1st Quarter, 2019

Your companies’ revenue and earnings growth of 11% and 10% during the first quarter of this year were even more exceptional than last quarter’s results because the comparable revenue and earnings growth achieved by the S&P companies was only 5% and minus 0.3%, respectively. In commenting on your companies’ exceptionally good results, we have cited some of the innovations they have introduced such as IDEXX’s sales representatives’ success in helping vets introduce new wellness programs and CME’s astonishingly successful introduction of the new Micro E-mini equity index futures. Another bold success is Ecolab’s new digital service providing customers with alerts helping them stay in compliance with food safety regulations before Health Department inspectors arrive for routine inspections. We pay attention to your companies’ innovations because it helps us when we meet with managements who enjoy telling us about the successes and know we will ask about initiatives that need more work.

IDEXX Laboratories

IDEXX Laboratories’ first quarter revenue of $576 million grew 10% in constant currency over the first quarter of 2018. The strong U.S. dollar reduced reported revenue growth to 7%. Companion Animal Group diagnostic recurring revenue, which includes revenue from in-clinic instrument consumables, reference lab and rapid assay tests, rose 12% to $509 million and accounted for 77% of total revenue during the quarter. Operating expenses of $198.5 million rose only 7%, lifting operating profit 21% to $133 million while the operating margin rose 2.1 percentage points to 23.1%. Earnings per share of $1.17 rose 27% over the same period a year ago.

According to IDEXX’s proprietary analysis of 7,500 vet clinics in the U.S., clinical visits rose 2.2% during the first quarter, while revenue per practice rose 5.0%. The market for diagnostics is growing slightly faster at 8.0% to 8.5% per year. Although diagnostic tests account for about 15% of a practice’s revenue, only 15% of clinical visits include a chemistry panel and only 36% of dogs get any testing for heartworm or tick-borne disease. An analysis of 29,750 wellness profiles performed at the company’s U.S. reference labs showed that one-third of adult dogs who appeared in good health during their annual physical exam needed a follow-up visit to treat a medical condition. IDEXX’s Preventive Care Challenge program includes care protocols, bundled pricing, materials for pet owners along with training to start the program and support for the practice as it implements it. Offering wellness testing is a big change for everyone in the vet practice. The program’s success depends on the work of the territory sales representatives who visit 100 practices at least twice a month and work closely with their customers to make it work. In addition to practicing better medicine, vets that implement wellness testing increase the revenue and profitability of their practices. Vets do not need additional staff to add wellness testing because the protocols, which use IDEXX’s proprietary tests, are run in their reference labs. 2,800 practices of the 29,000 practices in the U.S. now offer preventive care testing, an increase from 1,200 practices a year ago. 330 practices joined the program during the quarter. IDEXX estimates that the total addressable market for preventive care testing in the U.S. is $3 billion. Diagnostic recurring revenue for practices in the program rose 15% over the past 12 months compared to 11% growth for practices not in the program. IDEXX Laboratories’ stock price is up 42% since the beginning of the year.


CME’s first quarter revenue of $1.2 billion and adjusted earnings of $1.62 per share rose 6% and declined 13%, respectively, from the prior year.  Revenue this quarter includes $191 million from the recently acquired NEX business while expenses from NEX were $137 million.  Average daily volume (ADV) was 18.6 million contracts, the third highest quarter ever, but down 16% from a record quarter a year ago.  Overall non-U.S. average daily volume declined 8%, increasing its share of total ADV to 27% from 24.5% a year ago.  Asian ADV was flat year-over-year but was the second highest quarterly volume on record and included an 8% increase in interest rate futures and a 227% increase in interest rate options volume.  During the quarter, CME’s OTC (over-the-counter) clearing volume grew 15% year-over-year to $135 billion across all products and currencies and revenue reached a multi-year high.  The good volume growth was supported by strength in Latin American currencies and growth in U.S. dollar volumes driven by client activity on the short end of the yield curve. CME launched several new contracts including the Micro E-mini equity index futures contracts which surpassed 1 million contracts in the first three days of trading.  Micro E-mini equity index futures are one-tenth the size of CME’s existing E-mini equity index futures and offer traders of all sizes a flexible way to access the equity index futures markets.

