2nd Quarter, 2017

Our examination of the second quarter earnings of your companies reinforces our belief that most of these businesses are getting better at increasing sales by giving greater discretion to employees who deal directly with customers. The good results we see come from the differing ways your well-managed companies have empowered their employees to learn from their successes with one group of customers and apply what they’ve learned to benefit other customers. They are still selling, but it results in sales they might not have gotten and it seems to make everyone sound smarter when we hear it. We believe that business conditions are getting better and have scheduled meetings with the managements of companies that meet our criteria to determine if they, like the companies you own in your portfolios, are capable of becoming better at meeting their customers’ needs. We know that you know that a decision to add a company’s stock to your portfolio is not made on the basis of any economic or political forecast.

Automatic Data Processing

ADP’s fiscal fourth quarter and full year revenues of $3.1 billion and $12.4 billion each rose 6% while adjusted earnings of 66¢ and $3.70 declined 4% and rose 13% respectively from the prior year. The results were overshadowed by news that “activist” hedge fund manager Bill Ackman’s fund, Pershing Square, controlled 8.3% of ADP’s outstanding shares, of which 24% are owned directly and 76% through options. The announcement temporarily propelled the stock to just over $120 per share before it settled back to its current price of $107. Its total return since the beginning of the year is 6%. The total return on the S&P 500 is 13.1% year-to-date.

We think Ackman will not succeed in changing ADP management nor the way they manage the company. ADP noted in a press release that during Carlos Rodriguez’ six years as CEO, ADP’s total return has been 202%, well above the total return for the S&P 500 of 128% and many multiples higher than Pershing Square’s total return of 29% during the same period. The superior results ADP has delivered for many years make it a surprising target for an activist investor. Carlos Rodriguez and his management team have been upgrading their core product platforms to be cloud-based and mobile friendly. This has improved customer retention amongst customers who have upgraded to the new integrated platform. These customers generate 20% more revenues because it is easier to purchase additional integrated cloud-based services. Once customers upgrade and the old platforms are shut-down, the business becomes more profitable. ADP has completed the upgrade of its small business customers and is seeing strong growth and a lift in margins. It is in the midst of upgrading its mid-size customers and has begun upgrading its large customers. This time consuming process requires additional resources to facilitate the customer upgrades. At the same time, ADP is rationalizing the way its product and service teams operate to better serve their customers once they have adopted the new platforms. This initiative involves additional costs now, but will provide growth and higher operating margins when the upgrades and service alignment are completed.


Visa’s payments volume and processed transactions rose 38% and 44%, respectively during their fiscal third quarter, driving Visa’s revenues and earnings per share 26% higher to $4.6 billion and 86¢. Including Visa Europe’s operations in last year’s results, processed transactions grew 13% to 28.5 billion, an acceleration from last quarter’s 12% growth rate. Cross border volume growth was stable at 11%. All geographic regions produced payments volume growth, particularly India, Russia, Mexico, Australia and the United States, where the 12.1% increase was supported by credit growth of 18.8% from the conversions of Costco and USAA during last year’s fiscal third quarter. Visa’s 55.7% share of US consumer credit volume is nearly 2.5 times its largest competitor and has expanded by 3.7 percentage points from 2015. In India, the number of payment transactions doubled and volume surged 80% amid strong government support for electronic payments.

The proliferation of mobile devices around the globe, with more than 5 billion now connected to the internet, provides new ways to make and accept electronic payments that will digitize some of the world’s $17 trillion of paper payments. E-commerce growth of 20%, five times the growth rate of offline commerce, favors Visa because it handles 43% of online spending versus 15% of in-person transactions. To support growth in electronic payments Visa invests 35% of its operating budget in technology. Part of that investment funds the maintenance of network capacity and the cyber and physical security of its data centers. The rest of Visa’s technology budget supports the provision to third-party technology developers of secure entry points to VisaNet, Visa’s core processing network comprised of 350 applications and 15 million lines of code capable of processing 65,000 transactions per second. Visa’s clients and financial institution partners access over 60 Visa services to create commercial applications that securely connect to VisaNet and make digital payments easier for consumers. Visa’s share price has increased 36% since January 1.

CME Group Inc.

