1st Quarter, 2017

We are pleased to report that your companies’ financial results were good. The earnings of many of your companies surpassed the expectations of analysts and investors which propelled their stock prices higher. The rise this year of 8.7% in our stock market as measured by the S&P has occurred in spite of the frustration of many of our President’s initiatives which belies the notion that this is a Trump Rally. We think the economic and political problems apparent throughout the world make the United States appear more hospitable for investment than elsewhere. The emerging markets touted by investment gurus have economies dependent on commodities and for the most part are ill-governed. We think the strength in our market is attributable in part to investors continuing to seek an assured safe haven, even though the return is low. That may be the reason why the yield on the ten-year Treasury bond has dropped even though the Fed has announced that it intends to raise rates and curtail its bond purchases.

We continue to hold reserves because the companies meeting our criteria are as expensively priced as those we own. We think it prudent to wait for the market to consolidate after its surprising post-election upturn before we add new stocks to your portfolio.


Mettler-Toledo’s first quarter revenue grew 12% in local currencies to $594.6 million with strong growth in all geographies and product areas. Sales reported in U.S. dollars grew 10% over the first quarter of 2016. Productivity gains in both products and service contributed to the quarter’s gross margin of 57.7%, an increase of 2.1 percentage points over the gross margin of 55.6% reported a year ago. Operating profit grew 25% to $127.3 million with SG&A expense, which includes higher sales commissions and the salaries of new sales reps, growing only 9% to $184.2 million. Earnings per share of $3.34 grew 36% over earnings per share of $2.46 reported a year ago.

The company’s Product Inspection business had a great quarter with sales in the U.S. up 30% over the first quarter of 2016. Mettler is building a new X-ray plant in England and an assembly plant in Tampa, FL to accommodate the strong demand for these systems. With a global service organization, the most reliable machines with the most sensitive sensors, Mettler is the market and technology leader in product inspection, which accounted for about $500 million or 20% of 2016 revenue. Large food companies such as Kraft choose its systems to inspect packages that move down production lines at 500 to 1,000 packages per minute when they implement global manufacturing standards. The company’s new global key account sales force develops relationships at a high level in food and pharmaceutical companies which facilitates these global mandates. Mettler’s local teams then install and service the equipment at sites around the world. Key account teams also work with senior management at these large companies to become the preferred vendor for certain instruments. Mettler-Toledo’s stock price has risen 44% since January 1.

IDEXX Laboratories

IDEXX Laboratories’ direct sales force which reaches 70% of companion animal vet practices worldwide successfully used its deep clinical expertise to increase the company’s first quarter revenue by 11% over the first quarter of 2016 to $462 million. Diagnostics recurring revenue, sales of in-clinic instrument consumables, reference lab tests and rapid assays, grew 13% to $347 million and premium instrument placements rose 18% to 2,340. Higher volumes and realized price increases of 3% for consumable and reference lab sales lifted gross margin by 1.5 percentage points to 55.9%. Good operating expense control enabled IDEXX to post a first quarter operating margin of 20%, an increase of 2.6 percentage points over last year. Earnings per share of 65¢ rose 27% excluding a 12¢ per share benefit from using a new method to account for share-based compensation. The company is reinvesting $10 million of its earnings into high-return projects including increasing the number of U.S. sales regions from 23 to 26 and adding 45 new sales professionals to increase their field presence from 390 to 435. Sales professionals’ productivity continues to grow as their expertise and customer relationships deepen. Since pets cannot tell us how they feel, vets must use diagnostic tests to identify health issues. The field professionals demonstrate how IDEXX’s combination of software tools and new tests improve the value of their investment in IDEXX’s instruments and reference lab services. IDEXX Laboratories stock price is up 46% since January 1.

CME Group Inc.

