EARNINGS LETTER

1st Quarter, 2018

The first quarter results of the companies you own reflect the direct benefit of the lower corporate tax rate along with the stimulative effect of rising profitability on sales. We continue to hear from the realistic managers of your companies that conditions in their markets are getting better, which makes them more confident that they will realize their plans for growth. Their optimistic, matter-of-fact statements expressing confidence in their business plans is a reminder of how sensible these men and women are.

Our economy is prospering despite the political rhetoric threatening to disrupt international trade. Trade agreements among nations are replete with mind-numbing specifics, which makes implementing change a tedious task that would make an old-fashioned bookkeeper groan. Trump’s tariff threats seem to have diverted attention from good economic numbers confirming the strength of the US economy. Nominal GDP increased 4.7% year-over-year in the first quarter, which means that other economic measurements soon will confirm that our economy is experiencing healthy growth.

Red Hat

Red Hat’s revenue for the fourth quarter and the fiscal year that ended on February 28, 2018 grew 23% and 21% to $772 million and $2.9 billion, respectively. Favorable foreign currency translation accounted for five percentage points of growth for the quarter and one percentage point of growth for the year. Full year subscription revenue for Red Hat Enterprise Linux, the company’s enterprise-grade open source operating system that runs on servers in data centers was $2.0 billion. It rose 15% over revenue of $1.7 billion achieved last year. Application development and emerging technologies revenue of $624 million rose 42% to 21% of total sales, up from 18% a year ago. Training and services revenue rose 25% to $346 million as the company’s consultants worked with large customers to install Red Hat’s emerging technologies in their data centers and in the public cloud.

Red Hat invested in its sales force in fiscal years 2016 and 2017 to increase the company’s capacity to sell its cloud-based technologies to its largest customers by building sales capabilities in telecom, healthcare and financial services to better serve these demanding customers.  The number of large deals closed during the year with sales of multiple products reflects the success of this investment. In fiscal 2018, Red Hat closed 373 deals greater than $1 million and 71% of these deals included products from Application development and emerging technologies. Last year the company closed 283 deals greater than $1 million with 57% including more than one product. Red Hat closed 54 deals greater than $5 million in 2018. At the end of 2018, the company had 1,055 customers who spent between $250,000 and $1 million per year. Improving revenue growth from this segment is the focus of the company’s effort to train global systems integrators to help these customers install Red Hat’s cloud-based technologies. The company is building its partner ecosystem and managed services on public clouds to reach smaller customers. At the Red Hat Summit in May, the company announced that Atos and Accenture, two large systems integrators, have developed robust cloud-based offerings for these customers. Red Hat now has 20,000 certified consultants for its emerging technologies, up from 10,000 in 2017.

GAAP earnings per share were a loss of 7¢ for the quarter and $1.40 for the year. Both results include a one-time charge of 67¢ per share associated with the repatriation of foreign earnings under the new tax law. Non-GAAP earnings per share of 91¢ for the quarter and $2.98 for the year were up 49% and 31%, respectively. Results from all periods exclude stock compensation expense, amortization of purchased intangibles, acquisition-related transaction costs and one-time tax charges. Investor confidence in Red Hat’s central role in facilitating its customers’ shift to the hybrid cloud has lifted Red Hat’s stock price 41% since January 1.

Wabtec

Wabtec’s first quarter earnings of 92¢ per share were over 19% above earnings in the year ago quarter and lifted the stock price above $90 a share for the first time since mid-July of last year when it dropped into the mid-70’s. That price decline was caused by fewer sales of freight car components for new freight cars and for those in use. Wabtec also incurred a loss on cancellation of a sizeable locomotive contract with a major U.S. freight railroad. During this year’s first quarter Wabtec’s sales rose 15.3% to over $1.06 billion, on which the company earned a gross profit of $310 million. Freight sales rose 9% while transit sales increased 19.1%. Importantly, the transit margin rose 1.5% to over 10% while Wabtec’s total order backlog deliverable within a year rose 7% to $2.5 billion. Freight deliveries constitute 20% of that backlog, which confirms the sustainability of the current upturn in Wabtec’s sales to North American freight railroads. The acquisition of Faiveley means that now only 21% of Wabtec’s transit sales are in the U.S. while 55% of total transit sales are aftermarket parts and services, a majority of which are subject to long-term contracts with European transit systems.