CME’s second quarter average daily trading volume rose 9% from the prior year to 16.5 million contracts. Average daily volume of interest rate contracts, metals, energy and foreign exchange contracts were up 21%, 14%, 13% and 5% respectively while equity and agricultural commodity contracts declined 8% and 13% respectively. CME’s introduction of new options contracts and technology upgrades enable more complex options contracts to trade electronically which encourages more customers to trade options. During the quarter average daily options volume rose 21% led by electronic options which surged 30%. CME’s investments in sales and customer support outside the U.S. are paying off. Trading volume from Europe and Asia grew 16%, reaching record levels and accounting for 21% of total volume. Adjusted earnings per share of $1.23 rose 8% from the same period a year ago on revenues of $924.6 million. CME’s interest rate franchise, which generated 32% of clearing and transaction fee revenue during the quarter, provides exceptional liquidity, capital efficiencies and innovative new product introductions for customers. Notable volume gains occurred in Eurodollar and Treasurys including the Ultra 10 Year and the Fed Funds contracts. CME’s total return since the beginning of the year is 16%.


Mettler-Toledo delivered excellent second quarter results with sales of $653.7 million growing 10% in local currencies over the second quarter of 2016. Sales rose 7% in U.S. dollars. All geographies and businesses contributed to the quarter’s revenue growth. Laboratory sales rose 9% during the quarter on top of 10% growth in the second quarter of last year. They now account for 50% of Mettler’s total revenue. Earnings per share of $3.92 rose 22% over earnings per share of $3.22 reported a year ago. Results from both periods exclude amortization of purchased intangibles and other one-time charges.

Mettler’s service business revenue grew 7% during the first six months of the year and accounts for almost 25% of the company’s total revenue. Its 2,700 field service technicians in 39 countries have been trained and given tools to provide more services in addition to responding to calls to fix broken instruments. Mettler has successfully increased the sale of service contracts with new instruments by 40% since the launch of a specialized sales program four years ago. Service contracts currently account for about 50% of service sales and are sold mostly in North America and Europe where almost every instrument is purchased with a service contract to ensure high up-time and compliance with regulations. Service contracts are more profitable for Mettler because technicians can plan their calls in advance. Mettler now uses fleet management software to maximize their productivity. Clients receive better service because the technicians focus on preventive maintenance and training to ensure that clients understand all of an instrument’s features and use it in compliance with regulations. High customer satisfaction with Mettler’s service increases customer retention rates and thus reduces future selling costs. Mettler-Toledo’s stock price has risen 49% since the beginning of the year.

IDEXX Laboratories

IDEXX Laboratories delivered another strong quarter with second quarter revenues of $509 million, up 10% over the same period a year ago. Earnings of 95¢ per share increased 28% over earnings per share of 74¢ a year ago. Earnings per share rose 18% excluding an 8¢ per share gain from a change in share-based compensation accounting. Instrument consumables’ revenue growth of 17% and reduced costs resulting from higher volumes in IDEXX’s reference labs contributed to a 12% increase in gross profit to $293 million and a 1.7 percentage point increase in gross margin to 57.5% from 55.8% a year ago. The quarter’s operating margin of 24% includes a 9% increase in sales and marketing expenses associated with the expansion of the U.S. sales force.

IDEXX’s successful 2016 implementation of a new incentive program for the U.S. sales force contributed to global instrument consumables revenue growth of 17% to $132 million in the quarter. The program rewards sales representatives for placing instruments in vet clinics which generate the highest sales of instrument consumables over the seven-year life of an instrument. While a complete diagnostic work-up for a cat or dog includes chemistry, hematology and urinalysis, 81% of IDEXX instrument consumables sold are chemistry consumables. The placement of Catalyst chemistry analyzers in new accounts in North America grew 14% to 341, a record 82% of the total instruments placed in the region during the quarter. IDEXX Laboratories’ stock price is up 35% since January 1.

Red Hat

Red Hat’s stock price is up 55% since the beginning of the year! It jumped 10% on June 20, 2017, the day the company reported its fiscal first quarter 2018 results. Revenue grew 19% over the same period a year ago to $677 million. Subscription revenue from Red Hat’s infrastructure offering, primarily the open source operating system Red Hat Enterprise Linux (RHEL), grew 14% to $458 million and is approaching annual revenue of $2 billion. The quarter’s largest deal for $20 million consisted entirely of RHEL subscriptions. The growth of subscription revenue from application development and other emerging technologies offerings continues to accelerate, growing 41% over the same period last year to $139 million. It accounted for 20% of the quarter’s revenue, up from 17% of revenue in the previous quarter. Training and consulting revenues of $80.3 million rose 21% as customers used Red Hat’s consultants to deploy the company’s cloud technologies in production. Red Hat’s largest customers also continue to increase their use of Red Hat’s offerings with the 25 largest deals renewing at more than 120% of their previous annual size. The company closed 44 deals over $1 million and 68% included application development and emerging technologies offerings. GAAP earnings per share of 40¢ rose 21% over earnings of 33¢ per share a year ago. Non-GAAP earnings of 56¢ per share grew 12%. Non-GAAP earnings exclude stock compensation, amortization expense and non-cash interest expense related to Red Hat’s convertible debt.