CME’s overall trading volumes remain robust. Total average daily volume during the quarter of 17.1 million contracts set a new record. Quarterly volume records were also set in interest rate futures and options, metals futures and equity options. Total revenues of $929.3 million and adjusted earnings of $1.22 per share declined 0.5% and rose 2% respectively from the strong year ago period. CME has produced demonstrable success introducing new products and product extensions to meet customers’ needs to manage risk. This history of innovation provides growth even when market volatility is subdued. Within CME’s interest rate complex, average daily trading volume of the Ultra Treasury Bond and Weekly Treasury futures and options, first introduced in 2012, now each exceed 100,000 contracts per day, more than double the level achieved during the same period a year ago. Ultra 10-Year Treasury Notes, introduced last year, generated trading volume of nearly 100,000 contracts per day during the quarter while Monday and Wednesday Weekly Equity Options are generating about 80,000 contracts per day. All these new contracts added an incremental 360,000 contracts to average daily contract volume during the quarter. Additional successful contracts were recently added in Metals (Aluminum Premium products launched last year) and Equities (S&P Select Sector futures). After reaching a licensing agreement with the owners of the Russell indexes, CME will launch Russell 2000 futures and options contracts next month.

CME continues to focus on expense discipline and operating efficiency. During the quarter, CME announced the closing of its European exchange and clearing house by year-end. This will reduce expenses by $10 to $12 million beginning in 2018 and will free up $150 million of capital which can be returned to shareholders through the annual variable dividend. Its European customers have shown that they prefer to use CME’s Globex trading platform for access to global products, deep liquidity and capital efficiencies. Average daily volume on Globex from Europe was 2.7 million contracts during the quarter, nearly double the level of five years ago. CME’s total return is 7% since the beginning of the year.

Automatic Data Processing

ADP’s fiscal third quarter revenues of $3.4 billion increased 5% and earnings from continuing operations of $1.31 per share rose 12%. Organic revenue growth was 6%. The company’s PEO (professional employer organization) drove revenue growth with a 12% increase from the prior year to $969 million as the average number of worksite employees paid increased 12% to 471,000. Employer Services revenues rose 3% organically during the quarter as the number of worksite employees on existing ADP small to large business payrolls increased 2.5%. New business bookings declined 7% from the strong period a year ago when the company benefitted from the mandate for companies to become compliant with the Affordable Care Act (ACA). No additional clients purchased ACA services this quarter. Interest earned on funds held for clients rose 9% to $112 million because average funds balances reached $27.3 billion and the average interest yield went up 10 basis points from a year ago to 1.6%. ADP’s total return is minus 1% since the beginning of the year.

ADP continues to invest in its products and services to help its customers manage their HR needs. As employment and wages increase companies look to ADP to provide assistance finding and retaining talent. During the quarter, ADP purchased the Marcus Buckingham Company, a leading provider of leader development, employee engagement and performance management services to augment these capabilities.


Persistent growth in payments, transactions and cross-border volume in addition to the inclusion of Visa’s European operations propelled Visa’s fiscal second quarter revenue to $4.5 billion, an increase of 23%. Adjusted earnings per share improved by 27%, or 31% in constant currencies, to 86¢ in the quarter. Overall payments volume grew 37% to $1.7 trillion and the number of processed transactions rose to 26.3 billion, an increase of 42%, or 12% if Europe was included in the prior period. Robust U.S. payments volume growth of 11.7% was powered by U.S. credit card spending which rose 20.7% as consumers travelled more. Visa also continued to benefit from its recent contract wins with Costco and USAA. Slow but broad-based global economic expansion fueled stable cross-border and European volume growth of 11% and 9%, respectively which helped Visa achieve $1.5 billion in international transaction revenues, 41% higher than a year ago.

Management has completed the first phase of the Visa Europe integration by streamlining operations and eliminating redundancies. The next phase is the migration of Visa Europe’s payments system onto the global VisaNet system which will take about two years. While more challenging than the first phase, Visa successfully integrated disparate systems during its reorganization in 2007 prior to becoming a public company in 2008. Visa’s European customers and consumers will benefit from Visa’s continuing investments that expand the capacity, security and speed of VisaNet, as well as investments that improve integration with mobile and other internet-connected devices. The acquisition on February 1, 2017 of Cleveland, Ohio-based CardinalCommerce helps Visa build a risk score for online purchases by gathering and delivering data from the retailer, such as the consumer’s transaction history, browser and device information, in less than a second, enabling a quick risk-based authorization decision by the card’s issuer. Visa previously distributed this value-added service to the 400,000 businesses that use its e-commerce solutions CyberSource and Authorize.net but will now be able to offer it more widely to online retailers that accept Visa. Visa’s stock price is up 23% since January 1.


