4th Quarter, 2017

Once again, the managers and employees of the companies you own have achieved results that make our task of reporting to you informative and enjoyable. We learn from examining the companies’ reports how they have adapted to changes in their markets and in the government policies prevailing in countries where they operate. Collectively, your companies’ sales and earnings during the fourth quarter increased 12.7% and 18.4%, respectively. The comparable numbers for the S&P 500 companies were 8.3% and 14.9%. For the year, your companies’ revenues rose 10.7% while earnings increased 14.1%. The comparable figures for the S&P 500 are 6.6% and 11.7%, respectively. The foregoing earnings figures include the benefits of lower U.S. taxes.

We wish to allay any anxieties you may have as a consequence of hearing or reading alarming forecasts of stock market strategists or asset allocators who tell people what countries or markets to invest in or the ETFs or bond funds to buy. We see that many of these forecasters advise people to sell U.S. stocks and especially those in the S&P because they have gone up so much. They ought to have gone up. They are making more money and the tax changes let them keep more of it. In many instances, they have a record of investing the retained earnings well. Stocks of well-run consistently profitable companies are reasonably priced when compared to the return of no more than 2.8% available on ten-year U.S. Government bonds. Well managed U.S. companies are even more attractive when compared to European ten-year bonds. Germany’s yield less than .6%, Italy’s yields less than 2%.

IDEXX Laboratories

IDEXX Laboratories’ fourth quarter revenue of $506 million rose 12% over the same period a year ago on an organic basis, which excludes the impact of acquisitions, divestitures and foreign currency fluctuations on revenue growth. Sales for the year rose 10% to $1.97 billion. Recurring Companion Animal Group (CAG) Diagnostics revenue rose 13% in both periods to $359.8 million and $1.45 billion, 71% and 74% of total revenue for the quarter and the year, respectively. CAG Diagnostics recurring revenue includes consumables for in-clinic diagnostic instruments, reference lab tests and rapid assays used in clinics to test for infectious disease. Record global premium instrument placement growth of 15% in the fourth quarter of 3,650 chemistry, hematology and urinalysis analyzers along with 97% retention rates for clinics that use these instruments drives this profitable recurring revenue growth. The global installed base of Catalyst chemistry analyzers rose 22% to almost 30,000 in 2017 with 3,839 Catalysts placed during the year, a 34% increase over placements in 2016. Earnings per share of 70¢ for the quarter and $3.28 for the year grew 19% and 21%, respectively, over the same periods a year ago and exclude a charge of 34¢ per share related to the implementation of the tax reform law.

Reducing the corporate tax rate from 35% to 21% benefits both IDEXX and its customers who operate small businesses. IDEXX plans to use some of its tax savings to mine its vast collection of diagnostic test results and practice profitability measurements to quantify the value of increased diagnostic testing to the quality of care and profitability of an individual vet practice. IDEXX also is using some of the cash to expand its contribution to U.S. employee retirement savings by matching up to 5% of employee contributions to its 401(k) plan. Vet practices will have more cash to invest in IDEXX’s diagnostic instruments and software offerings. IDEXX Laboratories’ stock price has risen 30% since the beginning of the year.


Mettler-Toledo’s fourth quarter revenue grew 6% in local currencies over the same period a year ago. Sales for the full year of $2.73 billion rose 8%. Earnings per share of $5.97 for the quarter and $17.57 for the year rose 13% and 19%, respectively. Earnings for both periods exclude restructuring charges, amortization of purchased intangible assets and a one-time income tax charge of $2.74 per share associated with tax reform. Economic conditions in the Americas, Europe and China remained strong during the fourth quarter of 2017 and contributed to sales growth of 9% in the Americas, 13% in China and 3% in Europe. Revenue growth in Europe excludes an expected decline in sales from Mettler’s small Retail business which sells weighing systems to large grocery chains in the U.S. and Europe. The Retail business accounted for 8% of 2017 sales and is managed to maximize profitability not growth. It was 25% of Mettler’s business in 1999.

