2nd Quarter, 2019

We are pleased to report that your companies’ financial results for the year’s second quarter were once again better than the S&P companies which earned three tenths of one percent less during this year’s second quarter on sales that were only 4% higher. The sales and earnings growth achieved by your companies were 10% and 15% higher than their year ago results without including Wabtec’s results which benefited greatly from a well-conceived and executed acquisition. The appreciation of our stocks has surpassed the 21% gain recorded by the S&P although IBM’s takeover of Red Hat contributed only a 8% gain this year. We plan to add two stocks to our portfolio although in stating this, we acknowledge that our painstaking research process has caused us to not invest in two stocks that seemed promising. We mention our inclination to invest some of the reserves in your portfolios even though the determination of the European Central Bank and the Federal Reserve to lower interest rates seems odd when rates are already low. So low that over $16 trillion of bonds currently yield negative interest rates i.e. the bond owner pays the issuer interest on the bonds.


On October 3, 2019, Costco will report operating results for its 16-week fiscal fourth quarter and fiscal year ending September 1, 2019. On September 5, Costco reported retail sales of $46.5 billion in its fourth quarter and $149.4 billion in its full fiscal year, increases of 7.0% and 7.9%, respectively. Sales at Costco warehouses open more than twelve months rose 5.1% and 6.1% during the quarter and year, respectively, excluding changes in gas prices and foreign exchange rates. Costco added 21 warehouses to its operations in fiscal 2019 bringing the total number of warehouses to 783, including the successful opening of its first warehouse in China on August 27, 2019. The Shanghai location signed up 139,000 members on its opening day and had to close at 1:00 pm because of the crowd. Costco’s online business, which excludes the rapidly growing same-day fresh grocery delivery now available to members who live within a 20-minute drive of 99% of Costco’s warehouse locations, grew 23.3% during the year. Unlike most retailers, Costco’s e-commerce business is more profitable than its physical retail business because slightly lower gross margins are more than offset by even lower selling, general and administrative expenses. Costco opened a $100 million automated fulfillment center in Mira Loma, CA to handle direct fulfillment of small packages for e-commerce orders. Two other e-commerce fulfillment depots are planned. The total return on Costco’s stock is 44% since January 1.

Automatic Data Processing

ADP’s fiscal fourth quarter and full year revenues of $3.5 billion and $14.2 billion rose 6% and 7%, respectively, from the same periods a year ago on an organic constant currency basis. Management continues to execute its plan to deliver consistent growth by investing in its sales force, its products and improvements in productivity. Adjusted earnings for the fiscal fourth quarter and full year rose 15% and 20%, respectively, to $1.14 and $5.45 per share. ADP’s continued focus on streamlining operations and using technology to reduce costs led to a 160 basis point improvement in its operating margin to 22.3% for the year. ADP’s key operating metrics remain strong. For the year, revenue retention increased 40 basis points to 90.8%, close to its all-time high of 91.4%. This increase is largely attributable to last year’s migration of its mid-market businesses to its new platform Workforce Now. New business bookings increased 11% for the quarter and 8% for the year. The number of employees on each existing client payroll increased 2.8% for the quarter and 2.7% for the fiscal year. ADP’s PEO Services, which provide comprehensive employment administration outsourcing solutions, generated revenue growth of 9% in both the fourth quarter and the full year to $1.1 billion and $4.2 billion, respectively. Average worksite employees enrolled increased 8% during both periods to 563,000 and 547,000, respectively. ADP’s average client fund balances upon which it earns interest increased 5% during the quarter and the year to $26.2 billion and $25.5 billion, respectively. The average interest yield increased 20 basis points to 2.3% for the quarter and 30 basis points to 2.2% for the fiscal year. The interest earned by ADP on these client funds rose 17% to $147 million for the quarter and rose 20% to $562 million for the fiscal year.