Wabtec’s first quarter earnings of 84¢ per share were 20% below the $1.05 per share earned during the comparable quarter a year ago. The quarterly results reflect the full magnitude of the $90 million contraction in Wabtec’s sales to freight railroad customers from $448 million during last year’s first quarter to $357 million this year. The majority of the foregone sales were high margin electronic Positive Train Control products and signaling equipment most of which are deferrals. U.S. railroads are required to install most of this equipment by the end of 2018 to comply with the Surface Transportation Extension Act. A slight upturn in freight traffic this year and the acquisition of Faiveley added a $270 million increase in transit sales. The operating margin earned on Faiveley’s transit sales is 1.8% less than Wabtec earned on its sales. Costs incurred for the $1.7 billion acquisition of Faiveley Transportation of $8.9 million and interest costs of $115 million which were expensed in the quarter are the principal reason for the 20% year-to-year decline in earnings during the quarter. These combined costs amount to 25¢ per share, and are well worth the cost because Faiveley transforms Wabtec from being 60% dependent on the cyclical demand from North American freight railroads to a company deriving 60% of its revenues from railroad transit customers in Europe, Asia and North America. Transit demand is increasing and technology solutions are sought in return for long-term government contracts. Faiveley obtains 45% of its revenues from maintenance contracts with transit systems throughout Europe and Asia. The combined company has 85 operating units in the U.S., 64 in Europe and 41 in Asia. The good execution of the merger of these two complementary businesses is enhanced by the high regard the two operating leaders of Wabtec and Faiveley, Ray Betler and Stephane Rambaud-Measson, developed when they worked together at Bombardier twenty years ago. They have respected one another since and express enthusiasm about the prospect of realizing the full potential of the combination of the two companies. Wabtec’s stock price is up 3% since the beginning of the year.

Ecolab, Inc.

Ecolab’s first quarter sales of $3.16 billion rose 2% in local currencies over revenue of $3.10 billion in the first quarter of 2016. Earnings per share, excluding one-time tax benefits, gains and charges, rose 4% to 80¢. Earnings per share grew 9% excluding a 4¢ per share currency hedge gain from the first quarter of 2016. Revenue of the Global Institutional, Global Industrial, Pest Elimination and Equipment Repair businesses grew 3% to $2.4 billion with revenue from Ecolab’s newest businesses, Healthcare and Life Sciences, growing 5% and 8% respectively. The Healthcare business provides cleaning and sanitizing systems to about 9,000 acute-care hospitals, including large hospital systems like Johns Hopkins and the Mayo Clinic, to reduce hospital acquired infections by focusing on four sources: hand hygiene, patient rooms, instruments and operating rooms. In February, Ecolab closed the $800 million acquisition of Laboratoires Anios, a leading manufacturer of hygiene and disinfection products for the healthcare market based in France. This acquisition will accelerate Healthcare’s growth in Europe and lifts annual revenue by $245 million to $750 million. The Life Sciences business combines a $60 million business that provided hard surface cleaning and sanitizing services to pharmaceutical and personal care companies as part of the Healthcare business with a $40 million business in Food & Beverage that provides clean-in-place technology to these facilities. Clean-in-place technology, proprietary to Ecolab, cleans, rinses and then sanitizes liquid processing plants between product runs which reduces changeover time and water and energy consumption. Combining these businesses under one management team allows Ecolab to build a corporate accounts sales team to capture more business from large multinational pharmaceutical and personal care companies who value having one supplier who can help them implement global standards in their local facilities. These businesses expand the market for Ecolab’s existing technology and services to new industries.

The Energy business improved significantly over previous quarters with revenue down only 2% to $757 million over the same period a year ago versus a 14% year-over-year decline in the fourth quarter of 2016. Sales of Wellchem products increased over 20% with increased drilling in unconventional oil reservoirs in the U.S. This growth was offset by a small decline in the sales of chemicals for oil production because of the normal lag that follows increased drilling as well as moderate price reductions implemented in contracts last year. However, the abrupt decline in the Wellchem business from 18% of Energy revenues in 2014 to 8% today accounted for 75% of the reduction in operating income over that period. With a growing Wellchem business and more oil that requires more chemicals to produce it, the Energy business is no longer a drag on Ecolab’s overall business. The total return on Ecolab’s stock is 13% since January 1.