Sales for the Laboratory business grew 11% in the quarter with sales from recently-acquired Biotix contributing two percentage points of growth. Sales for the year rose 10%, lifting this profitable business’s sales to 50% of the company’s total. The strong growth reflects the successful investment in sales personnel, marketing programs that generate new leads for the direct sales force including an increased focus on key account management. Key account managers identify cross-selling opportunities at the company’s large global clients through detailed data analysis. This information about a client’s product mix identifies selling opportunities for the specialized sales representatives who focus on selling a single instrument such as balances, pipettes or pH meters. Mettler’s product pipeline for the Lab business remains strong with a recent focus on improving the efficiency of its analytical instruments with a new automatic sampler as well as expanding its highly-regarded LabX software to maintain data integrity for these instruments. These improvements matter to the company’s clients in regulated businesses. Mettler-Toledo’s stock price is down 1% since the beginning of the year after rising 48% in 2017.


Compared to an exceptionally strong quarter a year ago, CME’s fourth quarter revenue declined slightly to $900 million and adjusted earnings of $1.12 per share declined 2% from the prior year. During 2017, revenues rose 1.4% to $3.64 billion. Management continues to focus on operating efficiency. They held operating expenses flat with the prior year which resulted in full year adjusted earnings of $4.77 per share, up 5%. CME’s average daily volume (ADV) of 15.9 million and 16.3 million contracts during the fourth quarter and full year declined 2% and rose 4%, respectively.  Open interest at year end rose 5% from a year ago to 108 million contracts. Led by CEO Terry Duffy, CME continues to invest in the business to increase volume from customers outside the U.S. and to further develop its electronic options franchise. These investments in its consultative worldwide salesforce have lifted non-U.S. ADV to 3.5 million contracts, up 10% during the fourth quarter. Volumes in Europe and Asia were up 34% and 18% during their respective trading hours. Investments in Globex to enable the placement of complex options trades helped lift the volume and share of options traded electronically. Options volume on Globex increased 11% during the year and accounted for 62% of the total.

Additional options volume growth came from the launch of new weekly options such as Wednesday Weekly Treasury options generating volume of 18,000 contracts per day and Monday and Wednesday Weekly S&P options generating volume of 90,000 contracts a day. This volume growth further strengthens CME’s futures business because options traders tend to hedge their exposures in CME’s underlying futures. Since January 1, CME’s total return is 14%, reflecting continued good execution and strong growth in contract volume since the beginning of the year. In January CME reached an ADV of 19 million contracts, up 18% from a year ago and February’s ADV reached a record 27.3 million contracts, up 48% from February 2017! Options volume rose 59% to 6.1 million contracts per day in February. Open interest reached 130 million contracts, up 21% from January 1.


Economic growth around the globe helped Visa’s fiscal first quarter net revenues rise 9% over the same period a year ago to $4.9 billion. Earnings per share, adjusted for a reduction of deferred tax liabilities and tax on the repatriation of foreign earnings required by the Tax Cuts and Jobs Act, increased 26% to $1.08. Implementation of the new tax laws increased earnings per share by 9 percentage points in the quarter and will reduce Visa’s effective tax rate by six percentage points, from 29% to about 23% in fiscal 2018. One-sixth of the tax savings will be reinvested in Visa’s workforce and the company has raised its contribution to employee 401(k) retirement accounts. Visa’s Board of Directors increased the quarterly dividend by 8% to 21¢ after an 18% increase in November.

Global payments volume rose 10% in constant dollars and 12% nominally with strong growth in the Gulf countries in the Middle East, Latin America, particularly Argentina, and Canada. Europe, which accounts for 20% of Visa’s payments volume, maintained stable payments volume growth at 9%. Cross border revenues rose 12% and volume increased 9%. The weak dollar dampened some outbound U.S. commerce which partially offset increases in people travelling to the U.S. and e-commerce at U.S.-based businesses. U.S. payments volume growth accelerated one percentage point to 10%, driven by strong holiday season spending in retail and entertainment as well as higher gas prices. Growth in e-commerce spending, where Visa handles 43% of the payment transactions, rose four times faster than offline spending. In 2017, Visa’s U.S. credit card purchase volume grew 14.8% to $1.8 trillion, the fifth consecutive year Visa’s volume growth has exceeded its primary competitors. Its share of U.S. credit card spending has risen eight years in a row and reached 53.0% in 2017. The percentage of all U.S. credit, debit and prepaid card spending on Visa credit cards rose 1.9 percentage points to 32.0% while all other brands and products lost share. Visa’s stock price has increased 8% since January 1.