Customer demand for Amazon Web Services (AWS) tools on Red Hat’s OpenShift application development platform led to a May 2, 2017 announcement that Red Hat will make available 11 or 12 widely-used tools from AWS on OpenShift so developers can use them to develop software that runs in company datacenters as well as on AWS. OpenShift provides software developers with the tools and services they need to develop new applications. These same tools and services are also used to run the programs. Using these tools reduces the time and cost to develop and deploy new software because the operations team knows that software developed on OpenShift will run without glitches once it is in production. The alliance with AWS confirms the importance of the hybrid cloud and Red Hat’s position as a strategic vendor to companies whose business depends on agile application development.


Alphabet’s second quarter revenue grew by over $4.5 billion dollars, or 23% in constant currencies, to $26.0 billion. Operating income was reduced by the European Commission’s (EC) decision on June 27, 2017, to fine Google €2.42 billion and to require changes to its search algorithm because Google’s ranking and display of shopping search results and ads infringed European competition law. Google has appealed the decision. European law allows regulators to evaluate whether competitors are disadvantaged by a company and is broader than US antitrust law which focuses on whether consumers are hurt. The US Federal Trade Commission closed its antitrust investigation of Google’s practices in 2013 without penalty. Excluding the EC fine, Alphabet’s operating income rose 15% to $6.9 billion and earnings per share increased 27% to $8.90. Advertising revenue from Google’s sites including google.com and YouTube provided 81% of Google’s advertising revenue and 71% of Alphabet’s total revenue. This revenue continues to grow rapidly, increasing 20% to $18.4 billion in the quarter. Google’s non-advertising revenues jumped 42% to $3.1 billion from strong growth in app downloads (82 billion in the last year), hardware sales and Google Cloud Platform, where Google’s investments in their sales force and technical expertise helped triple the number of deals worth over $500,000.

With the increasing use of smartphones, more than 20% of mobile queries are now spoken instead of typed. Google’s vast computing infrastructure and significant investments in machine learning give it an advantage in voice recognition and speech comprehension. Native speakers read common phrases to train Google’s models which improve in accuracy as they are exposed to more phrases over time. Google’s services now understand 119 languages and have English word accuracy of 95%, equivalent to humans. Consumers can interact with Google’s speech recognition capabilities regardless of device manufacturer or operating system. These investments encouraged Walmart, the world’s largest retailer with nearly $500 billion in sales, to partner with Google to offer hundreds of thousands of items for voice shopping via Google Assistant. Other large retailers such as Costco and Target already offer products on Google’s shopping platform. Alphabet’s share price is up 13% since our initial investment in February.


Wabtec’s second quarter earnings of 75¢ per share, 25% below the $1.00 per share earned in the year ago quarter were especially disappointing because the quarter was the first that fully reflected Faiveley’s operations, all of which positively contributed to the results. The addition of Faiveley increased Wabtec’s transit sales 80% during the quarter but the near 4% lower margin earned on transit contracts meant that Wabtec’s management did well to keep the operating income from dropping more than 15%. Interest expense of $15.4 million incurred to acquire Faiveley increased the drop in net income to 25%.

The added sales from Faiveley brought transit sales up to 63% of Wabtec’s total sales for the quarter on which the company earned a 28% margin. Contracts signed during the quarter brought the company’s book to bill ratio up to 1.6 to 1. The transit orders won were in Germany, France, Australia, the U.S. and China. The company’s freight backlog rose during the quarter for the third quarter in a row while traffic rose 6%. Surprisingly, however, the number of freight cars in storage increased 5% during the quarter and there was no upturn in aftermarket sales to refurbish or replace worn parts such as brakes or brake shoes. Positive train control sales of $67 million during the quarter were 22% lower than a year ago, although they are scheduled to increase during the second half of this year. The systems must be operable in the U.S. by the end of 2018. The two largest Class I U.S. railroads, Burlington Northern and Union Pacific, have publicly stated that they will meet the deadline.