In January, CME paid its annual variable dividend of $1.75 per share for a total payment of $624 million.  The amount paid each year is based upon how much free cash flow accumulates during the course of the year after making capital investments in the business, regular quarterly dividends and acquisitions.  CME has returned $11.5 billion to shareholders in the form of dividends since it implemented the variable dividend policy in 2012.  During May, the average daily volume of futures and options transacted at CME surged to the second highest monthly volume ever as market uncertainty related to the timing and pace of interest rate moves by the Fed increased.  The 23.9 million ADV in May rose 19% from the same month a year ago.  CME’s total return is 7% since the beginning of the year.


Revenue growth in local currencies of 8% in Mettler-Toledo’s Laboratory and Industrial businesses lifted its first quarter revenue to $679 million, an increase of 7% over the first quarter of 2018. Food retailing revenue, which accounted for 7% of the company’s sales, declined 5% during the quarter and reduced the company’s sales growth by one percentage point. Market conditions remain good across the globe as country teams continue to execute Mettler’s targeted marketing programs and productivity initiatives. Sales in the Americas rose 6%, excluding the impact of food retailing, while sales in Europe and Asia/Pacific each grew 9%. Sales in Europe benefitted from a late Easter holiday and excellent execution of Mettler’s marketing programs. The company’s new Shift 5 program, which allows marketing organizations to use savings from productivity improvements in the back office to invest in front-end salespeople, also lifted revenue growth. Double-digit revenue growth in Laboratory and Core Industrial in China contributed to excellent revenue of growth of 13% during the quarter. Earnings per share of $4.10 rose 10% over the same period a year ago. The impact of tariffs and unfavorable foreign exchange reduced earnings growth by seven percentage points.

Mettler-Toledo’s sales to the fast-growing biopharma segment of the pharmaceutical industry have risen because of the success of its targeted selling programs and the introduction of new laboratory products. R&D and quality control labs purchase pipettes and other analytical instruments, especially the company’s recently launched spectrometers that have been designed specifically to measure the concentration of proteins in solution. Mettler’s Process Analytics business provides sensors to ensure that the water used in a bioreactor is free of microbes in addition to monitoring levels of oxygen, carbon dioxide and acidity in the water to provide an optimal environment for the cells to produce the proteins of interest. Biopharma companies will spend $600 to $900 on a sensor to protect a $10 million batch of product. They also use single-use liners in their reactors to avoid cross-contamination. Mettler sells a new set of sensors as well as a scale to measure ingredient levels every time a new

batch of a biologic drug is made. The Process Analytics business is one of the company’s most profitable businesses with an operating margin of 40%. Mettler-Toledo’s stock price is up 42% since the beginning of the year.


Retail sales of $34.0 billion in Costco’s third fiscal quarter, a twelve-week period ending May 12, rose 7.4% reflecting continued success stocking a highly curated assortment of in-demand items at low prices. Member visits increased 3.7% and average spending per visit rose 1.8%. Total revenue of $34.7 billion including membership fees of $776 million also rose 7.4%. Earnings of $1.89 per share, which exclude a one-time tax benefit of $73 million, increased 11.2%. High-end Sony and Samsung TVs and newest generation Apple products drove strong growth in electronics and bareMinerals cosmetics drove growth in health and beauty aids. Big ticket items also added to sales growth, including a $400,000 diamond ring and several $14,000 golf simulators which sold in five days. Costco’s jewelry department sold 196,000 Carats, or over 86 pounds, of diamonds in fiscal 2018. Costco’s e-commerce business operates in the U.S., Canada, Mexico, the U.K., Taiwan and Korea, and will launch in Japan and Australia later this year. Online sales grew 22.0% during the quarter to 6% of total sales driven by growth in grocery, consumer electronics, health and beauty products and “white goods” appliances such as refrigerators, washers and dryers. Sales of white goods rose to over $500 million in fiscal 2018 from $50 million just 4 years earlier. In its online grocery business, Costco delivers dry goods ordered online in two days to all 50 states, including the 6 states where no Costco warehouses exist. Non-members pay a 5% surcharge. The total return on Costco’s stock is 27% since January 1.