Almost four weeks after Wabtec reported and reviewed its good first quarter earnings, the company announced on a conference call on Monday morning May 21, its agreement to acquire control of GE Transportation through a complicated tax-advantaged spin-off merger transaction called a Reverse-Morris Trust transaction. It will result in Wabtec controlling GE Transportation which the transaction values at $10 billion after a $1.1 billion net tax adjustment which accrues to the participants and is an integral part of the transaction. The ownership change results in Wabtec owning 49.9% of the new GE Transportation, GE Shareholders owning 40.2% with GE left with 9.9% which it must sell within three years after the closing. The acquisition will double Wabtec’s revenue this year to $7.8 billion and more than double Wabtec’s profit because GE Transportation’s operating margin of 14.9% is higher than Wabtec’s. GE Transportation is the leading locomotive manufacturer in North America and has manufactured 58% of the 39,500 locomotives in service on the continent. Its current $18 billion backlog includes delivery of 1,800 new locomotives and modernization of 1,000 of the 23,000 GE locomotives in service in North America. Approximately 70% of GE locomotives in service are covered by long-term service contracts. We think the acquisition is a well-structured good deal at a favorable price. Wabtec’s stock price is up 25% since the beginning of the year.

IDEXX Laboratories

IDEXX Laboratories had a terrific first quarter with revenue of $538 million growing 12% over the first quarter of 2017 on an organic basis, which excludes the effect of acquisitions and divestitures as well as fluctuations in foreign currency rates from revenue growth. Favorable foreign currency rates lifted the quarter’s revenue growth to 16% in U.S. dollars. The direct sales force continues to become more productive, which contributed to operating profit growth of 18% to $113 million or 21% of the quarter’s sales. Earnings per share of $1.01 grew 32% over 77¢ reported a year ago. Premium instrument placements rose 21% to 2,822, which includes 1,403 Catalyst chemistry analyzers and 664 SediVue Dx urinalysis instruments, both of which generate the most recurring consumables revenue. IDEXX introduced Catalyst in 2014 and placement rates have continued to grow as the sales force becomes better at explaining the value of diagnostics to vet practices. The value of the instrument to the vet grows with the introduction of new tests. Four months into the launch of the SDMA test for Catalyst, IDEXX’s proprietary assay to detect early kidney disease in dogs and cats, 42% of North American Catalyst customers have used the test in their clinics with most using it on a regular basis. This uptake rate is extremely fast for usually conservative vets. Increased in-clinic use of SDMA tests and SediVue analyses, which are paid per run, accounted for three percentage points of the 17% growth in consumables sales of $150 million during the quarter. IDEXX Laboratories’ stock price has risen 39% since January 1.

CME

CME’s average daily volume reached an all-time high of 22.2 million futures and options contracts during the quarter, a 30% increase from the same period a year ago. Global growth remains strong with contract volumes up 41% in Asia and 37% in Europe. Equities, metals and interest rate contract volumes rose the most increasing 48%, 39% and 30% respectively. Energy contract volumes rose the least, up 10%. Total revenue of $1.1 billion and adjusted earnings per share of $1.86 rose 19% and 52%. Its operating profit rose 25% and CME’s operating margin exceeded 70%! Its incremental margin on each additional dollar of revenue is over 90%. The remainder of the increase in earnings per share came from a sharp decline in its tax rate from the Tax Cut and Jobs Act of 2017.  In April, CME’s average daily volume was 17 million contracts, an increase of 4% from April 2017. In May, CME’s average daily volume of 20.1 million contracts, rose 22% from May 2017. Volumes reached an all-time high of 51.9 million contracts on May 29 when Italy’s President Mattarella vetoed a proposal from the populist coalition that had been set to form a government after it nominated a skeptic of the European Union as its economy minister. CME’s total return since the beginning of the year is 18%.