ADP’s fiscal second quarter revenues of $3.2 billion rose 8%, 7% organic, while adjusted earnings of 99¢ per share rose 14% from the same period a year ago. New business booking during the quarter rose 6%. The average number of employees on existing clients’ payrolls increased 2.6% and average worksite employees paid by PEO Services rose 10% to 498,000. Client fund balances of $22.5 billion rose 7% from a year ago and generated interest of $107 million, an increase of 16%, as the average interest yield increased 10 basis points to 1.9%.

ADP management, led by CEO Carlos Rodriguez, continues to invest in innovative new products and services such as its next generation payroll and tax platforms. ADP also acquires companies with market leading capabilities which help solve customer problems. In January, ADP announced the acquisition of WorkMarket, the leading cloud-based freelance management solution provider for multinationals and small-to-medium sized businesses. This capability is important because 90% of ADP’s mid-to-large size clients use freelance workers, especially in the field of technology where the labor force is increasingly hired on demand. WorkMarket allows freelance workers on the platform to receive their payments using a Global Cash Card paycard. ADP acquired Global Cash Card in October in order to provide its customers with flexible and integrated payment options. ADP’s total return is unchanged year-to-date.


Costco’s revenue grew 10.8% to $33.0 billion and earnings per share rose 35.9% to $1.59 including benefits from U.S. corporate tax reform in its fiscal second quarter, a twelve-week period ending February 18, 2018. Excluding the $74 million tax benefit, earnings per share increased 21.4% to $1.42. Management will use some of its tax savings to offer its members even lower prices. Selling, general and administrative expenses increased 8.5% to $3.2 billion, but decreased as a percentage of revenue from 10.0% to 9.8%. This 0.2% reduction equates to additional operating income of $66 million, or 6.5% of Costco’s operating income of $1.0 billion. Membership fee income from Costco’s 49.9 million member households rose 12.6% to $716 million. The growth was enabled by a 9% membership fee increase in 2017, strong member renewals of 90.1% in the U.S. and new member sign-ups. In the first 24 weeks of its fiscal year, Costco’s revenues increased 12.0% to $64.8 billion and earnings per share rose 26.1% to $3.04. Excluding currency and gas price fluctuations, sales at Costco’s U.S. stores open more than a year rose 7.1% in its first two fiscal quarters and 7.8% at its international stores outside Canada.

Costco’s efforts to build its online business in the U.S., Canada, U.K., Mexico, Korea and Taiwan generated 33.7% e-commerce growth during the first two fiscal quarters. Costco has improved merchandise offerings, search and checkout on its website, increased targeted email marketing, and added in-store signs and staff with tablets to assist members with online purchases at 195 U.S. locations. Its increasing online presence attracts more in-store traffic as members return for in-warehouse “hot buys” advertised in emails and on Costco.com and to pick up higher-value online purchases, such as jewelry, laptops and handbags. Over half of those who come to the warehouse to pick up their online purchases end up shopping too. Store traffic rose 3.7% during the second quarter and members spent 4.6% more per visit. The total return on Costco’s stock is unchanged since January 1.

Red Hat

Red Hat delivered excellent fiscal third quarter results on December 19, 2017 with revenue and earnings up 22% and 25%, respectively, to $748 million and 73¢. Earnings excludes share-based compensation expense, amortization of purchased intangible assets and transaction costs associated with acquisitions. CEO Jim Whitehurst noted that his customers’ CEOs have not seen such strong demand for their products and services since 2008 and are committed to investing in IT to improve their digital marketing, data analysis, e-commerce experience and web sites. Red Hat participates in many strategic discussions with Chief Information Officers, developers and IT operations staff to determine which services to include on OpenShift, Red Hat’s Platform-as-a-Service product which gives the operations staff confidence that they will be able to quickly deploy the new applications that developers create. OpenShift along with Red Hat’s other management tools ensures that applications will work the same way on servers in the datacenter or on private and public clouds because they all use Red Hat Enterprise Linux (RHEL) as the operating system. The Swiss National Railway (SNR) used OpenShift to develop its on-line ticket purchasing service. Searches for schedules and fares takes place in the public cloud because search volume can vary dramatically by time of day and season. The search engine automatically adds or removes computing power as needed to meet demand. Once a customer decides to buy a ticket, SNR processes the transaction at its datacenter where it keeps all customer data. Traffic to purchase tickets is more constant which makes it cost-effective to process transactions there.