Last fall, ADP launched Wisely Pay which provides clients and their employees with a proprietary electronic payment solution. Employees can receive, spend and manage their money in a mobile digital wallet and on Wisely payment cards that run on Visa’s debit network. Recently, ADP enhanced its electronic payment offering with the launch of Wisely Now which leverages ADP’s compliance expertise and reduces customers’ compliance risks by bringing automation to instant payments such as unscheduled or off-cycle pay and termination pay. The total return of ADP’s stock since the beginning of the year is 23%.

IDEXX Laboratories

IDEXX Laboratories’ second quarter revenue of $549 million rose 10% in constant currency over the second quarter of 2018. The strong U.S. dollar reduced reported revenue growth by one percentage point to 9%. Recurring Companion Animal Group (CAG) diagnostics revenue, which includes instrument consumables, rapid assay tests and reference lab services, grew 11% to $402 million and accounted for 73% of the quarter’s revenue. Gross margin of 57.7% increased 0.3 percentage points, reflecting benefits from 2 -3% net price increases and profitable instrument consumables (+19%) and rapid assay tests (+5%) revenue growth. Some of these gains in scale and productivity were offset by increased investment in reference lab capacity and increasing the number of software field service representatives. Good operating expense control lifted operating margins to a record 26.5%, while operating profit increased 14% to $164 million. Earnings per share of $1.43 rose 19% over the same period a year ago.

International sales of $216 million grew 8% over the same period a year ago. International CAG recurring revenue rose 11% during the quarter with reduced purchases in the U.K. because of Brexit and the timing of European holidays lowering sales growth by 1.5 percentage points. Instrument consumables sales rose 20% excluding these one-time factors. A growing and more experienced group of territory representatives and 21,000 Catalyst chemistry analyzers in clinics, up 28% from the second quarter of 2018, supported this growth. IDEXX placed 761 Catalysts in new and competitive accounts, 66% of all Catalysts placed in International accounts during the quarter. The market for companion animal diagnostics and software outside the U.S. is $1.8 billion and is growing about 10% per year. It has four times the number of eligible vet practices and three times the number of pets, but only 6% of clinical visits in international markets include bloodwork compared to an average of 15% of clinical visits in the U.S. Vets outside of the U.S. see more sick animals and are trained to perform a physical exam and then confirm the diagnosis with tests. Vets in the U.S. use diagnostic tests early in the exam to identify possible causes of an illness. The International sales organization focuses on placing in-clinic instruments so that small practices, often one or two vets and a receptionist, can get test results quickly. The strong growth in instrument placements demonstrates the success of IDEXX’s direct sales approach in all regions. Direct sales account for 95% of the revenue for the International business.

Jay Mazelsky’s success as interim President and CEO after a serious bicycle accident on June 27, 2019 that forced CEO Jonathan Ayers to take an extended medical leave demonstrates Ayers’ success in building a strong, collegial management team that uses data to show the value of IDEXX’s business to its customers and investors. The announcement had no impact on the stock price, a reflection of investors’ confidence in IDEXX’s management team. IDEXX Laboratories’ stock price has risen 43% since January 1.


CME’s average daily volume of 20.9 million contracts was up 14% from a year ago, its second highest quarterly volume ever, driven by global trade concerns, geopolitical worries and Fed policy uncertainty. Volume growth was 24% outside the U.S. reaching a record 5.4 million contracts a day. The average rate per contract declined 8.5% to 69¢ from the prior year after the successful launch of the Micro E-mini equity futures contracts. They are one-tenth the size of E-mini contracts and are priced at 4¢ per contract instead of 35¢. Over 25 million contracts traded since launch on May 6, making it the most successful product launch in CME’s history. CME also had record average daily volume in Agricultural Products and Interest Rates which rose 6% and 26%, respectively, from a year ago.