On March 29, CME announced an agreement to acquire NEX Group plc for $4 billion, half in cash and half in CME stock. (CME’s market cap is $56 billion.) NEX is the leading provider of electronic trading platforms for OTC spot foreign exchange and cash fixed income securities including U.S. Treasuries, U.S. Repos and European Repos, complementing CME’s leadership in futures and options for foreign exchange and interest rate contracts. A Repo or repurchase agreement is a type of short-term borrowing backed by collateral, typically U.S. Treasuries. In addition, NEX’s post-trade and capital optimization services complement CME’s clearinghouse services. The combination will provide clients improved cross-market trading, analytics, capital efficiency and regulatory compliance. CME expects to cut expenses by $200 million from technology, operations and overhead within three years. The transaction, which is expected to close by year-end, is immediately accretive to CME’s adjusted cash earnings per share.

Visa

Double-digit growth of Visa’s payments volume, cross-border volume and total processed transactions drove fiscal second quarter revenue of $5.1 billion and earnings per share of $1.11, up 13% and 29%, respectively, from the year ago period. Earnings grew faster than revenue primarily because of the reduced U.S. statutory tax rate in the Tax Cut and Jobs Act of 2017. Payments volume growth rose by more than ½ percentage point from the first fiscal quarter to 10.5% in constant dollars with broad strength across all geographic regions. Strong growth in China and Japan drove Asia-Pacific region payments volume up 10%, an increase of 1.8 percentage points over the December quarter, to $468 billion, or 23% of Visa’s $2.0 trillion total payments volume in the second quarter. U.S. debit card volume rose 9.8%, a 2.2 percentage point increase from the December quarter, from strong consumer retail spending. Travel spending helped U.S. credit card volume increase 10.5%. Cross-border volume rose by more than two percentage points to 11%. The weaker dollar and stronger euro and British pound spurred double-digit growth rates in inbound U.S. commerce for the first time in over four years and in outbound European commerce. The continuing worldwide shift from cash and check to electronic forms of payment helped raise the number of total processed transactions 12% to 29.3 billion in the quarter.

Visa completed the technical migration of Visa Europe’s clearing and settlement operations from the legacy European system to the global VisaNet system on schedule in March. VisaNet, which is capable of processing 65,000 transactions per second, operates on four synchronized data centers around the world while the legacy European system runs on one. Using VisaNet will provide redundancy for Visa’s European business and for its clients. Over the next few quarters Visa will execute the final step of the European technology integration by transitioning each client’s authorization system. Once complete, Visa will stop maintaining the interoperability of the two systems while its European card issuers and merchants will benefit more from VisaNet’s risk and security tools and digital products. In Europe, 41% of personal consumption expenditures, or $3.5 trillion, still occur with cash and check versus 22%, or $3.2 trillion, in the U.S. and Canada. Visa’s share price has increased 17% year-to-date.

ADP

ADP’s fiscal third quarter revenue of $3.8 billion rose 18% overall, 6% in organic constant currency from a year ago, while adjusted earnings of $1.52 per share rose 16%. The total return on ADP shares since the beginning of the year is 16%. New business bookings rose 9% during the quarter and retention improved. Growth in the number of employees on each existing client’s payroll ticked up to 2.9% and average worksite employees paid by ADP PEO Services rose 9% to 512,000. Interest earned on funds held for clients rose 21% to $135 million as the average balance increased 6% to $28.8 billion and the average interest yield rose 20 basis points to 1.9%. On April 11, ADP declared a regular quarterly dividend of 69¢ per share, a 10% increase representing a return to shareholders of a portion of the benefit from the Tax Cuts and Jobs Act of 2017. A further increase will occur in November consistent with the company’s 43-year track record of annual dividend increases.

Since beginning its Service Alignment initiative two years ago, ADP has closed 61 of 68 targeted subscale service locations. Its larger strategic service locations and common technology platforms enable a simpler, lower cost, streamlined operating environment. On March 1, ADP announced an early retirement program to further reduce operating expenses. The company will fund a majority of the program’s cost from the existing surplus in ADP’s defined benefit plan.