In reducing its earnings forecast for the year to $3.55 at the low end, Wabtec management cited a decision by the new management of the CSX, the fourth largest U.S. freight railroad, to overhaul 100 locomotives itself instead of contracting with Wabtec for the work. Wabtec remains the sole provider of the technology to manufacture Tier 4 compliant locomotives. The company’s 2017 forecast no longer anticipates any revenues from this source. Wabtec’s stock price has declined 14% since the beginning of the year.

Ecolab, Inc.

Ecolab’s second quarter revenue of $3.46 billion rose 4% in constant currencies over the second quarter of 2016 with revenue from all businesses contributing to the growth. Sales in the Industrial and Institutional businesses rose 3% to $1.2 billion each. Energy business’ revenue grew 5% to $792 million and reflects the improvement in North American energy industry activity. Sales in Ecolab’s Other businesses, Pest Elimination and Equipment Repair, grew 6% to $215 million with the Pest business contributing most of the growth. Operating income rose 1% to $496.3 million as profits from new business, new products and cost reductions were offset by higher raw material costs. Lower interest and tax costs lifted adjusted earnings per share to $1.13, an increase of 5%. The adjusted earnings exclude one-time tax benefits, gains and charges.

Ecolab’s 26,000 service technicians and 1,600 scientists in research and development spend time at customer facilities to ensure that their cleaning, sanitizing and water treatment chemicals and dispensers are working properly. They also address new challenges their customers face as they arise. When Legionella bacteria in cooling water caused outbreaks of infection worldwide, Ecolab’s Light Water business created a water safety program to address the problem for its institutional customers. The program includes the development of water safety plans, disinfection and filtration of the cooling water in addition to treating the water to increase reuse, as well as monitoring and testing to ensure that the water is free of bacteria. This program protects the reputation of a hotel or hospital, but increases the cost of treating cooling water from $19,000 per year to $58,000 per year. Adding infection control to cooling water management creates a new market with potential sales of $1 billion for Ecolab. The total return on Ecolab’s stock is 12% since January 1.

Core Laboratories

Core Laboratories’ second quarter sales of $164 million and earnings of 52¢ per share were respectively 4% and 27% higher than its comparable first quarter results. The apparently good earnings increase however did not lift the stock price because it came entirely from a near 56% increase in the operating margin of Core’s Production Enhancement Division on only 2% more sales than in the first quarter. Core is continuing its practice of ceasing production of tools before they become commoditized while introducing more precise tools to measure the effects of fracing. These tools complement its new HeroPerFRAC perforating tool and its Flow Profiler of soluble tracers which provides analytic data from each frac, along with diagnostic tracers to identify liquids from other frac stages from the same or surrounding wells. The success of these tools has lifted Production Enhancement’s operating margin from 7% during this year’s first quarter to 18% in the second. This improved profitability accounts for all of the earnings increase during the quarter.

Reservoir Description, Core’s largest and most profitable business which produces 64% of Core’s revenues, experienced a miniscule decline in revenues from the first quarter and just a 17% increase in profit. The profit improvement was not enough to lift the stock. We think many other investors, like us, wish to own Core stock when its Reservoir Description business begins to revive. That depends upon major oil companies such as Exxon proceeding with plans to develop new deepwater production such as its immense Liza discovery offshore Guyana. As befits a well-managed company, Core on September 5 following the devastation wrought by hurricane Harvey, reduced its third quarter revenue and earnings forecast to $161 million and 44¢ per share. Core’s stock price is down 20% since the start of the year with over half the decline occurring after it reported its second quarter results.

Johnson & Johnson

Johnson & Johnson’s second quarter sales of $18.8 billion grew 2.9% in constant currency over the second quarter of 2016. Revenue from acquisitions accounted for 2.4% of the growth. Sales in U.S. dollars rose 1.9%. Earnings per share of $1.83 grew 5.2% over earnings of $1.74 a year ago, excluding amortization expense and one-time gains and losses from both periods. Pharmaceutical sales of $8.6 billion rose 4.5% over the same period a year ago, excluding acquisitions, divestitures and $340 million of prior-period adjustments for rebates and discounts to managed care plans and Medicaid in the second quarter of 2016. Medical Devices sales grew 5.9% to $6.7 billion. Revenue from recently-acquired Abbott Medical Optics accounted for 5.1% of revenue growth. Consumer sales of $3.5 billion declined 0.8% with 1.2% growth in the U.S. and a 2.3% decrease outside the U.S, excluding acquisitions and divestitures. The imposition of the national goods and services tax in India caused some market disruption and reduced international sales by 0.5%. An inventory build-up in advance of the implementation of a new IT platform also decreased sales by 0.5%. The Vogue hair care acquisition contributed most of the 3.1% revenue growth from acquisitions during the quarter.