Automatic Data Processing

ADP’s fiscal third quarter revenue of $3.8 billion and adjusted earnings of $1.77 per share rose 5% in constant currency and 13%, respectively, from the prior year.  During the quarter new business bookings, an indicator of future revenue growth, rose 10% while the number of employees on existing client payrolls rose 3.1%.  The number of employees paid by ADP’s PEO (professional employer organization) rose 8% to 554,000, increasing revenue 6% to $1.1 billion.

The interest earned on funds held for clients rose 24% to $164 million as average funds balances increased 4% to $30.0 billion and the average interest yield increased 30 basis points to 2.2%.  ADP benefits both from higher interest rates and wage growth.  The company’s operating margin rose 140 basis points from the prior year to 25.6% driven by continued execution of transformation initiatives which provide operating leverage even as it continues to invest in new and improved products and services. ADP’s voluntary early retirement program and lower costs to maintain legacy systems and data centers had the greatest impact on its cost structure during the quarter. ADP now spends more on innovative technology-based solutions for its customers.  During March, ADP acquired a client list from a mid-size regional payroll services provider for the right to sell and convert these clients onto its Workforce Now or RUN platforms for mid-size and small businesses, respectively.  ADP’s total return since the beginning of the year is 27%.


Visa delivered fiscal second quarter revenue of $5.5 billion and earnings per share of $1.31, growth of 8% and 17%, respectively, over the year ago period. Foreign exchange rate shifts relative to a year ago reduced revenue and earnings growth by 1.5 percentage points. Payments volume of $2.1 trillion rose 8.2%. Credit card volume accounts for 55% of Visa’s total payment volume and rose 6.8% while debit volume rose 10.0%. European payments volume of $407 billion rose 6.6% and accounts for 20% of Visa’s global payments volume. Uncertainty surrounding Brexit has slowed economic activity in the U.K. which accounts for much of Visa’s European transactions despite accounting for just 17% of E.U. consumption spending. Excluding the U.K., payments volume in Europe grew 10%. Visa has ample opportunity to expand payments volume in Europe with 12 countries generating over $200 billion in annual consumption spending.

Visa continues to expand the capabilities of VisaNet, its payment network, which now connects over 3.3 billion cards issued by 15,900 financial institutions to 54 million points of acceptance. While Visa has primarily facilitated payments from consumers to merchants, Visa Direct enables debit cardholders to transact directly with each other in near real-time by using VisaNet to connect bank accounts attached to Visa debit cards. This offers businesses the ability to send and receive payments instantaneously instead of using time-consuming checks and bank transfers or costly wire transfers. Over 50% of these business-to-business (B2B) payments around the world are still made by check. Businesses can also use Visa Direct for disbursements to consumers (B2C), such as payroll and insurance claim payments, and consumers use this functionality with person-to-person (P2P) transfer apps such as Zelle and Venmo. Visa Direct payments volume, while still a small component of overall volume, doubled during the quarter and added half a percentage point to Visa’s payments volume growth. The total return on Visa’s stock is 30% since January 1.

Ecolab, Inc.