Costco

Costco’s revenue of $32.4 billion and earnings per share of $1.70 rose 12% and 21%, respectively, during the company’s fiscal third quarter, a twelve-week period ending May 13, 2018. Earnings per share in the year ago period exclude a one-time 19¢ per share tax benefit. At Costco warehouses open more than one year, shopping frequency increased 5.1% while the average spending per shopper increased 4.9%, equating to same-store sales growth of 10%. Excluding the impacts of gas price inflation and foreign currency fluctuations, same-store sales grew 7.0% globally and 7.7% in the U.S. Sales from e-commerce initiatives grew 37% in the quarter. With about 10,000 items online versus 3,800 in-store, Costco has gained incremental sales from high-ticket items such as household furniture which historically was only showcased in warehouses about eight weeks each year but is now available online year-round.

Other large-scale retailers lack the efficiency and inventory turnover to operate and grow profitably at Costco’s gross margin level. Walmart, Costco’s largest competitor, maintains a 25% merchandise gross margin to achieve an operating income margin of 4% of sales and operating income declined 1.6% in its most recent fiscal quarter. Costco’s merchandise gross margin decreased nearly ½ of a percentage point to 11.05% in the quarter as Costco absorbed higher freight costs rather than passing them on to its members with higher prices. Despite this, its operating income margin declined just 0.05% to 3.30% while operating income of $1.1 billion grew 10.2%.

Costco will use $110-$120 million of the approximately $300 million it expects to save from lower taxes to reward its loyal U.S. workforce of 130,000 with higher wages. The starting wage will increase $1 per hour to $14 – $14.50 per hour and other hourly warehouse employees will receive smaller raises. Costco’s stock price has risen 9% since January 1.

Alphabet

Alphabet’s first quarter revenue of $31.1 billion grew 26%, an increase of two percentage points over revenue growth in the fourth quarter. Earnings per share rose 28% to $9.93 after adjusting for an accounting rule change that caused reported earnings per share to rise 72% to $13.33.  Advertising revenue generated from Google’s core properties, including Google.com and YouTube, and from search distribution partners who use Google.com as their default search tool in internet browsers and toolbars, increased 26% to $22.0 billion in the quarter, or 71% of Alphabet’s total revenue. Consumers’ increasing use of mobile phones to perform Google searches and Google’s improvements in mobile ad formats contributed most to this growth and drove a 59% increase in the number of times people chose to look at ads on Google sites. Advertising revenue from Google Network Members, non-Google websites and mobile apps that use Google’s advertising platforms to display relevant ads, increased 16% to $4.6 billion in the quarter. Management continues to steadily grow Alphabet’s non-advertising revenue, which at $4.5 billion rose 35% and accounted for 14.5% of Alphabet’s revenue in the quarter, up from 13.6% in the year ago quarter. This growth has been driven by Google Cloud offerings, hardware sales and digital purchases from Google Play, primarily in-app purchases.

The cash generated by Google’s operations provides management with significant resources to invest in its computing infrastructure. Cash from operations in 2017 was nearly $50 billion, excluding U.S. tax reform and a European Commission fine, and $11.6 billion this quarter. Google has invested $20 billion over the past five quarters to support the nearly instantaneous delivery of search results, hosting and delivery of YouTube videos, and to strengthen its cloud offerings, including storage, data processing and machine learning applications for its business customers. Google constructs new data centers and furnishes them with computers incorporating the latest technologies to maximize compute capacity. Investments in undersea cables expand global network capacity. Google’s high-performing computing infrastructure, data analytics, security and machine learning tools have helped it win larger cloud services deals from businesses. Alphabet’s stock price is up 7% since January 1.

Mettler-Toledo

Mettler-Toledo’s first quarter sales of $660.8 million grew 5% in local currencies over the same period a year ago. Revenue for Biotix, its recent acquisition, accounted for 1.5% of the growth. Revenue reported in U.S. dollars rose 11% with favorable foreign exchange contributing 6% to the growth. Earnings of $3.74 per share rose 12% over earnings of $3.34 reported a year ago. Earnings from both periods exclude restructuring charges and amortization of purchased intangible assets.

Mettler’s management currently sees no signs of slowdown in it business as the world economy remains strong. Most of Mettler’s revenue comes from replacing customers’ existing precision instruments, so the company invests in research and development and marketing programs to introduce a continuous stream of products with new features along with marketing tools that demonstrate their value to encourage customers to replace their instruments sooner than planned. As long as the global economy remains strong enough for customers to stick to their planned replacement cycles, Mettler’s management believes it can achieve annual local currency sales growth of 5% to 7% as customers replace their existing Mettler instruments and some of their competitor’s instruments with Mettler’s newest versions. In addition, because most customers are individual scientists and engineers who purchase new instruments infrequently, Mettler realizes price increases of two percentage points per year.