Revenues of $1.3 billion rose 20% from the prior year from strong transaction volumes and the benefit of last year’s NEX acquisition which generated $187 million of revenue. Adjusted earnings of $1.76 per share were slightly higher than a year ago with 5% more shares outstanding, higher interest expense and cost reductions from the acquisition still being implemented. CME has completed the first phase of the NEX integration process, combining the sales forces and converting the NEX administrative systems onto CME’s which allows for the streamlining of internal support functions. The sales force integration has enabled cross-selling as NEX sales forces have strong customer relationships that may be new to CME Group. Office consolidation has occurred in Hong Kong and will occur in London and New York by year end. CME expects to achieve $50 million of expense reduction by the end of 2019.

In addition to new products like the Micro E-Mini, CME continues to improve existing products by adjusting them to make them more attractive to customers. Earlier this year, CME reduced the minimum price increment of its Two-Year Treasury Note futures by half which reduced the cost to trade by 50%. This increased the Two-Year Treasury futures contracts’ share of the entire Treasury futures complex from 12.7% to 15.0%. New product launches in recent years like the Ultra 10-Year Treasury Note future have led to CME Treasury futures’ average daily volume, relative to the volume of the Treasury bond market, moving up to an all-time record of 117% from 55% several years ago. The total return on CME’s stock since the beginning of the year is 10%.


Mettler-Toledo’s second quarter sales of $731.4 million grew 5% in local currencies over the second quarter of 2018. Unfavorable foreign currency rates reduced sales growth in U.S. dollars by four percentage points to 1%. Laboratory sales rose 8%, strong growth following 10% sales growth in same quarter a year ago. Investments in field resources, targeted sales and marketing initiatives and R&D accelerated this growth. Industrial sales rose 3%, with all regions contributing to 5% sales growth in Core Industrial. Product Inspection sales fell 1% with weak spending by European food manufacturers accounting for the decline. Food retailing sales fell 8% and reduced Mettler’s quarterly sales by one percentage point. The company manages this business for profitability not for revenue growth. Sales depend on winning and completing projects for large retailers which results in wide fluctuations in quarterly sales. The company’s good price realization and control of SG&A expenses more than offset a 7% increase in R&D spending to deliver earnings per share of $5.16, up 11%. Excluding the impacts of the U.S. – China tariffs and foreign currency, earnings per share rose 15%.

Mettler-Toledo’s stock price has risen 26% since the beginning of the year but is down 18% from its all-time high on July 3 because of investors’ concern about the impact of slowing global manufacturing growth on the company’s business. While Mettler is not immune to a global economic slowdown, its business is less impacted because it focuses on specific segments within the industries it serves. The company produces 2.5 million segment newsletters annually and they are a key part of its successful targeted marketing strategy. Mettler creates 27 different newsletters for the Lab, Process Analytics, Core Industrial and Product Inspection businesses across 18 segments. These newsletters are customized for the decision-maker, such as a scientist, R&D manager or production engineer. They publish two editions each year in as many as 15 languages. The Spinnaker marketing and sales system identifies opportunities in specific segments and generates detailed leads which allows the sales organizations to capture new opportunities quickly which offsets weak sales in other segments. While Mettler sells a range of low-price instruments to labs in China, they saw that Chinese chemical companies were using their Autochem instruments to design safer chemical production processes because of recent explosions at several chemical plants and a heightened government emphasis on safety. Sales in this segment have grown because its Autochem solutions help set the standard for chemical safety in China.


Global payments volume of $2.2 trillion rose 9% in constant currencies and processed transactions of 35.4 billion rose 12% during Visa’s third fiscal quarter lifting revenue to $5.8 billion, an increase of 13% in constant currency. While revenue increased $600 million, Visa added only $20 million, or 2%, to its personnel expense during the quarter contributing to operating expense growth of 10% to $1.9 billion. Personnel expense accounts for 45% of Visa’s operating expense. This operating efficiency helped constant currency earnings per share rise 18% to $1.37. An increase of 7% to $528 billion in U.S. Visa credit card spending was driven by spending growth of 11% on credit cards issued by Visa’s largest client, J.P. Morgan Chase. Among card issuers, Chase has steadily gained U.S. credit card spending market share, primarily from American Express, growing from 17.7% in 2010 to 20.1% in 2018. American Express, which issues cards and processes transactions on its own network, lost more than four percentage points of market share during this period from 24.6% to 20.5%. The success of the partnership encouraged Chase to extend its agreement with Visa four years before the existing agreement was set to expire. The new agreement extends through 2029. The total return on Visa’s stock is 35% since January 1.