In addition to acquisitions, J&J’s investments in new products continue to drive revenue growth. Demand for Tylenol rapid release capsules outstripped supply and contributed to a 2.1% increase in OTC quarterly revenues to $1.0 billion. Sales of new daily contact lenses for astigmatism lifted Vision Care’s revenue by 7%, while sales of devices to treat atrial fibrillation grew more than 15% and contributed to the 13% growth of J&J’s cardiology device revenue to $523 million. Sales of Stelara, the company’s fastest growing immunology drug, rose 23% to $983 million during the quarter. It gained 1.8 points of market share in the total immunology market because of the strong uptake of the drug for Crohn’s disease. Stelara received FDA approval to treat moderate to severe Crohn’s disease in September 2016. J&J’s oncology drugs Darzalex (multiple myeloma) and Imbruvica (leukemia and lymphoma) continue to gain approvals for use in earlier stages of treatment. Darzalex sales increased to $299 million from $108 million a year ago and Imbruvica sales of $450 million rose 55% over the same period a year ago. The total return on Johnson & Johnson stock is 19% since the beginning of the year.

Varian Medical Systems

Varian Medical Systems’ fiscal third quarter revenue of $661.7 million grew 3% over the same period a year ago. Adjusted earnings per share of $1.04 were up 4% with share repurchases accounting for the increase. Oncology Systems’ revenue, which accounted for 90% of Varian’s revenue during the quarter, fell 2% to $594 million. Sales in North America rose 3%, primarily from a 7% growth in service revenue, while sales outside the U.S. fell 7%. The company installed more radiation treatment systems in emerging markets than in Europe during the quarter. Varian recognizes revenue on its systems once they are installed, which can take three to six months in emerging markets. It took longer to install several of these systems than management expected, so these sales slipped into the fourth quarter. The strong growth in service revenue, good price discipline and supply-chain efficiencies contributed to a 1.9% percentage point rise in Oncology Systems’ gross margin to 47.9% from 46% during the same period a year ago.

Oncology Systems’ third quarter orders rose 5% to $708 million with growth in all regions. Orders in North America grew 3% with an 8% increase in service orders. Orders in Europe rose 2%, while orders in Asia-Pacific grew 13% with 30% growth in China and multi-million dollar orders in Vietnam, South Korea, Thailand and the Philippines. On June 29, 2017, Varian received FDA approval to sell its new Halcyon radiation treatment system in the U.S. In addition to orders from 10 countries during the quarter, PetCure Oncology placed an order for six Halcyon systems and Varian’s most advanced treatment planning and information management software to deliver advanced radiation treatments to the six million dogs and six million cats that are diagnosed with cancer each year in the U. S. Varian Medical Systems’ stock price is up 36% since the beginning of the year.


Roche’s first half revenue of CHF 26.3 billion grew 5% in both Swiss francs and constant currency over the first half of 2016. Core earnings per share, which excludes the amortization of purchased intangibles, restructuring and other one-time charges and gains, rose 6% to CHF 8.23 from CHF 7.74 a year ago. The Pharmaceutical Division’s sales of CHF 20.5 billion rose 5% in constant currency. Operating profit grew 3% to CHF 9.3 billion with marketing and distribution costs increasing 2% because of the costs to launch new products. Sales in the U.S. of CHF 10.2 billion grew 8% with sales growth of Roche’s newest drugs, Tecentriq (immunotherapy for lung and metastatic bladder cancer, Alecensa (a targeted lung cancer treatment) and Ocrevus (multiple sclerosis) accounting for almost half of the growth. Increased use of Perjeta before surgery and in newly-diagnosed cases of metastatic HER2+ breast cancer lifted sales 10% in the U.S. to CHF 507 million. Global Perjeta sales rose 17% to CHF 1.06 billion for the first half of the year. Revenue of Roche’s immunology drugs rose 9% to CHF 3.7 billion.