Over the past three years, the company has added 450 field and internal sales staff in geographic areas and product lines where data analysis indicates opportunities for increased sales growth. The success of this “Field Turbo” program has lifted Mettler’s annual revenue growth rate from 5% in 2015 to 7% in 2017. By increasing sales in its most profitable products and through Stern Drive, its new program that systematizes supply chain and manufacturing productivity throughout the organization, the company’s operating profit rose 10% to $139.4 million or 21.1% of sales. The operating profit margin of its best businesses is over 30%. Mettler-Toledo’s stock price has fallen 5% since the beginning of the year. Investors have sold the stock because of the company’s comments about tough sales comparisons in China and in the fast-growing Product Inspection business.

Ecolab

All of Ecolab’s businesses contributed to first quarter revenue growth of 10% over the first quarter of 2017. Revenue of $3.5 billion grew 6% organically with acquisitions and favorable foreign currency translation accounting for one and three percentage points of growth, respectively. Organic revenue growth for the Global Industrial business rose 3% to $1.2 billion. Global Institutional and Global Energy organic revenue grew 5% and 9% to $1.2 billion and $847 million, respectively. Revenue for the Other businesses, the Pest business and a small specialty chemical business, rose 8% to $197 million. Operating income of $354 million grew 2%, excluding one-time gains and losses. Lower interest expense and a lower tax rate lifted earnings per share 14% to 91¢ from 80¢ a year ago. Earnings per share excludes one-time items and tax benefits in both periods.

The successful U.S. launch of Ecolab’s SMARTPOWER warewashing program contributed to the lift in Global Institutional’s first quarter sales growth. SMARTPOWER’s new biodegradable and safe-to-handle cleaners were tested in 300 foodservice environments across 21 countries on a wide array of food stains, especially proteins which are difficult to remove. The new cleaners reduced the number of racks washed daily by 10%. SMARTPOWER’s digital monitoring system optimizes chemical use and allows sales representatives to ensure that the equipment is running properly as well as offering on-line training videos developed for the staff in the back of the kitchen. Ecolab estimates that by reducing the need to rewash dishware, a restaurant saves 304 hours of labor and $557 annually in energy and water costs. This amounts to an annual savings of $650,000 for a chain with 50 locations. The total return on Ecolab stock is 9% since the beginning of the year.

Core Laboratories

An increase in the oil price into the mid-$60’s, and briefly up over $80, along with Core Laboratories’ management’s success in achieving earning’s growth has lifted Core’s stock price almost 17% since the start of the year. Services which allow oil companies to sustain production from existing fields while prolonging their productive life by managing the composition of the reservoir fluids are the source of 60% of Core’s revenue. During this year’s first quarter, Reservoir Description revenue fell to $108 million, 4% below the revenue earned during the year ago quarter. That revenue shortfall was more than recouped by a 34% increase to $69 million in Core’s Production Enhancement sales. The higher sales of more effective chemical tracers and more precise explosive charges to shale oil operators resulted in a year-to-year profit increase of 128%, lifting earnings for the quarter 34% to 54¢ per share although Core’s total revenue was up only 8.4%. The surging profitability of Production Enhancement results from the close working relationship Core has developed with the most technically proficient shale oil producers in the U.S. They prod Core’s engineers to improve the precision of its fracing and chemically laden charges which they now use when drilling 24 multi-directional wells from a single centrally placed drilling pad. From there they drill and frac zones in all four directions, modifying the plan as they learn more about the structure from analyzing the chemical tracers and the oil produced.