While it takes longer to sell OpenShift subscriptions, they cost $15,000 per server per year versus $800 for an annual subscription to RHEL. Many clients also use Red Hat’s consulting and training services to perform proof-of-concept trials and training. Adding Red Hat’s JBOSS middleware products to OpenShift requires a separate subscription. With 60% of the 94 deals over $1 million in the quarter including middleware (application development) and one of the company’s cloud-based technologies such as OpenShift, revenue for Application development and emerging-technologies grew 44% to $162 million. Strong growth in the use of RHEL offered by the hour or minute by 150 cloud-service providers, including Amazon, Microsoft, Google and now Alibaba, contributed to Infrastructure-related revenue of $495 million, up 15% over the same period last year. Red Hat’s stock price has risen 29% since the beginning of the year.


Alphabet’s fourth quarter revenue and operating income rose 24% and 15%, respectively, to $32.3 billion and $7.7 billion. Earnings per share increased 28% to $9.70, excluding a $9.9 billion tax charge primarily for foreign earnings not previously subject to U.S. income tax. Operating expenses including research and development, sales and marketing, and general and administrative costs, rose more slowly than revenue at 19% to $10.4 billion, or 32% of revenue. Full year revenue of $110.9 billion increased 23% over 2016 and adjusted earnings per share rose 29% to $35.90. Advertising revenues grew 22% to $27.2 billion in the quarter, or 84% of Alphabet’s total revenue, driven by more YouTube consumption and growth of Google searches both on mobile phones and desktops. Other Google revenue increased 38% in the quarter to $4.7 billion, driven by sales growth of Google Home smart speakers and Pixel phones, its cloud services and digital content purchases from the Google Play store.

Google is the fastest growing major cloud provider with its Google Cloud Platform and G Suite productivity applications generating over $1 billion in fourth quarter revenue. Google Cloud Platform customers pay Google to run key applications, modernize and scale their technology operations and store, analyze and process their data. In 2018 Google will become the first cloud company to solely fund the construction of a private intercontinental cable, a subsea connection between Los Angeles and Chile, to complement ten other submarine cables in which it has direct investments. It will add five new regions to the thirteen current Google Cloud Platform regions, including in Hong Kong, Los Angeles, Montreal, the Netherlands and Finland. Having more regions and connections reduces latency and encourages large companies with high processing volumes such as PayPal, HSBC and Spotify to leverage Google’s network and infrastructure for secure, instantaneous and economical computer processing. G Suite, Google’s set of cloud-based work and collaboration tools including email, calendars, document creation applications and storage, now has four million paying business customers, up from three million a year ago. Alphabet’s stock price is up 12% since January 1.


Ecolab’s fourth quarter revenue of $3.56 billion grew 7% in constant currency over the fourth quarter of 2016. Higher prices and volumes contributed 1% and 5%, respectively, to revenue growth while acquisitions added another 1%. Operating income rose 3% to $577 million as higher raw material costs, the installation of new dispensing systems at customer sites and investments in the company’s internal and customer-facing information technology platforms offset some of the gains from revenue growth and cost reduction projects. Lower interest and tax payments lifted earnings per share to $1.39, up 11% over a year ago. Revenue and earnings per share for 2017 were $13.8 billion and $4.69, increases of 5% and 7%, respectively. Results from both periods exclude a 55¢ tax benefit associated with changes in corporate tax rates. They also exclude one-time gains and charges. Fourth quarter revenue for the Global Industrial and Global Institutional businesses of $1.3 billion and $1.2 billion, respectively, rose 5% and 3% over the same period a year ago. Strong demand for the Energy business’s well stimulation products along with solid gains in international sales for the production business lifted revenue 12% to $853 million. Energy’s operating income grew 3% to $823 million, its first increase in several years.

Ecolab has invested about $80 million per year for the last three years to connect the three million dispensing systems at 2.2 million customer sites to the cloud. Each system collects detailed data about its operations such as water temperature, volume and chemical use that service representatives download to a tablet at the beginning of a monthly site visit and then use to make recommendations to reduce the water, energy and labor costs of its systems. Collecting this information automatically and storing it in the cloud allows service reps to access the information in advance of client visits. They can spend more time working with clients and selling programs that others have used to reduce water and energy consumption. Ecolab began this initiative with its larger industrial clients. A brewery that has optimized its brewing process using Ecolab’s programs uses 1.5 liters of water to produce a liter of beer. Service reps show other breweries that currently use three to four liters of water to produce a liter of beer the proven programs they can adopt to lower their water consumption. Ecolab uses the data to measure a company’s progress in real time. It is the only supplier that has access to this information and the only one with a large field service force to use the data effectively. The total return on Ecolab’s stock is 2% since the beginning of the year.