Ecolab’s first quarter sales of $3.5 billion rose 4% in constant currency over the first quarter of 2018. Unfavorable foreign exchange translation reduced revenue growth in U.S. dollars to 1%. While Global Industrial and Pest revenue of $1.29 billion and $207 million, respectively, each rose 7%, Global Institutional revenue of $1.21 billion grew only 1%. Low shipments to distributors during the quarter and revenue lost from exiting two low margin businesses reduced the business’ revenue growth by two percentage points. Energy revenue declined 2% to $812 million following 11% revenue growth in the first quarter of 2018, a result of strong drilling activity in North America. Improved margins in the Industrial and Energy businesses lifted the operating margin 1.4 percentage points to 11.7% from 10.3% a year ago. Earnings per share of $1.03 grew 13%, excluding special gains and charges.

Revenue of the Specialty business, which serves quick-service restaurants and grocery stores, is approaching $1 billion per year and grew 7% during the first quarter. In addition to providing effective, safe and easy-to-use products to clean and sanitize food preparation and eating areas, Ecolab’s registered food safety sanitation professionals are in the facilities every day and see exactly what the issues are. The company combines the results of these surveys with data collected by the automated dispensers and sanitizing stations to give a regional manager a detailed picture of the degree of compliance with food safety regulations in every facility. Ecolab can also compare a customer’s performance to other restaurants and grocery stores in the region. At the National Restaurant Association show in May, Ecolab launched a new digital service that automatically collects Health Department reports from 3,000 counties in the U.S. and standardizes the data to provide dashboards and digital reports to its subscribers. Adding this unique data source to the data that the company collects for its customers, Ecolab can predict when a facility is at higher risk for failing a Health Department inspection. Customers are adopting this digital service because they know that Ecolab’s expert field service representatives can help them implement programs at individual locations before they fail a Health Department Inspection. The total return on Ecolab stock is 34% since January 1.

Varian Medical Systems

Varian Medical Systems’ second fiscal quarter revenue of $779 million grew 10% in constant currency over the same period a year ago. Tariffs reduced revenue growth by 1.3 percentage points and the strong U.S. dollar reduced reported revenue growth to 7%. Tariffs and foreign currency also contributed to a 9% decline in the quarter’s earnings per share to $1.05 from $1.15 a year ago. Oncology Systems’ revenue of $747 million rose 10% in constant currency over the second fiscal quarter of 2018. Order growth was very strong, up 18%, with orders in the Americas of $366 million, up 7%. Orders in Europe of $233 million and in Asia of $167 million rose 17% and 35%, respectively, excluding the impact of tariffs on sales in China. Order growth exceeded 10% in China, Japan and Southeast Asia. During the quarter, Varian signed a framework agreement with Tata Trusts to increase access to advanced radiation therapies in India. Varian is the preferred supplier in this three-year agreement which provides for the installation of as many as 200 systems.

Software revenue rose 14% to $144 million and grew at twice the rate of growth for radiation systems as customers install Varian’s new software to improve the quality of their treatment plans and the productivity of their operations. Orders for HyperArc, the company’s high definition treatment planning software for radiosurgery on the TrueBeam, have almost doubled since a year ago. Radiation oncologists currently use HyperArc to treat patients with more than one brain tumor in 15 minutes, the standard treatment time. 350 sites have placed almost 1,000 orders for Varian’s multi-criteria optimization (MCO) software, an add-on to its treatment planning software that quickly finds the best compromise between delivering radiation to the tumor and protecting healthy tissue. In some cases, the dosimetrist can increase the dose to the tumor while reducing the dose to the organs by 20% to 30%. Many clinics use Varian’s RapidPlan software to develop an initial treatment plan based on its best plan for that type of cancer and then use MCO to customize the plan for the individual patient. These software products help address the skills shortage faced by clinics in low and middle-income countries. Varian Medical Systems’ stock price has risen 15% since January 1.