The continued innovative success of Production Enhancement has helped lift Core’s stock price above its trading range, but to regain its position as a pre-eminent oil service stock, Core’s Reservoir Description business needs to secure more business. That maybe about to happen as the major oil companies proceed with their plans to develop major offshore reservoirs they have discovered throughout the world. Last year the majors, along with some of the national oil companies, publicly announced 25 Final Investment Decisions (FID) for offshore fields on which major discoveries had been made. Since the beginning of this year, 6 FIDs have been announced. Heretofore FIDs have meant that the oil companies are allocating capital to fund development. Core has received some cores for analysis from Conoco’s North Slope discovery but has yet to be engaged to analyze Exxon’s cores from the discovery wells it has drilled offshore Guyana. There are enough deep-water discovery wells drilled or scheduled to cause industry experts to predict that more than 25 FIDs will be announced this year. In the meantime, international exploration expenditures have not risen, so most projects underway continue to be funded from operating budgets. There is no apparent rush yet by the major international oil companies to develop the fields they have discovered.

Johnson & Johnson

Johnson & Johnson’s first quarter revenue of $20.0 billion rose 8.4% in constant currencies over the first quarter of 2017. Favorable foreign currency translation added 4.2% to deliver growth of 12.6% in U.S. dollars. Organic sales growth of 4.3% excludes a 3.9% contribution from acquisitions and divestitures during the quarter. Earnings per share grew 5.5% in constant currencies to $2.06. Earnings in both periods exclude amortization of purchased intangibles and one-time charges.

Pharmaceutical sales, excluding the contribution from Actelion, rose 7.5% to $9.8 billion. Sales of recently launched drugs of $417 million, which include Darzalex (multiple myeloma), Imbruvica (B-cell blood cancers) and Tremfya (psoriasis), accounted for 26% of the division’s revenue growth during the quarter. Revenue growth of J&J’s immunology drugs Stelara and Simponi more than offset the $283 million decline in sales of Remicade that resulted from increased competition from biosimilar products. Medical Devices sales grew 3.2% to $6.8 billion with acquisitions and divestitures accounting for 2.1% of revenue growth. On March 16, 2018, J&J announced the sale of LifeScan, its glucose monitoring business, to a private equity firm for $2.1 billion. Annual revenue growth for Medical Devices will increase one percentage point once the divestiture is complete. Strong sales of Beauty products lifted Consumer’s sales 1.2% to $3.4 billion. Excluding effect of the sale of some International wound care and oral care businesses, revenue grew 2.0% over the same period last year.

On May 16, 2018, J&J reviewed its Consumer and Medical Devices businesses at its annual Investor Day. The update on DePuySynthes, J&J’s orthopedics business, demonstrates management’s ability to fix its weaker businesses. DePuySynthes is the largest and most diverse global orthopedics business with 2017 sales of $9.26 billion in a global orthopedics market of $45 billion. While revenue of the Trauma, Hip and Sports Medicine businesses have grown faster than their markets, the Knee and Spine businesses have not performed as well. The Spine business has faced the most challenges since J&J acquired Synthes, a Swiss orthopedics company with a market leading trauma business, in 2012. Both companies had Spine businesses which once combined made DePuySynthes the #2 in global market share. Synthes, however, received an FDA warning letter regarding the manufacture of some of its Spine products about 2 months before the acquisition closed in 2012. Difficulty integrating the two Spine businesses resulted in the loss of sales representatives which led to revenue and market share losses. J&J has completely overhauled Spine’s quality systems which led to the lifting of the FDA warning letter in February 2018 after 21 successful FDA inspections. The company has invested in faster growing markets in minimally invasive spine surgery, complex neck surgeries, spinal deformities and the aging spine, and launched 10 products during the last six months from internal development as well as filling some of the gaps in the product portfolio through alliances and small acquisitions. Having new products to sell and a full pipeline of new products in development has reduced attrition and attracted sales representatives interested in selling the latest technology. J&J tracks the number of sales representatives joining the Spine business from the competition versus the number who leave to join the competition. This metric shows gains for the first time in years. It is a good early indicator of future success for the business. The total return on Johnson & Johnson stock is minus 11% since the beginning of the year.

Varian Medical Systems

Varian Medical Systems’ fiscal second quarter revenue grew 10% to $730 million with favorable foreign currency rates contributing 4% of that growth. Earnings per share of $1.15 grew 28% over 90¢ per share reported a year ago. Earnings from both periods exclude one-time charges and amortization of purchased intangibles. Oncology Systems revenue of $698 million increased 10% over the fiscal second quarter of 2017 with product revenue, which consists of sales of radiation systems, services and software, growing 9% to $364 million and services revenue (hardware and software maintenance agreements and training) growing 13% to $334 million. Over the past 12 months, Varian installed 263 radiation systems, an increase of 3%, bringing its global installed base to 7,954 systems.