Core Laboratories

Core Laboratories’ first quarter revenues and earnings rose 2.7% and 17.1% above the comparable results for last year’s first quarter. The sizable percentage earnings increase is entirely attributable to an upsurge in demand from the most proficient onshore U.S. shale oil producers. Their heightened demand increased Core’s Production Enhancement division’s quarterly revenues 19% to $52.9 million, $8.4 million above revenues for the quarter ending last December. The technical superiority of Core’s new Hero Perfrac perforating tool resulted in first quarter deliveries 52% above the fourth quarter’s volumes. Most of the increased demand came from the most technically proficient producers in the Permian Basin, the most active area in the U.S. There the number of stages fraced by many of these successful companies has grown to 40 with an average of 200 feet between them along an 8,000 foot pipe within the formation. Amazingly, this technology allows operators, from a single drilling site in the center of a section, to drill and complete wells stretching a mile and a half laterally from the site while providing them with precise information about where the oil is flowing and where it’s not. We think, however, that this improving business including the high margin ancillary services which are an integral part of product sales is not enough to lift Core’s stock price appreciably.

Risk averse investors like us need to see renewed growth of Core’s Reservoir Description business, which still generates 66% of the company’s revenues and 70% of its operating profit, before we add to the position. Currently, 60% of Reservoir Description’s revenues come from analyses of reservoir fluids from offshore deepwater producing reservoirs. These analyses allow operators to change the chemical mixture of the additives used to stimulate production as the reservoir fluid composition changes as a result of depletion of the oil and gas in the reservoir. These additives increase the rate of current production while maximizing the recovery realized from the reservoir before it is depleted. We believe Core is positioned to receive commitments soon from major oil companies, such as BP and Exxon, for services related to major deepwater drilling planned in the Gulf of Mexico and offshore Guyana, Brazil and Africa. The prospective customer for the wells planned offshore Brazil is not Petrobras. Core’s stock price is down 13% since the start of the year.


Alphabet’s first quarter revenue of $24.8 billion increased 22% over last year, or 24% in constant currencies. Earnings per share, including the cost of stock-based compensation, rose 28% to $7.73. Operating income, a key metric used by Alphabet’s managers to assess the performance of its business, rose 23% to $6.6 billion. Disciplined control of operating expenses offset the increase in payments made to third parties who display Google ads or make Google Search available on their platforms to deliver an operating margin of 26.5%. Alphabet’s constant currency revenues grew by at least 19% in each of its geographies with U.S. revenues, at 48% of total revenues, growing 25%. Advertising revenue on Google sites including Google.com, Gmail, Maps and YouTube increased 21% to $17.4 billion. Most of the growth came from consumers’ increasing use of these services on their mobile devices. In the U.S., spending on ads for mobile devices grew 77% in 2016 and now makes up over half of all online advertising spending, up from 35% in 2015. To address this growing market, last year Google launched an open source project to speed up mobile web browsing because consumers often leave mobile web pages that do not load quickly. Accelerated Mobile Pages (AMP) allows web developers and advertisers to make websites display faster on mobile devices. In tests of the newest version of AMP with Johnson & Johnson, specific pages loaded ten times faster which increased audience retention by 20%.

Google’s non-advertising businesses also had a good quarter with revenues rising 49% to $3.1 billion. Growth in the Google Cloud Platform, hardware sales of Pixel phones and Google Home Assistants and purchases in the Google Play store drove the increase. Over two billion smartphones worldwide, manufactured by more than 400 different companies, run on Google’s Android operating system and connect to the Google Play store where users purchase digital music, video and apps. Alphabet’s stock price has risen 20% since our initial purchase in February.