Alphabet’s first quarter revenue grew 19% in constant currency to $36.3 billion. Earnings per share, excluding a €1.5 billion European Commission (EC) fine and gains on private venture investments, rose 9% to $10.81. This EC fine, the third in three years, is a retroactive penalty related to Google’s AdSense program which helps third-party websites earn advertising revenue by embedding Google search on their sites. Between 2006 and 2009 Google required AdSense customers to exclusively display Google’s search ads on their sites. Google relaxed this exclusivity in 2009 and by 2016 removed all ad placement restrictions in response to EC objections. Despite the more restrictive competition framework and a low growth economic environment in Europe, Alphabet’s revenue from Europe, the Middle East and Africa rose 16% in constant currency to $12.4 billion, a third of Alphabet’s total revenue. Google’s advertising revenue rose 15% to $30.7 billion, or 85% of Alphabet’s total revenue, as mobile search and YouTube helped drive a 39% increase in revenue-generating ad views. Revenue from non-advertising businesses rose 25% to $5.6 billion. These businesses include Google Cloud Platform, the Google Play app store, hardware such as phones and connected Nest thermostats, and further afield bets such as Google Fiber’s ultra-high-speed fiber optic networks, Verily’s life sciences research and Waymo’s autonomous driving.

Management’s intent to grow its cloud business was apparent at Google’s fourth annual cloud conference held in San Francisco in April. New Google Cloud CEO Thomas Kurian, a veteran technology executive who spent 22 years at Oracle, is simplifying customer pricing and contracting while significantly expanding Google Cloud’s sales and support organization to service large business customers such as JP Morgan Chase. Most of the 4,688 new Alphabet hires during the first quarter were for technical and sales roles in Google Cloud. Google Cloud has also grown its service partner network and number of certified developers by four times in the past year. Google helped Kohl’s migrate 70% of its applications to the cloud, including Kohls.com and the Kohl’s mobile app. With Google, Kohl’s cost-effectively scaled up its capacity to handle more website traffic and transactions during the busy holiday shopping period, with no downtime, and reduced capacity when it was not needed. 88% of large companies are adopting a “multi-cloud” strategy in which they run workloads on several cloud service providers such as Amazon Web Services, Microsoft Azure, Google Cloud Platform as well as in their own datacenters to avoid single vendor lock-in and to reduce risk. With 80% of legacy enterprise workloads still running in datacenters and most new workloads being built to run in the cloud, Google developed Anthos, a programming tool based on open source software that provides developers the flexibility to write code once and ensure interoperability across datacenters and multiple cloud platforms. Anthos helps customers modernize legacy programs by automatically converting their code to a universal format that can run in any cloud environment. Alphabet’s stock price has risen 4% since January 1.


Wabtec’s first quarter earnings, which included only five weeks of GE Transportation’s results, were $1.06 per share compared to the 92¢ per share earned during the comparable quarter a year ago. These results, however, excluded the full cost of the acquisition which on a GAAP basis wipe out the earnings for the quarter leaving a loss of 4¢ per share. The guidance provided by Wabtec’s management during the telephone discussion of the earnings with investors was augmented with a succinct six-page income statement, balance sheet, cash flow and other non-GAAP figures supporting the $1.06 per share earnings number reported for the first quarter. Management also, during the call, clearly stated that earnings for the next two quarters would be only $1.01 and $1.03 respectively while the fourth quarter would improve to $1.10 or better. We think that Wabtec has the capacity and capability to achieve these estimates which would deliver earnings of $4.20 per share for the year. The prospect of earning only $1.01 per share in the second quarter, which is especially slow in Europe, may keep the stock from rising along with the market if it goes higher. Wabtec is selling at a relatively low multiple of sixteen times earnings despite long-term assurance of GE Transportation’s revenue, 70% of which is secured by long-term contracts for locomotive maintenance. We think that Wabtec has strengthened its business immensely by acquiring GE Transportation and strengthened its management by elevating Rafael Santana, the President of GE Transportation, to be the President and CEO of Wabtec at the end of this month. He is 47 and succeeds Ray Betler who is 63.