Orders rose 5% to $664 million and included an order of eight TrueBeam systems at a hospital in Sweden and an order from a hospital in Mexico for five VitalBeam radiation therapy systems and a top-of-the-line EDGE radiosurgery system. Both orders include Varian’s complete suite of treatment planning and oncology information software. Varian received 19 orders for Halcyon systems during the quarter with 60% from clinics in emerging markets and with five replacing older, smaller radiation systems. About 20 sites worldwide are treating patients on a Halcyon with some sites, including Clinique Charcot in Lyon, France, treating over 80 patients per day. It took eight days from the start of installation to first treatment in Lyon versus four weeks to install and qualify a TrueBeam system. Varian’s stock price has risen 9% since the beginning of the year.

Air Lease

Air Lease’s revenue of $381 million and earnings of $1.00 per share rose 6% and 30%, respectively, from the prior year. Most of the increase in earnings per share came from a 33% drop in income taxes, a result of the 2017 Tax Cuts and Jobs Act. Adjusted earnings before income taxes increased 4% to $1.38 per share. Air Lease’s total return is minus 5% since the beginning of the year. During the quarter, Air Lease took delivery of four new aircraft from its order book, purchased five aircraft in the secondary market and leased all these aircraft to airline customers. Supply chain and engine technical issues have delayed some Airbus deliveries, which has led management to source aircraft opportunistically in the secondary market. The company expects 121 aircraft to be delivered from its order book with Boeing and Airbus during the remainder of 2018 and in 2019. All of these aircraft are placed on lease with airline customers. Air Lease owns 253 aircraft that average 3.9 years old and have 6.7 years of lease term remaining, which will generate $10.2 billion in revenue during the remaining lease term.

During the quarter Air Lease added three new customers including Hi Fly in Portugal, Atlantic Airways in Denmark and IndiGo in India. This brings its total to 96 airlines in 56 countries. Air Lease’s order book and consultative sales approach has enabled the company to become a strategic partner to its customers. This gives the company a competitive advantage that results in higher and more stable lease rates.

SGS

SGS will report first half 2018 results on July 18. Since the beginning of the year, the company has made six small acquisitions. The largest is Vanguard Sciences, a leading provider of food safety testing services based in North Sioux City, South Dakota with additional operations in Oklahoma City. Vanguard generated $11 million in revenue in 2017 and expands SGS’ existing microbiological, chemical and physical testing capabilities. Other acquisitions include Polymer Solutions, a materials testing lab specializing in polymer science in Virginia and Traitgenetics, a plant breeding specialist in Germany which helps seed companies reduce time to market. The total return on SGS ADRs since the beginning of the year is 4%.

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Capital Counsel’s investment strategy combines disciplined fundamental analysis with patient execution. We hope this letter helps you understand that stock selection is at the core of our investment strategy. We seek to invest in profitable well-managed companies that generate recurring free cash flow. These companies should possess strong balance sheets and earn attractive rates of return on shareholders’ capital. We know the companies and their proven execution focused managers well. They deal with problems openly and effectively, and have incentives aligned with shareholders. We evaluate the company, as an informed private buyer might, to determine the value of the business based upon its ability to generate free cash flow. We manage concentrated portfolios which have provided our clients with good long-term results. The financial strength of the companies held in client portfolios has lessened the drop experienced when markets decline.

Client portfolio holdings may change, and stocks of companies noted may or may not be held by one or more client portfolios from time to time. Investors should not consider references to individual securities as an endorsement or recommendation to purchase or sell such securities. Transactions in such securities may be made which seemingly contradict the references to them for a variety of reasons, including but not limited to, liquidity to meet redemptions or overall client portfolio rebalancing. Investing in the stock market involves gains and losses and may not be suitable for all investors. Investment return and principal value of an investment will fluctuate.

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2017 – 4th Quarter EARNINGS LETTER