Wabtec’s third quarter earnings along with management’s comments on the results and their forecast for this year reconfirmed the wisdom of their decision to acquire Faiveley. The acquisition has transformed Wabtec from a company primarily reliant on the North American freight car and locomotive business into a company securing 64% of its revenues from transit systems in North America, Europe and Asia. The freight car and locomotive business is highly cyclical whereas the transit business is secured by long-term contacts. Over two-thirds of Faiveley’s transit system maintenance revenues are governed by long-term contracts. These long-term commitments make it possible to manage the business for realization of a predictable operating margin. Last year’s margin was adversely affected by non-recurring $44.5 million end-of-contract adjustments paid to transit customers in connection with the transfer of the contracts required by the merger. Excluding these one-time payments and higher warranty expenses of $21.5 million for those contracts, Wabtec earned 90¢ per share in last year’s fourth quarter and $3.47 per share for the year. Sales for the year were $3.88 billion, 32% higher than sales in 2016. Management’s goal this year is for sales of over $4.1 billion and earnings of $3.80 per share. Wabtec’s order backlog is $4.6 billion, half of which is deliverable within the year. As part of its effort to realize efficiencies, Wabtec has closed or consolidated six plants and is reviewing all its contracts with suppliers to obtain cost savings. Review of the completion requirements on all customer contracts along with an upturn in Wabtec’s North American freight business has encouraged management to express confidence in realizing its forecast.

We think the decision to have Stephane Rambaud-Measson’s office at Wabtec’s headquarters in Wilmerding, Pennsylvania helps further the integration of Faiveley’s and Wabtec’s operations. Stephane is now the Chief Operating Officer of Wabtec. Before the merger, he was the Chairman of the Management Board and Chief Executive officer of Faiveley Transport. He and Ray Betler, Wabtec’s Chief Executive Officer, worked together at Bombardier over a decade ago and remain friends. Wabtec’s stock price has risen 1% year-to-date.

Core Laboratories

Core’s fourth quarter earnings of 49¢ per share were 40% higher than the results for the comparable quarter in 2016 and lifted earnings for the year 29% to $1.88 per share. The 2017 results reflect a transformation in Core’s business which managed to respond resourcefully to changes in their customers’ needs. Core’s fourth quarter results underscore the transformation made by the company. It was achieved by the company’s management and engineers in its Production Enhancement division continuing to develop methodologies, tools, charges and chemical tracers to equip customers with tools to learn more about shale oil bearing formations from every frac. The charges are more effective at producing oil. Most of the successful producers of shale oil rely upon Core, which continues to develop new more effective and informative tools.

Without Production Enhancement’s 45% sales increase and 500% leap in profit, Core’s earnings would have declined. Reservoir Description continues to generate over 60% of Core’s revenue and almost 60% of its profit, but its revenues and profits declined last year. We read and hear that Final Investment Determinations have been made for 20 major offshore developments, but so far only exploratory drilling has occurred. Core’s opportunity for sizeable continuing revenues from deep water prospects such as Exxon’s Liza discovery offshore Guyana begins when drilling to delineate the extent and depth of the reservoir starts. The profit opportunity expands when production starts and lasts until it ceases. We are waiting for Core to begin working on some of the 20 prospects that received Final Investment Determinations last year. The total return on Core’s stock is minus 3% since the start of the year.

Johnson & Johnson

Strong revenue growth in Johnson & Johnson’s Pharmaceutical business lifted fourth quarter revenue 9.4% in constant currency from $18.1 billion in the fourth quarter of 2017. Full year revenue grew 6% to $76.5 billion from $71.6 billion a year ago. Favorable foreign currency rates increased revenue reported in U.S. dollars by 2.1% for the quarter and 0.3% for the year. Organic revenue growth, which also excludes acquisitions and divestitures, was 4.2% for the quarter and 2.4% for the year. Earnings per share of $1.74 for the quarter and $7.30 for 2017 rose 10.1% and 8.5%, respectively. Earnings from both periods exclude a $13.6 billion charge associated with the repatriation of overseas cash as well as amortization of purchased intangibles and non-recurring charges.