Red Hat

Red Hat’s fiscal fourth quarter revenue of $629 million rose 16% over the same period last year. GAAP earnings per share were 36 cents up from 29 cents last year with non- GAAP earnings of 61 cents per share, up 17% from 52 cents a year ago. Non-GAAP earnings per share exclude employee stock compensation, amortization of intangible assets, acquisition-related transaction costs, and non-cash interest expense from convertible debt. Full year revenue and non-GAAP earnings per share of $2.4 billion and $2.27, grew 18% and 19% respectively. Subscription revenue for the quarter of $560 million accounted for 89% of total revenue and grew 17% over the fiscal fourth quarter of 2016. Revenue from infrastructure subscriptions, which is mostly subscriptions of Red Hat Enterprise Linux (RHEL), rose 11% to $435 million and accounted for 69% of the quarter’s sales. Revenue from application development and emerging technologies, which includes its cloud technologies, grew 40% to $125 million and accounted for 20% of Red Hat’s quarterly revenue, up from 16% a year ago. Consulting and training revenue grew 11% to $69 million. The company’s total backlog at the end of fiscal year 2017 was $2.75 billion, which it defines as total deferred revenue from non-cancellable subscriptions and service agreements. The billed portion of $2.1 billion is deferred revenue on the balance sheet, an increase of $347 million or 20% over the same quarter a year ago. The unbilled portion from multi-year deals was $650 million, up 58% from $410 million a year ago.

Red Hat closed 110 deals above $1 million during the fourth quarter. The top 30 deals were all above $3.5 million with 16 deals above $5 million and four of those above $20 million. More than half of the large deals contained five or more cloud-based technologies, while 90% included at least one. The company has invested both in product technologies and in its sales force to address the needs of telecommunications service providers who accounted for three of the four largest deals in the quarter. Two of these telcos signed $10+ million agreements to install Red Hat’s version of OpenStack, a collection of open source applications that allow data centers to run a private cloud on commodity hardware. By virtualizing network functions telcos can manage their networks more efficiently and create, deliver and bill for new services quickly and accurately. These companies are installing Red Hat’s version of OpenStack because the company’s certifications for hardware and software vendors offers the same degree of consistency, reliability and ease-of-use as it does for the Linux operating system. IBM announced that it would offer Red Hat’s version of Open Stack to its customers as private-cloud-as-a-service with monthly subscription fees to facilitate its customers move to the hybrid cloud. Red Hat’s stock price is up 32% year-to-date.

Johnson & Johnson

Johnson & Johnson’s first quarter sales of $17.8 billion rose 2.0% in constant currencies. Acquisitions and divestitures reduced revenue growth to 1.2% over the first quarter of 2016. Good cost control in manufacturing and in selling, general and administrative expenses increased the quarter’s pre-tax margin by 0.5 percentage points to 33.4%. Earnings per share of $1.83 grew 5.8% and exclude amortization of purchased intangible assets, restructuring charges in the Hospital Medical Device business and transaction costs associated with the acquisition of Abbott Medical Optics (AMO) which closed on February 27, 2017. J&J will add AMO’s contact lens solution business to its contact lens business and AMO’s intraocular lenses used in cataract surgery and the related surgical instruments to its Vision Care business.

Pharmaceutical sales of $8.2 billion increased 4.7% over the first quarter of 2016 excluding favorable prior-period price adjustments of $200 million from lower than forecast 2016 rebates from managed care organizations and Medicaid that were reported during the first quarter of 2017. Pre-tax margin increased four percentage points to 45% because manufacturing costs were lower. Sales of its new oncology drugs, Darzalex (multiple myeloma) and Imbruvica (B-cell blood cancers) grew 83% to $664 million. Medical Device sales were $6.3 billion, up 3.4% over the first quarter of 2016. One month of sales from AMO added $124 million or 2 percentage points to the division’s growth. The Consumer business had a tough quarter with sales slowing in five of its six categories as part of a global decline in consumer spending during the quarter. Revenue of $3.2 billion rose 0.8% with the recent acquisition of Vogue hair products and other acquisitions in Beauty contributing 3.1% to revenue growth. Pre-tax margins rose 1.5 percentage points to 20.2% and are now competitive with Consumer’s peers.