Ecolab, Inc.

Ecolab’s second quarter revenue of $3.76 billion was up 4% over the same period last year, excluding the impact of acquisitions, divestitures and foreign currency translation effects. These effects reduced reported sales growth in U.S. dollars to 2%. Price increases of 3% and good cost control led to earnings per share growth of 12% to $1.42. Global Industrial sales of $1.39 billion rose 6% with Water’s and Life Sciences’ sales rising 8% and 14%, respectively. Global Institutional sales of $1.32 billion rose 3% with sales up 5% for the Specialty business which serves quick service restaurants and food retailers. Pest Elimination sales rose 7%, while weak sales in the Upstream Energy business contributed to a 1% decline in Energy sales. Excluding the Upstream business, which Ecolab expects to spin-out as ChampionX by the middle of next year, the company’s sales rose 5% for the quarter.

Ecolab continues to expand it business by finding new industries with large global companies that will benefit from its hygiene, water and digital programs. In 2015, Ecolab created its Life Sciences business to serve pharmaceutical and personal care product manufacturers by combining a small business in Food & Beverage that sold clean-in-place technologies for the non-sterile areas in these plants and a non-core business in Healthcare that sold sterilization programs for clean rooms in pharmaceutical plants. It is a concentrated market with the ten largest drug companies accounting for 40% of global market share. Life Sciences’ annual sales have grown 11% per year since 2015 and account for about 4% of a $4 billion market. Life Sciences has the longest sales cycle, 18 to 24 months, of all of Ecolab’s businesses. Each change to a manufacturing process must be validated to ensure no changes to product quality occur, so the plant is shut down when new processes are tested. Ecolab provides validation support to reduce the reluctance to make changes. Scientists in technical lab support test the solutions to increase the likelihood of a successful field trial. A team of microbial experts also works in the plants to ensure that the validation process goes as smoothly as possible. Most of Life Sciences’ sales opportunities arise when a plant has a problem or has received a warning letter from the FDA. Ecolab tracks these citations along with regulatory changes to help keep their customers aware of current FDA manufacturing safety concerns. The total return on Ecolab’s stock since the beginning of the year is 35%.

Varian Medical Systems

Varian Medical Systems delivered strong fiscal third quarter revenue and earnings growth over the same period a year ago. Revenue rose 19% in constant currency to $826 million, with an unfavorable foreign currency swing reducing revenue growth in U.S. dollars to 16%. Earnings per share of $1.32 rose 26%, excluding non-recurring costs associated with recent acquisitions and an asset impairment charge. Oncology Systems’ sales rose 22% to $793 million driven by constant currency growth of 20% to $386 million in the Americas, 30% to $256 million in Europe, Middle East, Africa and India and 14% to $151 million in Asia/Pacific where tariffs reduced sales by eight percentage points. Sales of TrueBeam and Halcyon radiation systems contributed to equipment revenue growth of 31%. Varian received 46 Halcyon orders during the quarter, an increase of 150% over the same period a year ago, with 60% going to sites in emerging markets. These systems went into new vaults, which contributed to a 5% increase in the installed base to 8,412 systems over the same period a year ago. The company has taken 284 Halcyon orders since its launch in May 2017 with 90 systems currently treating patients around the world. Software revenue grew 24%, driven by continued adoption of the company’s newest software products. In June, Varian completed its acquisition of Cancer Treatments Service International, which supplies over 7,000 treatment plans globally each year. The ability to purchase high quality treatment plans allows clinics in rural areas in the U.S. and in low- and middle-income countries to offer the best radiation treatments without employing a team of experienced medical physicists. Varian’s stock price fell 10% on July 25, 2019, the day after the company announced its third quarter results and is up 4% for the year. A 1% decline in orders in North America coupled with uncertainty about Medicare reimbursement changes increased investor concern that the company’s strong revenue and order growth are not sustainable.