The Pharmaceutical division’s 2017 revenue rose 6% to $36.3 billion, excluding the acquisition of Actelion which added 4.2% to revenue growth and favorable adjustments from lower than forecast rebates from managed care organizations and Medicare in 2016 which were recognized in 2017 that reduced revenue growth by 1.8%. Oncology revenue rose 25% to $7.2 billion with sales of Darzalex (multiple Myeloma) and Imbruvica (leukemia and lymphoma) of $1.2 billion and $1.8 billion, up 25% and 50%, respectively. Sales of Zytiga (prostate cancer) rose 10.5% to $2.5 billion with the announcement of a successful Phase III trial of 1,200 patients that demonstrated that Zytiga and hormone therapy reduced the risk of death by 38% in patients with early-stage metastatic prostate cancer that still responds to hormone therapy. J&J received FDA approval for this new use of Zytiga on February 8, 2018. Less than a week later, the FDA approved Erleada for the treatment of non-metastatic prostate cancer that no longer responds to hormone treatment. While the cancer has not yet spread to their bones or other organs, these patients have rising PSA levels and 90% of them will develop metastases. Erleada extended the time before the cancer spreads by two years compared to placebo. It is the first treatment for patients with this type of prostate cancer. Prostate cancer is the most common cancer in men with 161,000 new cases diagnosed annually.

Full year revenue for the Consumer business was $13.6 billion, a decline of 0.5% excluding revenue from the Vogue hair care which was acquired in July 2016. Medical Devices sales of $26.6 billion grew 1.5% over 2016. Changes in how the divisions sells its products to hospitals lifted sales of its advanced surgery products used in minimally invasive surgery and its biosurgery products used to control bleeding. The total return on Johnson & Johnson’s stock is minus 4% since the beginning of the year. The total return was 24% in 2017.

Varian Medical Systems

Varian Medical Systems’ fiscal first quarter revenue of $679 million rose 13% over revenue of $601.5 million a year ago. Favorable foreign currency rates contributed two percentage points of growth. Targeted investment in sales staff to sell software in Europe and Asia held SG&A growth to $10 million year-over-year or to 9% of sales. Operating income grew 18% to $126 million from $107 million a year ago, while operating margin increased 0.2 percentage points to 18.6% of sales. Earnings per share of $1.06 rose 25% over 85¢ posted last year. This quarter’s earnings exclude a tax charge of $211 million associated with the new tax law. Earnings exclude amortization of purchased intangibles and one-time charges in both periods.

Oncology Systems’ revenue rose 14% to $649 million. Increased installations of radiation systems in developed markets contributed to this growth. Orders rose 7% worldwide with large orders in the U.S., Denmark and Poland along with several orders for the full-featured EDGE radiosurgery system at three prestigious hospitals in China. Varian has received 62 orders for the Halcyon system since its launch in May 2017, with 25 to 26 of the systems going to new sites and seven systems replacing old systems in existing vaults that are too small to hold Varian’s larger radiation systems. The company expects to add on-machine CT imaging to the Halcyon in May which increases its value to clinics in North America and Europe and allows the company to offer discounts on the current version to new customers in emerging markets, a key part of Varian’s strategy for long-term growth. Varian’s stock price has risen 13% since January 1.

Air Lease

Air Lease’s revenues of nearly $400 million and $1.52 billion rose 7.6% and 6.9% respectively for the fourth quarter and full year 2017. Earnings, excluding the $354 million or $3.16 per share tax benefit from the remeasurement of deferred tax liabilities as a result of the Tax Cuts and Jobs Act, were up 19% and 6% to $1.06 and $3.65 respectively for the fourth quarter and full year. Air Lease’s fleet of 244 aircraft have a net book value of $13.3 billion, up 10.3% compared to a year ago. The average age of aircraft on lease is 3.8 years with a remaining lease term of 6.8 years. The aircraft are leased to 91 airlines in 51 countries. Europe represents 31.7% of aircraft leased, Asia (excluding China) 22.4%, China 20.5%, The Middle East and Africa 11.2%, Central America, South America and Mexico 7.0%, U.S. and Canada 4.5% and Pacific, Australia and New Zealand 2.7%. Air Lease finances its fleet with $9.7 billion of debt and $4.1 billion of equity, a debt to equity ratio of 2.35 to 1. 95% of its debt is unsecured and 85% is fixed rate. Its composite cost of funds declined to 3.20% as of December 31 compared to 3.42% a year ago.