With Wabtec’s freight car business once again achieving an 18% operating margin comparable to GE Transportation’s margin, Wabtec has the means to produce steady predictable growth even though its transit business margin is only 9%. We believe this low margin results from Faiveley making low bids for contracts to build transit cars in Europe to get lucrative maintenance contracts. Wabtec’s stock price is down 3% since the beginning of the year.

Johnson & Johnson

Johnson & Johnson’s first quarter revenue of $20.0 billion grew 3.9% in constant currency over the same period a year ago and 5.5% excluding the impact of acquisitions and divestitures. Unfavorable foreign currency translation reduced sales growth in U.S. dollars by 3.8 percentage points to 0.1%. Earnings per share rose 5.8% to $2.10. Excluding the impact of acquisitions and divestitures, consumer revenue of $3.3 billion rose 0.7% over the first quarter of 2018, while medical devices revenue grew 4.3% to $6.46 billion. The Pharmaceutical business posted another strong quarter with revenue of $10.2 billion, up 7.9% over the same period a year ago.

J&J presented the opportunities for growth of its marketed drugs and the strength of its pipeline at its Pharmaceutical Business Review on May 15, 2019. The company expects to file 40 line extensions for existing drugs with 10 having potential sales above $500 million from 2019 to 2023 as well as new drug applications for 10 novel drugs with potential sales above $1 billion. Eight of these drugs, with four developed in J&J’s labs and four either licensed in or developed in partnership with other companies, are new since Mathai Mommen became head of Global R&D two years ago. He has focused the R&D organization on projects that are truly transformational medical innovations and bring an unequivocal promotional advantage. R&D has added expertise in biological pathways to its focus on specific diseases. The company’s knowledge of IL-23 inhibition in psoriasis and Crohn’s disease, for example, is leading to research in Lupus, which has not had a new treatment in 30 years, and rare skin diseases.

The total return on Johnson & Johnson’s stock is 10% since the beginning of the year. The company’s stock price has been constrained by publicity about on-going talc and opioid litigation in U.S. district courts. J&J has won all the talc cases either directly or on appeal. The number of prescriptions filled by Medicaid programs for its drugs is so small compared to prescriptions for oxycodone that the company appears to have been sued because of its deep pockets.

Air Lease Corporation

Air Lease’s first quarter revenue of $486 million and earnings of $1.23 per share rose 22% and 23%, respectively, from the prior year.  During the quarter, Air Lease took delivery of 11 Boeing and Airbus aircraft at a cost of $1 billion and sold six used aircraft for proceeds of $264 million.  At the end of the quarter, Air Lease’s portfolio has 280 leased planes, up 11% from the prior year and 65 managed planes, up 33%.  These aircraft represent $12.2 billion in contracted minimum rental payments during the length of their lease term. The company has 361 aircraft on order with Boeing and Airbus which are scheduled to be delivered over the next five years.  Air Lease has signed contractual agreements to place 93% of these deliveries with airline customers through 2020.

The grounding of Boeing’s new 737-7 MAX by the FAA and other authorities around the world will delay deliveries of these aircraft.  Currently, Air Lease has 15 MAXs in its delivered fleet.  All of these leases have provisions which require the airlines to continue to make lease payments to Air Lease.  Before the grounding, the company was scheduled to take 28 more MAX aircraft by the end of the year. Air Lease is now extending current leases where they can and will sell fewer aircraft from its portfolio.  Lease rates, especially for the 737-800s which the MAX often replaces, are increasing.  96 of Air Lease’s 280 aircraft leased portfolio are 737-800’s. Air Lease’s total return is 32% since January 1.

Red Hat

Red Hat and IBM are making steady progress toward the completion of the deal. The companies received clearance from the U.S. Department of Justice on May 6th and the E.U. has set a provisional deadline of June 27th to rule on the acquisition. Thus, the timing for the completion of the acquisition remains on track for the second half of the year. There is still time to use Red Hat stock to make charitable gifts this year. Red Hat’s stock price is up 5% since January 1.

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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.