Revenue growth in mobile search, YouTube and Google Cloud contributed most to Alphabet’s 22% increase in constant currency revenue to $38.9 billion during the second quarter. Advertising revenue increased 16% to $32.6 billion and other Google revenue jumped 40% to $6.2 billion aided by growth in Cloud and Play store purchases. Revenue in each of Alphabet’s four geographic segments grew faster than in first quarter, ranging from 20% growth in the U.S. to 33% in Asia, which accounts for 46% and 17% of Alphabet’s revenue, respectively. Earnings per share adjusted to exclude gains, losses and fees on equity investments and the 2018 European Commission fine, rose 14% to $11.66 as the cost of operating Google’s huge data centers, including depreciation on computer equipment, outpaced revenue growth.

Google has invested $35.2 billion in technical infrastructure and office facilities since the beginning of 2018, significantly more than its primary cloud service provider competitors. Microsoft and Amazon invested $20.8 billion and $20.3 billion, respectively, during the same period. Approximately 70% of Google’s capital expenditure consists of investments in computing which includes data center land and construction, servers and network equipment. The data centers support Google’s core search advertising business as well as its cloud business, which is gaining traction as a provider of computing, storage and data analytics to large enterprises. Google’s cloud revenue has doubled since the beginning of 2018 to $2 billion per quarter as investments in its enterprise sales force have increased awareness of its stable and fast technical infrastructure, advantages in data analytics, industry-leading uptime and ability to integrate with other providers. Google also launched its Partner Advantage program to organize its referral partnerships and to market joint offerings. Google’s partnership with SAP, which provides enterprise resource planning software to large companies, has helped Google win business from companies including McKesson, Carrefour, Home Depot and Cardinal Health. With 77% of the world’s transaction revenue passing through SAP systems, keeping these systems running is critical to many large businesses. These companies can lose $3 million per hour when just one SAP system goes down. Running SAP applications and databases on Google Cloud Platform virtually eliminates downtime. Alphabet’s stock price has risen 20% since January 1.


Wabtec’s second quarter earnings, which were the first to include a full quarter of GE Transportation’s results were as good as management and analysts could reasonably expect and encouraged management to raise its earnings and cash flow forecast. Importantly, the good operating earnings of $1.06 per share, which excluded merger related accounting and restructuring costs, were 8.1% higher than the year ago earnings of 98¢ per share. Along with the announcement of the earnings, Wabtec raised the low end of its forecast for the year to $4.10 per share from $4.00. This quarter’s GAAP earnings of 54¢ per share after merger related charges and a 52¢ charge for purchase price accounting and restructuring costs was accompanied by an announcement by Wabtec’s new CEO Rafael Santana, who has run GE Transportation since November 2017, raising his cash flow forecast for the year to $900 million! This goal was cited minutes after he stated that the number of parked locomotives was among the highest in over a decade. The other positive effect of the good earnings was GE’s decision to sell the 20.5 million of the shares of Wabtec it still owned, leaving it with only 2 million of the 47.8 million shares issued to GE as part of Wabtec’s purchase of GE Transportation earlier this year. The total return on Wabtec’s stock is 8% since the beginning of the year.