Air Lease has 125 aircraft on order from Boeing and Airbus which are scheduled to be delivered in 2018 and 2019, with 44 aircraft scheduled for delivery in 2018 and 81 aircraft scheduled for delivery in 2019. All of the 2018 deliveries are placed on lease with customers while 99% of 2019 deliveries are already placed at stable lease rates. When interest rates increase between the time the airplane is placed on lease and the time the aircraft is delivered to the customer (and paid for by Air Lease) contractual interest rate adjusters incorporated in 90% of the contracts protect Air Lease’s margin. The total return on Air Lease’s stock price is minus 9% since January 1, after increasing 41% last year.


SGS’ second half and full year 2017 revenues of 3.3 billion and 6.3 billion Swiss Francs rose 5.8% and 5.4% respectively from the same period a year earlier in constant currency. During the year, organic growth was 4.2% and growth from acquisitions was 1.2%. Adjusted EPS rose 10% for the year and the return on invested capital rose to 21.3% from 19.3% the prior year. The annual dividend was increased by 7% from the prior year. Its largest business unit, Oil, Gas and Chemicals, accounting for 18% of revenues, rose 3% as double-digit growth in Plant and Terminal Operations was offset by weakness in trade related services in Western Europe. Agriculture, Food and Life, its second largest business generated 7.7% revenue growth with 6.6% organic, led by growth of food certification services. Transportation and Consumer/Retail delivered growth of 11.6% and 10.4% respectively and accounted for 15% and 9% of the revenue respectively. SGS has partnered with robot manufacturers and systems integrators to create a system for repetitive and high precision fatigue testing to improve efficiency, data integrity and automation for its automotive and aerospace customers. Its consumer radio frequency equipment testing business has increased significantly in the U.S. after being accredited as a Telecommunication Certification Body in 2016. The total return on SGS’ ADRs is minus 1% this year.


Roche’s 2017 revenue of CHF 53.3 billion rose 5% in constant currencies from CHF 50.6 billion in 2016. Core earnings per share of CHF 15.34 also rose 5% from CHF 14.53 a year ago. Core earnings exclude restructuring charges, amortization of purchased intangible assets and impairment of good will and intangible assets. Pharmaceutical and Diagnostics Divisions’ sales each grew 5% to CHF 41.2 billion and CHF 12.1 billion respectively. Increased marketing expenses for newly-launched drugs Tecentriq (immunotherapy drug approved for bladder and lung cancer) and Ocrevus (multiple sclerosis) and higher placements of lower-margin diagnostics instruments in the fast-growing Asia-Pacific region reduced the company’s operating margin by 0.7 percentage points to 35.7%.

With sales of CHF 869 million since its launch in April, Ocrevus is one of the most successful drugs launched in the U.S. in the last five years. More than 30,000 patients have been treated and 70% of physicians who prescribe the drug have prescribed it at least once. About 30% of MS patients are new to drug treatment and 70% have switched from other drugs. Roche priced the drug at $65,000 per year, well below the annual cost of $100,000 for the less effective interferon therapy. The Pharmaceutical Division spent CHF 9.0 billion on R&D in 2017, 21.9% of sales, to support the development of 14 new drugs and 30 important new indications for existing drugs. Sales of immunoassays in the Diagnostics Division grew 13% to CHF 3.8 billion and account for 32% of the division’s sales. Roche received FDA approval for its high-volume immunoassay instrument in June and has now placed 900 around the world. Immunoassays measure the quantity of hormones, proteins, drugs and other compounds in blood samples. Diagnostics sales in China rose 21% to CHF 1.9 billion, making it the second largest country in sales for the division behind the U.S.

The total return on Roche ADRs is minus 5% since the beginning of the year. We sold your shares because we believe that it will be difficult for the company to achieve revenue and earnings growth despite the quality of its science and pipeline as its three large oncology drugs, Rituxan, Herceptin and Avastin, face competition from biosimilar drugs over the next three years. They accounted for just over half of the Pharmaceutical Division’s 2017 sales.

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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.