organic growth. Prices declined in the U.S. and in Western Europe while low commodity prices, especially milk prices in emerging markets, kept prices low for many Nestlé products. Earnings per share, excluding a one-time charge in both years, were CHF 3.40, an increase of 2.7% over last year.

On February 17, 2017, Mark Schneider, the former CEO of Fresenius, a medical technology company based in Germany, presented his assessment of Nestlé’s competitive environment in his first earnings call since becoming CEO on January 1, 2017. Schneider is the first outsider to serve as CEO of Nestlé since 1922. He noted that consumer packaged goods companies face pressure from competitors such as Kraft Heinz that cut costs aggressively to improve near-term profitability as well as from local small or mid-sized companies that cater to new consumer trends in food and healthcare. While these small brands compete successfully for shelf space, not all of the consumer fads they address are sustainable or scalable; thus, few offer good new product development investments for Nestlé. New products must meet consumer needs to ensure that consumers will pay higher prices to deliver better organic growth for the company. Schneider expects organic revenue growth to remain at current levels for the next three years and then grow to 5% to 6% in 2020. The total return on Nestlé’s ADRs is 8% since January 1. We will use the proceeds from the sale of Nestlé stock to invest in companies with better opportunities for profitable growth.

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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.

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