J&J highlighted the strength of its Pharmaceutical business at its Investor Day on May 17, 2017. In addition to five currently marketed drugs that the company expects to have annual sales above $4 billion by 2021, the company has ten novel drugs in late-stage development with potential peak sales of at least $1 billion and 50 late-stage trials that expand the use of these drugs to other diseases by 2021. J&J spent $7 billion on its pharmaceutical R&D in 2016, which is 55% higher than its spending on sales and marketing. Its five therapeutic areas have control of the entire drug development process which helps develop the deep expertise needed to identify the best drug candidates wherever they are and to simplify the transitions through clinical development. J&J has reduced the cycle time, the time it takes to move a drug from phase I through phase III trials, from 9.1 years in 2010 – 2012 to 8.9 years in 2013 – 2015. Cycle times for its industry peers increased from 9.5 years in 2010-2012 to 10.5 years in 2013 – 2015. Their success rate has also increased faster. J&J achieves one drug approval for seven new drug candidates in pre-clinical trials versus one in sixteen for its peers. The total return on Johnson & Johnson’s stock is 15% since January 1.

Varian Medical Systems

Varian Medical Systems operated as a focused cancer treatment company for the first time during its fiscal second quarter. Sales of $655 million rose 6% over the same period a year ago with the strong U.S. dollar lowering local currency sales by 1%. Earnings per share of 89¢ was up slightly from the earnings per share of 87¢ reported a year ago. Earnings in both periods exclude amortization of purchased intangible assets and other one-time charges. Selling, general and administrative expenses of $132.2 million were 25% higher than a year ago because the company invested in marketing for its software products and prepared for the May 5, 2017 launch of Halcyon, a new radiation therapy system designed to perform the most advanced image-guided treatments in a smaller machine. It is easier to set up and to run, more comfortable for patients and more profitable for Varian.

Varian spent four years designing Halcyon which incorporates its latest radiation system technology and its in-depth customer research into what radiation oncologists, therapists and patients need in a new system. Its smaller size and internal radiation shielding allow it to fit into the 2,500 to 3,000 existing rooms worldwide that house cobalt-60 and older radiation treatment systems. It finally gives clinics an incentive to replace these old machines. Halcyon requires nine steps to deliver treatments regardless of their complexity, while the older systems required as many as thirty. It is quiet, operates at room temperature and has a low table that is easier for patients to access. Halcyon is shipped in two boxes, can be installed in two weeks (versus four weeks for a TrueBeam system) and does not require extra shielding of the room to contain the radiation delivered during treatments. Halcyon was also designed to be as profitable as a TrueBeam at the entry price of $2 million, so Varian expects to improve the margins of the systems installed in low and middle-income countries where the need for radiation therapy to treat cancer is greatest. Varian’s stock price has risen 31% since the beginning of the year.


Roche’s first quarter sales of CHF 12.9 billion grew 4% in constant currencies with revenue from Pharmaceuticals and Diagnostics of CHF 10.1 billion and CHF 2.8 billion, up 3% and 6% respectively over the first quarter of 2016. Roche’s newer cancer drugs, Perjeta (breast cancer), Tecentriq (immunotherapy for bladder and lung cancer) and Alecensa (targeted therapy for lung cancer) contributed CHF 230 million to the division’s revenue growth of CHF 377 million. The company’s immunology drugs contributed CHF 180 million to revenue growth as well. Sales of Avastin, one of Roche’s three large oncology drugs, declined 2% to CHF 1.7 billion as strong growth in China and other Asian countries was offset by an expected price decline in Japan and increased use of immunotherapy drugs, including Tecentriq, to treat lung cancer. Roche’s Diagnostics business continues to grow faster than the market for in vitro diagnostics by two percentage points. Revenue for the Centralized and Point of Care business, which benefits from the introduction of new instruments that double the speed of analyzing immunoassay tests and from the introduction of new tests, grew 9% to CHF 1.6 billion. Tissue diagnostics posted 15% revenue growth to CHF 236 million with 40% growth in its companion diagnostics business. The total return on Roche ADRs is 16% since the beginning of the year. It fell 5% on June 5, 2017 after analysts and commentators reacted negatively to the presentation of data from the APHINITY breast cancer trial at the American Society of Clinical Oncology meeting because the clinically meaningful results were not as good as they expected them to be.