Johnson & Johnson

Johnson & Johnson’s second quarter sales of $20.6 billion grew 1.6% in constant currency and 3.7% over the second quarter of 2018, excluding acquisitions and divestitures. Foreign currency translation effects reduced revenue growth by 2.9 percentage points. Adjusted earnings per share, which exclude amortization expense and one-time items, was $2.58, an increase of 25.2% over earnings per share of $2.10 reported a year ago. Earnings per share also includes a 61¢ gain from the sale of a subsidiary. Pharmaceutical sales of $10.5 billion rose 4.4%. Strong sales growth of 12.9% outside the U.S. and 7.8% global volume growth offset 6% price declines in the U.S. and the impact of U.S. generic competition for Zytiga, a drug that treats metastatic prostate cancer, which reduced the quarter’s sales by 3.0 percentage points. Sales from J&J’s Oncology and Immunology franchises rose 14.1% and 5.7% to $2.7 billion and $3.45 billion, respectively, and accounted for 58% of the division’s quarterly sales. Strong growth in sales of Aveeno and Neutrogena skin care and sunscreen products contributed to Consumer’s revenue growth of 4.6% to $3.54 billion. Acquisitions and divestitures accounted for half of that growth. Medical Devices’ sales of $6.5 billion rose 3.2% with double-digit sales growth in J&J’s interventional cardiac and stroke businesses, and good results from its Hip and Advanced Surgery businesses.

The total return on Johnson & Johnson’s stock is 3% year-to-date. The uncertainty of the outcomes of the talc and opioid litigation continues to weigh on the stock price. On August 26, 2019, the Oklahoma District Court found that Oklahoma made a credible case that J&J’s marketing of its drugs contributed to the state’s opioid addiction crisis and issued a $572 million judgement against the company. It will fund opioid addiction treatment and education programs in Oklahoma for one year. The company will appeal this judgment. Next up is a large opioid trial in Ohio that begins on October 21, 2019. The talc litigation continues as well.

Air Lease Corporation

Revenue at Air Lease during the second quarter rose 18.5% from the prior year to $471 million as the company took delivery of 16 aircraft from its order book at a cost of $1.6 billion. The company now owns 297 aircraft with a book value of $17.8 billion, up from 271 aircraft and a book value of $14.9 billion a year ago, increases of 19% and 10%, respectively. Earnings of $1.10 per share rose 6% from a year ago. During the quarter the company did not sell or realize any gains from the sale of older aircraft from its fleet.

The aircraft leasing business is a spread business where Air Lease and its shareholders earn the difference between the lease rate received from airline customers and the interest expense on debt issued to finance the purchase of aircraft.  Air Lease earns revenues representing over 10% of the value of its aircraft annually, its lease rate. Air Lease’s leased fleet will generate $13.5 billion of future rental payments over the 7.2 year average remaining lease term. The composite debt cost is 3.49%.  Air Lease’s management team, the most experienced in the industry, reduces interest rate risk by aligning average debt maturities with the average remaining lease term of the aircraft. 82% of its $12.9 billion of debt is fixed rate and 18% is floating. On September 9, Air Lease issued $600 million of notes maturing January 15, 2023 which carry an interest rate of 2.25% and $500 million of notes maturing October 1, 2029 at 3.25%. Its debt is rated investment grade by S&P and Fitch.

Air Lease’s management reduces the risk of aircraft ownership by buying the most commonly used, in-demand aircraft, forming a modern, fuel-efficient fleet. It regularly acquires new planes and sells older planes after approximately one-third of their 25+ year useful life. Air Lease management’s disciplined purchasing and knowledge of the marketplace have resulted in the company never recognizing a loss on the sale of aircraft.  Its aircraft fleet is diversified by aircraft manufacturer, plane type, airline and geography. 55% of its aircraft are manufactured by Boeing and 45% are from Airbus. Of these, 73% are single-aisle and 27% are larger twin-aisle. Its fleet of 297 aircraft are placed on lease with 100 different airlines in 57 countries, 95% of which are outside the US and Canada. These airline customers are generally healthy as a result of passenger traffic growth, low interest rates and manageable energy prices. The total return on Air Lease stock is 48% since the beginning of the year.

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

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