Roche’s Diagnostics Division also had a good first half with revenue growing 5% to CHF 5.8 billion. Operating profit also increased 5% to CHF 1.06 billion. Revenue for the Centralized and Point of Care Solutions business grew 8% to CHF 3.2 billion. This business provides highly automated, high volume in vitro diagnostics testing systems to large clinical laboratories. These modular instruments use the same test kits, reference intervals and software so a lab can add or exchange an old instrument for a new one without affecting other parts of the workflow. The company has also developed sample preparation protocols that allow large labs to integrate molecular diagnostic instruments with chemistry and immunology instruments into one high-speed line so a lab can perform both types of tests using the same sample. The total return on Roche ADRs is 14% since the beginning of the year.


SGS’ first half 2017 revenues of 3.0 billion Swiss francs rose 4.9% from the same period a year ago in constant currency with 3.4% organic growth and the remaining 1.5% from acquisitions. Organic growth improved from 1.6% during the second half of last year. Revenues from Europe/Africa/Middle East rose 4%, Americas 3% and Asia/Pacific 8%. Adjusted net profit of 293 million Swiss francs rose 7.7% compared to the same period a year ago. The overall operating margin of 14.1% matched the prior year margin while the tax rate and the number of shares outstanding each declined 1% from a year ago. The total return of SGS’ ADRs since the beginning of the year is 17%.

SGS’ non-energy related businesses achieved strong revenue growth and generated 69% of company profit. Consumer and Retail revenues rose 12%, with 8.3% organic and 3.7% from acquisitions. Strong growth was provided by restrictive substance testing activities for electronics products as well as electromagnetic compatibility and safety testing. Agriculture, Food and Life generated 8.2% revenue growth with 7.2% organic. Food testing services generated double-digit growth as recently launched services around food safety and sustainability continue to gain traction, especially in Europe and the Americas. Transportation, driven by testing services for car manufacturers who have implemented additional requirements for materials, components, engines and vehicles generated 14.6% organic revenue growth. During the period, SGS signed a contract with the State of California to utilize its Next Generation Electronic Transmission tests. These tests must be completed once a year for any vehicle in the State of California and generate recurring annual fees for SGS of $1.08 per vehicle.

After four years of decline, the Minerals business reported a 3.1% increase in revenues, 2.1% organic, and an improvement in margins. Trade service volumes are increasing across its network as volumes rise for major bulk commodities. Its geochemistry services delivered strong growth with six new contracts being awarded for onsite lab services, strengthening its leadership position. The continued contraction in capital expenditures in the energy market along with reduced public investments in infrastructure in South America led to a 4.9% organic revenue decline in Industrial services. This was partially offset by acquisitions leading to an overall decline in Industrial revenue of 1.3%, the only one of SGS’ nine business units to report a revenue decline during the period. High single-digit growth in plant and terminal operations enabled the Oil, Gas & Chemicals (OGC) unit to report 1.3% revenue growth during the period. This is the first time since 2014 that OGC reported positive revenue growth.

Air Lease Corporation

Air Lease’s second quarter revenues of $381 million and earnings of 92¢ per share rose 9% and 10% respectively. During the quarter, Air Lease purchased 14 aircraft at a cost of $637 million and sold 17 aircraft receiving net proceeds of $334 million. The sales generated a pre-tax gain of $17.6 million, 5% above the gain booked on aircraft sales during the same period a year ago. The company ended the quarter with 240 leased aircraft with a book value of $11.3 billion, an average age of 3.6 years, remaining lease term of 6.9 years and contracted lease revenue of $9.8 billion. Air Lease has lease commitments for 90% of the 136 aircraft on order with expected deliveries through 2019. The vast majority of these orders are for the most used Airbus A320/321neo and Boeing 737-7/8/9 MAX single-aisle aircraft which remain in strong demand.

The International Air Transport Association reported that global passenger traffic grew 7.9% in the first half of 2017 and industry-wide load factors were at an all-time high of 80.7%. In addition to traffic growth supporting aircraft demand, there is an ongoing need for new aircraft from the replacement cycle. Air Lease targets its placements with customers who are retiring planes built in the 1980’s and 1990’s. The new generation aircraft provide longer range, better fuel efficiency and are less expensive to maintain. As a result of airport slot restrictions imposed by more congested airports, many customers are also replacing their aging twin-aisle aircraft with new twin-aisle aircraft which accommodate more passengers. The total return on Air Lease shares is 16% 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.