Air Lease Corporation

Air Lease’s revenues of $360 million rose 5% and earnings of 78¢ per share declined 8% from the same period a year ago. Excluding $21 million in gains on aircraft sales during the prior year, and $3 million of additional one-time expenses in the current quarter, revenues and earnings rose 12% and 9% respectively. The company entered into an agreement to sell and continue to manage 19 mid-life aircraft from its leased fleet to a newly formed entity called Thunderbolt Aircraft Lease Limited, a group of third-party investors. Management expects to continue to create funds like Thunderbolt to enable investors to acquire their mid-life aircraft. Air Lease will receive a management fee of 3% of the rental revenues for managing the aircraft. The company now manages 50 aircraft for other owners.

Demand for new aircraft remains strong. The International Air Transport Association reported first quarter 2017 passenger traffic grew 7% globally from a year ago, above the long-term average of 5.5% annually. Industry-wide load factors of 80% confirms the healthy environment for airlines. During the quarter, the company purchased 11 aircraft for a total cost of $825 million bringing its total fleet to 243 aircraft with a book value of $12.6 billion. The average fleet age is 3.7 years with a remaining lease term of 6.9 years. An additional 34 lease agreements were signed during the quarter, bringing the percentage of order book deliveries that have been placed with airline customers through 2019 to 91%. Airbus deliveries, however, are falling behind schedule. These delays will reduce growth this year but management is opportunistically buying aircraft from airlines with excess fleet capacity to lease to customers who need more capacity. At the end of the first quarter, the company agreed to buy eleven Boeing 737-800’s from Pegasus Airlines in Turkey and will re-lease them to several other airline customers who want the planes. The total return on Air Lease shares is 11% since the beginning of the year.


SGS will report its first half 2017 financial results on July 17. The company has made four small acquisitions this year to enable its division managers to rapidly expand their reach by providing additional services across more geographies. One of these acquisitions was its March purchase of ILC Micro-Chem Inc., a Toronto-based provider of microbiology and food chemistry testing that analyzes raw ingredients and finished food products in Ontario. This acquisition will become part of the profitable and growing Agriculture and Food business which generated CHF 935 million or 16% of 2016 revenues and provides testing and regulatory compliance from the farm to the table. The total return on SGS ADR’s since the beginning of the year is 24%.

Express Scripts

A series of conversations with Anthem’s management during the first quarter made it clear that Anthem, Express Scripts’ largest customer, plans to move its business from Express Scripts after the 10-year outsourcing contract expires in 2019. In response, Express Scripts presented the performance of Anthem’s business, the departing business of Coventry and Catamaran and its core PBM business in its first quarter earnings release on April 23, 2017. While we knew that Anthem accounted for about 200 million of the 1.4 billion prescriptions that Express Scripts filled in 2016, we were surprised by their profitability. Operating earnings from the Anthem business of $2.2 billion accounted for 31% of the company’s operating earnings of $7.3 billion in 2016. They grew 21% over 2015 because of the addition of Amerigroup members, a managed Medicaid business Anthem acquired in 2012, and from increased prescriptions filled by members of the healthcare exchanges. Operating earnings of the core Express Scripts business rose 6% to $4.8 billion in 2016, while earnings from the departing Coventry and Catamaran businesses declined $450 million to $222 million.

Express Scripts’ expectation that operating earnings for its core business would grow 2% to 4% annually from 2017 to 2020 was more surprising. The company anticipates this slower growth despite excellent cost control, high client retention and successful new sales and an innovative suite of specialty drug programs such as its groundbreaking Hepatitis C program that saved its clients over $1 billion during its first year of implementation. While Express Scripts’ operating earnings growth may outpace that of its two major competitors CVS Caremark and Optum Rx, this forecast indicates that the PBM business is a mature, low growth, cash-generating business with sophisticated customers and strong competitors. The fundamentals of the business have changed. Express Scripts was one of your best performing stocks for years as George Paz successfully added new services and introduced them to more health plan sponsors. Express Scripts’ stock price is down 12% 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.